Economic Update

In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:

• Tensions ease in the Middle East post US bombing run, Israel and Iran truce.
• The US Federal Reserve held its interest rate ‘on hold’ citing tariff inflation risk, ECB cut 0.25%.
• Australian economy softening and expecting further RBA interest rate cuts
• US equities close June at all-time highs, markets in general looking through the short-term noise

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

At the end of June 2024, the S&P 500 had completed a stellar year with a gain of over 20%, while the ASX 200 recorded a solid gain of around 10% over that same period.

In spite of the chaos caused by Trump’s policies, and the ongoing conflicts in the Middle East, these two equity indexes did surprising well – again – in the year to June 30 2025. The ASX 200 rose 10.0% in FY25 and the S&P 500 rose 13.6%.

The reciprocal tariff policy announcement by US President Trump on April 2nd 2025, for the so-called ‘Liberation Day’, caused a sharp fall in the S&P 500 of 18%. The recovery since that fall is the fastest on record for a decline of that order of magnitude.

A year ago, central banks were only just getting started on cutting interest rates as the inflation problem seemed to have been close to being beaten. Now, many central banks are close to having brought interest rates down to near neutral levels. Interestingly, the US and Australian central banks are not yet among that
group.

The reason stated by the US Federal Reserve for not having cut further is ‘the unknown extent of the possible increase in inflation caused by Trump’s tariff policies’. There is yet no material sign of tariff-induced inflation in the US but many expect a one-off lift in inflation, driven by tariffs of around 1%.

Given that US Consumer Price Index (CPI) inflation-less-shelter has been running at around 1.5%, and shelter inflation (a third of the index) has been falling steadily, there is some optimism that US inflation might struggle to get above 3% even with tariffs (unless Trump revisits his trade-war policies). And then inflation should
subside back to 2% as the imposition of tariffs should only cause a one-off increase in prices.

Trump has been berating Federal Reserve (Fed) chair, Jerome Powell, for being ‘too late’ to cut rates. Trump has threatened Powell’s position and has used insulting language against the man. Despite this, Powell has been calm and steadfast in his management of monetary policy.

The US economy, in terms of growth and jobs, is reasonably strong and so interest rate cuts are not necessarily urgent – but some slightly softer economic data, and the apparent containing of inflation, creates the opportunity for two or three more interest rate cuts this year.

Market probabilities for the next interest rate cut were firmly for the September meeting. However, three members of the Fed’s Open Markets Committee came out in favour of a July interest rate cut during the last weeks of June. The probability of a July interest rate cut remains low at circa 20%.

The RBA is expected to cut its interest rate in July and again (maybe more than once) over the rest of the year. Australia’s GDP growth rate at 0.2% for the March quarter was unexpectedly low despite apparent resilience in the labour market.

A significant portion of new jobs in the last financial year were in the National Disability Insurance Scheme (NDIS) programme. While the majority of these jobs are possibly very useful additions to our health care initiatives, they are funded by the taxpayer and so do not reflect the strength of the economy. Moreover, 10 of the last 12 reported monthly unemployment rates were 4.1% (the other two were 3.9% and 4.0%); an unusually stable set of data. The results are based on a small sample of around 26,000 households which is scaled up to represent a population of nearly 11 million households! We would have expected much more sample variation from month to month, as we usually observe.

We see no alarming signals in the broad macro data for Australia and the US. However, there are many possible sources of volatility in equity markets in the year ahead.

Trump’s retaliation tariffs were announced on April 2nd but were put on hold for 90 days – to July 9th – but only a few seem to think that the tariff increases won’t further be delayed – or even abandoned.

The average tariff before Trump’s ‘Liberation Day’ tariff policy announcement was about 3% and now it is closer to 15%. Somebody has to pay for it. Tariff is only another name for tax.

Exporters might try to absorb some of the costs before they export. That doesn’t seem to be prevalent. Correspondingly the importer in the US can try to absorb the cost but that too is difficult. Marelli, a large supplier of auto parts in the US that imports parts for Nissan and Jeep amongst others, filed for Chapter 11 bankruptcy protection as it found it couldn’t pass on the tariffs and it could not viably absorb their costs. Others will surely follow.

The third agent to wear the costs is the US consumer. We haven’t seen any material impact on consumer price indexes as many companies built up substantial inventories before the tariffs came in and are only now starting to pass on the additional cost. Some say the US might still have one to two months inventory at hand. Nike just reported earnings and announced that prices will have to go up shortly; footwear is expected to rise in price by 8% to 15%.

Since lots of goods are not imported, or are imported from low-tariff countries, experts reportedly are estimating the increase in the CPI to be of the order of 1% p.a. If, however, Trump starts bringing back higher tariffs, the US economy is likely to be a casualty.

Tariffs, to date at least, are not bringing in anything like the tax revenue Trump had foreshadowed. Moreover, most if not all that revenue is coming from US consumers and businesses. It is largely a redistribution of tax revenue for the government and tariffs will almost certainly reduce consumption due to the price increases.

China redirected much of its exports to countries other than the US during Trump’s first term as President and is seemingly starting to do it again. And China is now switching to importing beef, soya beans and oil (amongst many other goods) from other countries. The US could become increasingly isolated, if it is not careful.

There is much more to these trade deals than tariffs. There is no mainstream economic support for tariffs to redress trade balances. Indeed, trade imbalances are to be expected and welcomed in many cases.

One contentious point for the US-China relationship involves the export of certain rare earth minerals to the US. China has a near monopoly on the production of special magnets (and other goods) from rare earths that are essential in the manufacture of Electric Vehicles, rockets (commercial and military), drones and other high-tech products.

The US reportedly thought that it had gained access to China’s rare earths through the Geneva talks held between the two parties in May, but the extensive text of the agreement only devoted one sentence to non-tariff trade barriers – and there was no mention of rare earths.

The London talks between China and the US, held in June, were then set up to resolve this issue but failed again. Rare earths were mentioned but sources reported that the agreement is only for six months and only covers commercial – and not military – uses. The can has again been kicked down the road, this time until the end of the year.

Ford reported several of its auto plants in the US were on idle as they awaited a supply of rare earth products. China is in the box seat with this and it is big enough to see this confrontation through.

Almost out of left field, Israel attacked Iran over its nuclear build-up. It does not have the fire power to resolve the issue on its own but that didn’t stop Israel starting a renewed, heightened conflict.

Trump went to the election last year on a non-aggression platform – as he did in in his first term. The US was in negotiations with Iran over uranium enrichment. After the Israeli rocket attack, Trump said he might do something over the next two weeks. It only took him a day or two.

The US sent B-2 stealth bombers and submarines to fire on Iran’s three main nuclear facilities that happen to lie in a straight line south between Tehran and Qatar on the Persian Gulf.

The US reported that all three facilities were destroyed without casualties and without serious damage to property other than that associated with the facilities. Perfect! And a cease-fire between Israel and Iran was ‘on the cards’ in the next 24 hours, so Trump said. That’s why Wall Street rallied hard that night.

CNBC reported that there was a long line of trucks outside the facility containing the enriched uranium over the weekend before the bombing. It was being speculated that the trucks were there to move the uranium to another location!

Trump called the raid something like the ‘most decisive raid in history’. An expert came on TV and said all the enriched uranium could have been placed in the boots of 12 standard cars.

Just to save face, Iran attacked the major Middle East, US base in Qatar. To make sure everything was fine, Iran gave prior warnings to Qatar and the US. Iran fired 14 missiles; 13 were intercepted and the other missed the target completely. Everyone was a winner!

Recall, Trump did ‘big trade deals’ with Qatar and Saudi Arabia only weeks ago. It is hard not to think there was collusion over orchestrating a face-saving resolution to the conflict and to take attention away from the failed tariff deals.

Other reports questioned whether the US bombs could have struck 300 feet [say 100m] below the surface [under a mountain?] to reach the facilities. We don’t know what the truth is but we are thinking the strike wasn’t as successful as Trump announced – but it might have been enough to make the Iranians seriously consider their options for continuing to engage in this current conflict.

The collective wisdom of experts we have seen is that Iran’s nuclear program has been set back months rather than years. But importantly, Iran now knows that stealth bombers can turn up when they are least expected and that and they can carry lots of very big bombs [up to 30,000 pounds each!]. And there is now proof that Trump is prepared to push the button.

As the dust settles on the upheaval Trump has caused to trade, immigration, and efficiency (through the failed DOGE project run by Elon Musk) we are more optimistic about a less volatile future for Wall Street in there nearer term at least. The S&P 500 finished June with a new all-time high. Recent earnings reports have been stronger than expected and the future of Artificial Intelligence (AI) seems far more secure than some considered earlier in the year.

On the fiscal front, Trump has been facing a multitude of problems in trying to get his ‘Big Beautiful Bill’ through Congress. It is now passing through the Senate but it has to go back to the House of Representatives after substantial changes being made, and agreed to, by the Senate. Even Republicans were demanding changes! Two are voting against the Bill and six were reportedly undecided.

The Bill, if it goes through, is likely to add just over $3 trn to the current $36 trn government debt. The bill includes tax breaks and a substantial lifting of the debt ceiling. The logic behind the bill is that it will stimulate the economy and that growth will improve government revenue to offset the tax breaks. Musk launched a scathing attack on the Bill and has vowed to back candidates against those Republicans that vote for the Bill.

On other matters that many think are likely to guide the future of the global economy, the advent of DeepSeek – a China ‘alternative’ to ChatGPT and other AI projects – earlier in the year caused many to think it might be the end for Nvidia and other big US technology firms. It wasn’t, and it looks unlikely to be. Nvidia reported well in June and many of the mega tech companies are promising to invest hundreds of billions of dollars in the years to come.

It is important for investors to appreciate what AI can currently do and what more there is to do. Without that, the fear of losing jobs to AI is not rational.
At this point in time, AI is good at collecting information and summarising it. But it still makes lots of mistakes and needs human oversight to ‘train’ the models.

What AI cannot do at this point in time is reason or generalise. For example, it cannot answer the question, ‘What strategy should we follow for success in a given business’. Moving to the ‘super AI’ that will bridge this gap is what is consuming the top tech firms. Not only is the solution likely to be a long way off – it might never be achieved. Meta has reportedly offered sign-on bonuses of $100m each in poaching up to 10 AI experts.

To reason with facts and alternatives requires ‘weights’ to be applied to consolidate alternatives. That’s what human brains can do to differing extents. AI cannot yet do it at all.

Repetitive, low-level jobs are already at risk. True leaders in thought and business are very safe at the moment – and maybe for our lifetimes.

The outlook for equity markets for the coming period remains positive supported by continued growth and utility of AI and modest aggregate earnings growth generally however, at current elevated valuations they remain vulnerable to macroeconomic (e.g. detrimental tariff policy changes) and/or geopolitical shocks.

US bond yields have stabilised at levels comfortably below the ‘trigger points’ of 4.5% for the 10-year and 5.0% for the 30-year that caused equity market volatility in April and May.

Australian economic conditions are not great but will probably be boosted by multiple interest rate cuts by the RBA in the remainder of 2025. The ASX 200 finished the year to 30 June only a fraction (less than 0.5%) off its all-time high.

Asset Classes

Australian Equities 

The ASX 200 made moderate gains in June (+1.3%) but gained +10.0% over the year to 30 June. If dividends were reinvested, the total return for the year (without franking credits) was 13.8%.

