The week started with the RBA raising rates by 25bps to 4.6%, the highest in 15 years. As the move was expected, attention was on the outlook, which was pretty hawkish, with the RBA flagging rising inflation risks from higher energy prices, strong domestic demand, and rising tech prices amid the AI boom.
Most importantly, companies are facing higher costs and are already raising prices or preparing to do so, while inflation has come in above previous forecasts. The economy is slowing, although Q2 growth was still stronger than expected. So the RBA is keeping the door open to another hike if needed to bring inflation back to target.
Australia isn’t alone here, with markets pricing in around a 70% chance of a Fed hike at the October 28 meeting for pretty similar reasons, according to CME FedWatch.
First, US inflation expectations are moving higher, with the University of Michigan’s year-ahead inflation expectations confirmed at 4.6% in September, up from 4% in August and the highest since June, while the five-year outlook also edged up to 3.4%. The focus now is on August PCE, with consensus expecting headline PCE to rise 0.5% month-on-month and core PCE by 0.3%.
Second, US consumers still look surprisingly resilient, with retail sales jumping 1.2% in August after falling in July, stronger-than-expected job growth suggesting the economy can still handle relatively high rates, and the 1.4% rise in the retail sales control group pointing to solid underlying consumer demand.
In Europe, Eurozone inflation is above 3% and could hit 4% by year-end, roughly double the ECB’s target. Adding to that, Lagarde remains pretty positive on the economy, pointing to solid manufacturing, a strong labor market, and investment, so no wonder markets are now pricing in up to four more hikes over the next year, on top of the two over the summer.
Hence, European government bond yields continue to rise, including in France, where the 10-year yield has climbed above 4.7%.
Where does this leave us?
If the tightening cycle continues, investors could become less willing to take risk, which could eventually spill over from bonds into equities (such as the S&P 500 and Nasdaq) and crypto assets like BTCUSD, ETHUSD, and XRPUSD.
Gold could also come under pressure, as it doesn’t generate any income, making higher yields a bigger opportunity cost, while a stronger dollar index (DXY) could add another headwind.