US rate cut run good while it lasted, but investors now pricing in ‘Trumpflation’

Yasmine Raso

Senior Journalist, Financial Newswire

22 January 2025

At the same time as Donald Trump acclimatises to his second term in office, investors have shifted expectations away from an ongoing rate easing cycle and towards a new era of ‘Trumpflation’.

Damien Hennessy, Head of Asset Allocation at Zenith Investment Partners, said investors have begun to price in more potential inflation under the new presidency, due to Trump’s history of enforcing pro-growth policy which will combine with the current record-high levels of US debt to generate even more market volatility. 

“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,” Hennessy said.

“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.”

Hennessy noted that US 10-year Treasury yields have risen to 4.8 per cent, with lasting effects on the US stock market and bond prices. A steady rise in the US dollar has also seen the Australian dollar slump to lows of US62 cents.

“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,” Hennessy said. 

“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.

“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.”

Hennessy also said conditions were not largely conducive for the local share market, considering a “flat earnings outlook and relatively high equity valuations”.

“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.