CIO market update for May 2025

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While President Trump’s tariff announcements continued to impact market performance in May, their potency is diminishing. In this CIO market update, we discuss a concept, which in behavioural finance terms is sometimes called “Habituation”, where investors become increasingly accustomed to surprise announcements, and the shock/volatility resulting from any subsequent announcements diminishes over time. That, however, does not mean the volatility is over; we will discuss this in the update below.

More important in May in driving market performances were a range of positive developments. These supported US and global equity markets and pushed US bond yields higher, including:

• The announcement of a 90-day pause in the implementation of US/China tariffs.
• The passage of President Trump’s Big, Beautiful Bill through the US House of Representatives.
• The continued resiliency of US “hard” economic data.

In Australia, the RBA cut rates (as expected) and the RBA alluded to a discussion at its policy meeting that included the potential for a larger 0.5% rate cut. Data releases, such as retail sales and inflation, suggest the RBA will have room to cut rates further in the coming months.

Tariff fatigue grows, but market resilience holds.

Day-to-day global market movements in May continued to be buffeted by President Trump’s announcements regarding tariffs. But, as time has passed since the shock of the initial April 2 “Liberation Day” announcements, most subsequent tariff-related announcements have proven to have diminishing market impact. During May, tariff rates on China were lowered, while EU tariff rates were increased to 50% and then reduced to 10%. The tariffs were subsequently declared illegal by the US Court of International Trade, a decision that was later reversed by a court of appeal.

Most investors had expected the tariff uncertainty to begin impacting the underlying US “real” economy. So far, there continues to be surprising resiliency in the so-called “hard” data. In fact, the survey-based (“soft”) data has actually begun to recover from extremely weak levels, confounding most investors.

Over the month, the reports of US economic resiliency had a positive impact on US (and global) equity markets. They caused them to rise and pushed US bond yields higher. Japanese government bond yields also rose sharply (from 1.32% to 1.5%), but most other bond markets were relatively little changed.

Currencies were also little changed over the month, with the trade-weighted US dollar (DXY) and the Australian/US dollar exchange rate both moving by less than 0.5%.

Key market movements over the month were as follows:

• S&P/ASX300 Accumulation Index (i.e., including dividends) rose 4.2%.
• S&P/ASX Small Ordinaries (Australian Small Companies) Accumulation Index rose 5.8%.
• The US equity market (S&P 500) rose 6.2%.
• Australian 10-year bond yield rose by just 0.09% to 4.26%.
• Australian 3-year bond yield was little changed at 3.33%
• The US 10 bond yield rose by a significant amount – +0.24% – to 4.41%
• The Australian dollar moved very slightly higher from USD 0.6400 to USD 0.6430

 

Key market movements over the month:

 

In this CIO market update, we look at:

• The pause in US/China tariff implementation.
• Passage of Trump’s Big, Beautiful Bill.
• Extreme weakness in US “soft” data releases gives way to recovery as weak survey data converges (upward) toward resilient hard data.
• “Hard” data, such as US retail sales, continue to surprise positively.
• Tariff volatility is severely distorting certain areas of the US economy; therefore, getting a clear read on the underlying economy is difficult.
• Inflation data in the US remains in a modest downtrend (disinflation) despite the tariff-related volatility. This gives the US central bank flexibility to cut rates again.
• The RBA cuts rates as expected.
• Trends in domestic data (retail sales and monthly inflation) are consistent with expectations for further rate cuts.
• The Australian share market continues its strong recovery from the lows of early April.

Tariff shocks and resilience: How markets adjusted.

We noted three months ago that our early 2025 cautious optimism about the market outlook had dissipated as we became more cautious due to the risks and uncertainties surrounding the new US administration’s policy announcements. As it turned out, early tariff announcements not only laid out the prospect of larger than-anticipated tariff increases but were (and continue to be) extremely volatile, with some being “walked back” in the days following their initial announcement.

