Weekly Market Update: Inflation Cools on Both Sides of the Pacific — But the Complications Are Real (03 August 2026)

“If Stupidity got us into this mess, then why can't it get us out?" 

- Charles Kettering (American inventor)

Cartoon of the Week

Source:  www.hedgeye.com

Movers & Shakers (week ending 31^st July):

Stocks (ASX 200 ↑2.33%, S&P 500 ↑1.05%, NASDAQ ↓1.78%)

Bond Yields (ACGB3Y 4.49%, ↓ 22 bps / ACGB10Y 4.93%, ↓ 16 bps)

Bond Curves (A$ 3s10s +44 bps, ↑ 6 bps)

Credit Spreads (Major Bank 5Y Senior +64 bps, ↓2 bps / Tier 2 +123 bps, ↑2 bps)

Oil (Brent US$90.12/bbl, ↓6.88%)

Gold (US$4,046/oz, ↓0.12%)

Inflation Cools on Both Sides of the Pacific — But the Complications Are Real

Executive Summary

• The week delivered a genuinely pivotal set of data releases that shift the balance of probabilities for both the RBA and the Federal Reserve.  In Australia, Q2 CPI rose just +0.6% for the quarter — below the +0.7% survey — with the trimmed mean at +0.8%, which annualises to approximately +3.2%.  In the US, the FOMC held rates at 3.75% as expected, core PCE eased to +3.3% YoY, and US GDP for Q2 came in at 1.5% annualised — below the 2.0% survey.  China's manufacturing PMI fell back into contraction at 49.2 for July, all three PMI readings contracting simultaneously for the first time since early 2025.

• For Australian investors, the message is both encouraging and nuanced: the inflation trend appears to be improving, but pipeline pressures from import prices, elevated credit growth, and China's deterioration create a complex backdrop.  Australian government bond yields fell sharply, equities rallied, and credit spreads tightened modestly.  The income case for quality fixed income and credit remains compelling — but a strategic pivot point is approaching.  

Market Overview

The dominant narrative: disinflation is back, growth is slowing — and that is not a simple story 

• The week's dominant theme is best understood not as a single headline but as a tension between two forces: the clearest evidence yet that the disinflation cycle is intact, set against a set of growth and pipeline risks that prevent any comfortable declaration of victory.  Both the RBA and the Federal Reserve now have more room to sit on their hands — but neither has the luxury of moving quickly toward easing without risking a premature pivot that could reignite inflationary pressure.

• In Australia, the Q2 CPI data was unambiguously the most important domestic release of the week and arguably of the past several months.  A quarterly headline CPI of +0.6% — below the +0.7% survey and less than half the +1.4% recorded in Q1 — signals a meaningful deceleration in price growth at face value, but the prior reading was impacted by oil prices.  The trimmed mean reading of +0.8% for the quarter is even more significant for the RBA: annualised, this sits closer to the RBA’s target range, but still outside.  The year-on-year trimmed mean came in at +3.6% — matching the prior and slightly below the +3.7% survey — confirming that underlying inflation is no longer accelerating and may be entering a sustained downward trend.

• The complication — and it is a real one — arrives in the form of the Q2 import price index, which surged +5.7% for the quarter against a survey of 0.0%.  This is a very large, unexpected move and reflects, in part, the sharp rise in Brent crude oil prices observed through late June and July (from around $73 at end-June to nearly $97 at the recent peak), as well as AUD depreciation effects. Import price increases flow through to consumer prices with a lag of approximately one to two quarters.  If this pipeline pressure is not offset by domestic demand weakness, Q3 CPI could surprise to the upside, undermining the progress demonstrated in Q2.  The RBA will be acutely aware of this.

• In the US, the FOMC's decision to hold at 3.75% was expected, but there was some dissension in the ranks with three members voting to hike.  Nonetheless, what probably matters more for investors is the continued easing in core PCE to +3.3% YoY, and the decline in the monthly PCE price index to −0.1% MoM — the first monthly decline since early in the tightening cycle.  Personal spending for June rose just +0.3% MoM against a +0.4% MoM survey, and real personal spending of +0.4% MoM was at the lower end of recent months.  Taken together, these readings paint a picture of a US consumer that is increasingly cautious, spending less freely, and generating less inflationary pressure at the margin.