The Energy sector (+9.0%) and Financials (+4.3%) were the best performers for capital gains in June. Over the year to 30 June, Telcos (+36.7%), Financials (+29.4%), Industrials (26.2%), IT (+24.2%) and Consumer Discretionary (20.8%) were the stand-out sectors in terms of total returns. Health (-4.6%) and Materials (-2.3%) were the only sectors to go backwards over that period.

Our analysis of broker-based forecasts of company earnings for the coming year varies but in general are pointing to a positive outcome, providing we get no big surprises.

International Equities 

The S&P 500 finished June very strongly – up +5.0% – and surpassed its all-time high on the last day of the month. For the year to 30 June, the S&P 500 gained 13.6%.

Of the major indexes we follow, the Nikkei gained the most over June at +6.6%. None of these indexes went backwards except for the DAX at -0.4% and the FTSE at -0.1%. Emerging Markets gain was +4.5%.

For the year to 30 June, the DAX gained +31.1%, the Shanghai Composite +16.1% and the FTSE 7.8%. Emerging Markets gained +10.6%. The Nikkei was the worst performer of the indexes we follow but it still grew by +2.3%. The World index grew by +14.7%.

With the US economy potentially going into expansionary territory due to the ‘Big Beautiful Bill’, another positive year might be expected. However, if the year to 30 June was any guide, good returns are usually not gained in a straight line. Volatility has not gone away but it has receded from its recent highs.

Bonds and Interest Rates

The Fed continues to resist Trump’s calls to cut interest rates but there is pressure coming from within for the Fed to cut in July. Two or three cuts are expected by the market in the rest of this calendar year.

The RBA is widely expected to cut its overnight cash rate (OCR) again in July. It appears to be on a rate cutting cycle taking this interest rate to around 3% by the end of the year – or lower!

The Bank of Japan was ‘on hold’ in June, as was the Bank of England. The Swiss National Bank cut its interest rate to 0.0%.

The big question facing policy and lawmakers in the US is what will happen to longer term rates. In the Senate hearing, a Republican senator berated Powell for costing the US economy $400bn this year by not cutting interest rates – due to the interest payments on debt.

The senator showed a complete lack of understanding of how monetary policy works. The Fed only has an impact on overnight rates and limited impact on yields one to two years out. It is possible, and has often happened, that an interest rate cut by the Fed might mean an increase the 10-year and 30-year Government Bond yields! Longer-term yields are greatly affected by inflation and growth expectations, amongst other factors.

Other Assets 

Brent Crude oil (+5.8%) and West Texas Intermediate Crude oil (WTI) (+7.1%) prices were up in June. Over the year to 30 June, the losses were -21.8% and -20.1%.
The price of gold was flat (0.0%) in June while the price of copper (+6.0%) was up sharply again. Iron ore prices (-3.6%) were down.

The VIX ‘fear’ index is almost back to a near-normal level at 16.7 after peaking at 22.2 earlier in the month. The VIX peaked at 52.3 in the year to 30 June.

The Australian dollar (AUD) traded in a modest range over June but finished up by +1.8% on the month. Over the year to 30 June, our dollar was down by -1.1% against the US dollar.

Regional Review

Australia

Australia jobs data for the latest month provided mixed evidence of an economy that is ticking along. There were -2,500 jobs lost but +38,700 full-time positions were created; there was an offsetting -41,100 part-time jobs lost. The unemployment rate was steady at 4.1%.

The March quarter GDP data were released in June and largely disappointed. Quarterly growth was 0.2%, which was less than the 0.4% expected. The annual growth rate was 1.3%. Per capita growth returned to negative territory with readings of -0.2% for the quarter and -0.4% for the year. The brightest spot in the National Accounts was a rise in the household savings ratio to 5.2% from 3.9%. We consider a reading in the range of 5% to 7% to be ‘normal’. After some time of having a low savings ratio, households are now back to trying to build for a solid future.

The Westpac and NAB consumer and business sentiment indexes were largely unchanged and weak.

The monthly CPI inflation data were at the low end of the RBA target range at 2.1% (headline) and 2.6% (core).

China 

Inflation was again negative for the year at -0.1% but China is actively trying to stimulate its economy. The wild swings in US import tariffs have disrupted shipments in the March and June quarters to try to minimise aggregate tariff revenue. For example, in May, China’s exports to the world were up +4.8% but down to the US at -4.5%. Imports from the US were -18.0% but only down -3.4% from the rest of the world.

Industrial profits slumped -9.1% in the latest month. It will be at least some months before we will get data that can readily be interpreted.

China must redirect lost US demand to domestic demand and to new markets.

US

US jobs were up +139,000 when only +125,000 were expected. The unemployment rate was steady at 4.2%. Wage growth was 0.4% for the month and 3.9% for the year.

GDP growth for the March quarter was revised down to -0.5% from -0.2% as imports were rushed in to beat the imposition of new tariffs. The Atlanta Fed puts out ‘nowcasts’ ahead of the official GDP data. Its current estimate for June quarter growth is 2.9%. The OECD predicts growth for 2025 to be 1.6% and the same for 2026.

The respected University of Michigan consumer sentiment survey reported a bounce back to 60.5 from 52.2. The 1-year inflation expectations data came in at 5.1% which is well above the Fed’s estimate of 3.2% but down from its previous month’s reading at 6.6%. The US population at large is lowering its inflation expectations.

Retail sales were -0.9% for the month and +3.3% for the year. When adjusted for inflation the readings were -1.0% for the month and +0.9% for the year. There are nascent signs of a weakening consumer, but an interest rate cut is not urgent – just desirable.

Europe 

UK growth slumped to -0.3% and the unemployment rate rose to 4.6% from 4.5%. The minimum wage was increased by 6.7% in an attempt to play catch up on the ground lost over the last couple of years due to the cost-of-living crisis.

The European Central Bank (ECB cut its interest rate for the 8th time by 25 bps to 2.0%. Inflation was under control at 1.9%.
The Swiss National Bank cut its rate by 25 bps to 0.0%.

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.

In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:

• US and China agree a 90-day truce in their tariff war and settle at lower rates
• US Court finds Trump tariffs illegal
• Equity markets look through tariff uncertainty and post strong returns for the month
• Court finds Trump’s use of emergency power to set tariffs is illegal
• Australian jobs and inflation data solid

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

On the 12th of May US and Chinese delegations met in Switzerland and agreed to a 90-day truce in their trade tariff war. The agreement does not apply to all tariffs but was certainly sufficient to buoy global markets post the announcement. Neither economy is sufficiently strong enough to weather the effects of a protracted trade war with each other without inflicting self harm. Finding a negotiated way forward is in the interest of both parties but that is not a guarantee. We await the elapse of the 90-day truce to see how further negotiations unfold.

After about four months of Trump seemingly randomly assigning – and charging – tariffs on a bilateral basis, a US Court deemed that the Administration had acted illegally on the reciprocal tariffs. However, they did not overturn the 25% tariffs on steel, aluminium and autos. The next day, that Court put a stay on the decision for seven days – to June 5th – after an appeal. Trump then retaliated by threatening 50% on steel and aluminium.

The issue that Congress sets tariffs and not the president has been known since the beginning. However, Trump invoked ‘emergency powers’. The Court disagreed that the emergency existed in law.

The market had already factored in that the big tariffs would not come back in – if not the reason why.

Markets launched a new acronym following the months of negotiations: TACO [Trump Always Chickens Out]. Trump looked very uncomfortable when answering a question about TACO but he fired back that what he did was how one negotiates.

There have been some statements made that say that Trump might find an alternative method for putting punitive tariffs on imports. We will have to wait and see but we think the worst of the tariff-induced volatility might be behind us.

The US consumer has been bruised by all the tariff chaos. The US has two highly reputable consumer sentiment indexes constructed one each by the University of Michigan and the US Conference Board. Both plummeted from November 2024 readings until a few weeks ago. The University of Michigan index reached an all time low (except for June 2022 during the lockdowns) but, at the end of May, the Conference Board index surged back up to the normal range after the reciprocal tariffs were pushed back 90 days.

Many commentators were confused by the relatively strong consumer data and the confidence data. That anomaly is now rationalised as confusion about an unknown longer-term future and short-term strong jobs and wages.

Trump imposed so-called reciprocal tariffs on April 2nd and pushed them back 90 days on April 9th. Arguably, the trigger for the turnaround was a surge in longer term US Treasury yields – to above 4.5% for the 10-year and above 5% for the 30-year. The issue at stake is the US Treasury needing to roll over about a third of its huge debt in June 2025.

Secretary for the Treasury, Scott Bessent, appears to have neutralised rogue trade advisor, Peter Navarro, in delaying the reciprocal tariffs. Bessent was key in negotiating tariffs between China and the US down from 145% and 125% to a more reasonable 30% and 10%. The 30% figure includes a penalty for distribution of Fentanyl.

Trump turned his attention to the Middle East following the big tariff backdown. He claims some massive deals of hundreds of billions of dollars with each of Saudi Arabia and Qatar. It appears Qatar also gifted a $400m jet which will be used as Air Force One and then on Trump’s personal account. There have been strong suggestions that Trump is intermingling his personal interests with those of the state.

There is little detail about the nature of these deals other than buying from Boeing is a big part of them. Presumably, there is a very long lead time on some of these planes and who knows if the plans will come to fruition.

Elon Musk appears to have failed to achieve his DOGE efficiency targets and left the project at the end of May.

As a result of the tariff chaos and government efficiency misses those elements will not contribute much to bringing down the $36.2 trn government debt. A lot, therefore, rides on getting gains in GDP growth through tax cuts and AI. An eminent commentator, Prof Jeremy Siegel, thinks AI could lift average growth from 2% to 3% pa which would be huge. However, if AI makes gains through redundancies, the gains won’t necessarily benefit the economy to the extent that it might otherwise.
At the end of May, Trump’s ‘Big Beautiful Bill’ passed through the House. Most people up with the details seem to think it will add to debt. The Senate also needs to pass the Bill and many have said senators will demand lots of changes.

The US Federal Reserve (the Fed) kept rates on hold in May possibly because of the uncertainty over tariffs. Since that meeting key inflation measures, the Consumer Price Index (CPI) and Private Consumption Expenditure (PCE) came in lower than expected.

There are problems with measuring shelter price inflation and that component is about one third of the CPI index. The official CPI-less-shelter inflation rate came in at 1.4% which is well below the 2% target. Indeed, in all but four months since mid-2023 that measure has been under target.

The Fed-preferred PCE inflation read was 2.1% and 2.5% after volatile items are removed. We see some reasons for the Fed to cut at its next meeting.
However, the market has priced the probability of an interest rate cut on June 18th at only 2% and 23% by July 29th. The odds for no US interest rate cut by September are currently 28%. We think the odds for an interest rate cut anticipated by the market will be priced in as news about the court’s views on reciprocal tariffs become clearer.

US jobs data have continued to be strong but there are some nascent signs that layoffs are starting to increase – particularly in Michigan the historical home of the US auto industry.

At home in Australia, the general election brought about sweeping support for the Labor party. Both the Coalition and Greens leaders lost their seats. As a result, the Coalition split into two parties but some resolution now seems possible.

Labor’s policies are, in the main, not controversial and could ultimately be good for the nation. However, the proposed changes to taxation on super are contentious. The issue for most people is not that tax should be increased for big balances. It is that unrealised capital gains will be taxed at 30% above some threshold.

