Economic Update May 2026
In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.
Key points:
- Ceasefire talks drag on, but Wall Street has rebounded strongly
- The RBA increased the cash rate to 4.35%, the third increase so far this year
- Inflation spikes as oil prices jump
- Consumer confidence has fallen sharply in both the US and Australia
The Big Picture
The S&P 500 and the ASX 200 have each suffered two important setbacks during the Trump second term (to date). The first correction was a result of a poorly thought-out tariff policy for US imports. The S&P 500 bounced back from the April 4th 2025 delay in the reciprocal tariff implementation. The ASX 200 followed suit.
The S&P 500 charged up 37% while the ASX 200 gained a creditable 25%, to arrive at their February 2026 highs. These important gains were made while Trump policy uncertainty clouded the outlook.
The war between the US and Iran on the one hand, and Israel and Lebanon on the other, caused both indices to fall between 8% and 9% from February 27th before another strong retracement, especially on the part of the US index. That index rose 14% in a quicker retracement than that which followed the tariff uncertainties. The ASX 200 rose 6% in around the same time frame but it stalled from early April.
While there is some sort of ceasefire in the Middle East, the Strait of Hormuz has largely been closed to shipping – trade that typically accounts for about 20% of the global oil supply in addition to key fertilizers and industrial chemicals.
The fact that both sets of strong recoveries occurred during a high degree of uncertainty suggests that the market was, and is, looking through these incidents to strong underlying fundamentals. Recent earnings reports in the US have been strong, and the AI boom is largely intact.
While most agree that the AI technology will be transformational, it is difficult to analyse the projected spend on data centres. No one realistically knows how much compute (yes, compute has become a noun replacing ‘computing power’) will be needed. There is also confusion over the possible overlap and interaction between different company projections. There could be some important disruptions to these projections in years to come – but not yet, we think.
Another strong sign in market behaviour over ‘Trump 2.0’ is that there has been a rotation from the Magnificent 7 ‘mag 7’ US mega tech companies dominating market gains to a much broader-based rally. Even the Russell 2000 index, representing US small cap stocks, has also performed strongly in recent times,
There are two big takeaways from the last 12-15 months of market behaviour. Investors who were ill-prepared for what was to come possibly sold out in fear at the start of the two big drops in the indexes, and then possibly were too late into getting back into the market. They would have lost more compared to those that stood their ground.
The second takeaway is related to the first. Whatever we all thought about Trump being elected in November 2024, we have all learnt now that Trump is making far more erratic and frequent decisions than in his first term. We argued all along that the tariff policy was ill-advised and the US Supreme Court overturned a large part of that policy. Companies are now in the process of trying to claim back the taxes (tariffs are nothing but taxes) they were illegally charged.
General Motors (GM) is reportedly looking to claim back about 400-500 million dollars of tariff revenue. Jack Daniels, the iconic distillery, made substantial losses through its trade with Canada. When Trump threw around seemingly random numbers for new tariffs with Canada (and claiming Canada should be part of the US going forward), Canadians simply stopped buying the product in retaliation. There are surely many other cases of economic loss.
The German Chancellor, Friedrich Merz, recently claimed Trump had been exposed by Iran over his attack. As the adage goes, it is easy to invade a country, it is difficult to make a successful exit even if one had a plan. No one seems to be aware of Trump’s plan, if indeed he had one. Since Trump started the attack without consultation with possible allies, it would make no sense for other countries simply to follow Trump into battle. Allies need a co-ordinated, well-thought-out plan. When troops first invaded Kuwait in the first Gulf War, only 40% of those troops were American!
The US Federal Reserve (Fed) chair, Jerome Powell, said goodbye to the press corps after his final post-FOMC (Federal Open Markets Committee) media conference – but he emphasised he’s not leaving the Board of Governors yet. He vowed to stay on until the legal issues surrounding him have gone away. He promised to keep a low profile.
The Fed kept interest rates on hold at 3.50% to 3.75% in an 8-4 split vote. There have not been four dissensions in the voting since October 1992! However, only one person voted for a rate cut: Stephen Miran, Trump’s recent appointee. The other three dissenters wanted to remove the statement that the Fed was on an easing bias (in favour of a neutral stance) going forward. The Fed and markets are now in agreement about a multi-meeting period of interest rates being ‘on hold’.
Powell reiterated that he believes the US economy is experiencing solid growth and that the unemployment rate is low. The latest GDP growth number at the end of April for the March quarter 2026 was 2.0% (annualised) and 2.7% year-over-year.
Just before the FOMC decision was handed down, the Senate Banking Committee approved Kevin Warsh’s nomination for Fed chair progress to the full Senate Committee for confirmation in the week of May 11. Warsh, as did Powell, argued that he will stand up to pressures from Trump.
The consensus seems to be that there may be no change in the Fed funds interest rate for the rest of this year. Powell thinks it is far too early to say how long the high global oil prices that have elevated inflation will continue. The Fed is watching inflation, tariffs and oil prices closely.
