Damien Hennessy

Despite markets pricing in up to two further US rate hikes this year, Damien Hennessy, investment director at Zenith Investment Partners, expects the Federal Reserve to delay any move to raise rates, and the Reserve Bank of Australia (RBA) to likely remain on hold ahead of a possible cutting cycle.

The US is battling core inflation that is still rising, while Australia appears close to the end of its tightening cycle. US core inflation is running at 3.4 per cent and moving away from the Federal Reserve’s target, prompting markets to anticipate further tightening.

Despite this shift, Hennessy believes the central bank, under new chair Kevin Warsh, is more likely to sit tight.

“The US market has almost two rate hikes priced in – payrolls have ticked up, the AI cap-ex story has been strong, so the US economy has seemed fairly resilient,” Hennessy says.

“Core inflation is 3.4 per cent, which is going in the wrong direction of the target. The Fed has to show that it has a bias toward tightening and it has done that at the recent FOMC.

“Our modelling, based on current core inflation, unemployment close to NAIRU and a real neutral rate of 1 per cent, suggests the Fed should be at between 4 and 4.25 per cent now, but I suspect we could well see the Fed on hold for an extended period.

“What the Fed should do and what it actually will do could be two different things though. I suspect Kevin Warsh is likely to delay any move to tighten rates, which could be based on three different factors.”

The first factor is energy. Although risks in relation to the Middle East crisis remain, oil prices have retreated to the levels seen before the conflict, and market measures of expected inflation have fallen alongside them.

“Oil prices have basically returned to pre-Iran war levels. If you look at implied inflation expectations in the US, it currently sits at 2 per cent which is well down on the 3 per cent we saw in the early days of the conflict. Markets have priced it down and eventually this will flow through to core inflation,” Hennessy says.

The second factor is the Fed Chair’s own conviction that technology-driven productivity gains can do some of the heavy lifting on inflation.

“I think Warsh is a strong believer in the productivity narrative and would like to give that scenario more time to play out.”

The third factor is the underlying condition of the US economy, which Hennessy considers weaker than headline data suggests, pointing to strain in the housing sector and among small businesses.

He believes the US economy isn’t as strong as some people have suggested, adding that the outlook for US company earnings is being driven by forces largely separate from interest rate policy.

“The earnings story is quite separate from the interest rate story,” Hennessy says.

“The earnings story in the US is very much driven by an AI cap-ex boom that’s flowing through to markets, and although we are seeing increases in earnings outside of the Magnificent 7, it’s in the order of 12–13 per cent, not 25 per cent.

“I don’t think the Fed lifting rates by 25 or even 50 basis points is going to have too much impact on the earnings outlook for US companies.”

Australia is at a different stage of the cycle, having moved earlier than the US, and Hennessy believes the RBA is likely to keep rates where they are before potentially turning to cuts in 2027.

“In Australia, the economy reached a point of about 2.5 per cent growth, and we were unable to sustain that without contributing to inflation, so the RBA could be poised to tighten if it gets another bad inflation number,” Hennessy says.

“However, the case for doing nothing is greater than it has been in the past three to four months. This is due to a combination of softer employment data, weaker business and consumer confidence, and the impact of the budget on the housing sector following recent rate rises. Borrowing capacity could have dropped by as much as 10 per cent, which has to have an impact on lending and an impact on growth.

“My view for the RBA is that it is probably going to hold, and that we could well get to the end of 2026 and be discussing the next cutting cycle.”

By Damien Hennessy, investment director

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Damien Hennessy

Australian equities are likely to remain under pressure in 2026, with a combination of limited domestic exposure to artificial intelligence and relatively tight local monetary policy making it difficult to build a strong case for the broad local market, Zenith head of asset allocation Damien Hennessy says.

“The lack of AI exposure in the Australian market has been a factor, but our interest rate positioning is also a headwind for markets, particularly when you go it alone,” Hennessy says.

“Australia’s monetary policy path is encouraging investors to look elsewhere. Rate hikes will eventually impact growth, and that gives investors an excuse to look to other areas where growth outlooks are improving.”

Hennessy says while the ASX’s materials and resources sector has provided some relief, most large cap stocks have disappointed.

