The second quarter of 2026 was defined by two developments: the easing of the Middle East conflict that had dominated at the end of the first quarter, and a decisive shift in the outlook for interest rates. Early in the quarter, a deal between the United States and Iran to reopen the Strait of Hormuz removed the immediate supply-shock that had driven oil and gas prices sharply higher, allowing energy prices to retreat and inflation fears tied to the conflict to unwind.

Attention quickly turned, however, to the Federal Reserve, where new Chair Kevin Warsh made clear that inflation running above target for several years would not be tolerated. Market expectations moved from pricing rate cuts to pricing in hikes. The result was a quarter of rotation, with sharp divergence between sectors and styles beneath relatively contained index-level moves.

Leadership narrowed and dispersion widened over the quarter. Materials and energy were the standout contributors, supported by firm commodity prices and, in the case of resources, a strategic bid tied to electrification and power infrastructure, while healthcare was a notable laggard.

The biggest divergence was within technology itself. The chipmakers surged, as strong demand for their hardware let them raise prices, while the large cloud companies fell behind under the heavy cost of their artificial intelligence spending.

The Australian market, with its natural tilt toward energy and resources, was relatively well placed, although the shift in the rates outlook and a hawkish Reserve Bank tempered sentiment into quarter end.

Bonds again offered little shelter. Even though the belief we were nearing the end of the conflict eased some inflation pressure, inflation stayed too high, and the US Federal Reserve signalled it was more likely to raise rates than cut them, which pushed yields up. With other central banks equally cautious, investors settled in for a period of higher interest rates.

Gold and oil, the standout performers of the prior quarter, both gave up some of their returns. Oil fell back toward US$80 a barrel as the reopening of the Strait of Hormuz unlocked disrupted supply, although a fragile deal and a weakened OPEC kept the door open to further volatility, keeping oil prices higher than pre-conflict levels.

Gold came under sustained pressure, tracking the repricing toward higher rates almost mechanically as the rising opportunity cost of holding a non-yielding asset drew flows out of the metal. Gold also behaved unusually during the quarter. Rather than rising as a safe haven during the conflict, its price was driven by central bank buying and predictions of the US Federal Reserve's next moves on interest rates.

The US equity market held up well overall, but that steady headline hid large movements underneath.

The clearest example was within artificial intelligence: the chipmakers rose strongly on high demand and rising prices, while the large cloud companies lagged as investors questioned whether their heavy spending would pay off.

The Federal Reserve's shift toward higher rates weighed most on the expensive, fast-growing parts of the market, and therefore cheaper "value" shares outperformed after the June meeting. Materials and energy helped, while healthcare clearly lagged.

The third quarter was a market that rewarded picking the right shares rather than simply owning the index.

In Australia, the market's tilt toward energy and resources again worked in its favour, with materials and energy the main contributors to broader returns. Beneath that, the picture was highly dispersed.

Bank share prices continued a gradual decline as the Reserve Bank leaned more hawkish. The re-emergence of inflation concerns and a Reserve Bank explicitly prepared to raise rates further kept questions about the domestic outlook front of mind and dampened sentiment into quarter end.

Emerging markets were mixed. North Asian markets, particularly Korea and Taiwan, were supported by the strength in the semiconductor and memory cycle, with Korean earnings expected to rise sharply on the back of the artificial intelligence hardware boom. That strength was held back by the stronger US dollar and the move toward higher interest rates around the world, both of which usually weigh on emerging markets.

As a result, returns across these markets were uneven and depended heavily on how exposed each market was to the technology cycle.

Currency markets in the second quarter were shaped almost entirely by the shift in Federal Reserve expectations.

Having spent the previous quarter influenced by safe-haven flows tied to the Middle East conflict, the US dollar found firmer footing as new Chair Kevin Warsh signalled an inflation-first stance and the market repriced toward higher rates. The US dollar rose to its strongest level in over a year. Higher US interest rates relative to other countries drew money toward the dollar, which more than offset the fading of the safe-haven demand that had supported it during the conflict.

The move was most pronounced against the lower interest rate currencies, with the Japanese yen notably weak as an accommodative Bank of Japan lagged well behind other central banks.

The Australian dollar was relatively well supported despite broad US dollar strength, helped by the Reserve Bank's own hawkish stance and firm commodity prices. The Reserve Bank held the cash rate at 4.35% over the quarter but framed its decision as a hawkish hold, describing the economy as operating with excess demand and inflation still materially above target.

The RBA stated explicitly that it was prepared to raise rates further if required.

Global fixed income markets remained under pressure over the quarter, driven this time not by an energy shock but by a shift in the outlook for monetary policy.

Bonds rose early on, as the easing of the Middle East conflict reduced inflation fears, but those gains were more than wiped out when the US Federal Reserve signalled higher interest rates. With realised inflation still running well above target, markets moved from pricing rate cuts to pricing hikes, pushing front-end yields sharply higher and leaving most major bond markets in negative territory.

