Three strikes and you’re out

Due to travel commitments, this week’s Bites is a shortened version without the usual charts. 

Global week in review

It was a fairly quiet week in global financial markets despite simmering concerns over the Israel-Iran conflict. 

Markets were on tenterhooks, wondering whether US President Donald Trump would eventually support Israel’s assault by launching bunker-busting bombs to take out any Iranian nuclear research facilities buried deep in the ground.

Although Trump said he would decide over the next two weeks, that appeared to be a ruse. Over the weekend, it was announced that the US struck three Iranian nuclear facilities.  

So far at least, market reaction to the escalation in Middle East tensions has been remarkably contained. This is perhaps based on the view that Iran won’t follow through with threats to disrupt oil flows through the Strait of Hormuz, and other Middle East countries are loath to get involved.  

The good news from the weekend announcement, at least, is that the uncertainty over whether the US “will or won’t” strike Iran won’t last for two weeks. We know the answer. What’s more, given the US appears to have been successful in its aims, there’s probably a good chance that the US action is already over – especially if Iran doesn’t seek to escalate the fight further with retaliation against US bases.  

A recap of developments outside the Middle East

In other news, the US Federal Reserve kept rates firmly on hold as widely expected. Reflecting the likely effect of tariffs, the Fed also marginally revised up its inflation and unemployment forecasts further – and revised down its expectations for economic growth.

The Fed now expects modestly below-trend economic growth this year (1.4%) and next year (1.6%). It expects a lift to the unemployment rate to 4.5% (from 4.2% currently). It also expects consumer inflation to lift to 3% by end-2025, before falling back to 2.4% by the end of 2026.  

In short, the Fed anticipates only a short-run hit to economic growth and inflation from Trump’s tariffs, and on average Fed members still anticipate two rate cuts this year. In 2026, however, the Fed now anticipates only one rather than two further rate cuts.

The Bank of England left rates on hold as expected, although it still expected to cut rates further in the months ahead due to soft labour market conditions. 

The Bank of Japan also left rates on hold and announced a slower deceleration of bond buying next year – out of concern that it does not place too much upward pressure on long-term bond yields. Despite inflation being above its 2% target, the BOJ also seems loath to raise official rates again any time soon for the same reason.

Global week ahead

Apart from any updates on the Israel-Iran situation, the key global developments this week include US consumer price inflation, US consumer confidence and Congressional testimony by Fed Chair Jerome Powell. 

Following the benign consumer price index (CPI) report, the May monthly gain in the US core private consumption expenditure deflator (PCED) is expected to remain at a remarkably benign 0.1% – keeping the annual rate steady at 2.5%. US consumer confidence is also expected to bounce back a little further, following an earlier slump on tariff concerns.

Powell is likely to be pressed again by Congress on the impact of tariffs on the economy. He’s expected to maintain a cautious ‘wait and see’ approach.     

Australian week ahead

Last week’s local economic highlight was a surprise 3k dip in employment during May. However, given the large 88k increase in April, it likely merely reflects monthly volatility. Overall employment conditions remain firm, consistent with the unemployment rate holding steady at 4.1%.

That said, lead indicators do suggest some easing in the pace of labour demand. This should be reflected in another modest decline (from still high levels) in quarterly job vacancies this week.

Of perhaps most importance will be the monthly CPI report for May. In what was a mildly disappointing print, annual trimmed mean monthly inflation ticked up to 2.8% in April from 2.7% in March, moving in the wrong direction for further RBA rate cuts.

My expectation is that it will tick back down to 2.7% in May, keeping hopes alive for a 2.6% June quarter trimmed mean annual inflation result when it is released in late July. This, in turn, would give the RBA the green light to cut rates again in August.