“Australia has a healthy mining sector, but everything outside that in the large cap space has been a drag on the market, and the outlook isn’t looking much better for the rest of 2026,” Hennessy says.

“Earnings signals indicate that the most positive markets are the US and Japan. Japan also stacks up well on monetary conditions. And on a valuation basis, the UK and Europe stand out.

“Australia doesn’t really rate highly on any individual driver, and this is a problem.

“Until we start to see a valuation signal or earnings signal that looks positive, it is hard to build a case for the broad Australian market to do well. But that is not to say the resource sector specifically can’t do well.”

As a result, Hennessy prefers global equities over domestic equities but flags the global monetary policy cycle as a key risk for months ahead.

“We are overweight global equities and underweight Australia. We like the US, emerging markets and Japan specifically,” Hennessy says.

“One of the key factors we will be looking at over the next few months will be the monetary policy cycle. We seem to be coming out of a phase where the majority of central banks were easing, to a phase that could see central banks tightening.

“Traditionally, when that happens, it tends to be a headwind for the likes of emerging markets and Japan. We aren’t at that stage yet, but it is certainly something we’ll be watching closely.”

On fixed income, Zenith is more positive on Australian, Japanese and UK sovereign bonds, which it regards as trading near fair value. US bonds, by contrast, are considered relatively expensive at current levels, which Hennesy says warrants a more cautious approach.

“While we are negative on Australian equities, it’s almost the complete opposite when you look at Australian bonds,” Hennessy says.

“To build a case for rates to go above 4.6 per cent, then you’re arguing that the economy is either going to be amazingly resilient and growing at 2.5 per cent, or inflation is going to move beyond 3.5 per cent in core terms – neither of which I think is likely. So, with bond markets close to 5 per cent, I think it’s factoring in all the bad news.”

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Damien Hennessy

Emerging Asian economies are highly dependent on imported oil, particularly through the Strait of Hormuz, so it is not surprising that these equity markets have come under pressure over the past two weeks, says Zenith Investment Partners investment director, Damien Hennessy.

Higher oil prices and the prospect of higher inflation suggest that hopes for near term rate cuts have faded, he says, and along with a stronger USD, this has undermined emerging market equities during March.

“Our view remains that emerging market equities are set to climb in 2026 driven by an improving global cycle, improved external and internal balance sheets, a modestly weaker USD and more attractive valuations compared to developed markets,” says Hennessy.

“Emerging markets have lagged developed markets since 2021. It’s been one-way traffic in favour of the United States.

“But that has shifted over the past 12 months, as investors reconsider high valuations in US equities and rotate towards cheaper opportunities across Asia and other developing economies. The USD has fallen by around 10 per cent over the past 12 months, which is a historical indicator of positive emerging market performance,” he says.

While the softer dollar has helped support US corporate earnings and share prices despite stretched valuations, Hennessy says that the opportunity now lies outside the US.

“There’s no doubt that the weaker US dollar has played a central role in the broad shift away from expensive US technology and AI stocks, toward more attractively priced AI exposures across Asia, particularly China.

“In South Korea, a couple of AI-related stocks have dominated performance although corporate reforms have also helped drive a re-rating. The market’s price-to-earnings ratio has lifted from below 8 times earnings to around 10 times today.”

In addition to more attractive valuations, Hennessy says emerging market balance sheets are in stronger shape than many developed economies, while government debt as a proportion of GDP is generally lower compared to some major global economies.

Inflation trends have also improved, with several emerging economies able to bring inflation under control and begin cutting interest rates, which has supported domestic growth and equity markets. An extended conflict in the Middle East would alter that outcome.

“There’s a combination of factors that have helped drive equities performance in emerging markets, and we believe the improvements we saw last year broadly remain in place,” Hennessy says.

“While the near term will be challenging, from a strategic asset allocation perspective, we’ve increased exposure to the asset class as it offers relative value, earnings potential and better quality than it has for many years.”

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Damien Hennessy

A potential productivity surge, stretched valuations, the prospect of Fed easing, and the trajectory of the US dollar are the four critical themes that will shape global markets in 2026, says Damien Hennessy, investment director at Zenith Investment Partners.

