- By Thursday, with Brent through $109 and producer prices reaccelerating, a Fed hike is looking like the right move. We outline why.
- Iran struck ships near the Strait of Hormuz this week, the broadest escalation since the conflict began, and Brent moved from $97 to $109 in four sessions.
- US producer prices jumped on a 24% rise in diesel alone, pushing headline inflation to 5.4% from July’s 4.8%. Core prices told a calmer story. Which one the market believes matters more than either number on its own.
- Stanley Druckenmiller called US borrowing costs “a little low” this week and dismissed the idea that policy is restrictive at all. Paul Tudor Jones, the same week, compared AI’s trajectory to a Category 6 hurricane. Two of the sharpest minds in the industry. We dissect the messaging.
- Consumer sentiment in Australia fell, and business conditions turned negative for the first time in years, and markets are still pricing better than even odds of a hike at this month’s RBA meeting.
- The yen was the strongest major currency for most of the week while the dollar index barely budged off its lows, until Thursday, when it did. Whether that was noise or the start of something matters more than some people realise.
Report Spotlight: James Hardie
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The Verdict
Our expectation for the Federal Reserve changed this week. Our constructive outlook for markets into year-end did not. We began the week believing the Fed could leave rates unchanged while economic pressure brought Iran closer to negotiations. Instead, the conflict broadened, and Brent rose from $97 on Monday to $109 on Thursday. August’s producer price report also showed renewed energy-led inflation pressure. We now expect a rate increase and believe it could be the better outcome for financial markets.
By Thursday, the US 10-year Treasury yield had reached 4.96%, and the 30-year stood at 5.37%. Equities retreated, but the adjustment remained relatively orderly given the rise in oil and borrowing costs. A Fed hike could initially unsettle shares while reassuring bond investors that inflation will be contained.
Friday’s CPI release, still to come at the time of writing (Thursday afternoon Sydney time), could be pivotal. The response in longer-dated bonds will also matter. Falling yields after a hike would support our view, while continued increases would warrant reassessment.
We continue to favour buying September weakness, with low cash balances and a positive outlook for commodities and selected international markets. Our weaker-dollar thesis has yet to deliver the broader move we expect, but remains central to that positioning. The immediate policy outlook may have changed, but the case for a stronger finish to the year remains intact.
The Calls
Early in the week, we believed the Fed could afford to wait. Sanctions and the naval blockade are placing Iran under mounting financial pressure, raising the prospect of renewed negotiations, which in turn would likely lower oil prices and ease inflation concerns. That could leave a bond market pricing further rate increases as too hawkish.
By Thursday, the immediate balance had shifted. Iran said it had attacked ten ships near the Strait of Hormuz following US strikes on five Iranian tankers. The Houthis seized the Yemeni port of Mocha, while attacks on Saudi energy facilities widened the threat beyond a single shipping route. Sanctions may still bring Iran back to negotiations, but the Fed now faces a more pressing inflation risk while that process unfolds.
Brent reached $109, and WTI broke above $100. August’s producer price figures reinforced the concern. Energy costs rose 4.2% over the month, including a 24.1% jump in diesel. Annual headline inflation accelerated to 5.4% from July’s revised 4.8%. There was some reassurance in core prices, which increased 0.2% on the month, slightly below expectations. The report showed renewed energy pressure, rather than an unambiguous acceleration across every category.
The conflict is clearly broadening, with attacks on Saudi energy facilities, which are raising the risk of global supply disruption. Oil is back on the ascent.
We now favour a hike. The risk of holding is that bond investors conclude the Fed is tolerating a further rise in inflation expectations and demand still higher yields. An increase could put near-term pressure on equities, but also help stabilise longer-dated bonds by reinforcing confidence in the central bank’s response.
Thursday’s moves illustrated the urgency from markets. The two-year Treasury yield rose 15 basis points to 4.58%, the ten-year added 11.5 basis points to 4.96%, and the thirty-year rose 7.5 basis points to 5.37%.