• US Q2 GDP at +1.5% annualised disappointed against the +2.0% survey, though personal consumption of +3.2% was well above the +0.5% prior and the +2.3% survey — suggesting the consumer remains the primary engine of the US economy even as other components moderate.  The genuinely uncomfortable number in the GDP release is the price deflator of +6.2% — more than 200 bps above the +4.0% survey.  This reading, which captures broad economy-wide price changes, suggests that inflationary pressure in sectors not well-captured by CPI and PCE remains substantial.  It is a significant counterweight to the more constructive monthly inflation data.

• China's July PMI data represents the clearest signal yet that the recovery momentum observed in the first half has stalled.  With manufacturing PMI at 49.2, non-manufacturing at 49.0, and the composite at 49.3 — all simultaneously in contraction — the picture is one of broad-based softening rather than sector-specific weakness.  This has direct implications for Australian commodity exporters, the AUD, and the broader regional growth outlook.

Equity Markets

Risk-on returns as inflation fears recede — but the composition matters

• The ASX 200's +2.33% weekly gain was among the strongest of any major global index, and the reason is straightforward to explain: Australia's Q2 CPI result delivered exactly the kind of inflation improvement that rate-sensitive equity markets need to re-rate higher.  When the probability of additional RBA tightening falls — as it did materially this week — the discount rate applied to future Australian corporate earnings declines, which mechanically raises the present value of those earnings and pushes equity prices upward.  This effect is amplified for the ASX's large weightings in financials, real estate and infrastructure, where earnings are directly tied to the interest rate environment.

• The ASX 200's forward PE of 18.3x — with an earnings yield of 5.5% and a dividend yield of 3.3% — sits at a level that is supportable if the current rate environment is at or near its peak.  At 4.93%, the 10-year ACGB yield still provides meaningful competition for equities, but the equity risk premium remains positive (but still well below historical averages).  If bond yields continue to fall as the inflation outlook improves, the relative attractiveness of equities theoretically improves. 

• Globally, the picture is mixed in ways that are instructive. The NASDAQ's -1.78% weekly decline — against positive performance from virtually every other major index — reflects a continuation of the intra-market rotation we have discussed in recent weeks. Technology stocks, which carry the highest forward multiples, are most sensitive to two competing forces this week: lower discount rates (positive, as inflation falls) versus weaker growth expectations (negative, as US GDP disappointed – but also whether these companies will make meaningful returns on the vast sums of capex they have invested).  On balance, the growth concern appears to have dominated for NASDAQ-weighted names.  The S&P 500's more modest +1.05% gain — dragged down by the NASDAQ but buoyed by broad market participation — is consistent with this reading.

Fixed Income & Credit

A week of genuine progress: yields fall, spreads tighten, the rate cycle turn

• The Australian bond market's response to the Q2 CPI data was swift and significant.  The 3-year ACGB yield fell 22 bps to 4.49% — one of the larger single-week moves in this cycle — reflecting a rapid repricing of the RBA's expected policy path.  The 5-year yield fell 21 bps, and the 10-year fell 16 bps, creating a modest flattening of the yield curve at the shorter end as markets aggressively reduced the probability of further tightening. 

• The interpretation of these moves requires care.  A 22 bp fall in 3-year yields in a single week is large — comparable to the moves seen around major central bank decisions — and suggests markets are not merely noting improved inflation data but actively repricing the probability distribution around the RBA's next move.  Before this week, the market was pricing the most likely next RBA move as a hold, with a meaningful tail probability of a further hike.  After this week, the distribution has shifted decisively: the most likely outcome remains a hold, but the tail probability of further tightening has fallen sharply, and the probability of an eventual cut has increased in a meaningful way.

• However, we urge investors to resist over-extrapolation.  The RBA will point to three factors that prevent any premature declaration of victory.  First, private sector credit grew +0.8% in June (above the +0.6% survey), with year-on-year growth at +8.5% — the fastest pace in years.  Credit growing this quickly is not consistent with a monetary policy that is fully doing its job of restraining demand and inflation.  Second, the import price surge of +5.7% in Q2 creates genuine pipeline inflation risk for Q3 data.  Third, even with the Q2 improvement, the year-on-year trimmed mean remains at +3.6% — above the top of the target band. 