Mr Hennessy says that while recent US equity performance has been extraordinary, the path ahead depends on whether current enthusiasm for a tech-driven productivity boom against a backdrop of Fed policy easing eventuates.

“The US market is up 16 per cent year to date, following gains of 23 and 24 per cent in the previous two years. The last time we witnessed a comparable productivity surge was in the second half of the 1990s, which delivered five years of 20-plus per cent returns,” he said.

“There are clear parallels being drawn between that episode, which famously ended in the dot com bubble and burst, and now. That said, we may well be on the verge of a genuine boom in productivity.”

A significant boost in capital expenditure over the past 12-18 months, alongside a resilient consumer sector, have emerged as key factors determining whether a productivity boom eventuates.

In that scenario, Mr Hennessy says that strong corporate earnings could continue, helping to minimise inflationary risks as productivity gains allow for non-inflationary growth, which could result in an environment of steady bond yields and a steady Fed funds rate.

“This is a powerful scenario, but one that is more narrowly focused on the US tech sector. I see it as a narrative rather than an outcome at this stage, but if it eventuated, it would override concerns about valuations,” Mr Hennessy says.

“Our research places a productivity boom at a probability of around 30 per cent.”

Regardless, Zenith’s central forecast remains a soft-landing, which has largely transpired over the past 12 to 18 months.

“Our base case is a soft-landing, helping drive a rotation into other regions and market cap segments. If we see slower US growth and two to three rate cuts, we are likely to see further evidence of a global recovery,” he says.

“In an environment with a slightly weaker US dollar, emerging markets can do well, alongside Europe and Japan. We have already seen this broadening out over the past three months.”

Mr Hennessy says current lofty valuations are a minor factor in the short term, though are far more important when looking at returns over a 7–10-year horizon.

“If you were to look at valuations right now, you could reasonably argue that US equity returns over the next 7-10 years are likely to be in the very low single digits,” Mr Hennessy says.

“However, if the productivity surge materialises and corporate margins remain high, then US equity returns are more than likely going to be around 6-8 per cent.”

Mr Hennessy said geopolitical turbulence has been a key concern for markets since 2022, which is unlikely to change.

“Policy is polarised across countries and trading groups, and I don’t expect this to change any time soon.

“As investors, there’s little we can do other than continue to monitor situations as they unfold. This turbulence is one of the reasons why gold has firmed as an option for defensive assets other than bonds.”

On the US Dollar, Mr Hennessy challenged the view that the currency is on track for a major bear market.

“There was a consensus that it could go into a major bear market with a 20 per cent decline, but we aren’t of that view,” he says.

“The direction of the US dollar is critical for investors, particularly when making decisions about investing in emerging markets and whether to hedge currency exposure.

“It’s certainly at risk of some downside, but not to that extent.”

In terms of what could create headwinds in 2026, Hennessy highlighted two key risks: the Fed doesn’t cut rates, and AI-related corporate earnings and capex plans disappoint.

However, Zenith believes that although valuations are challenging in some markets and sectors, 2026 is shaping up as a year where a soft-landing should encourage investors to look beyond the US tech sector for opportunities in a broadening global market rally.

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Andrew Yap

Zenith Investment Partners has promoted Andrew Yap to Head of Portfolio Solutions.

In his new role, Mr Yap will help lead Zenith’s Portfolio Solutions team of 12 investment professionals, overseeing the construction and delivery of portfolio solutions for clients. He will report to Damien Hennessy, Investment Director. The appointment comes as Zenith’s Portfolio Solutions business approaches $6 billion in funds under management, reflecting strong client engagement and performance.

Mr Yap has been with Zenith for more than a decade, holding a number of senior positions, including Head of Multi‑Asset & Australian Fixed Income research, before being appointed Deputy Head of Portfolio Solutions in July 2024. Over this time, he has been instrumental in advancing Zenith’s multi‑asset, real return, and Australian fixed income research capabilities, as well as driving innovation in portfolio construction and governance.

With over 20 years’ industry experience spanning research, consulting, financial advice, audit, and management accounting, Mr Yap brings deep technical expertise and a proven track record in delivering strong client outcomes. Prior to joining Zenith, he was Associate Director and Head of Multi‑Asset at Standard & Poor’s Funds Management Research Division and has also held senior roles at PPB Advisory and Pitcher Partners.