There are three major problems with that ruling. People with large assets such as property in their super funds may have to pay tax on any capital gains without the income to cover the CGT. Secondly, illiquid assets such as property are difficult to price and so there would likely be disputes over valuations. Thirdly, for realised capital gains outside of super, made over a period longer than 12 months, are taxed at half of the investors top marginal income tax rate – potentially a lower rate than income tax paid by people with lower incomes.

Interestingly, many or most politicians and public servants are on Defined Benefits’ pensions which, for technical reasons, are not included in the proposed new taxes. It seems possible that a senior public servant or government minister could have a substantial defined benefits pension and, say, just under $3 in a super fund and not have to pay the new taxes! We wait to see if this change will be introduced without amendment.

Our jobs data were also quite firm with 89,000 new jobs created in the latest month. The unemployment rate was steady at 4.1%. A ranking of all countries by the proportion of all people employed by the government put Australia at number one in the world. Hence, much of our jobs data looks good because the jobs are funded by the taxpayer and are not subject to market forces like private jobs!

With the policy chaos likely becoming more subdued in coming months and Australian data holding up, the ASX 200 and S&P 500 market indexes are getting back on track to have the strong year expected at the start of the year by many commentators – and the broker-based forecasts of company earnings we analyse on a daily basis. US Treasury yields have stabilised at near 4.5% p.a. for the 10-year Government Bonds and 5.0% for the 30-year Bonds.

Asset Classes

Australian Equities 

The ASX 200 had a very strong month gaining 3.8% as part of the recovery from the impact of Trump’s reciprocal tariffs. The index ended May only 1.4% off its all-time high and up 3.4% since 1 January.

The IT sector (+19.8%) and Energy sector (+8.6%) were the standouts. No sector had negative returns for May.

International Equities 

The S&P 500 finished May very strongly – up 6.2% but it is still nearly 4% off its all-time high and almost flat (+0.4%) since 1 January.
Of the major indexes we follow, the German DAX gained the most over May rising +6.7% and Japan’s Nikkei gained 5.3%. The Emerging Markets index gain was more modest but still quite strong at +2.9%.

Bonds and Interest Rates

The Fed continues to resist Trump’s calls to cut its interest rates. Indeed, Trump summoned Powell for a meeting at the end of May. Nevertheless, the Fed kept rates on hold at the May Federal Open Markets Committee (FOMC) meeting. Markets are expecting the next cut in September.

The RBA cut its Overnight Cash Rate (OCR) by 25 bps to 3.85% on May 20th and is expected to cut again in July with possibly two more cuts after that this year.
The Bank of Japan kept its interest rates on hold. It’s auction of 40-year Government Bonds (JGBs) did not go as expected, so long yields (interest rates) rose. The Bank cut its inflation forecasts for this year and next year. It also trimmed growth forecasts.

The Bank of England (BoE) cut its rate by 25 bps to 4.25% even though its quarterly economic growth rates came in at a solid 0.7% for the quarter.

There was some market instability in bond yields over the month – particularly in long-duration US Treasury yields. There is set to be a very large roll-over of Treasuries during June as the US treasury refinances a large amount of maturing bonds. Some more bond market volatility is, therefore, expected.

Other Assets 

Brent Crude oil (+1.2%) and West Texas Intermediate Crude oil (WTI) (+4.2%) prices were up in May.

The price of gold was down -0.7% in May while the price of copper (+4.7%) was up sharply again. Iron ore prices (-0.3%) were flat.

The VIX ‘fear’ index is almost back to a normal level at 18.6 after peaking at 24.8 earlier in the month.

The Australian dollar (AUD) traded in a wide range ($US0.6394 to $US0.6527) over May but finished up by only +0.3% on the month against the US dollar.

Regional Review

Australia

Australia jobs data for the latest month provided more evidence of an economy that is ticking along okay. The 89,000 new jobs in the month with 59,500 of those being full-time positions.

The unemployment rate was steady at 4.1% maintaining a range of 3.9% to 4.3% for the last 12 months.

Retail sales for the month were -0.1% and 3.8% for the year. When adjusted for inflation, sales were -0.3% and 1.4%.

The Wage Price Index rose 0.9% over the March quarter and 3.4% over the previous 12 months. While this rise is above that of inflation (2.4%), inflation-adjusted wages are down 6% from the 2020 peak and down 3% since Labour was elected in 2022.

China 

Inflation was negative for the year at -0.1% but China is actively trying to stimulate its economy. The wild swings in US import tariffs have disrupted shipments in the March quarter and to date in the June quarter to try to minimise aggregate tariff revenue.

US

US jobs (non-farm payrolls) were +177,000 in the latest month well ahead of the +133,000 expected with an unemployment rate steady at +4.2%. The wages growth rate was +3.8% for the year.

US CPI came in at 2.3% (headline) and 2.8% (core). CPI less shelter inflation was only 1.4%. PCE inflation was 2.1% (headline) and 2.5% (core).

The respected University of Michigan consumer sentiment survey reported another big drop – down to 50.8 from 52.2. The 1-year inflation expectations data came in at +7.3% which almost certainly cannot turn out to be accurate. Professor Siegel estimates that tariffs might add 1.5% (or at most 2%) to current inflation of 2.1%.

And that estimate was revealed before the court result on the legality of reciprocal tariffs.

The Conference Board index for consumer sentiment rose sharply from 85.7 to 98.0. The previous two months were 93.9 and 100.1. This release was the first to exclusively include survey data after the April 9th 90-day delay on US tariffs being introduced.

Europe 

UK growth beat expectations with a +0.7% gain for the quarter. Nigel Farage’s right-wing party did particularly well against both Labor and Conservative parties in local elections. It even won a seat in parliament in the Runcorn by-election.

Reuters reports the European Central Bank (ECB) is likely to cut its rate by 25 bps to 2.0% in its June 5th meeting and then skip in July.

Rest of the World 

Trump spent time in the Middle East with an entourage of government and tech CEOs. Few hard details were reported but the tone of the statements and media coverage was positive for Trump – apart from the news he is to be gifted a $400m plane by Qatar. The distinction between Trump’s public and private negotiations continues to be blurred.

Trump removed all sanctions on Syria.

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.

In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:

• Trump suspends reciprocal tariff policy above 10% hours after introduction
• Markets respond positively to tariff hiatus, but many companies suspend forward earnings guidance
• US consumer confidence falling sharply
• RBA looks set to cut rates in May

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

The global economy is highly dependent on the US economy. The current performance of the US economy is highly dependent on the policies of the incoming president – Donald Trump.

New presidents are often judged by what they achieve in their first 100 days. That window is now closed.

Trump campaigned on several initiatives. We think at least four were central to his dream to ’Make America Great Again.’ There is no doubt the US debt is unsustainable at $36 trillion. Neither Biden, nor Trump in his previous term, addressed the issue in a meaningful way. Action on debt is appropriate but is Trump misguided in his current strategy?

Trump promised to end the Russia-Ukraine war on ‘day one’. He was to stop immigration at the borders and deport large swathes of existing illegal, or ‘undocumented’, immigrants; there are reportedly well over 11 million of them in the US! He was also to impose import tariffs that he claimed would rapidly generate substantial revenue to reduce US debt. And he was to reduce government wastage and inefficiencies (using deregulation) to stimulate business growth and cut debt.
After 100 days there have been no noticeable improvements in the resolution of the Ukraine conflict. Trump did, however, berate the Ukrainian president, Zelenskyy, in the White House on live television. It was embarrassing to watch. No leader should be treated like that. We can only presume Trump was venting his frustrations at having made no progress on ‘stopping the war.’

It appears that some gains have been made in reducing the inflow of legal and illegal immigrants. Several attempts have been made to deport groups to Central America but some of these actions have fallen foul of the law. Various court orders were made to reverse some of the deportations. Indeed, at least three US citizens were incorrectly deported – at least two of whom were small children. The process is in chaos. Trump seems to be challenging the judicial demands more in the fashion of a dictator than an elected president. Trump did reverse his decision on student visa cancellations.

The tariff policy was destined to fail before it was implemented. We know of no respected economist who supports the policy as a mechanism for redressing trade deficits. The trade advisor to Trump, Peter Navarro, has been accused of fabricating academic support for his views.

Before Trump returned to the White House, the average import tariff in the US was 3%. After the so-called ‘reciprocal tariffs’ were announced, that average jumped to 27%. On delaying the introduction of the reciprocal tariffs, the average tariff fell to 23%. When China is excluded (with a 145% tariff), the average tariff is to be still massive at 18%.

The reciprocal tariffs are not as named. They are penalties to attempt to reduce trade deficits on goods on a bilateral basis. There is nothing wrong per se with trade deficits. Such deficits reflect investment wishes of the US exceeding savings. There are proper ways of addressing trade deficits; imposing tariffs is not one of them.
Importantly, the Smoot-Hawley tariff act of 1930 in the US most probably caused the Great Depression!

The situation got to boiling point as Trump has been accused of lying about the trade deals he claims he is doing. One report we saw said Trump claimed to be negotiating with China and talking to President Xi Jinping on the phone. China claims there have been no phone calls and no negotiations. Trump blustered under questioning by the media.

Navarro claimed that they could do 90 deals (with 90 countries) in 90 days. When asked why no deals had yet been announced, Trump said lots had been done. Indeed, he claims 200 have been done. Since Trump apparently has no trouble telling lies to the media there is no knowing how this will all end. However, Trump has apparently added a few more concessions here and there. He needs an exit plan.

At the time of writing the US Customs and Border Protection department claimed about $500 million had been collected in tariffs over the period of a few weeks but Trump claimed they would collect about $2 billion per day.

One particularly important retaliatory non-tariff response by China was the cessation of the granting of export licences for its reserves of several ‘heavy rare earth minerals’. China has a near monopoly on about six of them which are essential in the manufacture of EVs, fighter jets and drones, etc. The US has been operating on a just-in-time inventory of them so the US could soon suffer serious consequences. China has also stopped importing beef from the US. Instead, it has reverted to importing beef from Australia.

Elon Musk was appointed as a non-elected official in charge of DOGE (Department of Government Efficiency). Many claims have been made about savings, but few are backed up with receipts. Trump claimed there will be $2 trillion of savings. So far only $160 billion had been recorded on their web site and 60% of that sum was not itemised.

Several pre-emptive moves have been made to alleviate the impact of the tariffs. China exports grew 12.4% in March against an expected 4.4%. US orders for autos in the US soared 9.2% in March compared to 0.9% in February. People wisely bought ahead of time to reduce tariff payments.

From our reading, the US Secretary of the Treasury, Scott Bessent, appears to be changing his stance. He was very pro-Trump in the beginning, but he appears to have been the architect behind delaying the reciprocal tariffs by 90 days – conducting the meeting on the topic when Navarro was known to be otherwise engaged.
Equity markets have been recovering from the initial impact of the tariff saga. More than half of the loss from the recent high in the S&P 500 has been regained. The VIX ‘fear index’ has retraced from the recent high in April of 52.3 to about 25 at the end of that month. Values in the range 12 to 15 are usually considered to reflect normal conditions.

Australians voted in the Federal election on May 3 and have returned the Labour government in a land slide win that has increased their majority in the House of Representatives. Our assessment is that the election outcome does not result in any material changes to the course of the Australian economy or financial markets in the near term.

Australian labour force data reflected an economy that is ticking along. A total of 32,200 jobs were created in March and the unemployment rate was 4.1%, an historically low rate. Retail sales adjusted for inflation grew 1.3% over the prior 12 months.

