Graeme Petroni: What’s driving Aussie equities this week

Here are the main factors driving the ASX this week according to Pendal investment analyst GRAEME PETRONI. Reported by portfolio specialist Chris Adams

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RISING oil and bond yields gathered pace last week.

Brent crude rose 9%, bond yields increased 20-25 basis points (bps) and equities responded, falling 1-2% across most markets.

The key economic focus was the US consumer price index (CPI) where core inflation surprised to the upside and bond markets responded by increasing the odds of a rate hike at this week’s Federal Open Market Committee (FOMC) meeting.

But offshore equity markets reacted more positively on Friday night (Australian time) because the CPI detail left room for debate on whether it will be a prolonged hiking cycle.

The Australian market (S&P/ASX 300 -2.8%) underperformed the S&P 500 (-0.8%) and most other major European and Asian markets.

Domestically, RBA speakers focused attention on the need for local rate rises to contain inflation.

This brings renewed risk for a household sector already struggling with weak sentiment post-budget.

Oil

There is renewed concern at the prospect of persistently higher oil prices. Key issues are:

• Flows through the strait have improved but remain constrained.
• Renewed conflict brings risk, with news of an attack on the Saudi East West Crude Oil pipeline.
• China is back in the market buying crude.
• There is continued focus on falling reserves.

Looking first at flows through the strait, US Energy Secretary Chris Wright made comments suggesting a return to 17 million barrels per day (mb/d), which is on par with pre-conflict levels.

The US has been providing safe passage, clearing mines, and widening sea lanes – all of which is improving flows, but not back to pre-conflict levels. Market estimates are in the range of 7-10 mb/d, based on satellite analysis of ship-to-ship transfers.

In the near term, there is a risk that progress slows.

There have been press reports suggesting the US is now asking tankers to restrict passage to two time slots per day, which will vary by day, saying safety was no longer assured during nighttime passage.

The latest hope for easing tensions has shifted to a deal between Iran and Oman, who will meet members of the Gulf Cooperation Council to try and build support. The key issue is that the US has said it will not tolerate tolls.

There were also some negative developments outside the strait late last week.

First, Saudi Arabia officially confirmed temporary closure of its East-West pipeline, which typically facilitates the transit of ~5 mb/d, following a drone attack.

The extent of damage remains unclear, with Saudi Arabia not confirming fires that have been reportedly detected by satellite and instead describing the shutdown as precautionary.

It is therefore unclear whether the shutdown will last days, weeks or longer.

Second, Houthis have also seized control of the port city of Mocha and three islands in the Red Sea, giving them control over the Bab al-Mandeb, with a military spokesperson claiming the strait was safe for everyone except Saudi ships.

Even before tensions resurfaced in the Middle East, the oil price was rising with renewed purchases by China.

A sharp decline in its crude imports has been a key factor in helping contain the oil price response to the conflict-related disruption.

However, since June its crude imports have lifted from 7 mb/d to 9 mb/d in August, with the market watching whether this returns to pre-conflict levels of 10-12 mb/d.

Reserves have also been cited as a contributing factor for oil price moves, although they do not appear to be an imminent risk.

Over the past six months, US strategic petroleum reserves (SPR) have reduced from 413 million to 285 million barrels, which is a drawdown of 21 million barrels per month.

If that continued, there would only be 1.5 months before reaching the congressional minimum of 252 million barrels.

However, on a weekly basis the drawdown has started to slow significantly, from 7 million to 3 million barrels, with the latest read just 1.2 million.

While the SPR is in focus, it doesn’t appear likely to be a hard stop.

While oil prices dominate headlines, the move in refined products is equally stark with US diesel spreads (the difference between the price of a barrel of crude oil and that of an equivalent barrel of diesel) at all-time highs – from a range of US$30-40 for 2024-25, to over US$100 today.

During the week, there were comments from the CEO of Vitol (the world’s largest independent energy and commodity trading company) that only 1 mb/d of shipments through the strait relate to refined products.

He suggested the market was missing 2 mb/d day from each of the Middle East and Russia and highlighted that refined stockpiles were “pretty much at the bottom”.

Pressure on oil and refined product spreads is showing up in inflation prints. There has been little flow through to other prices. But further pressure will add to central bank concerns.

Bond yields

The oil price was fuel to the fire in bond markets, adding to concerns over persistent inflation, fiscal sustainability and AI investment.

The US Treasury tried to lean against what it viewed as liquidity issues at the long end, with a buyback program of US$5.19 billion during the week, up from an initially flagged US$2 billion.