Matthew Warren, General Manager & Group Head of Product & Data, said Mr Yap’s appointment reflects both his leadership within the business and his commitment to delivering value for clients.

“Andrew’s deep knowledge of our business, our clients, and the broader investment landscape makes him uniquely placed to lead our Portfolio Solutions team. During his 10 years with Zenith he has consistently demonstrated the ability to unite and inspire teams, add value to our research and portfolio capabilities, and deliver innovative solutions that meet the evolving needs of advisers and investors. His leadership will ensure we continue to deliver exceptional outcomes for clients,” Mr Warren said.

Mr Yap is based in Zenith’s Melbourne office and will lead the recruitment of an additional consulting resource in response to client demand.

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Damien Hennessy

The risk of a US recession has dropped markedly since US President Trump first announced widespread tariffs in April, with a soft landing now the more likely outcome, according to Zenith’s head of asset allocation, Damien Hennessy.

“For us, the only indicators at this point in time that are pointing to very high or elevated recession risk in the US would be consumer sentiment. There’s currently a lot of distortion in much of the data around shopping and consumer expectations and we think it pays to look through that. And generally, when you look through a lot of that data, the US still seems in a reasonable shape,” he says.

There is also an investment regime shift occurring with the usual negative correlation between bonds and equities, which obviously aids the diversification benefits of bonds, inverting itself.

“In this sort of high inflation environment, we’ve seen a positive correlation develop between bonds and equities. You really have to go back to the 1960s and 70s, to see a similar period, and then a little bit during the early 80s. It’s in stark contrast to what occurred during the last 10 to 15 years, where you had a quite strong negative correlation,” Hennessy says.

“There’ll be periods where the negative correlation resumes, but by and large, I think we’re in an environment where we’re more likely to see inflation spikes from time to time creating this sort of positive correlation.”

Even with these changes in the investment regime, Zenith expects a soft landing to be the more likely outcome in the US with most of the hard data fitting in with this outlook.

Such a scenario would see tariffs averaging between 10 and 15 per cent, a slowing in growth to below trend of around 1.5 per cent and inflation at 3 per cent. It would also have the Fed looking through the tariff impact on inflation and cutting to 3.75 per cent. The US dollar would be steady or fall slightly, and bond yields would sit at around 4 to 4.25 per cent.

“In that sort of environment, we still feel that there’s enough there for investors to search out beyond those parts of the market that have led over the last two years,” Hennessy says.

Countries and regions that could do well include Europe, Japan and potentially some emerging markets. China and the UK are also looking better from a valuation perspective, according to Zenith.

“Small caps can offer value to some extent and the mid cap space would probably be a preferred area for us, and then also in areas like global REITs, which is an area that we’ve nominated as being well placed and having reasonable value,” Hennessy says.

In terms of high-level asset allocation decisions, sectors where investors may want to consider overweight positions also include, Australian credit, the Australian dollar and infrastructure.

Infrastructure and Australian credit investments represent defensive positions in the current environment.

“The Aussie/US dollar seems to be pretty good value to us. It’s about 10 per cent cheaper on a Purchasing Power Parity basis,” Hennessy says. “We have an overweight to Aussie dollars at the moment, so we think there’s a bit of room for the Australian dollar to move higher.”

But Zenith is very wary of global credit – both investment grade and high yield – where it has meaningful underweight positions. It is also underweight cash.

“In terms of information within the credit market, the quality of credit is a lot better than what it has been in the past within the high yield market, but I still think they’re way too optimistic,” Hennessy says. “High yield is also an asset class that comes up as being quite expensive at the moment. That’s just purely on valuation alone.”

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Damien Hennessy

“The macroeconomic picture will continue to dominate, and the events of the past month have reminded us that the environment that we are in now, geopolitical risk and policy risk is a key feature.”

“Coming into this, it looked as if the US was very close to achieving its soft landing, but what I expect to see over the next three months are signs that the US economy is slowing. Markets are pricing in a 20-30 per cent recession probability, whereas going back just three weeks, it was 50-60 per cent. To me, markets are becoming a bit complacent to some of the downside risks that we still see out there.”