The RBA held interest rates ‘on hold’ in April but the chance of a rate cut or two in May is judged to be high by the RBA interest rate tracker tool on the ASX website.
It is never an option not to have an opinion about the investment future. Even just holding cash is an actively made decision.

We see more volatility in months to come but the medium term for the major asset classes does not appear to have yet been put materially off track. That said, the path of US economic policy and the many twists and turns we expect it to take will be a major source of volatility. This being the case, we may need to amend our views, but we do not consider it necessary at this juncture as we await further developments to the tariff policies. Despite the elevated inflationary risk resulting from these policies both the US Fed and the RBA look set to cut rates several more times this year as recession risk builds.

Asset Classes

Australian Equities 

After a wild ride in April, the ASX 200 finished up 3.6% on the month which was much stronger than most major indexes. In April, only the Energy sector (-7.7%) returned a capital loss on sharply falling oil prices.

The index is now 10.0% off the low for 2025 but still -5.0% from the high.

International Equities 

The S&P 500 finished April strongly with seven consecutive daily gains. However, it was still down -0.8% on the month and -5.3% on the year. Most of the other major indexes made modest gains or losses in April. The ASX 200 was the stand-out performer at +3.6%!

The March 2025 quarter reporting season in the US has produced some big earnings forecast beats, mainly in Financials and the ‘Mag 7’. Most companies were limited in their forward guidance given the uncertainty over the Trump tariff policies and the impacts that they may have.

Bonds and Interest Rates

The Fed has been in a public conflict with Trump. Trump keeps saying rates should be lower and he “can’t wait until he gets a new Fed chair.” Jerome Powell, the current Fed chairperson has been steadfast in his calm view that he is poised to react to any new situation.

Nobody really knows what will happen with tariffs and whether they would cause inflation. They will certainly increase prices, but will the change just be transitory? If long-term inflation does ensue, changing rates would not be the solution. It would be appropriate to reverse the cause and cut tariffs!

The 10-year US Treasury yield fell to 4.0% before the reciprocal tariff narrative took centre stage. This yield shot up to 4.5% and this rise caused consternation. A huge tranche of US Treasurys is set to mature in June and needs to be rolled over (refinanced). The last thing Trump, the Treasury or the Fed wants is higher yields for this big roll-over. It was the day that the 10-year US Government Bond yield hit 4.5% that the reciprocal tariffs got delayed by 90 days! There is some common sense in the governing bodies.

Since the delay, the 10-year yield has got back to under 4.2% and equity markets have stabilised. The US dollar is weaker.

The RBA kept interest rates on hold in April as was widely expected as a move then might have been seen to be political given the impending general election.

The market has all but priced in at least one RBA cut on May 20th with a reasonable probability of a double cut of 50 bps. We think it is quite possible the RBA will cut by 35 bps to restore the pre-emergency rates of simple multiples of 0.25%. 3.75% in May rather than 3.6% wouldn’t make a big difference to the economy. The official cash rate can always be cut again in June if the RBA wants. Cutting by 60 bps in May might be seen as destabilising.

Other Assets 

Brent Crude oil (-15.5%) and West Texas Intermediate crude oil (WTI) (-18.4%) prices were down sharply in April.

The price of gold continued its strong rally with a gain of +5.9% in April.

The price of copper (-2.4%) was down, as was the price of iron ore (-4.7%).

The VIX ‘fear’ index is still elevated at 24.7 but well down from its intra-month high of 52.3.

The Australian dollar (AUD) traded in a wide range ($US0.5975 to $US0.6437) over April finishing near its high ($US0.6402).

Regional Review

Australia

Australian jobs data for the latest month provided some evidence of an economy that is ticking along. The 32,200 new jobs in the month translates to a growth rate over the year of 2.2%. The full and part-time growth rates for the year are 1.6% and 3.3%. The big bulge in part-time growth rates above 6% last year have now dissipated.

The unemployment rate was 4.1% maintaining a range of 3.9% to 4.3% for the last 12 months.

Retail sales for the month were up 0.2% and 3.6% for the year. When adjusted for inflation, sales were up 0.1% and 1.3%, respectively.

China 

There were a few surprises in China macro data in April. GDP growth came in at 5.4% against an expected 5.1%. Exports were 12.4% against an expectation of 4.4% but imports missed at -4.3% against and expected -2.0%. We put these big discrepancies down to a reorganisation of trade flows to try to beat the new US tariffs that were to kick-in during April.

The 10% points outperformance of exports in March translates to about a month’s worth of exports. CNBC reported that about 25% of container ships from China to the US were cancelled for April.

Since US Treasury Secretary Scott Bessent is freely commenting that the tariffs with China are unsustainable, we expect some mollification of the current situation. Trump even signed an executive order to that effect on the last day of April.

US

US jobs were up +228,000 in the latest month with an unemployment rate of 4.2%. The wage rate was up 0.3% for the month or 3.8% for the year.

US CPI inflation came in at 2.8% from 3.1%. With shelter inflation at 4.0%, CPI-less-shelter inflation was well under target at 1.5%. There are well-known problems with the shelter inflation calculations. We deduce that inflation is under control when measured properly but the future of inflation is now uncertain. The Fed-preferred Private Consumption Expenditure (PCE) inflation measure was flat for the month in both headline and core but up 2.3% headline and 2.6% core on the year.

The respected University of Michigan consumer sentiment survey reported another big monthly drop in the index – down to 47.3 from 76.9 last November at the time of the presidential election. The 1-year inflation expectations data came in at 6.5% – the worst result since November 1981. The 5-year inflation expectations were 4.4%. Both inflation expectations are sharply above those of last November.

The Conference Board consumer confidence index also fell sharply – to 86.0 from 93.9 in the prior month and down from 112.8 in November 2024. The volatility/uncertainty created by Trump’s tariff policy has caused the US consumer to be less confident hence the decline in the confidence measure which is expected to feed into consumption data.

The preliminary GDP growth rate for the March quarter of 2025 was published on the last day of April. The prior Atlanta Fed forecast was -2.5% for the quarter (annualised). The official estimate was -0.3%. While this rate mayalarm some there are three sets of unusual circumstances to explain the big change from the 2.5% level reported for the December quarter of 2024.

There were several devastating hurricanes on the East Coast early in the March quarter; the wildfires in California around the northern region of Los Angeles were significantly larger and far more impactful than normally experienced. Finally, there is reasonable evidence that imports boomed in the March quarter to get in ahead of the tariffs that were scheduled to start on April 2nd.

The way GDP is calculated, imports detract from growth unless they are offset by inventories or investment in the same period. We expect this negative to be a one-off result, but we still expect growth to be lower in 2025 than 2024. Whether there is a recession, a slight recession or low growth is too hard to predict at this point in time given the fluidity of Trump’s policy changes. The latest Fed forecast is for trend GDP growth of 1.7% in 2025.

Europe 

The European Central Bank (ECB) cut its reserve interest rate by 0.25% points to 2.4%.

UK inflation dropped to 2.6% from 2.8%.

Rest of the World 

Egypt cut its official interest rate by 2.25% points to 25.5% while Turkey hiked its rate by 3.5% points to 46% to defend the value of its currency.

Japan’s inflation climbed to 3.6% for the headline rate and 3.2% for the core rate which strips out volatile items. Japan is still on course to raise its interest rate from its current 0.5% to end the year at 1.0%. After decades of weak or negative inflation, a reading of 3.6% is not yet a problem for them.

The Reserve Bank of India cut its rate by 0.25% points to 6.0%.

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.

In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:

• Trump policy changes continue to drive instability and uncertainty
• Trump’s global tariff policy has the potential to bring on economy sapping trade wars
• The US Federal Reserve keeps interest rates on hold as it awaits the outcome of tariffs on the economy
• Markets reflecting concerns that US tariffs could result in slower growth and consumption

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

It is nigh impossible to keep up with Trump’s claims and executive orders. Even if we compiled a detailed list, Trump changes his direction – sometimes within 24 hours – and judges have thrown out many of his attempts to change policy. Trump has already signed more than double the number of executive orders he did in his first term as president (Trump 1.0) during the first 100 days!

Trump’s strong supporter, and unelected official leading the Department of Government Efficiency (DOGE), Elon Musk, seems to be accountable only to Trump. He appears to try and close departments without reasoning, and he too gets some of his policies overturned by judges when his actions are challenged through the courts.

There has been a very strong pushback against Musk both within and outside the US. The share price of his flagship company, Tesla, has fallen from over $400 to nearly $250 since Trumps inauguration on 20 January. Sales of Tesla cars have fallen by 30% to 40% in a number of countries, including the US, and by a reported 70% in Germany. To make matters worse Tesla was forced to recall nearly every cyber truck to fix a defect. And there are reports of the vandalising of Tesla vehicles in the street and in car dealerships as a protest. With the apparent chaotic approach of this Trump administration there are very few parallels with that of the former Biden presidency.

Here in Australia, we have had a Federal Budget and Prime Minister Albanese called an election for May 3rd. The importance of this has been overwhelmed by events in the US this week.

We are uniquely in the position of being able to count on Dr Janet Yellen’s expertise. We recently heard her speak on this topic to a closed room. She spent a five-year term as Governor of the US Federal Reserve – the equivalent of the Governor of the Reserve Bank of Australia (RBA) – and a four-year term as Secretary to the US Treasury. She held several other public offices, including leading the White House Council of Economic Advisers – and she has been a long-serving Professor of Economics at the prestigious University of California – Berkeley (since 1980).

There is no one more qualified to speak on these issues from both an academic and a public office perspective.

One of Trump’s main stated reasons for introducing tariffs is to redress the US trade deficit. Yellen says they won’t; exchange rates adjust to accommodate the tariffs. Historical evidence supports this view.

Trump seems to talk in terms of import tariffs being paid by the exporting country. Yellen says the US consumer will bear the brunt and consume less as a result. We agree. Even Trump urged current Fed Chair, Powell, to cut rates now to ease the burden on the consumer.

Yellen thinks tariffs might only cause a blip in inflation unless they seep into the formation of inflation expectations. The latest University of Michigan estimate of long-term inflation expectations is 4.1% which is the highest since 1993!

Some countries have already responded with new retaliatory tariffs for US exports. This tariff war could end badly. But Trump has often said – and we have written in past Updates – that Trump wants to use tariffs as a bargaining chip to get his way on other things – such as concessions on the location of industry, curbing drug importation and immigration. He said at the end of March – just before his April 2nd reciprocal tariffs are due to kick in – ‘there’s some flexibility on reciprocal tariffs’.

We, like Fed Chair Powell, think it is wise to wait for policies to be firmed up before we finalise our opinions. But the US consumer is confused (and why wouldn’t they be?). Both the well-regarded University of Michigan and Conference Board consumer confidence indexes have plummeted in the last three months.

On top of falling confidence, retail sales in the US are weakening yet, unlike in Australia, wage inflation is outpacing price inflation, so people are getting better off but not spending! The danger of stagflation is mounting as there are some signs of inflation rising a fraction – whether it be from tariffs or not.

At the time of writing, Trump has imposed or increased tariffs on Canada, Mexico and China. He has imposed tariffs on all aluminium and steel imported into the US. At the end of March, he imposed a 25% tariff on all (finished) autos but, importantly not on auto components.

Had tariffs been imposed on car parts, the US auto export industry would have been hurt. A significant proportion of the components of autos built in the US are imported. And, according to Yellen, autos cross the Mexico border six to eight times as autos pass through the production process. Will foreign auto makers like BMW start to export autos as components with final assembly in the US? We don’t know but quite likely the world might respond to Trump’s tariffs.

