Jim Taylor: What’s driving the ASX this week

Here are the main factors driving Australian equities this week, according to portfolio manager JIM TAYLOR. Reported by head investment specialist Chris Adams

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MEASURES of economic policy uncertainty are approaching four-decade highs, just as quickly as US business and consumer confidence fall to new lows.

To use a financial analogy, the US government is in the very early stages of a “de-grossing” strategy and reducing its exposure to the economy.

After an unprecedented run-up in government spending during Covid and then (via Treasury Secretary Janet Yellen) in the lead up to last year’s Presidential election, the private sector has been crowded out.

As government spending is stripped back, we will get a much better gauge on the underlying health of the ex-government economy.

The key risk is that the private sector swings from being “crowded out” to a voluntary “stepping out” in the face of a government strategy that no one has ever experienced before – and for which no rule books have been written.

On some calculations, something like 70-80% of US economic growth over the last three to five years has been driven by deficit-funded government spending.

We are on the cusp of learning about the relationship between the US government’s deficits and corporate profitability. Some have postulated that 6% deficits equate to US$2Tr of excess spending across the economy.

The impact of current uncertainty is being seen in the data.

The Fed’s indicators of recession risk have picked up marginally, from the low-20% range to the mid-20% range.

Expectations for Q1 CY2025 earnings growth for the S&P 500 have fallen from 11.7% on 31 December 2024 to 7.3% on the 28 March. Unusually for recent times, US earnings revisions are falling faster than other major developed economies.

A key observation point from here will be following capital flows, spurred by either better relative opportunities or policy grievances – likely across the Atlantic toward Europe.

Tariffs remained very topical, with some negative news – such as the 25% tariff on non-US produced cars – somewhat offset by comments out of the EU on areas where they may offer concessions, as well as Trump commentary about being “very lenient” in terms of the first round of reciprocal tariffs.

We expect further developments this week, with 2 April looming as the point at which a new round of tariffs will be implemented – perhaps marking the point at which uncertainty peaks.

After providing a tailwind for market sentiment for much of the past three years, inflation has largely stalled in the mid-to-high 2% or low 3% range, depending on the measure. The Fed’s view is that more cuts are on the way, but fewer than previously thought and weighted to the backend of 2025.

The S&P 500 fell 1.5% for the week. In an unusual twist, the US Dollar is falling as the S&P 500 retraces, for reasons discussed later in this note. The S&P/ASX 300 rose 0.63% during this time.

FedSpeak

As Atlanta Federal Reserve President Bostic – a non-voting member of the FOMC – flagged some of the challenges for forecasts amid the current uncertainty.

He currently expects prices to move largely sideways for the rest of this year, given less progress of inflation and the impact of tariffs.

This would mean that “the appropriate path for policy is also going to be pushed back”, with Bostic shifting his dot plot forecast from two cuts in 2025 to one.

He also cited increasing concerns from contacts on the economic trajectory which have yet to be reflected in data, but added that it is not yet clear whether weaker consumer sentiment will play out as a leading indicator.

On tariffs, he was cautious about labelling any impact on inflation as “transitory” but noted that historically they have been a one-off impact, with businesses passing through additional cost. Consumer sensitivity to this remains to be seen.

St. Louis President Alberto Musalem said it is unclear if any inflationary impact from tariffs will prove temporary. He also noted that secondary effects could see the Fed hold interest rates steady for longer.

He said there is an increased risk inflation could stall above the Fed’s 2% goal – or move higher due to tariffs and other factors – and emphasised the importance of inflation expectations remaining stable.

The Fed is no longer on the “golden path”, Chicago President Austan Goolsbee said, adding that the next rate cut will take longer than anticipated.

Macro and policy Australia

Headline year-on-year CPI inflation fell by 17 basis points (bps) to 2.38% in February, below consensus expectations of 2.5%. This means headline CPI has been within the 2-3% target band for seven consecutive months.

The monthly decline was driven by seasonal price falls in the holiday travel and accommodation basket – which was down 7.6% month-on-month – as well as lower fruit and vegetable prices (down 0.5% month-on-month).

Electricity prices fell 2.5% month-on-month – versus expectations of a 0.5% rise – with all Victorian households receiving subsidy payments after some missed out in January.

The baskets seeing the highest annual inflation are food (+3.1%), alcoholic beverages and tobacco (+6.7%), rents (+5.5%), education (+5.6%) and finance and insurance (+4.5%).

Housing-related components such as rents and new dwelling prices have eased significantly from where they were mid-2024, but are flattening out at current levels.

The largest price falls have come in electricity prices (-13.2%), fuel (-5.5%) and travel (-7.6%).

The year-on-year trimmed-mean CPI fell 10bps to 2.7%, above expectations of 2.5%.

The CPI excluding volatile items (fresh food, fuel and holiday travel) fell from 2.9% in January to 2.7% in February.

Elsewhere, there was little in the 2025-26 Federal Budget to shift perspectives.

The deficit of $42.1bn was a touch larger than the $40bn consensus expectation and well ahead of the $27.6bn for 2024-25, but lower than the forecast of $46.9bn from the midyear update.

This equates to 1.5% of GDP. Forward projections suggest a deficit ranging from 1.1% to 1.3% through to 2028-29.

The main surprise was a modest tax break totalling $17.1bn over five years through a slight increase in the lowest tax bracket.

