Risk assets fell in March and then fell much more in the first week of April after President Trump’s announcement of higher trade tariffs. The US tariffs could cause recession in the US combined with higher inflation. Financial markets are not accepting President Trump’s assertion that the short-term pain for the US economy will be followed by long term gain. President Trump’s claim seems to have only the tiniest chance of happening because the tariff changes are causing an immediate large loss of consumer, business and financial market confidence in the US that can be countered only if tariff changes are reversed in a series of bi-lateral trade negotiations between the US Administration and the many countries and regions impacted. It is unlikely that all affected parties will negotiate with the US and even those that do face a lengthy process of negotiation and by then the lower growth plus higher inflation damage is done.
The deteriorating US and global economic environment may lead central banks to cut official interest rates more than seemed likely even a week or two ago, but they are facing the problem of sticky and high inflation. The continuing uncertainty about the US Administration’s economic policy program plus the difficulty that central banks face responding to the damage implies an extended period of weakness for risk assets.
Going back to March, almost all major share markets weakened with falls ranging between 0.1% for China’s CSI to 5.8% for the US S&P 500. Only Hong Kong’s Hang Seng showed a small gain, up 0.8%. Australia’s ASX 200 fell by 4.0%.
The concerns about President Trump’s tariff program turned to reality on 2nd April and the first four trading days of April showed big losses, -9.6% for the US S&P 500, -9.1% for Japan’s Nikkei and -10.7% for Europe’s Eurostoxx 50. The fall in Australia’s ASX 200 was smaller at -6.2%, but only because the worst of the selling occurred in Friday trading in Europe and the US after trading had closed in Australia.
Credit markets weakened in March but to a much lesser degree than share markets. Australia’s economic growth prospects will suffer because of the US import tariffs, but damage to our export trade both directly from the 10% US import tariff on Australian goods, as well as indirectly resulting from the higher tariffs imposed on our major trading partners, will be comparatively small and the impact on Australian GDP will be offset by improving domestic demand. Australian household disposable income growth has improved substantially since mid-2024 helped by lower borrowing interest rates, rising real wages and rising employment. Australian households remain well placed to spend more and meet their high debt servicing requirements.
In government bond markets, US bond yields were little changed in March and have fallen only about 20bps early in April amid the sharp fall in US share markets. The flight to safety in government bonds seems muted reflecting the likelihood of higher inflation ahead. In March, the US 2-year bond yield fell by 11bps to 3.88%, but the 10-year bond yield was unchanged at 4.21% and the 30-year Treasury yield rose by 8bps to 4.57%. The share market carnage in early April pushed the 2-year yield down 23bps to 3.65%, the 10-year yield down 22bps to 3.99% and the 30-year yield down 16bps to 4.41%. These are modest downward movements in bond yields if the US economy is about to suffer recession and imply that the Federal Reserve may cut the Funds rate from the current 4.50% to perhaps 3.50%. Although, the comments from Fed Governor Powell are that the Fed is still waiting to see data about how the economy and inflation are tracking. It is in no rush to cut rates again. We see the Fed cutting rates later this year but not as much as the bond market is expecting.
Australian government bond yields also moved little in response to share market weakness in March, but have fallen more in early April, notably short-term bond yields. In March, the 2-year bond yield fell by only 3bps to 3.69%, while the 10-year bond yield rose 11bps to 4.40%. The failure to rally in March seemed to reflect that while the share-market was soft, the real economy was showing signs of improvement. Also, the Government brought down a free-spending pre-election Budget making it likely that elevated real growth in public sector spending would continue. The RBA decided not to follow up its first rate cut in February with another at its early April meeting.
The RBA left the cash rate unchanged at 4.10% at its 1st April policy meeting. But the downside risks to global and Australian economic growth increased the next day with President Trump’s tariff announcements. The local bond market moved quickly from expecting one or two more rate cuts from the RBA this year to perhaps four or more. The 2-year bond yield fell 47bps from the end of March to 3.22% while the 10-year bond yield fell 30bps to 4.10%.
We see the RBA is in a similar position to the US Federal Reserve. It is likely that the US tariff changes will weaken growth, but the impact on inflation cannot be ignored. Both central banks need to see more data to be able to judge more confidently the growth and inflation consequences and that implies a delay before cutting rates further. For the RBA, another 25bps rate cut is likely in May taking the cash rate down to 3.85%, but if as we suspect Australian data stays comparatively firm, there may be only one more rate cut beyond May later in the year.