One point Yellen stressed was that all these new trade policies could be reversed in less than four years when a new president is elected. At the moment, US presidents can only serve two four-year terms in office. However, there is ongoing speculation that Trump will try to challenge this rule.

While all these political disruptions were taking place, some hard macroeconomic data were posted. Since data are published in hindsight and with a lag, there has not yet been much opportunity for the data to reflect Trump’s economic impact.

US inflation data has been ‘sticky’ in the sense that inflation is only slowly returning to the Fed’s 2% target. We have argued for some time, most of this stickiness is a statistical artifact created by the way in which shelter (or rent) inflation is calculated. The problem has been acknowledged by the Fed but they have not acted to correct the situation.

Our calculations based on official US data reveal that Consumer Price Index (CPI) inflation less shelter inflation has already returned to the 2% target. Moreover, there are sound economic reasons to believe further rate cuts could flow through to falls in mortgage rates and make room for landlords to cut rents. However, in the last couple of months there has been some signs of possible increases in CPI inflation.

US jobs data have continued to be reasonably strong both in terms of the number of jobs created and in the unemployment rate. The current unemployment rate is 4.1%, up from 4.0%, but low by historical standards. Of course, the nature of work has been evolving in recent times and it is not clear how appropriate it is to compare current unemployment rates with those of 5 to 10 years, or more, ago.

The US Fed is comprised of 12 regional Federal Reserve Banks. One such bank is the Atlanta Fed which provides updates on economic statistics before the official data are released. After strong GDP growth data in 2024, the Atlanta Fed came up with an early estimate of March quarter 2025 growth of 2.3% which was reasonably similar to the official 2024 growth. However, subsequent updates have turned sharply negative. The latest estimate is 1.5% which, if confirmed at the end of April, when the official data are released, could cause the Fed to quickly change tac with monetary policy.

The current year started with major hurricanes on the east coast of the US and an unusually destructive wildfire in California. They could have impacted the March quarter 2025 data. Furthermore, the Atlanta Fed’s early estimates often show some instability over the course of data collection and updating.

Until recently, most commentators were siding with the notion of a soft landing in the US. That is, the Fed was binging inflation down to target without causing a recession. In late March, the calls for a recession increased markedly under the barrage of Trump’s executive orders.

At the latest Fed meeting on March 19th, the Fed kept interest rates on hold. Fed Chair, Jerome Powell, argued that it was in a good position to act appropriately as new data are posted. The Fed’s ‘dot plots’ showed the individual views of members of the committee on where interest rates might be heading.

The latest dot-plot has two more interest rate cuts pencilled in for the rest of 2025. Market pricing gives a reasonable chance of two or three more cuts this year.
Importantly, Powell conducted himself with calm and self-assuredness under questions from the media after the recent interest rate decision. He is not a man who fears Trump. When asked whether his job was in jeopardy, Powell calmly replied, ‘I answered that question in previous meetings. Nothing has changed’. The president has no power to dismiss the Fed chair and Powell is not a man to be bullied.

The Australian Federal Budget, delivered by Treasurer Jim Chalmers, on March 25th was ‘election-friendly’ but it didn’t announce any big policy changes. After seven successive quarters of negative per capita growth, the latest quarter’s growth was deemed to have been positive to the tune of +0.1%. That rate is very close to zero!

Australia faces a cost-of-living crisis far more than that in the US. Australian wages, after adjusting for price inflation, are over 6% below what they were at the start of 2020. Even if these so-called ‘real wages’ caught up with that 2020 level, there would still be five years of ‘lost’ wages to regain before Australia could get back to its previous position.

Chalmers did deliver some improvements in the budget: Tax, healthcare, childcare and other social conditions. Albanese announced on March 28th that there will be a general election on May 3rd. Let’s hope both parties come up with a more comprehensive plan for Australia’s future by then.

Immigration has been central to Australia’s growth and prosperity. But immigration flows must be co-ordinated to match the needs in the workforce and the supply of suitable housing. Probably because of the pandemic, immigration and housing got out of kilter causing big increases in home prices and rents. Energy prices have also become unsustainable, but for other reasons.

The government did introduce a stop-gap measure by way of a flat subsidy for electricity, but this subsidy will end this year. The way the Australian Bureau of Statistics (ABS) has calculated CPI inflation has artificially brought headline CPI inflation to within the RBA’s target band of 2% to 3%. When the subsidy ends, CPI inflation will most likely jump well above the target band. A long-run solution is needed.

Some of Australia’s macroeconomic data looks quite reasonable. The latest labour force survey indicated the unemployment rate was steady at 4.1% but 52,800 jobs were lost in February. We are not alarmed like some over the job losses because there was an unusually large jump up in the prior two months. ABS data can be volatile.

The unemployment rate might be a bit flattering for those comparing it with rates in years past. Reportedly, the NDIS has contributed a significant number of jobs – some from people previously doing similar work without pay for family and friends. We are not arguing the scheme is not worthwhile, but it should change the way economists view labour market data. These jobs are funded by the taxpayer and not market forces. They are essentially a form of fiscal stimulus.

As expected, the RBA did not change our official cash interest rate at its April 1st meeting. A cut at the following meeting – after the election – is a possibility as are a couple more later in the year.

Even with this optimistic view of monetary policy, we will end 2025 with an interest rate above the so-called neutral rate meaning that monetary policy will still be restrictive.

Any relief to mortgage holders would be most welcome. The 6% fall in real wages we wrote about would still be a major issue but households would have a greater disposable income after mortgage payments fall. Renters too might gain from rate cuts as landlords may pass on the cost savings to tenants.

Elsewhere, the Banks of China and Japan kept their interest rates on hold. Both the ECB and the Bank of Canada cut their respective interest rates by 0.25% points to 2.5% and 2.75%. It was Canada’s 7th successive cut. By comparison, our official cash interest rate stands at 4.1% which is well above the neutral rate of 2.5% to 3%.

China’s Purchasing Manager’s Index (PMI) climbed back above 50 to 50.2 from 49.1 when 49.9 had been expected. Its retail sales beat expectations with a growth of 4.0% but industrial production was just under expectations at 5.9%. China’s trade data disappointed, possibly due to the tariff war. We expect China to add further stimulus as needed.

It is a difficult time to give strong guidance for investors. We do think Trump’s blustering style has led many to fear conditions far worse than may eventually transpire. Those who look at recent stock market falls as indicative of bad times might be over-reacting. So far, the US and Australia’s main markets have suffered no more than a 10% correction and that follows two successive years of gains above 20% for the S&P 500. Corrections are the norm and not the exception in stock market behaviour. It is too soon to run for cover.

By next month we should have a much better view of what is happening with Trump’s policy agenda. We should also know by then what the respective main election promises are for Australia.

Asset Classes

Australian Equities 

The ASX 200 fell sharply ( 4.0%) again over March with only one sector, Materials, registering a gain (+1.5%) while nine sectors recorded losses and Utilities was flat.

The index finished March down 8.3% since the recent all-time high of 8,556. During this sell-off – which is about the same as that on the S&P 500 – the broker-based forecasts of the ASX 200 component-companies’ earnings forecasts remained strong and forecast capital gains above the historical average over the next 12 months.

International Equities 

Except for the Shanghai Composite and the Emerging Markets indexes, all the six major international indexes we follow were well down.

Unsurprisingly, the S&P 500 was the worst, affected by news of tariffs with a loss of 5.8%; Emerging Markets gained +1.7%. The Shanghai Composite also posted a gain but only +0.4%. The Nikkei and DAX were down with losses of 4.1% and 1.7%. The London FTSE index was down 2.6%.

Bonds and Interest Rates

The ECB and the Bank of Canada have been the most active of the central banks we follow in cutting interest rates in this cycle. The RBA has been the least active in cutting rates.

Market pricing suggests that there will be two or three more interest rate cuts this year by the Fed in bringing the Fed interest rate down to a range of 3.5% to 3.75% or 3.75% to 4.0%. Market pricing also suggests two or three cuts in the RBA official cash rate to 3.6% or 3.85%.

It is important to note that most mortgagees in the US hold 30-year fixed rate mortgages and so many locked in very low rates during the pandemic. In Australia, most mortgagees have variable rate loans or a mix of variable and fixed-rate loans for a period of only 1 – 3 years. Therefore, Australian homeowners were hit much harder than their US counterparts when rates were on the hiking cycle. It is fallacious to state that the RBA should be in less of a rush to cut rates because they did not take rates to the same level as the US Fed.

The Fed left interest rates on hold in March but there is an 14% chance of a cut priced in at the next meeting on May 7th but a 76% chance of one or two cuts by June 18th. The RBA has a 75% chance of an RBA interest rate cut by May. There is a 91% chance of three interest rate cuts by the RBA during the rest of the year.

Other Assets 

Brent Crude oil (+2.1%) and West Texas Intermediate Crude oil (WTI) (+2.3%) prices were up in March.

The price of gold was up +9.6% in March finishing the month at $US3,125

The price of copper (+4.9%) was up sharply again but iron ore prices ( 1.6%) were down. However, the price of iron ore held above $US100 / tonne

The VIX ‘fear’ index is still elevated at 22.3 but down from its intra-month high of 27.9.

The Australian dollar (AUD) traded in a wide range ($US0.6191 to $US0.6375) over March but finished up (+0.5%).

Regional Review

Australia

Australia will hold its general election on May 3rd. Polls suggest the election may be close between the two major parties but the prospects for the Greens, Teals and Independents is much harder to judge. Rather than comment on recent press releases and speeches, we will reserve our opinion until we have seen the full set of election promises.

The jobs data posted in March disappointed many commentators because 52,800 jobs were lost. However, we note that there were unusually large increases in the two previous months of 59,800 and 30,500. After allowing for the usual noise in these data and possible inaccuracies in seasonal adjustment procedures we think it is far too early to suggest an imminent problem in the labour market.

When we look over the last 12 months, we see that total employment grew by 1.9%, full-time jobs by 2.0% and part-time jobs by 1.6%. This is the first time in a year or two that the three measures were in alignment. Recently, part-time employment was growing by over an unsustainably large 6%.

The unemployment rate was steady at 4.1% but we have noted that a big increase in taxpayer funded NDIS jobs makes it harder to understand the new dynamics of the labour market.

GDP growth for 2024, was released in March. Growth was 0.6% for the quarter and 1.3% for the year. Per capita growth for the December quarter 2024 came in at 0.1% after seven consecutive negative readings. The household savings ratio improved to 3.8% from 3.6% in the previous quarter. We regard 5% to 6% as a healthy savings ratio based on historical data. This ratio sank to 1.5% in 2023. Households need to put aside savings for emergencies, durable goods, holidays and retirement. The Superannuation Guarantee Levy is a part of this definition of household savings.

China 

Late last year China seemed to need a stimulus package, and it provided one. Most economic data – except trade – are getting back to normal. China has set 5% as its goal for growth this year.

Trump imposed a further 10% tariff on imports from China making 20% in total. In addition, the 25% tariff on finished cars and the steel and aluminium tariffs are headwinds facing China. It has been reported that China’s electric vehicles (EV) are providing stiff competition for US EV autos, particularly Musk’s Tesla offerings.

US

The nonfarm payrolls (jobs) data came under expectations at 151,000 new jobs as 170,000 had been expected. The unemployment rate climbed one notch to 4.1% from 4.0% and wage growth at 4.0%, undershot the expected 4.2%. With CPI inflation well below 4% – even with the shelter inflation problems – means that the US worker is experiencing improved compensation month by month.

