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Q1 2026 began with optimism but shifted to turbulence as the Iran–US conflict erupted in late February, disrupting the Strait of Hormuz and driving oil above $100 per barrel. Markets absorbed the shock within typical correction ranges, while central banks adjusted to resurgent inflation risks and AI infrastructure spending provided a counterbalance. January and February CPI data showed global disinflation stalling, with energy spikes adding to sticky services inflation. Central banks diverged, with the RBA hiking and others holding steady or easing cautiously, shifting consensus toward extended pauses.

Global Snapshot: Geopolitics Meets Stubborn Inflation

Global equities gained modestly early in Q1 on AI capex and soft-landing hopes, but the March escalation pulled MSCI World indices down 5 to 8 percent, still shy of bear territory. Bonds sold off as yields rose 20 to 40 basis points across curves, with 10-year bunds hitting 2.8 percent and JGBs 1.2 percent as inflation was repriced.

Central Bank Policy Rates:

Central Bank Divergence — BoJ Hikes, Fed Cuts, and Carry Trade Pressures

The BoJ hike to 0.75 percent, its sharpest in years, narrowed policy spreads with other major central banks and started to unwind the yen carry trade that had supported risk assets through 2025. Investors had borrowed cheaply in yen to fund higher-yielding positions in US Treasuries, equities and emerging markets, and rising funding costs plus yen strength — with USD/JPY down about 8 percent in Q1 — are now forcing positions to be reduced.

Markets expect two Fed cuts by mid-2026, to around 3.00–3.25 percent, reflecting confidence in US growth and AI-related productivity, which further closes the spread between US and Japanese rates and adds to carry unwind pressure. Japan holds around $1.1 trillion in US Treasuries, making it the second largest foreign holder, so significant yen repatriation could put upward pressure on US yields — with the 10-year already up about 35 basis points in Q1 to 4.4 percent — and tighten global financial conditions at the margin. This is not seen as a repeat of 1998, but the scale of leveraged carry positions means it remains an important risk to monitor, especially alongside Middle East volatility.

Oil (Brent) rose about 45 percent quarter-on-quarter to around $105, gold peaked near $5,200 before easing to about $4,950, and private credit spreads widened by roughly 15 basis points.

Australia — Resilient but Tested

The RBA February hike to 3.85 percent reflected trimmed mean inflation at about 3.1 percent year-on-year in February, combining sticky services with higher energy costs. Unemployment rose to roughly 4.6 percent, but vacancies and unit labour costs remain elevated, and housing prices increased about 2 percent over the quarter.

The ASX 200 delivered a return of about 1.2 percent for Q1 after a 7 percent drawdown in March, with energy and resources up around 12 percent cushioning weakness in cyclicals. Ten-year Australian government bond yields moved to about 4.9 percent. The external accounts were volatile due to swings in gold exports and fuel imports, but overall terms of trade remained firm.

United States — AI Boom and Oil Brake

The S&P 500 rose about 4.1 percent in Q1 despite a 6 percent pullback in March, led by the technology sector (up around 12 percent) on the back of more than $200 billion of announced AI data centre capex from Nvidia and the large cloud providers. Small caps finished roughly flat as investors favoured quality and larger balance sheets. The Fed held rates steady after January, and the 10-year Treasury yield ended the quarter near 4.4 percent.

AI Technological Developments

Q1 saw a further acceleration in AI infrastructure. OpenAI previewed GPT-5 multimodal agents with significantly faster reasoning, and Anthropic released Claude 4, which led many independent code and reasoning benchmarks. The major cloud providers announced around 15 new GPU clusters, equivalent to more than 500,000 H100-class chips, and also signed long-dated power contracts that highlight potential energy constraints by 2027. Adoption is broadening, with AI pilot projects among large companies up about 40 percent year-on-year, although AI now accounting for around 20 percent of IT capex has increased questions about long-term returns on this investment.

Private Credit — Cracks but Not Crisis

Private credit assets under management are now close to $2 trillion, and Q1 showed the first broad signs of stress. Delinquency rates moved to about 4.2 percent (compared with a 2025 average of 1.8 percent), most notably in mid-market cyclical businesses. Spreads widened to around LIBOR plus 525 basis points, refinancing volumes fell by roughly 25 percent, and two large funds (each around $5 billion) gated redemptions due to illiquidity.

There are clear echoes of 2007 subprime and mortgage-backed securities — in the form of higher leverage, less transparent valuation and complex sponsor structures. However, most observers do not see the same systemic risk. Average leverage is closer to 6× EBITDA, not the 20–30× embedded in some securitisations, banks hold about 5 percent of the exposure compared with roughly 30 percent pre-2008, and regulators require regular stress testing.

Aspect	2007 Subprime & MBS	2026 Private Credit
Leverage	20–30×, securitised	~6×, direct loans
Transparency	Low, rating agency failures	Moderate, mark-to-model
Bank exposure	High, ~30%	Lower, ~5%
Tail risk	Housing market collapse	Specific sponsor LBOs
Market view	Systemic catastrophe	Cyclical stress

Back at Home — Tax Policy Shifts

In Australia, tax policy has been back in the headlines, particularly for investors with property-heavy portfolios.

• The government is considering changes to the capital gains tax discount on investment properties. The current 50 percent discount for assets held more than 12 months has been flagged as a potential target, with discussion around a lower discount rate for future investment property gains.
• Division 296, which adds an extra 15 percent tax on earnings related to superannuation balances above $3 million, has passed both the House and the Senate and is now being drafted into legislation, with a proposed start date of 1 July 2026. This is already encouraging some higher-balance investors to rebalance and diversify.
• There is also renewed debate about negative gearing, including discussion of limiting interest deductibility beyond a second investment property. Although not yet legislated, any move in this direction would change the after-tax economics of heavily leveraged property strategies.

These potential changes, combined with higher interest rates and persistent inflation, call for caution on major moves until after the May budget when legislative details clarify. Property-focused investors should limit new leverage, diversify into listed real estate and equities, and stress-test after-tax returns across CGT and negative gearing scenarios in the meantime.

That said, the case for longer-term property appreciation remains intact given persistent supply constraints, ongoing construction bottlenecks, limited new dwelling approvals, and strong underlying demand from population growth and housing shortages. Basic supply-demand dynamics continue to support price growth, even if tax treatment evolves.

Portfolio Implications

For Australian investors, Q1 underlines the value of balance and diversification. AI-driven growth is offsetting some geopolitical risk, higher bond yields are improving income and forward returns from defensive assets, and private credit is showing early cycle stress that needs monitoring but does not yet look systemic. At the same time, yen carry unwind dynamics and Japan's large US Treasury holdings add another source of volatility in global rates.

A diversified mix across regions, sectors and asset classes, combined with disciplined rebalancing into weakness, remains the most effective way to navigate this environment. The near-term focus will be on the April RBA meeting after Q1 CPI, the March and June Fed decisions, the evolution of the Middle East conflict, and the detail of domestic tax changes.