”What’s interesting is that Australia seems to be immune from this – our market ended up in April – and so the Australian economy seems to be improving off a low base. So, although I expect to see the RBA cut rates, there may be only two moves over 2025.”

“Economies are more inflation prone, so in times like this we see appeal in real assets, such as infrastructure , as they tend to perform reasonably well in that environment. We’ve also added Global REITs more on valuation grounds, and we continue to maintain a focus on quality when it comes to equities.”

By Damien Hennessy, head of asset allocation

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Damien Hennessy

The global investment landscape has taken a sharp and unexpected turn following the recent announcement of sweeping U.S. tariffs—changes that were both faster and more extensive than markets anticipated. As of 7 April 2025, we’re facing the largest tariff regime since before World War I, with wide-reaching implications for inflation, economic growth, and financial markets. For advisers and clients invested in managed accounts, it’s a moment to pause, recalibrate, and reaffirm the principles of disciplined portfolio construction. 

What just happened?

The newly imposed U.S. tariff structure marks a dramatic shift in global trade policy. The average tariff rate has jumped from 2.5% to over 22%, largely targeting Chinese imports. A simple example tells the story: A washing machine that once landed in US ports at $100 now lands at $154 due to a 54% tariff. While the policy aims to make local manufacturing more competitive and reduce trade deficits, the immediate effect is akin to a tax hike on consumers and businesses.

This is not a theoretical impact. It’s a $700 billion tax shock, equivalent to roughly 2.6% of U.S. household income. Inflation is the first casualty, with core inflation expected to rise from 2.2% to above 4%, well beyond the U.S. Federal Reserve’s 2% target. Growth projections are equally sobering: U.S. GDP could lose up to 1.5 percentage points, potentially dragging growth close to zero and flirting with recession.

How we’re positioning portfolios

At Zenith, we remain committed to proactive and diversified asset allocation. Our approach is informed by fundamental analysis and risk assessment, and our portfolios are structured to navigate periods of uncertainty and dislocation.
Here’s how our portfolios are currently positioned:

• Bonds: Over the past 18 months, we’ve gradually increased our exposure to bonds. We’re now closer to a neutral allocation and importantly, bonds are once again offering genuine diversification benefits amid heightened volatility.
• Alternatives: Managed futures have helped cushion the impact of falling share markets. While not necessarily positive year-to-date, they’ve avoided the steepest declines and continue to serve as a defensive anchor.
• Global Listed Infrastructure & Property: Infrastructure, with its relatively low share market sensitivity, has delivered positive returns year-to-date. Meanwhile, global property—recently lifted within our portfolios—has outperformed broad share markets, even as they posted modest declines.
• Currency exposure: The depreciation of the Australian dollar—especially after holding up for much of the year—has provided a helpful offset to losses in global shares, reinforcing the value of maintaining FX exposure in international holdings.
• Active management: Many of our underlying active managers have taken a more cautious stance, with some raising cash levels to buffer against market shocks and exploit future opportunities.

Assessing the road ahead

Markets are currently pricing in a 50-60% probability of a U.S. recession. In a more optimistic scenario—where recession odds fall to 20-25%—the S&P 500 could rebound toward 5,700, but this would require a catalyst such as a signal from the US Fed that rates were about to be cut or a rollback of tariff hikes—neither of which appear imminent.

On the downside, historical averages suggest that share markets could fall another 10% in a typical recession scenario. That would take the S&P 500 down to around 4,600. Credit markets are key indicators here. So far, spreads have widened but are not yet at crisis levels. Should they deteriorate further, we expect the Fed to respond—either through rate cuts or through targeted credit market interventions. 

Key unknowns and watchpoints

We’re closely monitoring several uncertainties that could shape the investment landscape in the months ahead:

• Policy clarity: Negotiations behind closed doors may result in tariff exemptions or adjustments. Retaliatory tariffs from China and Europe are also in play.
• Capex & corporate behaviour: Will companies ramp up U.S-based investment to sidestep tariffs? Could prolonged uncertainty stall hiring and capital expenditure?
• Inflation vs. Margins: The extent to which tariffs are passed onto consumers versus absorbed by corporate margins will influence share market performance and central bank responses.
• Central Banks: For the RBA, the backdrop is shifting. Monthly inflation data is encouraging, with core inflation appearing to drop below 3%. While the market is pricing aggressive cuts to below 3%, our view is more measured—but we do see rate cuts on the horizon.