Retail sales, adjusted for CPI inflation, came in at 0.0% for the month and 0.3% for the year. These are not strong numbers, but we have noted that consumers have adopted a more cautious approach to spending. They have the money to spend but they are (sensibly) applying caution in these troubling times. Sales could spring back quickly when consumers feel more confident.

Europe 

Trump’s reaction to North Atlantic Treaty Organisation (NATO), and the Ukraine in particular, has acted to galvanise Europe in providing a more concerted and unified response to conflict and geopolitical tension in the region. Germany just passed a massive bill to issue over one trillion dollars’ worth of debt to build a military capability to make up for a possible US withdrawal or disengagement from NATO. Europe looks to be working hard to replace any gap left by Trump’s apparent receding commitment to NATO. Of course, in four years’ time, the old normal could be restored.

EU inflation fell to 2.4% and the European Central Bank (ECB) cut its rate from 2.75% to 2.5%.

Rest of the World 

Such is the extent of Trump-created chaos that so much of the world is now caught up in the ensuing economic maelstrom.

Mexico sent a number of drug-cartel ‘suspects’ to the US for trial but that didn’t seem to overly appease Trump’s appetite for blaming Mexico for the US’s drug problems.

Mark Carney, a celebrated former governor of both the Bank of England and the Bank of Canada was sworn in as the Prime Minister of Canada. He has the credentials and the apparent resolve to take on Trump over the tariffs imposed on Canada.

The cease fire between Israel and Hamas in Gaza has again run into difficulties.

Japan recorded stronger than expected economic growth in 2024. A rate of 0.6% for the December 2024 quarter was much stronger than the 0.4% which had been expected. That’s good for the global economy.

The Ukraine-Russia ceasefire seems to exist in concept only without any real headway being made save for a supposed naval truce in the Black Sea.

New Zealand recorded growth of 0.7% in 2024 – a bounce back from recession.

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.

In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:

• President Trump policy initiatives drive increased volatility in markets and geopolitics
• -Despite some economic softening corporate earnings continue to hold up
• Without the NDIS impact our labour market is not as robust

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

At last, the Reserve Bank of Australia (RBA) has started its interest rate cutting cycle by reducing its overnight cash rate (OCR) by 0.25% (or 25 bps) to 4.1%. The last hike (+25 bps to 4.35%) was made in November 2023 and the first hike in that cycle was in May 2022 after more than a year at the ‘emergency setting’ of 0.1% to help withstand the impact of the pandemic. While we believe the rate cut was needed last year, getting it now is a better outcome than continuing to wait.

The RBA is charged with a dual mandate of maintaining: (1) price stability and (2) full employment. The problem is, inflation and unemployment data have been confounded in the last few years by the interest rate rises and the growth in the NDIS scheme.

At the end of February, the Federal Treasurer, Jim Chalmers, argued that landlords should bring rents down in line with the first interest rate cut and those that might follow. We agree with this causal relationship but it makes no sense unless Chalmers also admits that the interest rate rises in the overnight cash rate, from 0.1% to 4.35%, flowed through to a rapid rise in mortgage payments and, hence, to rents. Part of the rate increases caused higher inflation – working against RBA reasoning.
Rents are a significant component in the Consumer Price Index (CPI) basket of goods and services and the current rate of rent inflation is 5.8%, which is down from 7.8% in August 2023. Because of the length of leases, rent inflation tends to react to changes more slowly than many other items in the CPI basket.

The RBA argument that inflation was sticky and that delayed making interest rate cuts is fallacious. Cutting rates sooner would have taken pressure off mortgage rates and rents.

Recent reports highlighted that the National Disability Insurance Scheme (NDIS) has expanded rapidly in the past two years. Many of the people now employed through the scheme were previously doing similar work but without being paid and, hence, classified as being unemployed.

While the principle of the scheme is laudable, the newly classified ‘carers’ and others as among the official employment data has led to a misunderstanding of how to interpret employment growth and levels of the unemployment rate.

It has been reported that the majority of jobs created in 2024 were due to the NDIS expansion. Since the jobs are funded from taxpayer revenue, they do not reflect how ‘hot’ the labour market is from market forces.

It is true that the same could be said about other government employees – such as teachers, nurses and police – but we are not saying that this source of employment and funding is inappropriate. We are saying that the rapid change in the NDIS means that a 4.1% unemployment rate today is not comparable with 4.1% two or three years ago. Our ‘back of the envelope’ estimate of what the unemployment rate would be without the NDIS is in the range of 5% to 6%. If the Australian Bureau of Statistics (ABS) had published unemployment rates in that range, the RBA would have been slashing its cash interest rate much earlier in this cycle.

When the growth in the NDIS slows as the programme reaches maturity, it will not make the unemployment rate rise but employment growth should fall. This situation will become the ‘new normal’; the ‘old normal’ is not entirely relevant now.

It has also been reported that the NDIS sector has lower productivity than the traditional sectors – and NDIS pay is lower. Therefore, we expect aggregate wage growth and productivity to continue to be lower going forward.

February began with US President Trump signing executive orders to impose 25% tariffs on Canada (but 10% on energy) and Mexico – and an additional 10% tariff on China.

The Mexico and Canada tariffs were pushed back from an immediate start to the beginning of March. The delay was due to Mexico and Canada each agreeing to put 10,000 more troops on their respective borders with the US to combat illegal immigration and the importation of fentanyl (an addictive pain relief medicine).

At the end of February, Trump announced in a speech that he was also going to impose a 25% tariff on the European Union (EU). On the last day of February, Mexico announce it was sending a number of ‘drug cartel lords’ to the US to face charges. That maybe enough to keep Trump pushing back the deadline for the new tariffs.

It is important to appreciate that Trump has a very different way of communicating from most other leaders. He blusters and barks to appeal to his supporters. He has stated that tariffs and other measures are designed, in part, as a negotiating tool to get other ‘deals done’. For this reason, it is extremely difficult to interpret what Trump will do as opposed to what is said in the threats. Markets move on these Trump diatribes and so cause market volatility as the normal market approach is to sell first and ask questions later.

We regularly analyse the LSEG (Refinitiv) survey data on forecasts of individual company earnings and dividends collected from prominent brokers. The data so far are holding up well so the medium-term market trend might be reasonable but short-term volatility might make for a bumpy ride.

Recent market volatility was exacerbated by the launch of DeepSeek by ‘high-flier’ a hedge fund based in China. This software uses a different technology to ChatGPT and other US generative AI applications. China claims it was very much cheaper to develop and has big efficiency gains in terms of the need for advanced chips (such as those designed and sold by Nvidia) and power consumption.

Since there appears to be no independent corroboration of the China claims, we do not know to what extent DeepSeek will be adopted in the West.
Nvidia, the once biggest stock in the US by market capitalisation, took a sharp price hit on the news but Nvidia’s CEO, Jensen Huang, seems confident about the future of its business. He predicts the next generation of AI will require ‘100x more’ computing power.

Five of the seven ‘mag 7’ stocks (7 largest technology companies listed in the US) just reported earnings above consensus broker expectations and similarly six of them on revenues as well. All the hyperscalers (large, powerful and heavy users of data) reporting their earnings after the DeepSeek launch. All predicted strong growth in capex (capital expenditure) going forward.

For security reasons, DeepSeek has been banned from use in various government and military departments in the US, Australia and elsewhere.

As far as the Artificial Intelligence (AI) boom is going, it is important to appreciate that companies like Nvidia provide infrastructure – advanced chips that are used in mammoth computing systems.

Some fund managers in the tech space are predicting that the next wave in AI will be in software. Currently, many of these companies are small but will grow rapidly over time. We think the AI boom will last many years, if not decades but, as always, we don’t expect markets to move in straight lines!

Around the world many central banks are scampering to cut their interest rates. New Zealand just made its fourth successive cut – the latest being 50 bps – to 3.75%. The ECB has cut interest rates four times since June and is expected to cut again in March. The German economy is struggling with 0.2% growth in the December quarter of 2024 after 0.0% in the September quarter. Canada made its sixth rate cut at the end of January.

In essence, there are long and variable lags between interest rate changes and the reaction in the real economy – these are typically of the order of 12 to 18 months. As we wrote last year, being ‘data dependent’ was destined to fail because waiting for weakness to appear before starting to reduce interest rates means at least another 12 – 18 months of economic weakness after rates are returned to neutral levels.

Australia’s situation has been masked by immigration flows and the growth in the NDIS. There have already been seven successive quarters of negative per capita growth. The RBA might not cut rates at its next meeting (April 1st) because of the proximity of that board meeting to the impending Federal election. The latest Sydney Morning Herald (SMH) poll has the Liberal National Party (LNP) ahead of Labor by 55:45 in a two-party preferred vote.

The US was thought to have dodged a bullet and engineered a soft landing – but some economic data softened at the end of February. GDP was revised downwards slightly to 2.3% for December quarter 2024 (from 3.1% in September) but per capita personal disposable income was revised downwards in December 2024 from 2.1% to 1.9%.

More telling is the latest US consumer confidence index published by The Conference Board. It fell from 112.8 last November to 98.3 in February coinciding with the increased chatter over Trump 2.0! And inflation expectations are up. It is not surprising if the pundits keep talking about problems arising from mass deportations and big tariffs that the general population factors in that scenario. We think the effects have been exaggerated not least because some of the measures will not be implemented – or will be quickly removed.

Markets are only pricing in one or two more interest rate cuts in the US this year and up to three more in Australia. US inflation (excluding shelter) has been on target for many months, but fear of the unknown exacerbated by Trumps policies and style of governing is unnerving many. If there are a few months of ‘reasonable’ Trump policies being enacted, the Fed could start cutting interest rates again.

Asset Classes

Australian Equities 

The ASX 200 fell sharply ( 4.2%) over February but the selling was not across the board. Indeed, four of the eleven sectors witnessed healthy gains. This behaviour is symptomatic of a sector rotation and not a panic sell-off.

The index is up 0.2% for the year-to-date. The financial (FY25) year-to-date witnessed gains of 5.2% which is a very reasonable return given past historical averages.

In essence there has been a big momentum rally over the last two years and it seems investors are now searching for the next big theme.

International Equities 

The S&P 500 also lost heavily over February before recovering somewhat in the last couple of trading hours ( 1.4%). The DeepSeek launch seems to have triggered a sell-off of the Mag 7 stocks but there has been plenty of interest in non-tech sectors.

The German share market index the DAX (+3.8%), London’s FTSE (+1.6%) and the Shanghai Composite (+2.2%) swam against the US tide.

Bonds and Interest Rates

Doubt surfaced towards the end of February that the Fed might not have successfully engineered a ‘soft landing’ (lowered interest rates without having an economic recession) for the US economy. The 3-month to 10-year bond yield spread (differential) on Treasurys inverted again (the yield on 3-month securities is higher than the yield on 10 year securities). Whilst this ‘inversion’ is touted as a precursor for a recession it didn’t work as an indicator of a recession in 2022 – and a few times before – so we are not in the recession-is-imminent camp but nor are we saying that a recession will not happen we are keeping an open mind and monitoring data and events closely.

The market has walked away from the US Federal Reserve’s (Fed) prediction of four interest rate cuts this year made in December 2024. However, the market is still expecting one or two rate cuts in the remainder of 2025 – and, maybe, even three.

