(Source: Merlea Macro Matters)

Global Markets Outlook — The War‑Driven Oil Shock and Its Market Consequences   

The global economy has entered a period of higher uncertainty. For much of the past decade, growth was supported by cheap energy, stable global supply chains, and very low interest rates. These conditions allowed governments, businesses, and households to take on debt with limited immediate pressure.

That backdrop has now changed

The ongoing war involving Iran has triggered a renewed oil shock. Disruptions to energy supply routes, particularly around the Strait of Hormuz, have pushed oil prices higher. Energy costs flow quickly into transport, food, and manufacturing, lifting inflation at a time when price pressures were already stubborn. This has made it harder for central banks to lower interest rates and support growth.

Bond yields have risen across major economies as investors demand greater compensation for inflation and rising government borrowing. Higher yields translate into higher repayment costs for governments and companies, and increased mortgage and loan rates for households. Financial conditions are tightening, placing pressure on property markets, credit, and highly indebted sectors.

Globalisation is also being reshaped. Supply chains are being redesigned for security and resilience rather than lowest cost. Trade relationships are fragmenting, and governments are playing a larger role in directing investment. While these shifts may improve long‑term stability, they tend to raise costs and slow growth in the near term.

These trends increase the risk of stagflation—slower economic growth alongside persistent inflation. In this environment, policymakers face difficult trade‑offs, as easing policy risks reigniting inflation while maintaining tight settings raises recession risk.

Australia reflects many of these pressures. Population growth and resource exports provide support, but households carry high debt and remain sensitive to interest rates. Rising bond yields lift funding costs across mortgages, businesses, and government finances, leaving little room for mistakes.

Risks are also building beneath the surface. Years of low interest rates encouraged borrowing to invest in higher‑yielding assets. As rates rise and volatility increases, these positions may unwind quickly, amplifying market moves.

Private credit is another area of concern. Rapid growth, limited transparency, and higher interest costs are increasing stress on borrowers. Although problems may emerge slowly, they could surface abruptly in a weaker economic environment.

For investors, caution is essential. Strategies that relied on falling rates and rising asset prices are less dependable. Greater focus on balance‑sheet strength, pricing power, liquidity, and capital protection is increasingly important in a world shaped by higher energy costs, higher rates, and geopolitical risk.

Bonds – Bonds at a Crossroads: Inflation, Risk, and the Case for Patience

Global bond markets remain under pressure as inflation stays higher than many investors expected. Rising energy prices, ongoing geopolitical tensions, and strong government spending mean price pressures have not fallen back to central bank targets. As a result, bond yields are likely to remain elevated in the near term.

The key risk for bond investors is capital loss. When yields rise, bond prices fall. Investors who bought longer‑dated bonds expecting rapid rate cuts have already experienced losses, and that risk remains if inflation proves persistent.

While bond income looks attractive on paper, higher yields alone do not guarantee strong returns if prices continue to decline.

Central banks are cautious. Most are unwilling to cut rates while inflation is still above target, even if economic growth slows. This “wait and see” stance increases the chance that yields stay higher for longer, particularly at the long end of the market. For investors, this means duration risk remains significant.

Before increasing exposure to longer‑dated bonds, several conditions should be watched closely. First, inflation needs to show clear and sustained improvement, not just temporary relief driven by base effects. Second, wage growth and services inflation must slow, as these are signs that prices are becoming entrenched. Third, central bank guidance needs to shift from caution to confidence that inflation is under control. Finally, bond yield curves should stop rising and begin to stabilise, signalling that markets believe policy rates have peaked.

Until these signals appear, shorter‑dated bonds and inflation‑linked securities remain safer options for managing risk.

Where Stress Is Appearing in Credit Markets

While government bond markets are adjusting through higher yields, stress is becoming more visible in parts of the credit market.

The private credit sector is a key concern. Higher interest costs are pressuring borrowers, while investors are questioning valuations and liquidity. Some funds have limited withdrawals, a sign that cash flow pressure is building beneath the surface.

In high‑yield corporate bonds, spreads have started to widen from very low levels. This suggests investors are becoming more selective and are demanding higher returns to compensate for risk. Defaults remain relatively contained, but refinancing risk is rising for highly leveraged companies.

