May’s market moves closely resembled those of April, with equities continuing their artificial intelligence (AI)-driven rally. Meanwhile, bond investors fretted over inflation, but sentiment improved following positive developments in the Middle East. While nothing is guaranteed, the U.S. and Iran moved closer to a deal that could extend the cease-fire by 60 days and potentially lead to the gradual reopening of the Strait of Hormuz. Government bond yields have been closely tied to oil market futures, and the pullback in the oil price contributed to the declining yields. Although higher yields briefly weighed on equities, given the increased discount rate applied to future earnings, momentum in equities remains strong and markets are remarkably resilient to potential macro risks.

Brent crude fell to USD 91/bbl by month-end on hopes of a resolution. While markets may be optimistic, the situation remains fragile, and the risk premium in oil prices has reset higher, limiting further declines. The move higher in oil prices impacted bond markets, as elevated expectations for inflation and tighter monetary policy pushed yields to multi-year highs in some regions. The yield on 10-year U.S bonds reached 4.66%, and 30-year yields reached 5.18%. The trend was not limited to the U.S. as UK Gilt yields touched 5.15% and 30-year Japanese government bonds hit a record high (4.13%).

Inflation rates are expected to peak globally around mid-year and remain above central banks targets, but the potential tightening cycle varies across markets. After three successive rate hikes, the Reserve Bank of Australia (RBA) appears to be entering a prolonged pause. The U.S. economic data is strong enough to avoid cutting rates, keeping the U.S. Federal Reserve (Fed) in a holding pattern for incoming Chair Kevin Warsh, while the European Central Bank is preparing for a hike at its June meeting.

These shifts in policy settings reflect the varied impact of higher inflation on each economy. Inflation in Australia was firmer in April but not as strong as expected, core-rates of inflation in the U.S are only gradually rising, while Eurozone inflation surged in April.

The disconnect between bond and equity markets highlights two aspects of today’s environment: the ongoing expansion of AI infrastructure and surprisingly resilient economic growth despite the magnitude of recent shocks. This is supporting both delivered earnings and elevated expectations. Market leadership is evolving as one company’s capex is another’s revenue, with hyperscaler capex flowing through the AI supply chain.

The events of May reinforce two conviction views for this year: global diversification continues to benefit equity investors, and active management remains essential for bond investors given the shifting rates and inflation outlook.

Australian economy

• The RBA delivered its third consecutive 25 basis point (bps) rate hike at its May board meeting, lifting the official cash rate to 4.35% in an 8-to-1 vote. The decision fully unwinds last year's easing cycle and reflects front-loaded policy tightening, as the inflationary impulse is assessed as posing a greater risk to the medium-term outlook than the drag on household consumption from higher rates.
  (GTM AUS page 56)
• Inflation had been running hot ahead of the decision; however, the April monthly consumer price index (CPI) indicator provided a more constructive read, and at 4.2% year-over-year (y/y) was softer than consensus expectations. Core inflation at 3.4% y/y is still too high for the RBA. However, with the RBA's baseline forecasts projecting a peak of 4.8% in the June quarter, the Apil figures provide a good start to either meeting or undershooting this view. As such, the market pricing  dropped to reflect less than one rate hike (22 bps) by year-end.
  (GTM AUS page 5)
• The labour market report for April was surprisingly weak as the unemployment rate rose to 4.5% and overall employment declined by 18,000 across both full- and part-time jobs. The unemployment rate remains low by historical standards and labour demand is still healthy when measured by the vacancy rate and a participation rate high.
  (GTM AUS page 9)
• The housing market continues to show softness, as sales turnover and auction clearance rates continue to decline, which is matched by the drop in homebuyer sentiment. National house prices were up 8.8% y/y but flat over the month. The impact of higher rates on mortgages, inflationary pressure on household budgets, and recent proposed tax policy changes all create headwinds for the housing market, making further declines in activity likely.
  (GTM AUS page 10)
• Household spending fell 1.1% in April, which was larger than consensus expectations. The higher cost of travel, from a rise in fuel costs, as well as travel subsidies, resulted in a large decline in travel spending. Discretionary spending fell by 0.8% month-over-month (m/m), consistent with soft consumer demand, tighter financial conditions, and weak real incomes.
  (GTM AUS page 7)
• Business confidence remained subdued while business conditions deteriorated in April. The rise in input costs and the yet to come increase in selling prices will be squeezing margins.
• A positive development has been the increase in private capex, which rose by 6.5% quarter-over-quarter (q/q), with equipment, plant & machinery jumping 18.1% q/q, and much of this is assumed to be driven by data centre build out.

Equities

• The ASX 200 gained 1.1% in May and is 1.7% higher over the year. However, performance was uneven across the sectors. Materials gained 10.5%, given the positive tailwind of higher iron ore and copper prices for miners. Other sectors in the green were consumer discretionary (4.7%), real estate (2.5%), and industrials (2.1%). Laggards were healthcare (-9.2%), utilities (-7.6%), energy (-5.9%), and communication services (-4.2%).
• The ASX 200 is still lagging global equities as the heavier weight in AI-related stocks boosts global markets. Asia ex-Japan rose 11.3% over the month, and Japan was up 6.2%, beating the strong run in the S&P 500 (5.3%) and European equities (3.2%).
  (GTM AUS page 32)
• The strength in earnings expectations is tempering the rise in valuations based on forward earnings expectations even as prices rise. Valuations have moved higher but remain below the January highs. The S&P 500 is trading at 21.2x forward P/E and Australia at 17.0x, both well above long-run averages.
  (GTM AUS page 33)

Fixed income

• Australia 10-year bond yields came close to reaching their year-to-date high in May at 5.11%, while U.S. 10-year Treasury yields rose to their highest in over a year at 4.66%. The 30-year yield touched levels not seen since 2007 during May, driven by fiscal concerns. However, the surge in yields unwound by month end as rate hikes were priced out of the market and oil prices retreated. The Australia 10-year yield ended the month 23 bps lower, at 4.84%, and the U.S. 10-year was 8 bps lower, at 4.44%.
  (GTM AUS page 56)
• The late drop in yields meant the Australian bonds were some of the strongest performers over the month, as Australian government bonds returned 1.6% and Australian credit was up 1.4%.
  (GTM AUS page 52)

Other assets

• Oil was the big mover, falling 27% over the month as hopes grew that a continued ceasefire in the Middle East would see the Strait of Hormuz re-open. At USD 91/bbl, Brent crude is 49% higher than where it started the year. The number of ships transiting the Strait has increased but remains a fraction of the pre-war levels.
  (GTM AUS page 64)
• Gold experienced significant intra-month volatility, trading in a range between USD 4,372 and USD 4,550 per ounce.
  (GTM AUS page 66)
• The U.S. dollar was broadly stronger through May, supported by both a repricing of the Fed’s policy path and the persistence of above-target inflation. The Australian dollar faced pressure during the peak of conflict-driven risk aversion in May but recovered by month-end.
  (GTM AUS page 68)

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