We think it is quite possible that the US labour market will start to worsen as the fiscal stimulus of the first half of 2026 subsides. Private sector jobs have not grown in six months. There is no problematic wage growth so demand pressures from the labour market are not the issue for inflation management.
What is particularly interesting is the fact that the US Treasury yields at 5, 10 and 30 years are all higher now than they were before the latest round of interest rate cuts, a total of 175 bps, took place from October 2024. The market determines the long-term rates that households and businesses pay and earn; the Fed only directly influences short-term interest rates at the front end of the yield curve.
While Powell is comfortable with US inflation being above 3% because of the supply-side dislocations (higher oil prices) that are elevating it, the same cannot be said for the RBA and Australian inflation. Our latest CPI Inflation came in at 4.6% which was up from 3.7% in the prior month. The so-called ‘trimmed mean’ that the RBA prefers was a more modest 3.3% and below the expected 3.5%.
The RBA increased its cash interest rate to 4.35%, the third interest rate increase at consecutive RBA meetings, going against the moves (or lack thereof) by other major central banks. Our cash interest rate at 4.35% is increasingly higher than the 3.5% to 3.75% in the US. Further, there is a strong market expectation that our rate will be 4.85% by the end of 2026. The RBA seems to be encouraging this view.
Powell thinks that the US interest rate is in the vicinity of a ‘neutral’ level – perhaps toward the upper end. If our interest rates get close to 5%, mortgagees will feel lots more pain on top of the reduction in spending power arising from the increases in petrol prices. These increases followed the global oil price shock and the lack of preparedness of the Australian government to have maintained adequate inventories of petrol to mollify such shocks.
The Federal Treasurer will hand down his budget in the second week of May. It seems that big changes will be made to cut expenditure from the NDIS which has grown like Topsy since it was introduced in 2016. At that time, it was hoped that the effect on the employment of formerly unpaid home helpers would have reduced the dependence on other government benefits. That reportedly has not happened with sufficient force. What started off as a $10bn per year scheme now costs over $50bn p.a.!
Government debt is headed towards one trillion dollars in two years. Twenty years ago, under Peter Costello’s stewardship, our debt was zero!
At last, the Treasurer has understood that taxing capital gains at anything like full income tax rates would be unfairly onerous as an allowance for inflation must be made for equity. It now seems Keating’s initial scheme, which taxed capital gains only above inflation at full income tax rates may now be restored. However, for lumpy assets like property, paying CGT on the full amount in the year that the sale is made would push many investors into higher tax brackets. Keating allowed averaging capital gains over five years to reduce this distortion.
The US-Iran and Israel-Lebanon (Hezbollah) wars are now entering their third month of conflict. Trump had initially speculated the conflict might be over in two weeks. The fall-out on US-Australia economic growth has not yet been significant but the impact on inflation has.
Consumer confidence has fallen, reflecting the impact of war, tariffs and inflation. The University of Michigan’s US consumer sentiment recorded its lowest reading since data started being collected in 1952! All the economic and military problems in those 74 years did not make consumers feel worse – at least by that measure – as they feel now!
At home the Westpac consumer sentiment index fell sharply but it is not yet quite as bad as it was in the pandemic or the GFC – but it is not that much better! The NAB business confidence index also hit a low only beaten by the GFC sentiment in the last three decades. However, the NAB business conditions index held up quite well.
Households and businesses are functioning but their expectations for the future are very weak indeed. As a result, they might spend less to help save for a rainy day. If they do so save, then growth will suffer.
There have been some excellent results in the first quarter company earnings’ reports on Wall Street. These results propelled the S&P 500 to finish April at a record close! Earnings’ expectations, as collected by LSEG, our data provider, are also holding up well for Australia.
If Pakistan and China can facilitate a resolution to the closure of the Strait of Hormuz, and the war more generally, the Australian and US economies could carry on for another good year in 2026. The growth in the creation of data centres in the US is a major factor in driving growth in the US and beyond. Government spending in both countries continues to be fiscal stimulus that is working against monetary policy.
Asset Classes
Australian Equities
Australian equities (ASX 200) gained +2.2% in April but that was insufficient to assist the index to a positive result for the year-to-date. The loss y-t-d was ‑0.6%.
The Energy sector lost ‑2.7% in April on the back of a ‑3.7% loss in the price of Brent oil over the same period. The Materials sector, on the other hand, posted a strong gain of +4.3% over the month.
The gainers for the broader index were unusually mixed over April: IT (+13.3%), Property (+8.6%) and Financials (+2.9%), along with Materials, were the above-index leaders; Health (‑8.7%), Staples (‑4.7%), Utilities (‑0.1%) and Energy recorded losses over April.
International Equities
International shares also posted a wide range of capital gains over April. Japan’s Nikkei (+16.1%), the US S&P 500 (+10.4%), the German DAX (+7.1%), China’s Shanghai Composite (+5.7%) and Emerging Markets (+13.1%) all performed better than the ASX 200. The London FTSE (+2.0%) moved in line with our index.
