What we liked

• Australia’s economy grew by 0.6% in the December quarter, and 1.3% through the year. The data show GDP per person increased by 0.1 per cent in the December quarter, which ended seven consecutive quarters of declines.
• The economic activity in the US service sector continued to expand an accelerating pace in February, with the ISM Services PMI rising to 53.5 from 52.8 in January. This reading came in above the market expectation of 52.6.
• US inflation showed further moderation, coming in at an annualised rate of 2.8%. This was slightly lower than the expected rate of 2.9%.
• China’s official Manufacturing Purchasing Managers’ Index (PMI) improved to 50.5 in March, slightly better than expectations. This is the second month of expansion in the Chinese Manufacturing reading.

What we didn’t

• Continued policy uncertainty regarding the imposition of trade tariffs. This is negatively impacting consumer and business sentiment, which is leading to apprehension on consumer and capital spending.
• 52,800 jobs were lost from the Australian economy, well below forecasts of a 30,000 increase in employment in February.
• Data from the Institute for Supply Management (ISM) show the Manufacturing PMI in the US receding to 50.3 in February, down from 50.9 in the previous month and falling behind analysts’ forecasts of 50.5. Meanwhile, the Prices Paid Index, which tracks inflation, advanced to 62.4 from 54.9.
• The University of Michigan Consumer Sentiment Index shows that U.S. consumer sentiment dropped to 57.9 in March, down over 6 points from 64.7 in February. The sentiment has dropped to the lowest level in 28 months, the sharpest drop seen since November 2022.
• Growing uncertainty over the US economy against the backdrop of tariffs and mass firings of federal government workers saw retail sales come in weaker than expected. While still growing at 0.2% month over month, it missed expectations of an 0.6% growth rate.

Base Case

Our view of the most likely scenario for markets over the coming months, for which our portfolios are currently positioned.

78% Probability

A cautious view on global growth over the short-term prevails, as global economic data continues to come in mixed. While the US has been the exceptional economy over the past few years, we are beginning to see signs of relatively improved economic activity outside the US. Economic surprises this year having surprised to the upside ex-US, while the US has begun surprising to the downside. This has led to outperformance of markets outside the US and should be expected to continue should this trend persist.

Our view remains that global inflation is expected to remain benign in the first half of 2025, although to remain above averages from the past decade. In isolation, this should remain supportive for credit markets as well as equities.
The recent announcement of tariffs by the US administration has increased the possibility of headwinds to the US and global economic growth base case outlined above. Fully implemented. tariffs with staying power, while not our base case, would likely see a deterioration in global growth expectations and impair equity prices. We continue to see tariffs as likely but their severity and duration subject to diplomatic negotiations between individual countries. Despite this, a more volatile market dynamic is expected to ensue over the coming months as these negotiations take place. Policy uncertainty emanating from the US also risks discounting asset valuations.

The current environment leaves central banks, particularly the U.S. Federal Reserve, in a difficult position. Developed economy central bank choices appear to be to ease financial conditions thus supporting the economy and financial system, while risking local currency weakness leading to higher bond yields and inflation or continue to fight inflation and risk more severe economic weakness and potential bond market/banking stress by tightening financial conditions and liquidity. The actions of policy makers to move in either direction will be a large driver of financial market performance over the coming months.

Global liquidity growth has recently picked up, providing some reassurance, but remains a key area to watch. This remains key to holding a constructive view on risk assets as we anticipate very high demand for new debt and debt rollovers over the remainder of 2025. So, while we remain constructive on economic activity and risk asset performance, in particular monetary inflation hedges such as precious metals, the risks to our base case rise should recent US tariff announcements be fully implemented and/or if large liquidity injections from the Peoples Bank of China or the US Federal Reserve are not forthcoming.

That said, we expect liquidity injections to continue to rise over the coming months. This is expected to provide continued support for financial markets over the medium-term. So, while short-term volatility may rise, we expect this addition of liquidity into the financial markets will be supportive of risk assets over the remainder of this year.
This scenario is likely to see us maintain a positive view on growth assets over the medium-term, albeit with the expectation that volatility is also expected to rise, pointing to a reduction in risk levels over the next 1-3 months. As previously stated, we have expected bouts of volatility to emerge as market positioning and sentiment has been very strong, increasing the possibility of growth fears or exogenous shocks adversely impacting markets.

Further weakening in employment leading indicators, or if we see central banks reducing their efforts to provide liquidity into financial markets would lead to this more defensive positioning, most likely expressed in higher cash holdings. Overall, asset allocation will retain a bias to growth assets, with short-term tactical positioning to be guided by macroeconomic developments and central bank actions.