Certain industries are under strain. Consumer‑linked businesses, chemicals, utilities, and companies with high debt and thin margins are showing more rating downgrades. Emerging market borrowers are also facing pressure from higher energy costs and a strong US dollar.

Bottom Line

Bond yields are unlikely to fall meaningfully until inflation clearly breaks lower. Until then, caution on duration is warranted, and credit risk should be approached selectively rather than broadly.

Listed Property-Hard Assets in a Soft Economy: Why A‑REITs Can Hold Up in Stagflation

A‑REITs (Australian Real Estate Investment Trusts) are often viewed cautiously in stagflationary environments, where economic growth slows while inflation remains elevated. However, history and current market dynamics suggest that high‑quality A‑REITs can perform more defensively than commonly assumed, particularly when inflation is driven by construction costs and supply constraints rather than demand excesses.

One of the most important tailwinds for A‑REITs in stagflation is the sharp rise in replacement costs. Escalating prices for labour, materials, energy, and regulatory compliance have pushed the cost of developing new commercial and residential property to record levels. As a result, existing high‑quality assets become increasingly valuable, as they cannot be easily or economically replicated. This dynamic strengthens the competitive position of incumbent landlords and places a natural floor under asset values, even in a low‑growth economy.

Rising replacement costs also play a critical role in closing the gap between Net Tangible Assets (NTA) and market prices. Many A‑REITs have traded at discounts to reported NTA following interest rate shocks and valuation write‑downs. As construction inflation persists, book values increasingly reflect conservative assumptions relative to real‑world build costs. Over time, this supports re‑rating potential as investors recognise that the stated NTA understates the true economic value of irreplaceable assets, particularly in sectors such as industrial, logistics, data centres, and prime residential.

Inflation can also support rental growth, even as economic activity slows. Long‑dated lease structures with CPI-linked escalators, fixed annual increases, or market-rent reviews allow many A‑REITs to gradually pass through inflation. This is especially evident in industrial and essential-use property, where tenants prioritise location and operational continuity over marginal rent increases. While discretionary retail and secondary office assets may face pressure, well-located, modern assets tend to retain pricing power.

Importantly, as inflation expectations stabilise or decline while nominal rents continue to grow, capitalisation (cap) rates can begin to improve. In a stagflationary setting, real assets with durable income streams regain appeal relative to financial assets, particularly once interest rates peak. Even modest cap rate compression, combined with rental growth, can materially enhance asset valuations and distributable earnings.

In summary, while stagflation presents challenges, A‑REITs with strong balance sheets, high-quality assets, inflation‑linked income, and limited development exposure are structurally well positioned. Rising replacement costs, improving rent dynamics, and the gradual closing of NTA discounts suggest that select A‑REITs can act as resilient, income‑producing real assets in an otherwise difficult macro environment.

Financial resilience remains a defining feature of the sector. Average gearing across A-REITs is conservative, and a substantial portion of debt is hedged against interest-rate volatility. This disciplined approach has allowed many trusts to navigate recent rate cycles without major capital raisings or forced asset sales.

While risks remain, particularly with higher bond yields and the potential for additional central bank action, the sector is beginning to move from a period of valuation adjustment toward a phase of measured recovery. For income-focused investors, distribution yields remain attractive, often exceeding 5%, underpinned by stable leases and robust operational performance. Overall, as Q2 2026 unfolds, the combination of stabilising valuations, resilient cash flows, and healthy balance sheets suggests that well-positioned A-REITs are starting to present selective investment opportunities despite the backdrop of a rising-yield environment.

Australian Equities – Australian Equity Market: Valuations, Geopolitics and Defensive Positioning

The Australian equity market enters the second quarter facing a fundamental contradiction: equity valuations remain around long‑term averages despite inflation risks that would normally justify lower price‑to‑earnings multiples. In a sustained inflationary environment, higher discount rates and greater earnings uncertainty typically lead to P/E compression. The fact that this has not yet occurred suggests markets are implicitly pricing in a moderation in inflation and a stabilisation in interest rates. If that assumption proves wrong, valuation risk becomes asymmetric to the downside.

Elevated inflation, particularly when driven by energy prices and supply‑side pressures, raises the cost of capital and erodes the real value of future earnings. Historically, periods of sticky inflation have coincided with structurally lower equity multiples, not simply earnings volatility. This creates a clear vulnerability: if inflation remains elevated for longer than expected, equities may need to adjust through either multiple contraction, earnings downgrades, or both.

