Global equity markets remain volatile, with sentiment being whipsawed by hopes of successful trade negotiations balanced against ongoing erratic statements from the Trump administration.
A renewed attack on Fed Chairman Powell from President Trump was the latest sound bite to roil markets. Trump’s attack saw markets dip sharply. However, it was closely followed by comments from US Treasury Secretary Scott Bessent at an investor conference, indicating that he expects the trade war with China to de-escalate and that he believes a deal can be reached. Trump followed with comments that “we never sought to fire Powell” and that a China trade deal was likely. This latest round of rapid-fire backtracking followed another spike in US Treasury yields.
Against this ongoing policy and asset market volatility, one seemingly clear trend is emerging. US assets are underperforming, while ex-US assets (including Australian assets) are proving more resilient.
Australian equities are now back to April 2 (Liberation Day) levels, while US equities remain 7% lower and are down 14% from their February highs (as at 23 April). We retain our neutral call on domestic equities, versus our underweight position on global equities.
The Australian dollar has climbed back to be a cent higher than pre-April 2 levels, while the US$ basket index (DXY) has fallen 5% since April 2 and 10% from its January peak. Australian 10-year bond yields are 16bp lower than pre-April 2, while US 10-year yields are 21bp higher.
Whether the trend of US asset underperformance can be reversed likely depends on how long the current policy misadventure is sustained. However, some US “brand” damage is likely permanent, particularly for US treasuries and the US dollar.
Credit markets remain orderly
On a slightly different tack, credit markets are proving to be relatively orderly despite the policy volatility. While credit spreads have widened, spreads are back down off their highs and remain well below previous periods of significant market stress. This provides hope that the US economy can respond to a more constructive monetary and fiscal policy backdrop in coming months, assuming the tariff mayhem stabilises at some point soon.
Waiting for the Economic Fallout: Soft Versus Hard Data
The US economy went into Trump’s tariff war in relatively robust shape. While soft data indicators such as consumer and business confidence have been weakening in recent months, the hard data, such as the key labour market indicators and consumer spending, has been relatively resilient.
We expect the dichotomy between hard and soft data to become even more marked over the next few weeks. The closely followed ISM Business surveys for the manufacturing and services sectors are due for release on May 1 and May 5 respectively.
We have concerns that a marked deterioration in business survey data has the potential to unnerve markets in the near-term.
Against an expected sharp decline in survey data, the hard data emanating from the April payrolls due on May 2, as well as the weekly jobless claims data (pending at the time of writing) will be closely watched. So far, the US labour market is holding up. We see a slowdown as inevitable, but it may take some time to play out, while the magnitude of the slowdown is still highly uncertain. Our base case is a moderate rise in unemployment over the rest of the year, not a collapse in labour demand.
Inflation spike but not stagflation
The market is also waiting for evidence of the inflation impact from tariffs. We are unlikely to see a genuine impact until the May CPI release, which is not due until June 11.
The magnitude of the CPI increase is hard to estimate, particularly given the tariff impost remains a moving feast. However, a 2% jump seems close to consensus. Tariff hikes are a negative supply shock, reducing demand and raising prices for both consumers and producers. While this is a negative for the US economy, our view is that the price hike will not carry over into a fresh bout of sustained inflation.
While we assign a relatively low probability to a sustained stagflationary outcome, it will probably feel that way for a few months, as tariffs boost a range of prices to a higher level. Importantly, long-term inflation expectations implied by bond yields have remained well anchored, even as short-term inflation expectations spike.
Given the uncertainty around both the growth and inflation outlook, we expect that the Fed won’t move to cut interest rates until its June 18 meeting, despite Trump’s agitations for an immediate rate cut (the Fed also meets on May 7).
The Art of the Deal. Hardball Turning Softball?
As discussed, comments from the Trump administration on trade negotiations continue to whipsaw markets, with the administration buoying hopes for some sort of partial compromise over the last week.
From our perspective, logic has always suggested at least a partial trade deal between the US and China will get done. The huge current bilateral tariffs would impose significant business and consumer pain and years of costly adjustments on both sides. This has been acknowledged by the US administration in the past week.
While the US-China rivalry is structural, there is a strong tactical incentive to agree on a partial deal rather than retain punitive tariffs, which essentially amount to a bilateral trade embargo.
Good but not great
While a deal will almost certainly be done, it is still uncertain as to how long current elevated tariff sanctions remain in place, and where the long-term tariff level lands. Recent media talk of a 50-65% “compromise” is still not a great outcome in our view
US /global equities face a game of cat and mouse between a likely deterioration in the growth and inflation backdrop, versus news of “breakthroughs” on trade. It is difficult to gauge which narrative will gain the upper hand in the near term.
Markets Looking for a Dose of the Good Stuff
Investors will also be looking to more growth friendly aspects of the Trump agenda over the second half of the year. The most contentious and restrictive elements of the Trump agenda have already been announced - i.e. tariffs and to a lesser extent attempts at reducing the size of Federal government (DOGE).
More constructive supply-side initiatives still lie ahead. The administration and the Republican controlled Congress have a strong incentive to boost the economy in the lead-up to the November 2026 midterm elections.
In terms of fiscal policy, we expect the “live” 2025 omnibus reconciliation bill to contain an increase in the debt ceiling, a full extension of the 2017 TCJA cuts, and probably a cut in the corporate tax rate from 21% to 15% for domestic production. A restoration of full expensing of R&D and equipment purchases for domestic production is also probable. Positive miscellaneous de-regulation announcements for sectors such as banking/financials are also likely.
This does not amount to a huge prospective stimulus. The US government is likely to continue to be hamstrung by the bond market, but the market will likely see these moves as an incremental positive.
We still think a full-blown recession can be avoided but risks are very elevated, versus a “normal” cycle and versus the backdrop of just a few weeks ago.
Brand damage?
There is a medium-term risk that US stocks may no longer be able to command forward P/E ratios which are, on average, almost 40% higher than in the rest of the world. The US dollar could also fall further from a 40-year peak in real terms reached at the start of the year, while US Treasury yields may need to maintain an elevated term premium for Washington to keep borrowing money.
None of this is to deny the underlying dynamism of the US economy and the exceptional quality of shares within the US stock-market. However, Trump has created some significant near-term headwinds for the US economy and US assets, despite the potential for recent trade war fears to ease.
We feel the likely near-term deterioration in US economic performance warrants a more cautious stance on US equities and a broader diversification into non-US assets - including Australia. We retain our neutral call on domestic equities versus our underweight position on global equities, and retain a preference for domestic fixed interest and credit versus global.
Australia does appear to be in a better economic position. The April 30 quarterly CPI should clear a path for a 25bp RBA rate cut on May 20.
Australia’s point of vulnerability near-term may be the commodity cycle. So far, the commodity price downswing has been relatively orderly, even though resources have sold off significantly (ex-gold).
Fresh China stimulus is likely, although there are no signs of an emergency big bang stimulus at this stage. Nevertheless, China will seek to support its growth targets, which should cushion the commodity price cycle but is unlikely to swing it back into a sustained uptrend.
Written by
David Cassidy, Head of Investment Strategy
David is one of Australia’s leading investment strategists.
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