Diversification doing its job

In times of crisis, correlations can spike and traditional diversification can break down. However, in the current environment, our multi-asset portfolios continue to find ballast through bonds, FX exposure, alternatives, and select real assets.

For Australian investors, the depreciation of the Aussie dollar—often 10-15% during major global drawdowns—serves as another line of defence. Historically, this currency effect has supported portfolios during market corrections, and we see this dynamic at work once again. 

Staying the course with active oversight

Our base case remains a soft landing, albeit one now under pressure from evolving trade dynamics and rising inflationary headwinds. While soft data—like consumer sentiment and inventory pressure—are flashing amber, hard economic data continues to suggest resilience. That said, vigilance is essential.

At Zenith, our portfolios are actively managed and under constant review. We’re prepared to act swiftly as the situation unfolds—whether to manage risks, undertake rebalancing back to strategic targets or take advantage of tactical opportunities. As always, diversification, discipline, and dynamic asset allocation remain our guiding principles.

Conclusion: Calm in the storm

Markets are navigating a period of elevated uncertainty, driven by policy surprises and macro cross-currents. For advisers, these moments underscore the value of partnering with an experienced asset allocation team and offering portfolios designed to weather volatility.

By Damien Hennessy, Head of Asset Allocation

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Damien Hennessy

Employing hard negotiation tactics means starting with extreme demands before following up with only small, slow concessions. Negotiations may have the appearance of ‘take it or leave it’ or might be designed to make the opponent flinch. This seems to be the Trump Administration’s strategy.

Yesterday, US President Donald Trump announced reciprocal tariffs on countries based on a calculation of the tariff equivalent of existing tariffs, other taxes and non-monetary barriers that impact US exports. In what was described as ‘kind’ reciprocal tariffs, Trump announced tariffs at half the level of these calculated tariffs and other non-monetary barriers placed on US goods. A minimum base level tariff of 10 per cent was applied across the board, a level applied to Australian exports to the US. For China, the calculated ‘tariff’ on the US was 67 per cent to which the US would reciprocate with a 34 per cent tariff, but on top of the existing tariff. In the case of Europe, the applied tariff would be 20 per cent, Japan would be 24 per cent, while larger tariffs would be placed on India, Vietnam, Taiwan and South Korea. There was no extra mention of Canada and Mexico, although they have already been hit with 25 per cent tariffs.

For Australia more specifically, beef was singled out by President Trump. Australia has a ban on US beef due to biosecurity rules, while the US is currently Australia’s largest beef export market (almost 400,000 tonnes worth $3.4 billion, or around 16 per cent of exports to the US). US accounts for around 5 per cent of Australian exports. Australia will say it has got off relatively lightly compared to the rest of the world and that the direct impact of the tariffs on Australian exports is relatively small, but the potential impact on the Asian region, and global growth, will have a flow-on to Australia.

Over the past six weeks, markets have been roiled by the seemingly hard ‘negotiation tactics’ employed by the Trump administration. Early this year many in financial markets expected the demands would be softened or modified over time. However, this somewhat comfortable working assumption has been challenged by the escalation in announced tariffs which, together with the collateral damage we’ve already seen on consumer and business confidence and the disappearance of the so-called ‘Trump put’, has sent markets into a tailspin.

Only eight weeks ago, markets were concerned about the risk of ‘high for longer’ interest rates. Now markets are factoring in the probability of recession anywhere between 20% and 40%. US equities have dropped more than 10 per cent, high yield credit spreads have risen 1 per cent, markets are expecting another four rate cuts and bond yields have dropped more than 0.5 per cent.

Are markets right in pricing in an elevated recession risk?

Our own estimated probability of US recession has risen from 20 per cent to an upwardly revised 35 per cent, a level that cannot be ignored. Why have we lifted recession risk? What economists call ‘soft data’ or survey-based data such as consumer and business confidence, or activity data such as ISM’s, have all dropped sharply. As yet, the so-called ‘hard data’ such as actual consumer spending, business investment spending, car and truck sales, have not turned down, but it’s early days. Housing activity has been weak.