The combination of a tightening RBA, elevated equity valuations, a slowing consumer, housing market softness, and an energy-driven inflation shock presents a more difficult environment for Australian equities.

The outlook for interest rates reflects this same tension. While markets continue to debate the timing of eventual rate cuts, the more immediate risk is that rates remain higher for longer — or that further tightening becomes necessary should inflation reaccelerate. Geopolitical tensions, particularly through energy markets, increase the likelihood that central banks remain cautious. Even without further hikes, restrictive policy settings sustained into the second half of the year would pressure highly leveraged sectors and long‑duration assets.

Rate‑sensitive sectors are the most exposed in this environment.

A‑REITs, infrastructure with aggressive leverage, and high‑yield equities reliant on cheap refinancing face valuation pressure if bond yields rise or remain elevated. While quality real assets can protect against inflation over time, near‑term equity prices are still sensitive to changes in funding costs. Similarly, growth stocks — particularly technology and consumer discretionary names trading on elevated multiples — are highly exposed to higher discount rates. Their valuations depend disproportionately on earnings far into the future, making them vulnerable to both rate shocks and earnings disappointments.

In contrast, defensive sectors are better positioned. Consumer staples, healthcare, utilities, and select financials benefit from more resilient demand, pricing power, and shorter‑duration cash flows. Banks, while not immune to economic slowdown, can perform relatively defensively if credit quality holds and net interest margins remain supported.

Mining stocks sit between these dynamics. Bulk commodities remain cyclical and exposed to global growth risks, but demand tied to electrification, energy infrastructure, and artificial intelligence supports longer‑term fundamentals for metals such as copper and energy‑linked materials. Large, diversified miners with strong balance sheets are better placed to navigate volatility than high‑cost or highly geared producers.

For investors, the implication is clear: this is not an environment to rely on valuation expansion. Portfolio construction should emphasise downside protection through quality bias, reduced leverage exposure, selective defensives, and real assets with demonstrable pricing power. Maintaining liquidity and avoiding over‑concentration in rate‑sensitive or high‑multiple sectors is critical if inflation stays elevated and interest rates fail to fall as quickly as markets expect.

US Equity Market Outlook: Valuations, Policy Transition and Geopolitical Risk

The US stock market is still trading at very high levels compared with history. Share prices assume that inflation will fall, company profits will stay strong, and interest rates will eventually come down. At the same time, economic and political risks are increasing, which makes the current market more fragile than it appears.

One major change ahead is at the Federal Reserve. President Trump has nominated Kevin Warsh to replace Jerome Powell as Chair when Powell’s term ends in May 2026. Markets believe Warsh will be more willing to support lower interest rates, especially because he believes improvements in technology and artificial intelligence can lift productivity. This expectation has increased the chance that US interest rates will ease and that the US dollar will weaken over time.

A weaker US dollar can support share prices in the short term, but it also makes imports more expensive. This can push inflation higher again, especially when energy prices are rising. History shows that high inflation and high share market valuations do not usually last together for long. If inflation stays high, share prices may fall simply because investors are no longer willing to pay such high prices for future earnings.

The war between the US and Iran adds to these risks. The conflict has driven oil prices higher, which has flowed through to petrol, transport, and household costs. Although the US produces more of its own energy than it used to, higher oil prices still hurt consumers and businesses. Recent inflation data shows prices rising more quickly again, mainly because of higher fuel costs.

These economic pressures are now showing up in politics. The 2026 US midterm elections are approaching, and the cost of living has become the most important issue for voters. Polls in April show President Trump’s approval rating in the mid-30% range, with most voters unhappy about prices and the economy. Generic congressional polls currently show Democrats leading by around five to six points, which puts pressure on the White House.

President Donald Trump’s approval rating, held at 40% in recent weeks, matching the lowest level of his current term, amid weak ratings from Hispanic voters, according to a Reuters/Ipsos poll

This creates a strong incentive for President Trump to reduce living costs and bring the Iran conflict under control. Lower petrol prices and a calmer global environment would help voters feel better about the economy. As a result, policy may lean toward easing financial conditions and avoiding actions that push prices higher, even if that creates longer-term inflation risks.