In the United States, the change in leadership at the Federal Reserve was the defining event. New Chair Kevin Warsh made clear that with inflation having run above target for several years, restoring price stability was the priority.

Markets responded by repricing sharply, moving from expecting cuts to pricing a hike, with the first move now expected later in the year. Front-end yields led the move higher, with the two-year Treasury yield rising notably.

In Australia, the Reserve Bank held its cash rate at 4.35% but delivered what markets read as a hawkish hold. The Board described the economy as operating with excess demand and inflation still materially above target and made clear it stood ready to raise rates again if needed.

With forecasts pointing to inflation returning to target only after a further two years, the front end had little scope to price cuts and Australian government bond yields moved higher in line with the global repricing.

Elsewhere, most major central banks stayed cautious, with several either raising rates or delivering hawkish holds. A notable feature of the quarter was the growing influence of artificial intelligence on debt markets. Technology and data-centre companies borrowed heavily, much of it over long time frames, which pushed up the cost of their longer-term borrowing even as it eased in other parts of the market.

Overall fixed income investors remained alert to a higher-for-longer environment, in which persistently above-target inflation and a less predictable Federal Reserve leave the path for yields uncertain.

Looking ahead to the remainder of 2026, the near-term focus has shifted from the Middle East to the path of interest rates.

Markets have moved from expecting rate cuts to hikes, but in our view the path for rates from here is far from certain. The environment remains genuinely uncertain, which makes decisive predictions on rates difficult. While we would hope to see central banks cut rates as soon as conditions allow, there are good reasons to think inflation could prove stickier than the market currently expects.

Part of this comes back to oil. Although the easing of the conflict has brought prices back down, the earlier spike has not yet fully worked its way through the economy, and these effects tend to take time to show up. On top of that, the peace deal remains fragile and if tensions in the Middle East were to reignite, oil prices could rise sharply again, reviving inflation concerns and giving central banks reason to stay cautious. This is not a prediction; it is simply a reminder of the uncertain environment we are currently in.

For fixed income, yields remain elevated, which is a genuine positive for investors. Higher yields mean higher income regardless of where rates head from here. We would not necessarily say bonds are more attractive than other asset classes, but the income on offer is real and worth having in a balanced portfolio.

What stands out is how differently central banks are responding, some leaning toward cutting, others toward holding or raising. This divergence points to a selective approach rather than simply buying the market and suits an active manager who can monitor these shifts and adjust as conditions change.

The opportunities are twofold: attractive income now, and scope for capital appreciation should rates fall. Given the uncertainty, we would suggest a medium duration approach encompassing a blend of government bonds and corporate credit to navigate the market ahead.

In equities, the Artificial Intelligence theme, along with Energy have been the main contributors to global market returns this financial year.  The global economy has proven resilient, and the outlook remains constructive, particularly in the United States, where the economy grew at an annualised rate of 2.1% in the first quarter, ahead of expectations, supported by strong business investment into artificial intelligence technologies.

Most forecasters expect growth of around 2% or more for 2026, with the risk of recession seen as relatively low. That said, this year has been a powerful reminder that market leadership can be narrow, with a small group of companies driving much of the return while others lag well behind. Wide gaps like these reinforce the value of a diversified, selective approach rather than chasing whichever part of the market is performing best at the time.

Bringing this together, it is difficult to make confident predictions about how the rest of the year will unfold, precisely because so much depends on factors that are inherently unpredictable, from the path of inflation and interest rates to the stability of the Middle East.

As we often highlight, this is exactly why diversification matters. Importantly, diversification today cannot rely on equities and bonds alone. The two have increasingly moved in the same direction rather than offsetting one another, so alternative investments have become a useful tool for providing genuine diversification.

No one can reliably foresee the future, and the events of recent years have shown this time and again. Maintaining a portfolio that is diversified across all asset classes, and that can hold up under a range of conditions, remains the most dependable way to pursue strong long-term returns while helping investors stay the course through short-term uncertainty.

General Advice Warning
This update is issued by Ventura Investment Management Limited (AFSL 253045), which is a related body corporate of Centrepoint Alliance Limited.

The information provided is general advice only and does not take into account your financial circumstances, needs or objectives. Where you are considering the acquisition, or possible acquisition, of a particular financial product, you should obtain a Product Disclosure Statement for the relevant product before you make any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. It is imperative that you seek advice from a registered professional financial adviser before making any investment decisions.

For more information, refer to the Financial Services Guide (FSG) for Ventura Investment Management Limited (available at https://venturafm.com.au/media/1729/ventura-fsg-update-nov.pdf).

Disclaimer
While Centrepoint Alliance Limited and its related bodies corporate try to ensure that the content of this update is accurate, adequate and complete, it does not represent or warrant its accuracy, adequacy or completeness. Centrepoint Alliance Limited is not responsible for any loss suffered as a result of or in relation of the use of this update. To the extent permitted by law, Centrepoint Alliance Limited excludes any liability, including negligence, for any loss, including indirect or consequential damages arising from or in relation to the use of this update.