December 2024 quarter economic and market commentary
Financial markets through the December quarter were dominated by assessments of the implications of the Trump ascendancy.
Certainly, those assessments were initially overwhelmingly positive for US domiciled risk assets.
Against a background of strong economic activity momentum and further policy rate reductions from the Federal Reserve, the incoming Administration’s agenda of corporate and income tax cuts and deregulation proved to be powerful tailwinds for US equity markets. Also important were increasingly positive assessments of the impact of the AI “mega force” on future earnings for US tech companies.
This was despite a noticeable rise in bond yields with indications of “sticky” inflation persisting and episodic concerns around the funding of the gargantuan US budget deficit. Those developments saw US bond yields rise to close to their 2024 highs. After starting the quarter at 3.78 per cent, the US 10-year bond yield ended the quarter at 4.57 per cent.
Ordinarily such a move in yields might have constituted severe headwinds for equity markets. However, the tailwinds from expected tax cuts and deregulation and the AI ‘mega force” more than offset those headwinds as US equity markets added to what had already been a stellar performance earlier in the year. The S&P 500 rose over 2 per cent in the quarter while the tech heavy Nasdaq rose over 6 per cent.
The forgoing developments, however, were very much an exemplar of “US exceptionalism” as other markets lagged the developments in the US. That was reflected in a surging USD (up around 7 per cent against the EUR and over 10 per cent against the AUD). The telegraphing by the Fed at its December meeting of some greater circumspection with respect to rate cuts in 2025 and the prospect of US tariffs added to that strong USD momentum.
Locally, at its last meeting for the year the RBA seemed to indicate that it was contemplating the possibility of a cut in the policy rate in the first half of 2025.
Where the RBA had differed from other developed country central banks during the tightening cycle was that it showed a reluctance to raise rates as far and as fast. That relative caution was aimed at minimising any dislocation in the labour market.
The possibility of a faster fall in inflation than previously projected and observed slowing wage growth excited expectations that the RBA could join other developed markets in cutting rates in 2025.
Despite the prospect of lower policy rates in 2025 the Australian equity market (ASX 200) fell by over 1 per cent through the quarter. The local bond market outperformed the US even as local yields were dragged up by movements in US bond yields.
Going forward, the key issues for 2025 revolve around the tensions between the tailwinds for US equities associated with the Trump 2.0 agenda and the headwinds that might arise from higher US bond yields. Overlaying those considerations are assessments of the power of the “mega forces” around AI and its impact on selected US stocks.
Also important will be any global fallout from the US tariff measures. Were the imposition of US tariffs on imports to see large scale retaliation from China, the EU and others then a global “trade war” might be the consequence. Global trade wars are inevitably internecine and would have potentially large blowback effects on global economic activity.
Of course, President Trump is a mercurial personality, and it is difficult to assess how much of the articulated agenda will be enacted.
That all suggests that there will be frequent episodic bouts of volatility where the potential for seismic shifts in sentiment and the prices of financial assets exist.