To date, investors have been confounded and wrong-footed several times by tariff-related developments. The initial tariff announcements shocked investors with their breadth and magnitude, causing sharp falls in equities and surveys of corporate and consumer confidence.

The sharp declines in sentiment surveys suggested a high probability that the US “real” economy would weaken sharply in time. Instead, confounding investors and actual real economy data reports (such as retail sales, employment, and investment) have remained resilient, and the previously weak survey measures have begun to improve.

US economic resiliency was a key factor driving equity returns in May. However, the risk of economic slowdown has not disappeared. Investors now seem too sanguine about the potential for a tariff-related slowdown. Which, if accompanied by a tariff-related inflationary pulse, would be a poor backdrop for growth assets such as equities.

Australia’s outlook remains comparatively strong.

Against this background of global uncertainty, we feel the Australian economy continues to be better placed than many other economies to withstand the expected negative influence of global tariff developments:

• Australia’s exports to the US are a very small proportion of the overall economy.
• Australia’s starting point of high cash rates means the RBA has significant room to move rates lower if required.
• Fiscal support for the economy is likely to continue to have a positive influence.

While we maintain our cautious stance due to the global backdrop, we believe Australia has significant potential to fare better than most other economies and markets during this highly uncertain period.

• USA •

Pause in US/China tariff implementation.

Around mid-month, the US and China announced that their tariffs on each other would decline by 115 percentage points (pp), leaving an increase of +30pp for US tariffs on China in 2025 and +15pp for China’s tariffs on the US. These lower rates will be effective for 90 days, after which rates on both sides will rise by 24pp unless a further pause is agreed to.

The US-China joint statement noted that the US and China will establish an ongoing dialogue on economic and trade relations. At the same time, the White House fact sheet on the issue implied that the two countries would work towards a rebalancing of trade.

As well as presenting markets with evidence of the negotiability of the previously announced tariffs (a market positive), the slightly smaller increase in the effective tariff rate and the reduced incentive to shift import demand away from China and toward higher-cost but lower-tariff countries implies a slightly smaller increase in consumer prices (than might otherwise have occurred), which will likely increase the probability of further rate cuts by the US Fed.

President Trump’s Big Beautiful Bill narrowly passes in the US House of Representatives.

Late in May, the US House of Representatives voted (very narrowly) to pass its budget reconciliation bill, titled the “One Big Beautiful Bill Act,” and send it to the Senate.

The bill would extend many of the expiring 2017 cuts while enacting new changes to both taxes and spending. In the coming months, the House and Senate will negotiate details. Still, the bottom line is that the bill will likely lead to a fiscal expansion (relative to current law), with enactment currently projected to occur in August.

Equity markets took the bill’s passage positively, with investors expecting the legislation to boost corporate earnings – see chart below of Goldman Sachs analysts’ estimates of the bill’s projected positive impact on corporate cash flows.

Expected 2026 corporate cash flow impact of the House reconciliation package

Source: Goldman Sachs

 

While investors have been waiting for “hard” economic data to weaken (following the extreme weakness already displayed by the leading “soft” (survey) data), the previously weak soft data has actually begun to improve, converging higher toward the still-resilient hard real economy data.

In trying to judge how much the uncertainty created by tariffs might impact the US economy, most analysts turned first to surveys of household and corporate sentiment and confidence (“soft” data) as a guide. These surveys contain forward-looking elements (e.g., new orders) but are not an infallible guide to how well or poorly the “real” economy will perform in the future.

However, given the sharpness of the declines recorded in recent months by many of these soft data surveys and the extremely low level to which many had fallen, most analysts had expected the US economy to be negatively impacted at some stage.

However, so far, evidence of weakness in “hard” US data remains scant. Moreover, some of the extremely weak “soft” data releases have begun to recover, such as the surveys of consumer sentiment conducted by the University of Michigan (UoM) and the Conference Board. This has had a very positive impact on market sentiment and contributed to the strength of the share market in May.

