Financial market sentiment has swung sharply towards counting the cost of the Trump Administration’s America First economic policies over recent weeks driving down share prices and government bond yields. The bounce in European and US share markets on Friday recovers only a small proportion of what has been lost over the past month. Essentially movements in the share and bond markets indicate a market belief that the US economy will suffer recession and even worse, a recession that will not bring down inflation. While US bond yields have fallen, the yields are at levels that still point to the Fed having little room to cut official interest rates.
If the US economy is heading into recession with sticky inflation and with the Administration wedded to a policy of tit for tat tariff increases reducing international trade that presents a substantial headwind to the growth prospects for the rest of the world, including Australia. Our view is that financial markets may have swung too far towards counting the cost of the changed US economic policy regime since President Trump took office. US economic growth is still running at close to long-term trend pace and has continuing momentum essentially from a tight labour market and growth in real wages and real household income.
President Trump’s tariff policies turning US demand from businesses and households onshore initially add to demand for labour before the impetus becomes more balanced from US exporters reducing demand for labour. Also, Elon Musk’s Department of Government Efficiency is reducing Government employment slowly with the numbers of jobs lost largely offset by the numbers of jobs becoming vacant as those migrant workers in America and judged illegal are expelled.
The US labour market is staying tight so far in the face of President Trump’s whirlwind economic policy changes. Nonfarm payrolls rose by 151,000 in February, more than the 125,000 increase in January and even though Federal Government employment was down by 10,000 in February. The unemployment rate lifted slightly to 4.1% in February from 4.0% in January but remained low.
Recent weekly initial jobless claims have been low, 220,000 last week from 222,000 the week before and are consistent with nonfarm payrolls growing monthly at a 150,000+ clip with the unemployment rate steady around 4.1%.
Wage growth has remained strong with average hourly earnings up 0.3% m-o-m, 4.0% y-o-y in February, above CPI inflation up 0.2% m-o-m, 2.8% y-o-y.
While US households are bewildered by US economic policy changes reflected in lower consumer sentiment and confidence readings, their ability to spend is untarnished and that is what will continue to count.
US business surveys remain strong. The February ISM manufacturing and non-manufacturing surveys were both above 50 (in expansionary territory) at respectively 50.3 and 53.5. However, businesses are also indicating higher inflation ahead as are consumers in various surveys too.
This brief examination of recent US economic reports and surveys indicates to us that financial markets are overplaying the extent of lower US and global economic growth prospects from US policy changes but may be underplaying the higher inflation cost. That would mean the downturn in share markets may not run much further while government bond yields have pushed down too far given an outlook that leaves little room for more rate reductions by the US Federal Reserve and the possibility of a return to hiking interest rates by early next year.
In Australia, growth momentum has been lifting in late 2024 and in early 2025 while labour market conditions have been relatively tighter than in the United States. Australia’s economic growth prospects will be tempered by softer US and global growth prospects but the damage to Australia’s overall growth prospects will be limited by accelerating growth in domestic demand.
Australia’s labour market is very tight with annual growth in employment at 3.5% y-o-y in February, record high 67.3% workforce participation and a low 4.1% unemployment rate. Wage growth is above 3% y-o-y and more likely to rise than fall while the CPI inflation rate is temporarily low at 2.3% y-o-y. Real wage growth is firm and real growth in household disposable income is even stronger. The signs of rising growth in consumer spending from mid-2024 are likely to continue and probably accelerate.
Meantime, growth in government spending shows no signs of slowing and accelerating in Q4 2024 to more than 5% y-o-y in real terms. With very strong growth in government spending, a persistently tight labour market, and strengthening household consumption spending, whatever damage occurs to Australia’s trade prospects as a product of US policy changes is going to be offset by stronger growth in domestic demand.
The risk of recession occurring in 2025 in Australia is very small in our view.
However, the risk of inflation rekindling, especially in the second half of 2025, is very high. Australian government bonds have rallied less than US bonds over the past month but are still likely to give up some ground as it becomes clearer that US policy changes are less of a threat to growth prospects than is feared but do risk sustaining if not promoting higher inflation.