With one interest rate cut under its belt, the RBA could be set for another two or three cuts this year, but a lot will depend on how the Trump tariffs and other policy machinations work out. There is too much ‘noise’ around to get a good feel for direction of the markets and economies.

The Bank of England (BoE) cut interest rates again in February – by 25 bps to 4.5%.

There is sufficient strength in Japan inflation to expect that the Bank of Japan (BoJ) will achieve its desired aim to get its interest rate up from the current 0.5% to 1% by the end of 2025. The decades of low inflation and even deflation now appear to be behind it.

New Zealand has a struggling economy, and the Reserve Bank of NZ (RBNZ) just cut interest rates at its fourth successive meeting – this time by 50 bps to 3.5%.
The Reserve Bank of India (RBI) just cut its interest rate for the first time in five years by 25 bps to 6.25%

Some have questioned whether the ’neutral rate’ that neither quickens nor slows the economy has increased in recent times. It was thought to be around 2.5% to 3% for Australia and the US before the interest rate hikes started post Covid. Some are now saying the neutral rate might be closer to 4%. We think this view might be misguided as the full force of the interest rate hikes has not yet filtered through to the real economy.

All four Australian major banks were quick to announce cuts to their mortgage rates – by 25 bps – after the RBA cut its interest rate in February.

Other Assets 

Brent Crude Oil ( 4.7%) and West Texas Intermediate Crude Oil (WTI) ( 3.8%) oil prices were down in February.

The price of gold rose 1.5% in February.

The price of copper (+5.1%) was up sharply but iron ore prices ( 1.3%) were down.

The VIX ‘fear’ index measure of US share market volatility rose to moderately high levels (21.1) towards the end of February as the possible tariff wars resurfaced, but it closed the month at 19.5. Given the intense concern over what Trump may or may not do, it is somewhat surprising that the VIX has not been trading higher.

The market seems to be trading on the ‘Trump put’ – that he will take corrective action when necessary. There is the common belief that he judges his success by the state of the market.

The Australian dollar (AUD) traded in a wide range ($US0.6116 to $US0.6397) over February but finished flat.

Regional Review

Australia

Australia must hold a general election by mid-May. Whoever wins the election will be faced with an uphill task to breathe life back into the economy. As population growth slows, it will become even more apparent that economic growth has stalled.

However, the jobs numbers just out for January seemingly painted a rosy picture of the health of the labour market. The unemployment rate only rose to 4.1% from 4.0% and 44,000 new jobs were created. We believe the faster-than-usual population growth, together with the rapidly growing NDIS scheme is masking the poorer level of health of the economy.

Retail trade grew over the year by 4.6% but that is reduced to 1.1% when price inflation is taken into account. The volume of sales are growing at about half of the pace of population – we are consuming less per person on average than a year ago.

CPI inflation was in the middle of the RBA target range, but electricity price inflation was 11.5% because of the way the ABS is trying imply a price inflation figure from a fixed-dollar subsidy per household.

The wage price index rose 3.2% over the year or 0.8% after price inflation is accounted for. Wages, after being adjusted for inflation, are still about 6% less than in 2020 as the pandemic began.

China 

China needs to expand its stimulus package. Last year, growth came in (exactly) on target at 5.0% and 4.7% is expected for 2025.

A lot will depend on how China and the US interact over the tariff and trade situation, and the related tensions that have escalated recently.

US

The nonfarm payrolls (jobs) data came in at an increase of 143,000 from an upwardly revised 307,000 in the prior month. The unemployment rate was 4.0% and wage inflation was 4.1%. We note many of the created jobs are in the government sector.

December 2024 quarter economic growth was only minimally revised in the first of the two planned revisions each quarter. December quarter 2024 growth stands at 2.3% compared to the 3.1% recorded in the September 2024 quarter. Per capita real disposable income was revised down for the December 2024 quarter from 2.1% to 1.9%.

Retail sales were up 4.2% on the year or 1.2% after allowing for price inflation.

However, the Atlanta Fed, that publishes a regularly updated GDP forecast reported that earlier in the month their preliminary forecast for the March quarter 2025 was 2.3% but it fell to 1.5% on the Private Consumption Expenditure (PCE) Inflation measure report on the last day of February.

Trump has started so many initiatives it is not possible to report and discuss all of these in this update. We prefer to wait and see what actually changes before attempting to assess the implications.

Europe 

The European Central Bank (ECB) continues to cut its interest rate and is expected to continue to do so. EU inflation rose to 2.5% from 2.4% but this is not, we believe, due to interest rate cuts. Rather, there are many factors at work in determining inflation. The EU economy is weak.

It was reported that the average German worker in 2023 took 19.4 days sick leave compared to 15 days the year before. The UK reported only 5.7 sick days in the same year. It was reported that the younger workers – GenZ – are struggling to keep up with the older workers.

German inflation came in at 2.8% for February after having been under 2% in September of last year. Rising inflation and a slowing economy are the preconditions for stagflation. It is too early to call that yet, Europe’s economy is struggling.

The BoE cut its rate to 4.5% from 4.75%. UK growth was 0.1% in the December 2024 quarter following 0.0% in the September 2024 quarter.

Rest of the World 

Trump started to negotiate directly with Russia over the Ukraine war. He started off without including Ukraine’s President Zelenskyy but when he did, in front of cameras in the Oval Office, the meeting got heated.

Trump blamed Zelenskyy for not wanting a cease fire and not thanking the US for its support. Trump campaigned on being able to negotiate a swift end to the war and he was visibly frustrated by Zelenskyy’s intransigence as he sought security guarantees as part of the deal. Trump all but threatened to withdraw support. Various European leaders followed up giving their support which has been lacking to date. Given the state of the European and UK economies, it is not obvious that they could match the support that the US has given to date.

The S&P 500 fell from about +0.5% before the discussion on the last day of February to 0.5% as Trump cancelled the press conference. A White House official reported (tweeted) that ‘Trump had kicked Zelenskyy out of the White House’ – with no official farewell. The index then rallied very hard to close up +1.6% on the session.

Trump also suggested that the USA should rebuild Gaza and resettle the current residents. That suggestion quickly lost traction as did the notion of taking charge of the Panama Canal, Greenland and turning Canada into the 51st state of the US. As they say, “The situation is fluid”.

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.

In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:

• Inflation has largely been beaten, but Trump policies pose a risk to its return
• – US Fed pauses interest rate cutting, as inflation concerns rise
• RBA likely to cut interest rates in February (with more cuts likely in 2025!)
• Global economy mixed, US strength, Europe fading and Australia somewhere in the middle

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

In many countries, including Australia and the US, inflation has largely been beaten. However, there are some data points that are causing some to question whether inflation could return again in the not too distant future.

In the US, the statistical agency produces separate data on the Consumer Price Index (CPI) measure of inflation, an index for shelter (largely rent), and CPI-less-shelter. For the last seven months, inflation in the official CPI-less-shelter inflation has been comfortably below the Federal Reserve’s (Fed) target of 2% p.a.

Except for three months (March to May 2024), US CPI inflation-less-shelter has been below the 2% target since May 2023. The average over the last 19 months (including the three aberrant months) is only 1.6% p.a.! The largest read in those three months was 2.3% p.a. So, what is the problem?

Residential rents in the US account for about one third of the CPI. But because of the way it is calculated, rent inflation only falls slowly after a spike. The Fed has acknowledged this fact in a recent research paper and its chair, Jerome Powell, discussed this point at a press conference last year. Powell noted other agencies calculate rent inflation differently (and hinted possibly better) but he said they were not about to change. Perhaps they will after this cutting cycle is well and truly over!

Rent inflation peaked at 8.2% p.a. in March 2023 and has fallen each month since – except for two small monthly increases – and it now stands at 4.6% p.a. It is highly unlikely rent inflation would increase with a lower interest rate. Indeed, the opposite is probably the case, as owners might pass on rate changes to their tenants. At the current speed of the falls in inflation, it could be 2026 before we see aggregate shelter inflation to get close to 2% p.a. In summary, inflation is not sticky, the calculation for shelter inflation is deficient!

The Fed did not cut rates again in January after three successive cuts totalling 1.00%, or 100 bps (basis points), to stand at a range 4.25% to 4.5% p.a. As it happens, the RBA interest rate in Australia is 4.35% p.a. and there have been no cuts (yet) in this cycle.

Models exist for predicting the chance of future Fed cuts based on the current market prices of interest rate futures and options. One such model prices an 80% chance of a single cut by May and an 80% chance of a second cut by the end of this year.

Powell is hesitant to cut US interest rates again for two reasons. First, economic growth as measured by Gross Domestic Product (GDP) is strong, (the latest estimate is 2.3% p.a. for the December quarter and 2.8% p.a. for 2024) and jobs are holding up (256,000 new jobs were created last month compared to an expected 155,000 and an unemployment rate which has been stable at about 4% for the past six months). Clearly, he feels damage to the economy is not being done at the current monetary policy settings.

Secondly, Powell and many others feel that President Trump will enact several inflationary policies and Powell wants to stay ahead of the game. All the time before Trump’s election, the Fed and most other central banks declared they are data dependent and not expectations dependent. It seems now they are trying to predict inflation from policies that have not yet been articulated in any formal sense – and then many would need to pass through Congress. They are switching from data dependency to expectations dependency without acknowledging it!

Trump talks about imposing lots of big import tariffs, repatriating lots of illegal immigrants, cutting taxes, reducing regulation, and cutting back government spending (among many other policies). Except for government spending, the major mooted policies could add to inflation.
Starting with tariffs, Trump has already walked back on his election campaign rhetoric. He recently said he will raise tariffs in s

mall increments and not from ‘day one’. However, at the end of January, he said he would impose 25% tariffs on Canada and Mexico from February 1st. He is too inconsistent to try and second guess what will actually happen. No details are yet available and Trump has a history of making changes to his views without any real explanation.

We believe that many of his statements were just a vehicle for ‘bullying’ other countries into doing things that would benefit the US.

Take the case of repatriating some immigrants to Colombia near the end of January. Two US military aircraft (with illegals on board) were refused landing permission in Colombia so Trump slapped a large tariff on Colombia that day by executive order. The next day, Colombia capitulated and allowed the US to repatriate the deported Colombians – and Trump removed the tariff after only one day. No inflation consequences. A very big stick indeed.

The President of Mexico was reported to have said Mexico does not think the 25% tariff will come to pass. But even if tariffs are imposed, will they be on all goods and services and for how long?

While Trump has made some big inroads into stemming the flow of migrants into the US it is not obvious that he yet has a plan to remove those already settled in the country.

By executive order, Trump cut international aid. He failed in his attempt to freeze government grants and loans after a judge put a temporary pause on that executive order. He then withdrew the order but that doesn’t mean he won’t try again!

The opponents to Trump’s new immigration policy did not claim slowing down immigration at the borders would cause inflation – just the removal of current cheap labour. The number of illegal immigrants within the US was estimated by the State Department to be over 11 million in 2022. Since then, under Biden, there was a massive increase in immigration. Migration flows best serve a country when they are controlled and accommodated with long-term objectives in place.

There is a long way to go before a reasonable estimate of any inflationary pressure of Trumps putative policies can be estimated. In the meantime, modest cuts in rates by the Fed should go ahead which can be reversed if new obviously inflationary policies get enacted.

In Australia, some economic data look quite reasonable but a deeper dive reveals some major cracks. The latest jobs data looked strong with 56,300 new jobs created in December but that number includes a loss of 23,700 full-time jobs and a gain of 80,000 part-time jobs. The latest unemployment rate was 4.0%, from 3.9% in the prior month. These results are mixed at best.

