Risk assets in February showed mixed performances in a month of high volatility as markets tried to digest the impact of rapid-fire policy changes in the US on prospects for global growth and inflation. US consumer spending, the mainstay of US GDP growth strength through 2024, became less certain to continue in 2025 with the start of cuts to public sector jobs, higher tariffs likely to underpin US inflation and the Federal Reserve finding it hard to continue cutting interest rates. Outside the US, central banks mostly still had leeway to cut interest rates facing weak economic growth prospects. Investors turned their attention away from richly priced US risk assets in February towards less richly priced Europe.
Major share markets showed a mix of losses and gains in February. Those suffering losses included the US S&P 500, down by 0.7%, Australia’s ASX 200 beset by weakness in resource stocks and banks, and Japan’s Nikkei, down by 3.5% with a stronger economy pushing the Bank of Japan to continue lifting interest rates and going against the grain of interest rate cuts in other major economies. Those enjoying gains included China’s CSI up 1.9%, Britain’s FTSE 100 up 2.6%, Germany’s DAX, up 5.2% and Hong Kong’s Hang Seng, up 13.5%.
Credit markets were mostly firmer in January with yield margins over government securities continuing to run at tight margins. In Australia, default rates are rising but are manageable in an economy still generating strong employment growth and low unemployment. The first rate cut from the RBA in February reducing the cash rate by 25bps to 4.10% and pass through to mortgage rates reinforces the pronounced improvement in household disposable income from real wage growth and lower taxation and means the household sector is well-placed to meet high debt servicing requirements.
In government bond markets, US bond yields fell in February as the market started to question whether a possible softer US economic growth outlook might provide scope for the Fed to go against guidance that it is in no hurry to cut the current 4.50% Funds rate. The US 2-year bond yield fell by 21bps to 3.99% while the 10-year bond yield and 30-year Treasury yield were down respectively by 33bps to 4.21% and by 30bps to 4.49%.
What signs there are of softer US economic growth are confined so far to consumer sentiment and confidence. On the firmer side, the US unemployment rate is low at 4.0% in January and inflation is hovering around 3%. Previously weak US manufacturing is lifting helped by President Trump’s America first policy changes. Our view is that the Fed will hold with guidance that it is in no rush to cut the Funds rate and that implies US bond yields trading towards 4.50% yield and higher over coming months.
Turning to the Australian bond market, bond yields fell in February, but by comparatively little given that the RBA delivered its first rate cut in 4 years in February. The 2-year bond yield fell by 7bps to 3.72% while the 10-year bond yield was down by 14bps to 4.29%. The muted bond market reaction to the rate cut was mostly because the RBA’s various commentaries accompanying the rate decision indicated that it was a close call. The quarterly Monetary Policy Statement released at the same time also showed revised economic forecasts showing a tight labour market persisting through 2025 and inflation a touch higher than previously forecast in 2026 extending through the first half of 2027. Those changes to the RBA’s economic forecasts imply limited scope for further cuts to the cash rate and a requirement for data reports showing inflation at or below the forecast trajectory to allow rate cuts.
In the near term, the RBA is unlikely to have data to hand that would warrant another rate cut at its next meeting in April meaning that May is the first possibility for another rate cut providing the Q1 CPI report at the end of April shows sufficiently low headline and underlying inflation. The Q1 inflation readings need to be very low to offset inflation-priming concern generated by still very tight labour market conditions and excessive growth in public sector spending with a new tailwind of pre-election spending promises.
Market opinion is split between those who see scope for several more rate cuts this year and those who see limited or no possibility of more rate cuts. This sharp division in market views implies a volatile run for bond yields depending upon which view is more strongly held on most recent economic data or events.
We are in the limited scope to cut camp. We see growth in Australian domestic demand improving with private sector spending running even faster after the huge potential additions to public spending made by both major parties in the run-up to the Federal election.With demand growth looking likely to run ahead of growth in supply it is hard to see progress reducing inflation continuing beyond the middle of this year.
Our view remains that the RBA has very limited scope to cut the cash rate further, perhaps two cuts at most taking the cash rate down to 3.85% by this time next year. Beyond that we see the next rate hiking cycle starting in late 2026 or early 2027.