For investors, this environment calls for caution and selectivity. Expensive growth stocks, especially large technology companies, are most at risk if interest rates or inflation stay high. More defensive areas of the market may perform better. Energy companies benefit from higher oil prices. Defence and industrial businesses gain from increased government spending. Healthcare and consumer staples tend to be more stable because people continue to need their products even when economic growth slows.

Overall, with high share prices, rising political pressure, and ongoing geopolitical risk, investors should focus on protecting capital. Diversification, steady cash flow, and exposure to businesses that can handle higher costs are more important than chasing short-term market gains.

 Europe Under Pressure: Inflation, Conflict and Weak Growth

The economic outlook for the eurozone and the United Kingdom has become more fragile in 2026 as the war involving Iran continues to disrupt global energy markets. Oil and gas prices have risen sharply after shipping routes were interrupted, and this has flowed quickly into higher costs for households and businesses across Europe.

Because most European countries rely heavily on imported energy, these price rises act like a direct tax on the economy, squeezing spending and slowing growth.

Earlier expectations that interest rates would be cut have been pushed aside. Inflation had been easing slowly before the conflict, but energy prices have risen again and are keeping overall prices higher than central banks would like. This leaves policymakers with little room to support the economy. Cutting interest rates too soon could push prices even higher, while keeping rates high for longer risks slowing growth further.

In the eurozone, growth is already weak. Many countries were only beginning to recover from years of low investment and slow productivity before this new shock arrived. Higher fuel and electricity costs reduce household spending power, while businesses face higher operating costs. This makes companies more reluctant to invest or hire, which in turn slows wage growth and job creation. The risk is a prolonged period where prices stay high but economic activity fails to improve.

The situation is particularly difficult in the United Kingdom. Energy price rises feed quickly into household bills, meaning consumers cut back spending faster than in many European countries. Inflation has proven stubborn, forcing the Bank of England to delay interest rate cuts. Higher borrowing costs continue to weigh on housing, small businesses, and consumer confidence, adding to the pressure on growth.

At the same time, Russia is benefiting from the conflict. Higher global oil and gas prices have lifted Russian export revenues, strengthened government finances and made it easier to fund military spending. This has weakened the impact of international sanctions and added to Europe’s economic and security challenges.

Military spending and government finances

Security risks have led European governments and the UK to raise military spending. While this supports defence industries and jobs in some areas, much of the equipment is bought from abroad. This limits the boost to local economies while increasing pressure on government budgets.

Higher defence spending is happening at a time when debt levels are already high and interest rates remain elevated. Governments now face tougher choices. More money spent on defence leaves less available for healthcare, infrastructure, tax cuts, or cost‑of‑living support. As borrowing costs rise, debt compared to the size of the economy is likely to climb further, reducing flexibility in future downturns.

Which European countries are best placed to cope?

Not all European countries face the same level of pressure. Some are better able to cope because they have stronger public finances, more secure energy supplies, or more flexible economies.

Germany is relatively resilient despite slow growth. Its strong industrial base, large export sector, and ability to borrow cheaply help cushion the impact of higher energy costs.

The Netherlands is also well positioned, with healthy government finances and a diversified economy built around trade, logistics, and services.

Norway, although outside the eurozone, is the strongest performer. As a major energy exporter with a large state savings fund, it benefits from higher energy prices and has ample capacity to support households and businesses.

Denmark combines low public debt with flexible labour markets, allowing it to adjust more easily to economic shocks.

Switzerland, while not in the EU, remains highly resilient thanks to low debt, high incomes, and a strong currency.

By contrast, countries with high debt, weaker growth, and heavy reliance on imported energy—such as Italy and parts of southern Europe—are far more exposed to prolonged economic strain.

Japan 2026: Rising Prices and Delicate Choices

Japan’s economic outlook in 2026 has become more uncertain following the war involving Iran and rising instability in the Middle East. Japan relies heavily on imported oil and gas, and disruptions to global shipping routes have pushed energy prices higher. These higher costs are feeding directly into electricity bills, transport costs, and food prices, increasing the cost of living for households and costs for businesses. This rise in prices is creating pressure, but it is not coming from stronger demand at home. Instead, prices are rising mainly because imports are more expensive. Wages have improved modestly, but not enough to fully offset higher living costs. As a result, many households feel poorer in real terms, which limits spending and slows economic momentum.