But this wasn’t the shock and awe US$10 billion program that some had expected, and ultimately fundamentals dominated.

US two-year yields rose 26bps and 10-year yields were up by 19bps, to 4.97%.

US economic data

Kevin Warsh made some hawkish comments a couple of weeks ago at Jackson Hole.

He said he wasn’t worried about the labour market; inflation was the bigger concern, the personal consumption expenditures deflator (PCE) remained the preferred measure and underlying inflation needed to move towards 2% at sufficient speed.

However subsequent Fed speakers have been more cautious, so the data was always going to be crucial.

The producer price index (PPI) came out first showing the impact of energy prices with headline inflation 0.4% month/month versus consensus at 0.3%.

Core PPI ex food, energy and trade was in-line with expectations at 0.3%, although there was pressure in components relevant to the PCE like airfares and hospital services.

This placed some small upward pressure on PCE forecasts.

CPI was more relevant as it accounts for a larger proportion of PCE components.

Heading in, the market view was that a core CPI (ex food and energy) of 0.3% month/month would force the Fed to hike – and core did indeed print stronger at 0.29% month/month (versus consensus at 0.2%) and 2.45% year/year.

This prompted the market to lift the odds of a September hike to 85-90%, after dipping as low as 51% following Fed Governor Christopher Waller’s comments a week earlier.

However, the equity market responded positively, perhaps because the detail left room for debate on whether it will be a prolonged hiking cycle, as is currently priced into bond markets.

One category – communication services – added ~0.1% to core CPI, with a one-off boost from AT&T repricing legacy plans. If not for that, CPI would have been 0.2%.

Core goods inflation was contained at 0.1%, which is important as it suggests no flow-through of higher oil prices.

Having said that, if energy prices are elevated, there will be renewed pressure on headline inflation.

EU economic data

The ECB delivered an expected 25bp hike to 2.50%. This is the upper end of the neutral range but revised economic forecasts suggest more work is required.

Inflation is expected to remain elevated through 2027 and 2028, even under the ECB’s baseline scenario which had been based on inputs in mid-August – current energy markets are closer to the “adverse” scenario.

The result was an increased likelihood of a further hike, with the market now pricing a 50% chance of a hike in October and 90% by December.

China economic data

China CPI and PPI data was released.

CPI picked up modestly to 0.8% year/year reflecting higher energy prices.

The 3.8% year/year lift in PPI was more notable, affected by energy and semiconductor prices.

The contrast between CPI and PPI highlights China’s K-shaped economy with weak domestic demand and continued strength in exports.

Trade data released during the week remained strong, with August exports +25% year/year, supported by AI and green technology (including EVs/hybrids, batteries, solar).

Australian economic data

Westpac’s consumer sentiment survey dropped 5% to 84.4, versus a long-term average of 100.

This unwound gains from a month earlier, reflecting the renewed outlook for rate rises.

The survey highlighted weakness in family finances versus a year ago, with more negative responses from homeowners, particularly those with a mortgage.

The latest house price data from Cotality has Sydney house prices down 7.5% from the peak six months ago.

The deterioration in NAB’s business survey was even more stark, with conditions down 5 points to a reading of -1, the lowest level since August 2020.

The survey had previously remained relatively robust despite higher oil prices and interest rates, but there are now more signs of margin being squeezed by input costs.

Conditions deteriorated for six of eight industries and for almost all states, with trends most negative for retail, manufacturing and Victoria.

Despite weak surveys, RBA speakers quickly returned the focus to inflation and suggested further tightening might be needed.

Chief Economist Sarah Hunter gave a fireside chat at a property conference and Deputy Governor Andrew Hauser appeared on the 7:30 Report.

Both talked about inflationary pressure from the Middle East and about demand running above a supply constrained economy, with Hauser also referencing pressure from the AI build out.

Hauser was particularly vocal when talking about people across the country being furious about persistent inflation and said the Board was alive to the risk of inflation taking too long to return to target.

Declining house prices were referenced by both but viewed as a partial offset to inflationary pressures.

The market is now pricing a 76% chance of rate rise in September and a 77% chance of a further rise over the next six months.

Australian markets

Macro dominated market moves. Energy (+2.3%) was strong on oil prices, while insurers were strong on higher bond yields.

Gold and lithium stocks came under commodity pressure plus some stock specifics, while software and platforms came under pressure following OpenAI’s launch of GPT-6 Astra.