The government expects the economy to grow 1.5% this fiscal year (down from 1.75% previously), 2.25 in 2025-26 and 2.50% in 2026-27. It is also forecasting CPI inflation to remain in the 2-3% target band, though rising to its top end next year.

Macro and policy US – policy uncertainty now leaking into the hard data

The March Composite Purchasing Manager’s Index (PMI) came in at 53.5, which was a three-month high ahead of consensus 51.7 and up from February’s 51.6.

The Services PMI of 54.3 was also at a three-month high. It also beat consensus (50.8) and was up from 51.0 in February.

The Manufacturing PMI of 49.8 was below consensus expectations of 51.9 and hit a three-month low as new orders growth slowed.

Forward-looking components revealed a degree of pessimism. The Future Activity Index component of the PMI fell to its second-lowest level since October 2022 given a cautious economic outlook and policy uncertainty.

The Conference Board Consumer Confidence Index fell from 101.1 in February to 92.9 in March – its lowest level since January 2021 and below consensus forecasts of 94.0.

The expectations component (down 9.6% to 65.2) and the present situation component (down 3.6% to 134.5) both declined.

The survey’s measure of 12-month ahead inflation expectations increased by 0.4pp to 6.2%, which is the highest level since April 2023. Tariffs were cited as the reason. While high, we note that the Fed is more focused on medium-term inflation expectations.

Other data points to note:

• New home sales in February rose 1.8% from January on a seasonally adjusted annual rate, slightly below consensus expectations.
• Initial jobless claims fell from 225K to 224K, marginally below the consensus (225K).
• Continuing claims fell to 1,856K, from 1,881K, below consensus of 1,886K.
• Real consumption rose 0.1% in February, below consensus (0.3%). February’s very modest rebound from a weak January suggests the emergence of a real slowdown in demand. Weakness was fairly broad based. A gain of ~0.3% in March see a 1Q annualised growth rate of about 0.5%, the lowest since 2Q 2020.
• Nominal personal incomes rose by 0.8%, well ahead of the 0.4% expected by consensus. Government transfers to households grew 2.2% while increases in personal taxes rose just 0.1%.
• The Core Personal Consumption Expenditures (PCE) deflator increased by 0.4%, above the consensus of 0.3%, and lifted the inflation rate to 2.8% from 2.6% in January. These numbers are less relevant until the impact of tariffs gets absorbed into the base.

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Markets

Evidence of the dramatic reversal in sentiment towards equity markets is seen in the positioning of US institutional asset managers, which have gone from the one-hundredth percentile of net long equity positioning in November 2024 to the 58th percentile in March.

US dollar

It is also interesting to note that of the 13 drawdowns of at least 10% in the S&P 500 since 2010, the US dollar has been at least flat – and usually up as part of a flight to safety – except in the current episode.

There are two factors that have changed.

First, on a short-term perspective, the story at the start of the year was a strong US economy and a weak Europe.

Since then, US growth expectations have dropped as uncertainty weighs on investment and spending, while European growth expectations have improved on the back of large German stimulus.

That led to the reversal of an undervalued Euro versus the US dollar. There is a view that this could begin to unwind if the tariffs begin to eat into growth of other countries more so than the US.

The second, longer-term case for a weaker US dollar goes to the argument outlined by Stephen Miran, chair of the Council of Economic Advisers within the Trump Administration.

The argument is that the US dollar is chronically over-valued as a result of all the payments being received by exporters in China and the EU being recycled into US assets.

There has been a very large increase in foreign ownership of US equities in last decade, which is now at all-time highs. If countries start to believe that the trade compact with the US is now broken, they are less likely to keep buying – and may actually sell – US assets, thus creating a long-term headwind for the US dollar.

This helps explain why the long-term negative correlation between equities and the US dollar has broken down.

The near-term outlook for the dollar remains unclear, because of the relative impact on tariffs.

However, we think the long-term trend may well be for a weaker US dollar, with the caveat that this is mainly against the Euro.

The Australian dollar may underperform the Euro given our own issues with government over-spending eventually requiring some response, which may lead to a headwind for growth.

Data centres

There was further negative news flow on data centres (DCs), as a US sell-side analyst flagged Microsoft is not proceeding with 2 giga-watts (GW) of data centre options in the US and Europe.

We understand that Microsoft has over procured around 1GW of capacity, given they have altered their exclusivity agreement with OpenAI on training generative AI models. OpenAI is now also partnering with Oracle. This is equivalent to roughly six months’ worth of supply.

Anecdotal feedback suggests that other hyperscale customers are stepping up to take capacity.

Lease agreements already agreed with global data centre operators in the G20 nations are ironclad, with no ability to back out. However, DC operators may be amenable to adjusting capacity to another location particularly, if they can sell the unlocked capacity at a higher price.

The DC market remains in balance for now.

In Australian equities, Financials (+2.5%) and Energy (+1.9%) were the best performers for the week, while Technology (-2.9%) and Real Estate (-2.2%) underperformed.

About Jim Taylor and Pendal Focus Australian Share Fund

Drawing on more than 25 years of experience investing in top-performing Australian companies and a background in accounting, Jim manages our Long/Short Fund and co-manages our Imputation Fund. He is a Chartered Accountant with membership of the Australian Institute of Chartered Accountants.

Pendal Focus Australian Share Fund is managed by Crispin Murray. The fund has beaten its benchmark in 14 years of its 18-year history (after fees), across a range of market conditions. Find out more about Pendal Focus Australian Share Fund here.

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