• In Australian credit, the week's moves were modest but directionally positive.  FRN spreads (AusBond Index) tightened -0.7 bps to 58.3 bps, and fixed rate credit spreads tightened -0.8 bps to 76.4 bps.  Both readings sit well within their one-year ranges — FRN spreads between 55.9 and 84.4 bps, and fixed rate between 68.3 and 103.2 bps — confirming that credit markets are pricing a sound, low-stress environment rather than any deterioration in issuer quality.  Big 4 senior 5-year spreads at 64 bps — tightening -2 bps on the week — sit at the tight end of their one-year range, reflecting strong institutional appetite for Australian bank paper.  Tier 2 spreads edging +1 bp wider to 122 bps is a negligible move that does not signal any stress.

• The US fixed income picture is more complex.  The FOMC held at 3.75% as expected, and the accompanying data — core PCE at +3.3% YoY, monthly PCE at −0.1%, initial jobless claims at 197K — collectively imply the Fed's next move is more likely to be a cut than a hike.  However, the 10-year Treasury yield rose +5.8 bps to 4.73% despite these constructive inflation readings — driven by the GDP price deflator's alarming +6.2% reading, which suggests broader price pressures in the US economy that are not fully captured by headline and core measures.  This yield curve steepening (short-end falling, long-end rising) is a regime worth watching carefully: it can indicate either a growth re-acceleration or a re-emergence of longer-term inflation expectations.

• For income-focused investors, the strategic question that this week sharpens is now urgent rather than academic: as Australian bond yields fall and the rate cut horizon draws closer, how should portfolios be positioned between floating rate and fixed rate instruments? The BBSW rate fell only -4.5 bps to 4.50% — meaning the current floating rate income stream remains very attractive in absolute terms. 

Outlook

A pivot is approaching — but the path there is neither straight nor guaranteed

• The RBA's August meeting. The Q2 CPI data has reduced the probability of any further RBA tightening and has shifted the conversation toward the conditions required for easing.  While latest inflation data is encouraging, we do not expect the RBA be considering cutting rates any time soon.  The most optimistic yet realistic medium-term outcome, for borrowers, is for policy to remain on hold.  Another hike, while not fully price, remains a possibility.  Perhaps not probable, but possible.  The reasons are clear: private sector credit at +8.5% YoY is running too hot; import prices surging +5.7% in Q2 create genuine upside risk to Q3 inflation; and the RBA will require at least two or three consecutive quarters of in-band trimmed mean readings before gaining sufficient confidence to ease. The most probable scenario is that the RBA holds through 2026 and well into 2027, with any hope of easing conditional on the inflation data continuing to improve.

• The Federal Reserve's path. Core PCE at +3.3% YoY, monthly PCE at −0.1% MoM, and a labour market that remains fundamentally sound (initial claims 197K, still low by historical standards) give the Fed a credible basis for holding rates through the northern hemisphere summer.  The GDP price deflator of +6.2% is a genuine concern that the Fed will not ignore — it suggests that inflationary pressure in the US economy has not fully resolved at the broader aggregate level, even as the monthly measures moderate.  Futures markets are pricing the next move as a hike, at this stage priced in for Q1 2027.

• China: the most important variable for Australian investors. The July PMI data — all three readings in contraction — is the clearest signal yet that China's post-COVID recovery momentum has exhausted itself without establishing a self-sustaining growth trajectory.  The structural headwinds are well-known: property investment down 18% year-to-date, FDI declining, household consumption cautious.  The policy response — holding loan prime rates unchanged, modest credit stimulus — has so far been insufficient to reverse the trend.  For Australia, the key questions are whether iron ore prices hold (driven by steel demand, which flows from Chinese construction and infrastructure spending) and whether LNG demand remains robust. We acknowledge significant uncertainty about both and would caution against any portfolio positioning that assumes a rapid Chinese recovery without clear policy evidence to support it.

• The pipeline inflation risk. The import price surge of +5.7% in Q2 and the PPI YoY acceleration to +3.6% YoY from +3.0% YoY are data points that complicate the otherwise constructive inflation narrative.  These are producer-side pressures that historically lead consumer prices by one to two quarters.  If Brent crude remains near $90/bbl — or moves higher — the Q3 CPI data (due in late October) could surprise to the upside, reversing some of the sentiment improvement generated by this week's Q2 results.  This is the single most important near-term risk to the current market narrative, and investors should position for it with appropriate caution Is the US inflation improvement durable, and when does the Fed begin cutting?  The June CPI and PCE data are genuinely encouraging — but the GDP price deflator of 6.2% is an uncomfortable counterpoint that suggests broader price pressure in the economy has not fully resolved.  The Fed will require several more months of consistent data before moving.  A cut from the Fed is not currently price in, with a hike more probably (per futures pricing).