Recovery clear, outlook less so

Markets rebounded swiftly from the April nadir. The next leg higher may prove more challenging. Our Chief Investment Office explains further.

Global share markets declined sharply over the first week of April before producing a sustained rebound over the back end of April and the early part of May. This included a nine-day winning streak for the S&P 500 that delivered a 10% gain to investors – the longest in more than 20 years.

Positively, most global equity markets now sit above or close to those levels prior to US President Donald Trump announcing tariff measures on 2 April. From here though, the conditions for equity markets, particularly the US, to grind higher look more challenging.

Q1 US GDP printed at -0.3%, with the headline figure dragged lower by a surge in imports as businesses scrambled to front-run tariffs. This import surge is expected to be a one-off shock to growth, and as such, the Q2 figure should again be positive. Nonetheless, consumer demand has started to moderate – personal consumption grew at 1.8% last quarter compared to 4% previously. Looking further ahead, the prospect of higher prices could put a more sustained dent in consumer confidence and spending, heightening concerns of US recession.

Our base case remains that the US will avoid recession in 2025, though this assumes that actions will be taken to offset the economic impact of tariffs, and that final tariff outcomes will be moderated from what is currently announced. As such, there are material downside risks to this call, and analysts have ratcheted up the prospects of a downturn – Bloomberg consensus expectations for a US recession have jumped from 20% to 40% in the past few months.

The outcomes of the US reconciliation budget – expected to be agreed to in late May or June – and US Federal Reserve Open Market Committee (FOMC) meetings in June, July, and September will likely be critical to the fortunes of the world’s largest economy. The former will decide whether Trump’s 2017 tax cuts can be extended (and increased), and where further fiscal spending would flow. Ignoring the potential longer-term implications of this spend, in the immediate term, the injection should provide a cushion for what we expect to materialise under the current tariff regime: namely softer demand, increased prices, weaker profits and ultimately higher unemployment.

The other watchpoint is the US Federal Reserve (Fed). Fed Chair Powell has been adamant that the Fed will be data-dependant. We believe the Fed is unlikely to look through the existing activity data (that paints a more supportive view of the economy) to focus on the deteriorating softer survey data (that is less compelling).

Among the more recent survey data, inflation expectations have risen sharply, while consumer confidence has fallen dramatically. The Conference Board’s Consumer Expectations Index, which gauges the short-term outlook on income, business, and labour markets, plunged to 54.4 last month, its lowest level since October 2011. An argument can be made to pay more attention to these but reacting prematurely would jeopardise the Fed’s credibility and possibly result in inflation expectations becoming completely unanchored.

Conversely, in the case of the most recent activity data, core inflation remains sticky but continues to trend lower. Meanwhile, unemployment has lifted modestly since the start of the year, but jobs continue to be created: the three-month moving average of 155k is only modestly lower than the 2024 monthly average of 167k. Looking at the market, credit spreads remain tight and a long way from levels typically preceding recession. Taken together, these inputs suggest there is no compelling reason for the Fed to cut at its upcoming meetings.

Consumer confidence has taken a hit

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Source: TCB, Macrobond, ANZ CIO

Based on the timing of future economic releases we believe the Fed is unlikely to cut in June. May CPI is released the same day as the June FOMC meeting, and we expect the Fed to take further time to digest the data and the impact of tariffs on prices. At this stage we look to September for the Fed to recommence its cutting cycle.

Of course, the other unknown for markets and the US economy will be how and when tariff negotiations conclude. Policy decisions can help to quickly stabilise the US economy and financial markets if necessary in the short term. The bigger unknown is how damaged the US reputation is, how quickly it can be restored, and what the new normal looks like for trade and asset flows.

For multi-asset investors this matters, not least because foreign demand for US denominated assets has provided a strong tailwind for asset prices over an extended period. While the Trump administration wants a weaker US dollar, it has already shown there are limits to what damage it is willing to inflict on financial markets and by extension, the net worth of US consumers, given a large amount of its citizens’ wealth is tied to US capital markets.

We may have already seen the limit to which tariff threats can be pushed. How quickly they can be forgotten is more contentious.

Without foreign purchasers, U.S. valuations are at risk

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Source: Strategas, Bloomberg, ANZ CIO. Regular Trading Hours (RTH) = 9.30am US EST to 4.00pm US EST. Overnight session = RTH close to RTH open the following day

What this means for our diversified portfolios

The market recovery has been swift, yet at current levels we believe recession risks are not adequately priced into markets, and we therefore find it difficult to upgrade risk currently.

Rather, portfolios continue to be positioned with a modestly defensive stance, and we remain selective within risk assets. Given the outlook for the US and prevailing uncertainty we recently elected to trim broad market US equity exposure further. We remain modestly underweight the US.

Elsewhere we took some profits from our overweight to gold, following its extended run over the past 18 months.  We expect the precious metal to remain well-supported given the current macro and geopolitical environment and continue to position with a mild overweight across portfolios.

The proceeds from both trades are sitting in cash. We remain broadly constructive towards developed market equities ex-US but given the sharp V-shaped recovery since the April market bottom, we are in no rush to add to our position in European or Japanese equities. 

We continue to position at benchmark to duration overall, with a modest preference for the long end of the curve. While yields have declined since the start of the year, the position continues to provide solid carry to portfolios, and we expect the allocation to further benefit if the probability of recession increases.