The University of Michigan conducts its surveys twice monthly, producing an initial and then a final reading each month. The “final” May consumer confidence reading surprised on the upside, with the weak “initial” May estimate revised upwards to a level equivalent to that of the final April reading. This ended a four-month period of sharp declines (January to April).

UoM analysts noted that consumer “sentiment had ebbed at the preliminary reading for May but turned a corner in the latter half of the month following the temporary pause on some tariffs on Chinese goods. Expected business conditions improved after mid-month, likely a consequence of the trade policy announcement”.

US Consumer Confidence – University of Michigan

Source: University of Michigan

 

Another positive development in the UoM report was a fall in consumers’ inflation expectations – falling for both the 1-year outlook from 7.3% to 6.6% and the more relevant 5-10-year outlook from 4.6% to 4.2%.

While the UoM’s consumer sentiment index seems to have stopped falling in the past month, the US Conference Board’s May Consumer Confidence Index was even more encouraging, rising from 86 to 98 versus the 87.1 consensus estimate. The expectations component of the survey rose very sharply from 54.4 to 72.8, which represents one of the sharpest recoveries on record. In explaining the rebound in May, the survey’s authors noted that “the rebound [in confidence] was already visible before the May 12 US-China trade deal but gained momentum afterwards”.

The strong rebound by the Conference Board Consumer Confidence index suggests that the “soft data” may be beginning to converge upward towards the resilient “hard data”.

US Consumer Confidence – Conference Board

Source: US Conference Board

 

“Hard” data, such as US retail sales, continue to surprise positively.

In yet another upside surprise in a “hard” data release, April US retail sales were reported at a higher-than-expected +0.1% (0.0% was expected), and the previous month’s sales were revised higher to a +1.7% gain from an initial estimate of 1.4%.

The continued resilience of hard data has alleviated some of the market’s fears that, following the sharply weaker survey measures, the real economy would, in turn, decline sharply.

Monthly change in US retail sales

Source: U.S. Census Bureau

 

However, tariff volatility is severely distorting other areas of the economy, making it difficult to obtain a clear picture of the underlying economy.

A month or so ago, the release of first-quarter (January-March) growth (GDP) data for the US highlighted the significant boost to imports in the quarter. It was likely caused by the “bringing-forward” of imports ahead of the expected imposition of tariffs by the Trump Administration.

Last month saw the release of the April trade report – the first trade report for the period subsequent to the March quarter, which showed a clear pay-back in import trends with the trade deficit for the month of April nearly halving to $87.6 billion, down $74.6 billion from $162.3 billion in March.

This sharp narrowing in the deficit was mainly due to a fall of US$ 68 billion in imports for the month, down to US$ 276 billion. These monthly swings are the largest in the history of US trade data.

Inflation data in the US remains in a modest downtrend (disinflation) despite the tariff-related volatility. This gives the US central bank flexibility to cut rates again.

Contrary to the broad consensus, inflation (as measured by the Federal Reserve’s preferred inflation measure – the Core Private Consumption Expenditure (PCE) deflator) continued to trend lower in April despite the sharp volatility in imports. The core PCE deflator remained at +0.1% for a second consecutive month in April. The annual change in core prices continued to drift lower.

It seems that US firms are absorbing some of the tariff costs, and consumers are substituting away from imports to domestic options.

US Personal Consumption Expenditure Price Indexes

Source: US Bureau of Economic Analysis

 

The combination of continued resiliency in hard data and ongoing disinflation is consistent with market expectations of further US rate cuts this year. By the end of 2025, a further cut of 0.5% (two rate cuts) is expected, with an additional cut expected by March 2026.

Expected change in the Federal Reserve’s policy rate

Source: Bloomberg, ANZ

 

• Australia •

RBA cuts rates as expected by 0.25% but discussed the merits of a 0.5% cut.

At their meeting on May 20, the RBA Board decided to lower the cash rate target by 0.25% to 3.85% (as expected). For the market, the key feature of the rate cut meeting and the subsequent media briefing was confirmation that the RBA board had discussed the possibility of an even larger rate cut of 0.5% at its May meeting.