Bank of Japan outlook

These conditions leave the Bank of Japan in a difficult position. After decades of very low inflation, the central bank has only recently started to move away from ultra‑low interest rates. Before the war, it planned a slow and careful path, lifting rates only if price increases were supported by steady wage growth. Higher energy‑driven inflation complicates that approach.

Raising interest rates too quickly could slow an already fragile recovery and increase borrowing costs for both the government and households. Moving too slowly risks allowing higher prices to become embedded. The most likely outcome is continued caution: small and gradual rate increases, combined with close monitoring of wages, energy prices, and the yen.

Foreign bond holdings and capital flows

There has been growing discussion about whether Japan is reducing its holdings of foreign government bonds, particularly U.S. bonds. So far, there has been no sharp or disorderly selling. Japan remains the world’s largest foreign holder of U.S. government debt. However, some Japanese banks and pension funds are slowly shifting new investments back toward Japanese government bonds as domestic interest rates rise. This reflects sensible rebalancing rather than a loss of confidence in overseas markets. Over time, this gradual shift could slightly reduce demand for foreign bonds but is unlikely to cause sudden market disruption.

Stock market valuation: cheap or expensive?

Despite recent strong performance, the Japanese share market still looks reasonably priced, especially when compared with the United States and parts of Europe. Many Japanese companies trade at lower price levels relative to their earnings and assets than global peers. Corporate balance sheets are generally strong, with high cash holdings, low debt, and improving capital discipline. Reforms encouraging better shareholder returns have led to higher dividends and share buybacks, making Japanese equities more attractive. A weaker yen also supports overseas earnings for exporters, helping profits when converted back into local currency. Taken together, Japan’s market appears fairly valued rather than expensive, with pockets that remain genuinely attractive.

Sectors offering the best opportunities

Several sectors look better placed than others in the current environment. Industrial and manufacturing companies remain attractive. Japan’s strengths in machinery, automation, robotics, and specialised components support steady demand, particularly from Asia and the United States. A weaker yen also helps exporters compete globally. Technology hardware and precision engineering firms benefit from strong global demand for chips, sensors, and high‑end components. Many hold leading positions in niche markets, giving them pricing strength. Banks and insurers are improving as interest rates rise slowly. Even modest increases can lift lending income and investment returns after many years of low profitability. Energy‑efficiency and infrastructure companies also offer opportunity, as higher energy costs drive demand for upgrades and alternative solutions.

In contrast, sectors focused mainly on domestic consumers face more pressure, as higher living costs keep household spending cautious.

China’s Economy in 2026: Quiet Strength, Policy Support, and a Changing Growth Model

China’s economy in 2026 continues to grow at a moderate pace, with the focus shifting from rapid expansion to stability and balance. Growth is expected to remain steady rather than strong. Exports still play an important role, but government policy is increasingly aimed at lifting spending at home, restoring confidence, and supporting more sustainable sources of growth.

China has been noticeably restrained in its public response to the current conflict in the Middle East. This has been a conscious decision. Beijing has called for calm and dialogue while avoiding direct involvement. The priority is to protect China’s key interests: secure energy supplies, stable trade routes, and steady economic conditions. By staying largely on the sidelines, China avoids the financial and political costs of conflict while allowing other countries to absorb the strain.

One of the brighter areas of China’s economy remains technology, particularly artificial intelligence. Chinese companies are gaining ground globally by offering technology that is effective and much cheaper than many Western alternatives. Because these tools cost less, they are being adopted quickly across factories, transport networks, healthcare, and everyday business services. This widespread use helps firms cut costs, improve efficiency, and raise output across the economy.

Government policy has clearly shifted toward encouraging domestic spending. Measures include subsidies to replace household goods, support for consumer credit, and higher spending on social services. At the same time, authorities are working to stabilise the property market. The aim is not to restart a housing boom, but to steady prices, complete unfinished homes, and reduce excess supply. This gradual approach is intended to rebuild household confidence without creating new risks.