Bear Case

Our worst-case scenario for the coming months, which we are prepared to position for should conditions deteriorate.

11% Probability

Global consumer demand for goods and services falls further than expected, with US economic growth showing signs of faltering and the rest of the world showing no sustainable signs of improvement from tepid recent growth. Inflationary pressures rebound placing the recent global general trend of interest rate cutting under pressure. Tariff plans from the US are more severe and longer dated than markets currently expect. This would lead to retaliation from US trading partners, with the effect being to further dampen global trade and economic activity. This would act to create further headwinds for discretionary spending, placing pressure on economic activity. At the same time inflation could remain elevated from the implementation of increased tariffs across borders.

Any reversion to bank stresses seen in March 2023 from volatile credit markets would be expected to further tighten bank lending standards also. This could act to place pressure on the currently very strong global employment conditions.

Geopolitical tensions could act to negatively impact supply chain bottle necks and energy prices, further exacerbating inflationary pressures and placing greater pressure on central banks to tighten monetary and financial conditions. Additionally, wage pressures and higher cost of lodging become more systemic as employees successfully lobby for wage increases. This will lead to a deterioration in company profits as increased input costs, and debt servicing costs (from higher interest rates) combined with lower demand converge to crimp company earnings.

Such a scenario would result in a tightening of financial conditions, while inflationary pressures remain elevated. This could see central banks continuing to withdraw monetary support (through higher interest rates) at a time when the economy is weakening. Additionally, an untimely withdrawal or reduction of central bank liquidity into the financial system could derail financial markets, which have become accustomed to liquidity support. When combined with reduced government expenditure, due to elevated indebtedness, this may cause consumer confidence and spending to fall, as prior government support is not fully replaced by gainful employment income.

With China’s property market remaining challenged, a potential debt/deflation spiral remains a risk. Should recent stimulus not act to support the property market and consumer confidence we could see high debt levels continue to place strain on economic growth. Such a scenario could also place further stress on the Australian economy as this would negatively impact demand for Australia’s largest export of natural resources.

Rapid escalation in geo-political tensions or a significant or systemic credit default, due to over-indebtedness in an environment of rising bond yields and elevated volatility in financial asset prices, could see a liquidation of risk assets within a compressed period. Such a situation would see us move rapidly and meaningfully into cash at the expense of equities. Further to this, the recent stresses seen in globally systemically important banks could lead to more bouts of liquidity events, which would be expected to have a pronounced negative effect on economic growth.

Above scenarios playing out will see us take a more aggressive defensive position and reduce equity exposures replacing them with defensive assets, such as cash. The accelerating bond yield scenario would require a more nuanced shift toward companies and sectors that would be the greatest beneficiaries of such a move. Focus will be on a more defensive posture with capital preservation being the primary objective. A further shift towards defensive sectors such as healthcare, consumer staples and utilities would combine with higher cash levels in this scenario.

Bull case

Our most optimistic view for markets over the coming months.

11% Probability

Economies across the developed world experience better than anticipated economic growth rates. When combined with benign and waning inflationary pressures, as supply chain and employment bottlenecks ease and productivity levels improve, we would expect a virtuous pro-growth asset environment as interest rate pressures subside. Additionally, current global conflicts remain mostly contained to their regions and trade tariffs are short-dated and watered down following diplomatic negotiations amongst the world’s largest trade partners.

In this scenario, inputs costs for corporates reduce resulting in resilient earnings growth for companies as economic growth accelerates and costs remain contained. Profit margins would be expected to remain strong and likely improve further.

Additionally, Donald Trump’s recent victory in the US could act to ignite “animal spirits” in the US economy, once current policy uncertainty is resolved. This increased confidence could lead to more spending from small business and consumers, combined these cohorts have a major impact on the US economy. Such a scenario could also lead to greater credit demand, further fuelling the economic impact.

In Australia, a general election could lead to strong fiscal spending. This would support economic growth and an improved environment for businesses.

Fiscal support from governments and central bank liquidity could combine with sound cash levels on household and corporate balance sheets to accelerate the speed of the global economic recovery. Additional support could also come from increased leverage on household and corporate balance sheets. In the event central banks resume measures aimed at suppressing interest rates below inflation levels and potentially adding further liquidity enhancement measures to support financial systems, we would expect this to further fuel asset prices.

This scenario would be positive for financial markets as loosening financial conditions act to fuel demand for growth assets in a low to negative real interest rate environment. We would act by ensuring a growth asset bias with low cash levels. Additionally, if leading economic indicators began surprising to the upside a net shift towards cyclical sectors leveraged to economic growth would occur.