The subsequent release of the meeting minutes reveals that the Board discussed the relative merits of three potential policy outcomes: no change in the policy rate, a 0.25% cut, and a 0.5% cut.

Of these three options, it seems the RBA swiftly dismissed the case for no cut, while a 50bp cut was actively considered. The Minutes note that a cut was justified on domestic conditions alone, given that underlying inflation is back in the target band and private consumption is weak. Global uncertainty amplified the decision and led to a full discussion of a 50-basis-point cut. A 0.25% cut was ultimately decided on with a preference to move predictably and cautiously in removing restrictiveness.

Market pricing suggests an expectation of two further 0.25% cuts by September and a third rate cut by the end of the year.

Expected RBA rate cuts

Source: Bloomberg, ANZ

 

During May, Australian economic data releases generally supported the market’s pricing of additional rate cuts, with April retail trade declining 0.1% (compared with an expected increase of 0.3%)

Total retail turnover

Source: ABS

 

Also supportive of the case for further rate cuts was the fact that inflation remained unchanged in April at 2.4% in annual terms (YOY).

Annual change in CPI measures

Source: ABS

 

The local equity market participated in the global equity rally in May, now up significantly from early April lows.

The local equity market returned more than 4% in May (S&P/ASX300 Accumulation Index +4.2%). Smaller cap companies performed even better – Small Ordinaries +5.8%. Positive performances were broadly based across sectors and individual stocks in May.

From the lows of April 7, the ASX 200 has rallied 15.3%, with all sectors contributing positively. Financials (contributing +631 bps) have had the largest impact on performance. Banks contributing +447 bps, more than half of which is from CBA (+241 bps).

During this recovery period, materials (+230 bps) have also been a significant contributor to performance, followed by Discretionary (+129 bps) and Technology (+109 bps).

Defensively oriented sectors have made more subdued (but positive) contributions – Utilities (+12 bps), Staples (+20 bps), Communication Services (+50 bps), and Healthcare (+85 bps).

• CIO market update: Outlook •

Where to from here?

The primary concern for investors is the ongoing volatility of policy announcements from the US, potential countermeasures from other countries, and the impact of these developments on economic growth and inflation. It is very difficult to form a concrete opinion about market direction in the face of such uncertainty.

On balance, it seems most likely that the extreme uncertainty created by the on-again, off-again tariff narrative will lead to a slowdown in the US economy, with ripple effects across the world. The extent of any slowdown is difficult to judge. But it will probably be determined by how long the uncertainty continues and the size of the tariffs. As noted at the start of this update, the “Habituation” demonstrated in May means that investors may be becoming more accustomed to the volatility of tariff announcements. However, this does not mean the volatility in markets has ceased.

To date, expectations of a slowdown have not eventuated, with US real economy data remaining resilient, AND recoveries are apparent in the previously weak sentiment survey measures. Against this background, equity markets have recovered sharply.

However, should the economic resiliency evaporate, it seems that markets are not priced for a significant slowdown in US and global growth. Consequently, any sign that the US was deteriorating, with a recession likely, would probably lead to renewed weakness in the equity market.

Australia: Well-positioned but not immune.

The Australian market, having posted a second solidly positive month, is not cheap. While it is relatively well-positioned, it remains vulnerable to market shocks. It is increasingly possible that the super-combative stance Trump was originally espousing is being gradually wound back. This has temporarily settled the nerves of investors. However, the near-term issue is that the US economy is likely to weaken in the short term. This will have implications for earnings. We would not be surprised to see markets weaken again. Perhaps it is now less likely that we will retest the lows we saw in April. Still, nevertheless, we do not feel overly optimistic about the short-term prospects for markets, particularly following the sharp rallies posted by most markets from April lows.

This sort of volatility, however, presents an opportunity for active managers like us. We continue to look to establish or add to our positions in excellent-quality companies that offer a real margin of safety over the long term.

 

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