Because our immigration rate has been high in recent times – resulting in a population growth over 2.5% p.a. – jobs need to be created to absorb the growing population. Jobs growth in aggregate does not signal a strong economy unless it is compared to population growth.

Recently, it was reported that a majority of the new jobs created in 2024 were in the National Disability Insurance Scheme (NDIS). While it might be laudable to create this service, it does not reflect the strength of the economy. These jobs are funded by the taxpayer and so reflect a fiscal stimulus and not an aggregate demand story. When the NDIS jobs reach their target, a serious deficiency in the demand for labour could be exposed.

In our latest round of data measuring inflation, all the key measures were within the RBA target band of 2% to 3% p.a. There is little argument for the RBA to not start cutting interest rates at its February meeting. The market has one interest rate cut priced in at 95% probability for this meeting and a better than a big chance (around 80%) of four cuts in total this year. That would still not get our rate down to as low as Canada’s or the European Central Bank’s (ECB) current rates – and our economy would be exposed to restrictive monetary policy while we are cutting.

Elsewhere in the world, Canada is in a per capita recession like us but the Bank of Canada (BoC) just cut for the sixth successive time to bring its rate down to 3% p.a. from 5% p.a. (before the interest rate cutting cycle started). Canada has endured six consecutive quarters of negative growth in per capita GDP – just like Australia!

The ECB just cut its interest rate by 25 bps to 2.75% p.a. In answer to a question at the media conference, the President of the ECB said they did not even discuss a 50 bps cut – even though the European Union (EU) growth was reported to be 0% in the latest quarter hours before the rate decision. Being so data dependent when the lags between policy change and the reaction in the economy are known to be ‘long and variable’ almost guarantees creating a recession – and then the central bank has to ease rates below the neutral rate to help the economy recover.

Japan has monetary policy moving in the opposite direction to most countries. The Bank of Japan (BoJ) had a negative interest rate for 16 years in its fight against deflation and low inflation. It has now increased its rate twice (to 0.5%) with an aim of achieving a 1% p.a. rate by the end of the year. Inflation had been too low for a very long time. Japan is hoping for modest inflation. The latest CPI inflation read was 3.6% p.a. when 3.4% p.a. had been expected! Stripping out volatile components to get the core rate, inflation came in on expectations at 3.0% p.a.

Asset Classes

Australian Equities 

The ASX 200 had strong capital gains in January (+4.6%) in spite of elevated market volatility. Presumably, much of the momentum is due to what investors think Trump might bring to markets and the heightened chance of several interest rate cuts by the RBA this year.

The Consumer Discretionary sector (+7.1%) and the Financials (+6.1%) sectors were the standout performers in January with only the Telco ( 1.5%) and Utilities ( 2.4%) sectors going backwards.

In the run up to the February reporting season, there has been a modest improvement in company earnings expectations (as surveyed by LSEG). We are now expecting a better than average capital gain in the ASX200 this year. The 4.6% gain in January does not put this index in anything more than a modest over-bought situation by our metrics.

International Equities 

The S&P 500 also had a strong January (+2.7%) but there was much disruption towards the end of the month for two reasons. Firstly, ‘DeepSeek’, a China generative AI app was launched causing NVIDIA, the US GPU chip manufacturer, and several massive US tech companies, together with energy companies, to have their share prices slashed. Secondly, Trump stated on the last afternoon of January that he would introduce tariffs of 25% on each of Mexico and Canada – and 10% on China in a punitive move to address the illegal importation of fentanyl into the US.

The London FTSE (+6.1%) and German DAX (+9.2%) had particularly strong months but the Tokyo Nikkei ( 0.8%) and the Shanghai Composite ( 3.0%) went backwards. There were modest gains in Emerging Markets (+1.5%). The World index rose +3.5% in January.

The DeepSeek story is far too complicated for an Economic Update. However, based on technical advice, we believe the rout in US technology company share prices was overblown on the first day. A simple version of the argument is that DeepSeek is far more efficient than competitors like ChatGPT and Gemini so less (NVIDIA) GPU chips would be needed and, hence, the AI industry would be less of a drain on energy resources.

The claim that DeepSeek only cost US$6m to ‘train’ is misleading. CNBC argues the true cost of getting to launch was in excess of US$500m!
Importantly, the -16% fall in the Nvidia stock price on the day of the DeepSeek announcement did not cause an across-the-board fall. On that day, more stocks had gains than losses. A big sector rotation had started.

But this DeepSeek story misses a big point in Artificial Intelligence (AI) work. There is a ‘model training’ part which is very expensive to run as models consume as much data as they can from the web and elsewhere. Then there is the ‘model inference’ component that follows the research and development (R&D) ‘training’ component. We believe we have yet to scratch the surface of what the inference component will require in years, decades and maybe more to come. Perhaps a parallel can be drawn from the 1940s when the then Chairman of IBM conjectured there might be room in the world for five computers!

There are also reasonable uncertainties regarding the veracity of the DeepSeek claims, security concerns and censorship. We saw a report that said DeepSeek couldn’t answer the question, “Who is the President of China?” [due to censorship].

We still see the S&P 500 achieving a positive return this year. In the latest US quarterly reporting season there have been some very strong earnings reports and outlook statements. One notable exception was Telsa, which missed expectations on many fronts but the share price went up in after-hours trading and the next day. Was this possibly due to the blossoming connection between Trump and Musk?

Bonds and Interest Rates

The Fed seems to have successfully engineered a soft landing for the US economy. The 10-year US Treasurys’ yield is now just over 4.5% from below 2% at the end of 2021. The yield curve is no longer inverted (which occurs when the 10-year bond yield is below the 2-year bond yield).

The RBA has yet to start cutting its overnight cash rate (OCR) but we expect the easing cycle to start in February 2025 and the RBA reduce the OCR from its current 4.35% p.a. by 0.25% to 4.10% p.a. with the prospect of more interest rate cuts to follow. Seldom does a central bank cut or raise interest rates only once in a cycle.

The BoJ just hiked for the second time in this cycle – to 0.5% – with the aim of a 1% p.a. interest rate by year end.

The UK is in danger of creating a serious recession not just because of interest rate policies but because it is introducing some sharp tax increases. The BoE was on hold at 4.75% p.a. at its December meeting.

The Bank of Canada (BoC) has just made its sixth interest rate cut in the current easing cycle – down to 3% p.a. from 5% p.a.

The ECB needs to cut rates further from the current 2.75% p.a. as the German economy – the powerhouse of the EU economy – has just posted its second year of negative GDP growth ( 0.2% in 2023 followed by 0.3% in 2024) and EU growth was 0% in the latest quarter.

Many central banks held rates too high for too long in their quest to be “data dependent”. Only the US seems to have dodged that bullet and possibly because – at least in part – of former President Biden’s Inflation Reduction Act producing strong fiscal stimulus.

Other Assets 

Brent Crude Oil (+3.2%) and West Texas Intermediate (WTI) Crude Oil (+1.1%) prices were up in January. The future of oil prices is clouded by any impact from Trump’s policies. He wants the Saudis to increase supply to reduce oil prices. In turn that would hurt the Russians and, potentially contribute to an end to lead to the war in the Ukraine.

Secondly, one of Trump’s new mantras (energy policy) is ‘Drill baby drill’. He is overturning much of Biden’s green energy push and wants fossil fuels to support the economy more until green energy can reasonably do its job.

If Trump is successful, oil prices could fall from current levels which, in turn, would lower headline rates of inflation.

Of course, if the Saudis bring down oil prices too much, there will be less incentive to “Drill, baby, drill”.

The price of gold also rose strongly (+7.0%) in January.

The prices of copper (+4.1%) and iron ore (+4.4%) were also up strongly in January with the price of iron ore closing out the month at $US105 per tonne after dipping to $US96.76 during January.

The VIX share market ‘fear’ index came down from its intra-month high of 19.5 to close the month at 16.4. We think of the normal range being around 12 to 14.

The Australian dollar (AUD) was largely flat (+0.1%) over January. If the Fed does slow down interest rate cutting, but the RBA becomes active in cutting interest rates, some further weakness might be seen in the AUD.

Regional Review

Australia

Australia is marching towards a general election – not yet called – and it is unclear at this stage what the protagonists are plotting in any detail for their campaigns.

Jobs data were mixed but, importantly, jobs growth has been reportedly dominated an expansion of NDIS jobs such that most of employment growth in the last year was due to NDIS. While this might be a great source of work for the employees and a source of benefit for the recipients, the jobs are funded by the taxpayer. While these jobs are genuine, they are not an indicator of the strength of the economy but simply from fiscal stimulus. The RBA encouraged to factor this component into its calculations when discussing the need for interest rate cuts.

Retail sales enjoyed a welcome bounce in the latest data. Sales were up 3% in dollar terms and 0.5% after an inflation adjustment. That’s not greater than population growth so we are all (on average) buying less ‘things’ than last year but, at least, ‘real’ sales did not go backwards as they have in recent history.

China 

The China story for January was overshadowed by the launch of the ‘DeepSeek’ AI software. NVIDIA, the biggest company in the S&P 500 had its price fall about 16% on the news. Lots of ‘Mag 7’ stocks fell a few percent with it as did lots of energy stocks.

As one broker wrote, China may have taken out lots of put options over the Nvidia share price. There is no doubt Trump and China’s President Xi are going toe to toe. Trump has so far changed from saying he would place a 60% tariff from ‘day one’ on China to a 10% tariff from 1 February 2025 – less than on Mexico and Canada!

But the good news (if it wasn’t generated by DeepSeek!) was that China Q4 GDP growth came in at 5.4% making 5% for the year – maybe a coincidence but exactly what the government’s policy target was. The last four quarters’ results were 5.3% p.a., 4.7% p.a., 4.6% p.a., and 5.4% p.a.. Looks like a bottom in Q3 when the big stimulus package was launched.

US

The nonfarm payrolls (jobs) data came in at 256,000 against an expectation of 155,000 with the unemployment rate at 4.1% and below the expected 4.2%. Wage growth was 3.7% which is not high enough to upset price inflation forecasts.

The initial reaction to the jobs report on Wall Street was negative because investors feared no more interest rate cuts – or even a rate hike! The inflation data that followed soothed market nerves.

CPI-excluding-shelter inflation is well under control and inside the 2% p.a. Fed target.

The preliminary estimate of December quarter GDP growth was 2.3% p.a. against an expected 2.5% p.a. The final estimate for the September quarter was 3.1% p.a. GDP growth for 2024 was 2.8% p.a. following 2.9% p.a. in 2023. Consumer spending rose by a very robust 4.2% in the December quarter.

Europe 

The ECB cut its interest rate to 2.75% p.a. and EU growth was flat in the latest quarter. EU inflation rose for the third consecutive month to 2.4% p.a. having previously been below the target of 2% p.a. Further interest rate cuts are expected this year. The rise in inflation has been attributed to energy prices no longer falling and cancelling positive inflation in other goods and services.

Germany posted its second consecutive year of negative GDP growth: 0.2% in 2023 and 0.3% in 2024.

The UK is reportedly facing a recession as new taxes are introduced.

Rest of the World 

Colombia has accepted some of its citizens who were deported from the US.

Slow progress has been made on a cease-fire and hostage exchange in the Israel-Gaza conflict.

Trump is calling on the Saudis to cut oil prices to increase financial pressure on Russia with the hope that it may help end the war in the Ukraine.

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.