Elevated uncertainty impacts spending, hiring and capex plans and eventually it can lead to a reduction in actual activity.

Will there be room to negotiate these tariffs?

President Trump noted that countries will have the ability to reduce these tariffs by taking action to reduce duties and other constraints on US trade, while corporations can avoid the tariffs by relocating investment, plant and factories to the US. Trump highlighted that many companies had already announced significant investment in the US.

The night before ‘Liberation Day’, US Treasury Secretary Scott Bessent noted that the tariff levels to be announced would represent the high-water mark. He went on to say countries could then take steps to bring the tariffs down. His comments can be construed as saying that there’s still a negotiating process ahead and that the worst case of high, unilateral tariffs that cause a major slowdown in growth and lift in inflation could still be avoided.

While there’s at least some clarity on tariff levels and an incentive for higher investment in the US, the impact on confidence, prices, real household incomes and the potential for ongoing disruption to hiring and investment plans means global growth and inflation will be worse off under this new regime.

By Damien Hennessy, head of asset allocation

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Damien Hennessy

As stock markets navigate heightened volatility and rising bond yields in 2025, investors are reducing bets on interest rate cuts in the US and pricing in more potential inflation under a Donald Trump government, which could continue to weigh on stock markets, according to Damien Hennessy, head of asset allocation with Zenith Investment Partners.

Given Donald Trump’s pro-growth economic policies, financial markets are pricing in a higher underlying level of real yields and modestly higher inflation. Combined with inflationary factors and record levels of US debt, this has driven bond yields higher and produced more volatility within equity markets.

“Bond yields are rising because the US economy has been much stronger than expected, and the disinflation we have seen over the last 12 to 18 months in the US economy has run into headwinds. That is now starting to challenge US equity market valuations,” said Mr Hennessy.

“Looking back to September and the lows in bond yields, investors were predicting a high risk of recession in the US, and markets were betting on official interest rates falling to 2.8 per cent by early 2026. That number has lifted to about 4 per cent. Bond markets have gone from anticipating perhaps nine interest rate cuts, to possibly one or two more – that is quite a turnaround.

“Investors are now asking themselves if they are being sufficiently compensated for the risk of investing in equities,” he said.

US 10-year Treasury yields have climbed toward 4.8 per cent this year, a jump that has shaken US stock markets and hurt bond prices. The US dollar has also jumped, pushing the Australian dollar down towards US62 cents, from around US69 cents in September.

While some bond traders now believe the US Federal Reserve could pause interest rate cuts at its next monetary policy meeting scheduled for 28-29 January after Donald Trump enters the White House, Mr Hennessy isn’t sure inflation will reaccelerate as much as markets expect under a Trump government.

“The market is pricing in a fair few of Trump’s policies being implemented quickly in 2025, and that economic growth will stay strong at about 2.8 per cent. However, we believe some of those expectations will be challenged and not all of Trump’s policies will be implemented as quickly as markets expect,” he said.

This has improved valuations in the bond market, which would draw investors.

“On balance, at close to 5 per cent, bonds start to look like reasonable value in a long-term sense and relatively attractive, so this could be an opportunity for investors to add bonds and duration to portfolios,” Mr Hennessy said.

“Up until now equity markets have largely ignored rising bond yields, but there comes a point at which rising bond yields challenge equity valuations.  Given that the extra risk premium from holding a broad index of equities compared to a bond has declined, investors need to be even more confident that earnings growth will be sustained.

“I expect that market concerns about high bond yields and how this impacts equity valuations will remain a focus for markets for most of 2025,” he said.

Regarding the Australian share market, Mr Hennessy expressed caution given a flat earnings outlook and relatively high equity valuations. While a potential cut in interest rates could boost investor sentiment, consumer and business confidence remain fragile, adding pressure to financial markets.

“Domestically, valuations are extended and it is an uphill battle for Australian equities. We don’t have an overwhelmingly positive outlook. A rate cut could help sentiment somewhat, but the Australian share market is still pretty challenged,” he said.

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