The Month Ahead

September was a volatile month for global financial markets, with oil prices surging by as much as 20% following an escalation of tensions in the Middle East. While oil prices subsequently retreated from their peak, they remained around 7% higher for the month, as of 28 September.

Bond markets were a key focus, with government bond yields in several major economies climbing to multi-year highs. The rise in yields reflected more than just higher oil prices. An interest rate hike from the US Federal Reserve (the Fed), robust economic data, and growing concerns over the expanding US government debt contributed to expectations that interest rates may remain higher for longer, weighing on bond prices.

US equity markets largely shrugged off the volatility in bonds and oil as the AI optimism saw the Nasdaq 100 Index trade to a record high, while the S&P 500 Index rose to within 1% of its all-time high. European markets were more susceptible to the volatility, which left both the Euro Stoxx 50 Index and the FTSE 100 Index lower over the month to 28 September.

Markets in New Zealand traded in similar fashion. The Reserve Bank of New Zealand (RBNZ) increased the Official Cash Rate (OCR) by 25 basis points to 2.75%, putting pressure on bond prices, while equity markets were more subdued with the NZX 50 Index slightly lower as of 28 September.

October will be another busy month for central banks, with the RBNZ, the Fed and the European Central Bank (ECB) all due to meet. As of 28 September, interest rate markets were assigning a greater-than-even chance of further rate hikes from each of these central banks.

At its September meeting, the RBNZ signalled that any further tightening is likely to be more gradual and increasingly data dependent. With third-quarter inflation data due just days before the October meeting, the release is expected to play a pivotal role in determining whether policymakers choose to raise interest rates again.

In the United States, expectations for an October rate hike firmed during the second half of September as economic data pointed to resilient business activity and ongoing price pressures. Inflation concerns have also been reinforced by record-high diesel prices, which are more likely than crude oil prices alone to generate broader inflationary effects. Diesel is a key input across freight, agriculture, construction and manufacturing, meaning sustained increases can raise the cost of producing and transporting goods and services throughout the economy.

Meanwhile, the ECB also appears to be leaning towards further policy tightening. Europe remains one of the regions most exposed to developments in the Middle East, given its reliance on imported energy and key shipping routes that pass through the region. Recent inflation data have also surprised to the upside, with annual inflation rising to 3.2% in August, matching May's reading and marking the highest rate since 2023.

At the tactical asset allocation level, we have closed our overweight positions in US and UK government bonds. Inflation risks remain elevated, driven by higher energy prices and ongoing conflict in the Middle East, with little indication of a near-term resolution. Reflecting these upside risks to bond yields, we have established underweight positions in both US and Japanese government bonds. We believe both central banks are behind the curve, and policy tightening is required. Additionally, expansionary fiscal policy (in the US this is partly due to the war in Iran) could see further pressure on bond markets.

In currency markets, we remain overweight the New Zealand dollar relative to the Australian dollar. While we have seen some recent relative weakness in the New Zealand dollar, the Australian housing market remains under pressure and we expect New Zealand to be gradually entering a stage of economic recovery, which should support this position.

In equities, our positioning remains broadly neutral, although we retain a modest constructive bias heading into year-end. One market that is becoming increasingly attractive is Japan. A combination of relatively stable macroeconomic conditions and targeted fiscal support underpinning growth present upside potential, while positive earnings momentum, including strong Q2 earnings breadth and marginally positive EPS revisions, could also be a tailwind to Japanese equities.