That does not mean another prolonged tightening cycle is inevitable. Far from it. As we wrote about this week, today’s starting point is very different from 2022, when rates had to rise from exceptionally low levels. A reopening of the Strait would also leave oil vulnerable to a sharp reversal. We continue to believe markets could look through a limited number of increases if earnings remain supportive and the adjustment in bonds stays orderly.
This is why we have not moved to a defensive portfolio stance. We remain constructive into year-end, are running low cash balances and favour using September weakness to add to positions. The route may be less comfortable than we expected, but a Fed hike need not derail that outlook.
There are three legends of the hedge fund industry that stand out. George Soros was the best of all time and, at 95yrs is now retired and understandably says very little these days about financial markets. The other two are Stanley Druckenmiller and Paul Tudor Jones, both over 70 and still very active. I pay very close attention to these money managers, whose comments often prove prescient.
In comments to a private audience reported by the Financial Times, Mr Druckenmiller argued that US borrowing costs remained “a little low” and dismissed the idea that monetary policy was restrictive. His test was straightforward: look at asset prices and the strength of investment spending.
That debate carries particular interest because of the professional relationships involved. Fed Chair Kevin Warsh worked for Druckenmiller’s Duquesne Family Office after leaving the Fed in 2011, while Treasury Secretary Scott Bessent also previously worked with the hedge fund manager. Druckenmiller described Warsh as one of his closest friends, although the report said they don’t currently communicate because of Mr Warsh’s position as Fed Chair.
He has also critiqued Bessent’s effort to support Treasuries through an expanded bond-buyback programme. This week’s announcement of purchases of up to $6bn in longer-dated government debt fell short of market expectations of $8bn–$10bn and failed to arrest the rise in yields. Against substantial public borrowing and the AI sector’s funding requirements, modest intervention may struggle to change the direction of the market.
We broadly agree with the distinction Druckenmiller draws. Higher yields are not inherently incompatible with rising equities. The question is whether earnings can support valuations and whether the repricing remains orderly. The exceptionally low borrowing costs of the post-financial-crisis period should not be treated as the only setting in which markets can prosper. In our view, a hike would likely be well received by financial markets and could be the catalyst for a big near-term rally at the long end of the curve.
Druckenmiller’s warning on AI was more cautious. Druckenmiller questioned whether the extraordinary investment programme is creating an “earnings bubble”. Profits may look durable while the build-out continues, but some of that demand could weaken when spending eventually slows. He also pointed out that banks earning substantial fees from bringing AI businesses to market are participating in the same boom. The exposure extends beyond the technology companies themselves.
Paul Tudor Jones raised a different, broader concern in the Wall Street Journal. His argument centred on AI’s accelerating capabilities and whether governments can establish effective safeguards before the technology becomes substantially harder to control.
Jones acknowledged the enormous potential benefits, including the possibility that AI could accelerate progress towards abundant, inexpensive clean energy. Nevertheless, he likened the wider outlook to waiting for a “Category 6 hurricane” and argued that AI could emerge as a third superpower alongside the US and China.
Our weaker-dollar view remains another important part of the investment outlook. The dollar index recovered to 99 on Thursday, but that modest response to a substantial rise in Treasury yields has not changed our medium-term assessment. Earlier in the week, yen strength was the more notable currency development.
We remain long the yen and overweight Japanese equities, particularly banks that stand to benefit from more normal interest rates. The risk of another disruptive unwinding of yen-funded trades deserves attention, although we believe investors are better prepared than during the sharp adjustments of 2024 and 2025. We expect the BOJ to raise the benchmark rate to 1.25% next week.
Our currency thesis supports our exposure to China, Hong Kong and selected emerging markets. A broader dollar decline would ease financial conditions and could encourage international investors to revisit markets where positioning is lighter and valuations more attractive than in the US. This is an opportunity we continue to favour.
