Middle East escalation is the dominant market driver, lifting oil prices sharply and weighing on global risk sentiment, with equities weaker and defensive sectors outperforming. Global bond yields have pushed higher

Risk sentiment is weaker, dampened by military strikes in the Middle East that sent oil prices higher. Global rates are higher, with fresh highs recorded in many countries, while most global equity markets are weaker. Although currency moves have been modest, the USD is broadly stronger, pushing the NZD back below 0.59. The RBNZ meets today, where a 25bps hike should be seen as a done deal.

Tensions in the Middle East escalated, with military strikes by the US and Iran rising another notch. Two oil supertankers attempting to exit the Strait of Hormuz with their transponders turned off were struck by Iran. US Central Command said it had begun striking IRGC targets in Iran following the attacks, while explosions were heard in southern Iran.

On social media, Trump threatened an even larger attack if Iran retaliated. An IRGC spokesman said Iran would deliver a “greater” response to the US strikes. Needless to say, oil prices have risen sharply, with Brent crude up nearly 5% on the day and approaching USD95 per barrel.

Also unsurprisingly, global rates are higher, with new multi-decade highs reached in many countries, including Japan, Australia, the UK, and Germany. Japan’s 10-year rate rose above 3%, reaching its highest level since 1996, before ending the day up 5bps at 2.99%. European 10-year rates are up about 3bps, the UK rate rose 8bps to 5.23%, and Australia’s 10-year rate rose 9bps to 5.18%.

US Treasury investors are nervous, with support levels broken and the 10-year rate rising to about 4.8%, its highest level since January 2025. The current rate of 4.79% is little changed from the NZ close. The prospect of higher oil prices driving inflation higher, alongside concerns about the sustainability of fiscal policy, has battered bond market sentiment, although recent moves have been orderly. There is no sign of bond market panic, with the MOVE Index of implied volatility remaining historically low.

Economic data did not move the needle. The US ISM manufacturing index fell slightly more than expected to 54.6 in August, after a strong recent run that had taken it to a four-year high. JOLTS job openings of 7.3m were broadly in line after accounting for revisions, and the survey conveyed a low-firing, low-hiring environment.

Euro area CPI inflation rose from 2.9% to 3.3% y/y in August, as expected, reaching its highest level in almost three years. However, the core figure nudged down to 2.4% y/y and services inflation fell to 3.0%. A 25bps ECB rate hike is fully priced for next week, and a further two hikes are essentially priced thereafter, although there is some doubt about whether the central bank will need to tighten much further.

Higher bond yields have weighed on equity sentiment, with key global markets mostly lower. The S&P500 is currently down for a third consecutive day, falling 0.8%, with a notable rotation supporting defensive sectors while higher-risk and cyclical sectors underperform. The Nasdaq is down 1.2%. The Euro Stoxx 600 index closed 0.6% lower.

In currency markets, the USD is broadly stronger on the day, although moves have been modest, with dollar indices up only 0.2–0.3%. The NZD has slipped below 0.59, while the AUD has slipped below 0.7150. USD/JPY has returned to a 160 handle. NZD crosses are mostly weaker, but movements have been small.

Yesterday’s backdrop of higher global rates, particularly in Australia, spilled over into the domestic rates market, led by the long end and resulting in steeper curves. NZGB yields rose 3–6bps across the curve. While other nations’ 10-year rates reached multi-year and multi-decade highs, NZ’s 10-year rate of 4.80% did not reach a new milestone, other than moving towards the top of its recent trading range. In the swaps market, the 2-year rate rose 4bps to 3.76%, still some 5bps below the July high, while the 10-year rate rose 7bps to 4.51%, about 4bps below the high set in March.

In the day ahead, the domestic focus will be on the RBNZ’s MPS. There is strong consensus for a 25bps OCR hike to 2.75%, and this is essentially fully priced. The market will be more interested in the outlook and in assessing the probability of further sequential hikes in October and December. It is clear that the RBNZ will need to maintain a tightening bias and take the OCR at least as high as the 3.3% level projected in May.

Elsewhere, the consensus expects Australian Q2 GDP to rise by a modest 0.3% q/q. US ADP private payrolls are released tonight, ahead of the more important employment report at the end of the week. The Bank of Canada meets, with little chance assigned to a policy adjustment, especially given recent developments in the trade war with the US.

Jason Wong is the senior Markets Strategist at BNZ Markets.