China has lived with very low inflation for several years, and at times, outright price declines. Weak demand, excess industrial capacity, and the property downturn have all contributed. Conditions are now slowly improving. Higher energy costs, steps to curb aggressive price discounting, and firmer demand for services are helping prices stabilise. Inflation remains low, but the trend is gently upward rather than falling.

After a strong rebound, China’s share market no longer looks extremely cheap, but it is still reasonably priced compared with many global markets. Many companies trade at lower levels than overseas peers, while earnings are gradually improving. Productivity gains from technology and clearer policy support suggest there may still be room for further gains, although periods of market volatility should be expected.

Emerging Markets Under Pressure: Higher Energy Costs Reshape the Outlook

As 2026 progresses, emerging economies are facing a more difficult environment. The relative stability seen late last year has been disrupted by the war involving Iran, which has lifted energy prices and changed the global outlook. For many emerging markets, this has brought back familiar challenges: higher living costs, slowing growth, and less room for economic support. The outlook is increasingly uneven, with clear differences between countries.

The main shock has come through higher oil and gas prices. Disruptions to shipping through the Strait of Hormuz, a key route for global energy supplies, have pushed fuel prices higher since March. These rises have quickly flowed into transport, food, and electricity costs. Inflation that had been easing earlier in the year is now rising again, particularly in economies where energy forms a large share of household spending.

Countries that rely heavily on imported energy are under the most pressure. India, Turkey, South Africa, and parts of Southeast Asia have seen higher fuel costs lift prices for everyday goods and services. Household spending has weakened, trade balances have deteriorated, and policymakers are facing difficult choices. Inflation is rising even as growth slows, limiting the ability of central banks to lower interest rates.

Financial conditions have also tightened. Higher energy prices have pushed global interest rates up and made investors more cautious. Many emerging markets are experiencing higher borrowing costs, more volatile currencies, and less reliable capital inflows. Countries with large foreign debts or limited financial buffers are especially exposed.

Not all emerging markets are struggling. Energy and commodity exporters in parts of Latin America, Africa, and the Middle East outside the conflict zone have benefited from higher prices. However, global uncertainty and higher financing costs are limiting upside.

Overall, emerging markets can no longer be viewed as one group. Differences in energy exposure, financial strength, and policy discipline are now driving outcomes, with volatility likely to persist through the rest of the year.

Commodities Sector How the War Is Changing Prices and Driving Inflation

The war involving Iran has had a major impact on global commodity markets in 2026. What was expected to be a calm year for prices has instead turned into a period of disruption. Problems with energy supplies and shipping routes have pushed many commodity prices higher, adding to inflation pressures around the world and increasing costs for businesses and households.

Energy is at the centre of the issue. Disruptions to shipping through the Strait of Hormuz, one of the world’s most important sea routes, have reduced the flow of oil and gas to global markets. As a result, oil prices have moved back above USD100 a barrel, while gas prices have risen sharply, especially in Europe and Asia. Because fuel is used to power transport, factories, and farms, higher energy prices affect almost every product people buy. This is one of the main reasons why inflation has stopped falling and is rising again in many countries.

The impact does not stop with oil and gas. Several other important commodity sectors are still facing shortages or rising costs because of the war.

Fertilizers and food production

The Middle East is a major supplier of fertilisers used to grow crops. Disruptions to trade routes have reduced availability and pushed up prices. Farmers are paying more to grow food, which increases the risk of higher grocery prices later in the year.

Industrial metals

Materials such as aluminium and copper are also under pressure. The Middle East plays a role in producing aluminium and in supplying key materials needed to process copper. Reduced supply and higher energy costs are making these metals more expensive, raising costs for construction, manufacturing, and clean‑energy projects.

Plastics and chemicals

Plastics and many chemicals are made using oil and gas. As energy prices rise, the cost of producing packaging, household goods, and industrial materials increases. These higher costs are being passed on to consumers over time.

Shipping and transport‑linked goods

Higher fuel prices and rising insurance costs have made global shipping more expensive. Even when goods are available, it now costs more to move them. This has added to price pressure across a wide range of basic materials.

In summary, the war has turned commodities into a key driver of global inflation in 2026. While prices could ease if tensions decline, shortages in fertilizers, industrial metals, energy, and transport‑linked materials suggest that cost pressures will remain elevated. Until supply routes become reliable again, commodity prices are likely to stay higher than expected, keeping inflation a global concern.