I also add that many global fund managers are very underweight emerging markets with little in the way of exposure. Conversely, most are overweight US equities, which accounts for around 70% of gross market cap. The setup therefore favours a coming rotation which could be significant in my view, where global fund managers could miss out on relative outperformance from emerging markets but also be buffeted by a falling US dollar where hedging is still very low.
The Local
It was a tough week for the local benchmark, with the ASX200 down -3% on the oil price rally and higher bond yields due to global and local factors. Australian 10-year government bond yields reached ~5.27% on Thursday, their highest since 2011. The Australian dollar had held around US72.2c for three sessions as markets priced an RBA increase, before easing to US71.6c as the US dollar strengthened.
Technology was hardest hit, falling more than -7%. Xero and WiseTech Global declined as higher yields place particular pressure on businesses whose valuations depend heavily on earnings expected further into the future. For patient investors, we believe the sell-off is creating opportunities, provided the underlying earnings case remains intact.
The Reserve Bank faces an uncomfortable combination of renewed inflation pressure and weakening domestic indicators. Markets assigned roughly a two-thirds probability to a hike at the 28–29 September meeting. Goldman Sachs brought its forecast increase forward to September, while RBC flagged November.
The Westpac–Melbourne Institute consumer sentiment fell 5.2% to 84.4, NAB business conditions turned negative for the first time in six years, and we continue to expect unemployment to exceed 5% within twelve months.
Those figures do not rule out a hike, but they highlight the difficult trade-off. Higher rates would add to pressure on households and businesses already facing elevated costs. The RBA must weigh that damage against the risk that energy-led inflation becomes more persistent. We remain cautious about the domestic demand outlook. The discretionary sector was -4% lower for the week.
This past week, the banks reversed an attempted recovery earlier in September. Insurers fared better. Higher yields can improve returns as their investment portfolios are reinvested, providing an earnings benefit that distinguishes them from other financial stocks. They helped buffer the financial sector’s weekly decline to just -2%.
Energy was a relative bright spot across the week, up +1%. Oil’s direction remains closely tied to the conflict. Continued disruption supports prices, while a reopening of shipping routes could bring a sharp reversal. That sensitivity helps explain why stronger crude prices have not translated into uninterrupted gains across the sector.
Materials fell over the week, as pain on Thursday and Friday overwhelmed the strong earlier performance. Copper’s reached record levels during the week, before a late fade. Iron ore has been much stronger than expected. BHP and RIO continue to be favoured picks. Any substantial weakness is a good opportunity to add or establish a position in our view.
Next week, attention turns to whether the Fed can reassure bond investors without implying a lengthy tightening cycle. A stabilisation in longer-dated yields would help investors refocus on earnings and the opportunities created by September’s weakness. That remains the outcome for which we are positioned.
Report Spotlight
James Hardie (US and ASX: JHX) – BUY
James Hardie’s June quarter beat guidance, with pro-forma sales up 12% and North American fibre cement organic growth of 20%. A change in how adjusted EBITDA is calculated flattered the headline beat — roughly half the apparent upgrade reflects the new definition rather than the underlying business — but on a like-for-like basis, momentum remains genuinely strong. The subsequent US$980m sale of the lower-margin European operations to Holcim should lift group margins by around 1.4 percentage points and accelerate deleveraging toward the 2x net debt target. After a strong year-to-date rally, valuation is less compelling than earlier in the year, but at roughly 13x forward EV/EBITDA, patient investors are still being offered reasonable value.
James Hardie US-listed ADRs are rising within a consistent uptrend after inflecting earlier this year. Support is well defined at $28 and below, while resistance above $31 has checked the recent advance. Whilst JHX is likely to consolidate in this new higher range over the near term, we have conviction that the stock will retest the record highs above $41 over the coming year.
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Have a great weekend.
Carpe Diem
Angus