Over the year-to-date, the Nikkei (+17.8%) and Emerging Markets (+15.1%) were the standouts of the indexes we follow more closely.
Bonds and Interest Dates
The Fed held its interest rate at the range 3.5% to 3.75% as was widely anticipated. As the prospective new chair, Kevin Warsh, is to be ushered in on May 15th, the voting at the April meeting reflected an opportunity for him to form a new consensus among the other 11 voting members. Eight members voted for staying on hold while 4 dissented. Three of the dissenters wanted to remove ’easing bias’ from forward guidance.
The CME Fedwatch tool has priced no change to the Fed funds interest rate over the rest of the year at 76.3% with 7.0% being attributed to the chance of an interest rate increase. There is a 16.6% chance of one or more interest rate cuts.
The 30-year US Treasury yield finished April at 4.97%, rising back to a level which greatly disturbed markets after the announcement of the reciprocal tariff policy 12 months ago.
These movements of yields at the long end of the US yield curve show how misguided Trump has been in demanding the Fed cut its Fed funds (Cash) interest rate. The market, and not the Fed, largely dictates the level of long-term interest rates.
The cash rates for the Bank of Canada (2.25%), Bank of Japan (0.75%), Bank of England (BoE) (3.75%) and the ECB (2.0%), among others, were ‘on hold’ in April but the BoE also had a split decision (8-1).
After increasing its interest rate to 4.35% in early May, the RBA is clearly out of step with the major central banks in terms of both direction and level. It has flagged further interest rate increases but all of its major developed world central bank peers remain ‘on hold’ despite facing the same global oil price inflation conditions.
Other Assets
Brent Crude (‑3.7%) and West Texas Intermediate (WTI) (+3.6%) oil prices were more settled in April after aggressive increases in March.
The price of gold was flat (+0.1%) in April.
The price of iron ore rose +1.0% in April to consolidate a positive gain (+2.3%) for the y-t-d. The price of copper was up very strongly in April at +5.4%.
The VIX US share market volatility index ended April almost in the normal range at 16.9 after peaking at 31.1 in the y‑t‑d.
The Australian dollar appreciated by +3.9% against the greenback over April ending the month at $US0.7113. Our dollar traded for $US0.6693 at the start of 2026.
Regional Review
Australia
The unemployment rate held firm at 4.3% in March. Total employment grew by +17,900 while growth in full-time jobs was higher at +52,500. Part-time job losses accounted for the difference.
The Australian Bureau of Statistics (ABS) ‘measured’ a 25.4% increase in electricity prices for the year to March because of the way in which it factored in the government rebates. The ABS equivalent measure without the rebate effect was only 3.9!
The monthly rebate-corrected change in March was 0.0% following a 1% change in February. We calculate that this dubious rebate correction is adding about 0.5% to the headline CPI inflation – which was 4.6% for the year to March. We think the RBA should ignore the current impact of the war on CPI and leave interest rates on hold. Indeed, no other developed nation saw fit to react in his manner. The US has been explicit in its reasoning behind being on hold.
China
China reported +5.0% economic growth against an expected +4.5% and government guidance of +4.5% to +5.0% for the year.
Industrial output was up +5.7% but retail sales growth missed expectations at +1.7%. Industrial profits stunned the market with growth of +15.5% but it transpires that much of this growth was due to the revaluation effect on its substantial oil inventories in the face of the large increase in global oil prices.
US
There were +178,000 jobs created in April, but this number was boosted by +35,000 returning strikers and a substantial number from adverse weather layoffs. The average monthly jobs gain over the last 12 months was +25,300. The unemployment rate was 3.4% and wage growth was +0.2% for the month and +3.5% for the year.
GDP growth for the December quarter 2025 was revised downwards to +0.5% from +0.7% resulting in +2.1% for the year. Powell referred to current growth as ‘solid’. Just after that press conference, growth for March quarter 2026 came in at 2.0% for the quarter (annualised) and 2.7% for the year.
Core Private Consumption Expenditure (PCE) inflation, the Fed’s preferred inflation gauge, released with GDP growth, was 3.2%. While this figure is firmly above the Fed’s 2% target, the tariff inflation shock has yet to work its way through the system and the effect of the oil price shock is possibly still increasing in magnitude.
Europe
EU inflation came in at 2.5%, up from 1.9%. UK growth was +1.0% for the year but its retail sales were the lowest level since 1983.
Rest of the World
The Strait of Hormuz was only briefly opened for shipping between the Persian Gulf and the Arabian Sea. The US has blockaded Iranian ships from travel to and from Iran.
It seems that the four leaders in the Middle East conflict are growing weary of the hostilities, but Iran has Trump on the back foot. With the US mid-term elections in November fast approaching, Trump needs a solution quickly to prevent the Republican Party from losing seats from their slim majorities in the Senate and the House of Representatives. Trump has already claimed victory in the war, but few would agree with him!
We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.
