What is next for financial markets?

At the time of this blog’s posting, the latest economic data for February 2025 is giving markets a lot to digest, with inflation cooling, interest rate cuts on the horizon, and global trade policies shifting. So, what does this mean for investors?

Australia’s inflation figure slowed to 3.2% in December, surprising markets and opening the door for potential rate cuts as early as next month. Similarly, the U.S. core CPI eased to 3.2%, which could encourage the Federal Reserve to continue trimming rates. In the UK, inflation came in lower than expected, further supporting the case for rate reductions.

For investors, this signals a shift in monetary policy. Central banks may start easing conditions, which historically supports equities and credit markets. However, the impact on currencies and bond yields could be mixed, requiring a balanced investment approach.

The U.S. economy continues to outperform, with unemployment dropping to 4.1% and a strong 256,000 job additions—well above expectations. However, retail sales growth slowed, hinting at potential consumer weakness ahead.

Meanwhile, China’s retail sales grew by 3.7%, exceeding forecasts, possibly indicating that recent stimulus efforts are working. However, its manufacturing sector is struggling, with the latest PMI contracting to 49.1. Over in the UK, retail sales have been declining for four consecutive months, highlighting persistent economic challenges.

The U.S. has announced new tariffs on Canada, Mexico, and China—policies that typically increase inflationary pressure and disrupt global trade. While markets have priced in some of these risks, and thankfully, the Trump administration has paused its threat against Canada and Mexico for now, prolonged trade conflicts could dent global growth and introduce more volatility.

Tariffs add uncertainty for investors, particularly in export-driven sectors. Diversification across industries and geographies remains key to navigating these risks.

We see three possible scenarios shaping financial markets over the coming months:

Base Case (74% Probability):

• Global economic growth remains uneven, but inflation continues to ease.
• Central banks shift toward rate cuts, providing support for equities and credit markets.
• Risk assets remain well-bid, but market volatility is expected.
• Key risks include a potential economic slowdown in China and the impact of U.S. tariffs.

Downside Scenario (12% Probability):

• Global consumer demand weakens significantly, especially in the U.S.
• Inflation rebounds, putting central banks under pressure to maintain or raise interest rates.
• Prolonged trade tensions and geopolitical risks dampen economic activity.
• A more defensive portfolio positioning would be required, favouring cash and defensive sectors like healthcare and utilities.

Optimistic Scenario (14% Probability):

• Economic growth exceeds expectations, and inflation continues to decline.
• Consumer and business confidence surge, driven by fiscal support and central bank liquidity.
• Markets experience a pro-growth rally, favouring cyclical sectors and growth assets.

Given the current environment, we maintain a positive bias towards growth assets but remain mindful of potential volatility. Tactical adjustments will depend on macroeconomic developments and central bank actions.

• For equity investors: A balanced approach with exposure to both defensive and growth sectors is prudent.
• For fixed-income investors: Credit markets should remain supported, but duration risk needs to be managed carefully.
• For risk-averse investors: Holding some cash and defensive assets remains a smart hedge against market uncertainty.

Investors need to stay flexible. While rate cuts could provide market tailwinds, trade tensions and economic slowdown risks remain. A well-diversified portfolio, tuned to opportunities and risks, will be essential in the months ahead.