Macro Pulse Episode 34

Hello and welcome to Macro Pulse. Global markets have remained resilient despite the ongoing conflict between the US and Iran and the Straits of Hormuz remaining closed, keeping the oil price well above $100 per barrel. Markets continue to benefit from AI investment optimism, strong first-quarter US earnings results, a resilient US economic data, and the hope that the Straits of Hormuz will reopen soon. However, the Middle East situation remains fragile and hopes that Trump’s visit to China last week would lead to further de-escalation were ultimately disappointed.

So Trump visited China to meet with leader Xi Jinping for the first time since 2017, and he took with him an impressive delegation of around 20 major US business leaders representing almost 25% of the S&P 500 market cap. While no formal agreements were released and some details still remain vague, both sides did signal stability and a more transactional relationship for now. Some of the key outcomes included China agreeing to purchase additional US agricultural goods, Boeing securing new aircraft orders from China, Nvidia has also been allowed to sell its H200 chip into China again, and some easing of rare earth export restrictions also were agreed on. So the US and China have further agreed to set up a board of trade as well as a board of investment to handle future trade investment dynamics in an effort also to bring down the trade deficit of the US. But importantly, China also warned the US about Taiwan, calling Taiwan the biggest long-term risk to the US-China relationship. So while the US and China, their tensions may have stabilized in the short term, the structural rivalry between these two countries remains very much in place.

So turning back to the Middle East, the US and Iran still appear far apart from a lasting peace agreement, and the US has now responded to Iran’s proposal with five broad conditions including some unfreezing of the Iranian assets, allowing one nuclear facility to remain operational, the transfer of enriched uranium to the US, and also potential limited sanction relief. But the ceasefire still looks fragile and with no agreement in sight, the probability of another flare-up in this conflict has increased.

And so this brings us back to the oil markets. Why has oil not moved materially above $100 despite the disruptions in the Straits of Hormuz? There are a few important reasons for this. Global oil inventories outside the Middle East were already relatively high going into the conflict, and China in particular has built up significant reserves before the conflict, and they are now in a position actually to decrease their demand. The US, Brazil, and Venezuela have also increased their oil exports recently. Although the US has not increased production, so the US effectively is drawing down their inventories, and markets still believe that the closure of the Straits of Hormuz may prove temporary. But all of these are temporary factors and global inventories are falling fast, which means that the longer the trade remains disrupted, the bigger the upside risk to oil later this year.

At the same time, global bond yields continue to move higher as investors demand greater compensation for both rising inflation and rising fiscal risks. So the rising oil price is adding to inflation concerns, while political developments in the UK and Japan have raised fiscal concerns, and under new chair Kevin Warsh, there remains considerable uncertainty around how the US Federal Reserve will respond to this persistent inflation and some resilient economic data out of the US. But for now, economic data in the US continue to surprise to the upside, and this is supported by strong AI investment, fiscal stimulus, tax cuts that are coming through, and earlier tariff reversals. These are all boosting activity. However, US inflation dynamics remain challenging. Headline and core inflation is on the rise again. Services inflation remains elevated and sticky, and some of the stronger recent US data like the retail sales numbers have somewhat been distorted by higher prices rather than stronger demand. But underneath the surface, US household consumption continues to slow in real terms. Consumer confidence remains weak as wage growth and earnings growth in real terms are slowing.

In South Africa, markets are now pricing in almost four 25 basis points hikes by the SARB over the next four meetings. The first of these meetings will be this week. These rate hikes are a result of high oil prices, high inflation expectations potentially as well as rand weakness. But the SARB also faces a difficult trade-off. The local economy is weakening. Unemployment continues to rise and social pressures are building on the back of higher food prices, higher fuel prices, and then more recently weather-related economic disruptions. So the recent storms in the Western Cape, for instance, which makes up 14% of the country’s GDP, are estimated to detract 0.3% of Q2 and Q3 quarterly growth due to losses in production, services, agriculture, tourism, logistics, as well as the loss of stock.

So in summary, the Straits of Hormuz remains closed despite expectations for a near-term reopening. The risk of renewed fighting has increased. Global equity markets have benefited from strong AI capex, decent earnings results as well as resilient data. And all of this while global bond yields are rising to very high levels. And historically, high bond yields and higher equity markets rarely last for prolonged periods.

That’s all for this week. Thank you for watching.