Statement on Monetary Policy – February 2025Box A: Implications of US Policy Settings for Financial Markets

Developments in US government policy can affect Australia via financial market channels – such as movements in exchange rates, global bond yields and global asset prices, as well as the ease of access to offshore funding – alongside any direct economic effects (e.g. via trade channels). In the lead-up to and following the US election, financial market participants have been weighing the prospect of higher tariffs, more expansionary fiscal policy, deregulation of banking, energy and other product markets, and more restrictive immigration policy in the United States. In response to these developments, the US dollar has appreciated relative to other currencies, including the Australian dollar, and sovereign bond yields have risen, particularly in the United States, while equity and credit risk premia have remained very low, including in Australia. There is considerable uncertainty about how policy settings will change in practice, how other countries will respond, and thus the outlook for the global economy and financial markets. Current market pricing is consistent with an expectation that these policies will boost US growth and inflation for a time, with less weight placed on downside risks to global growth from tariffs or the potential for a less sustainable trajectory of US government debt.

Tariff announcements have had modest impacts on financial markets to date.

Market participants have so far factored in only modest effects on US and global growth and inflation from the risk of higher tariffs, consistent with most economists’ forecasts (see Chapter 3: Outlook). In part, this may reflect views among most market participants that tariffs could end up being smaller or less expansive than suggested before the election or when first announced, following negotiations with affected countries. Nevertheless, the potential for a further rise in US tariffs has contributed to the appreciation of the US dollar, including against some of the currencies of some countries included in the initial round of tariff announcements.

While China is the only country where proposed increased tariffs have come into effect, Chinese authorities have so far acted to limit the depreciation of the renminbi. The appreciation of the US dollar and relative stability of the renminbi have contributed to the depreciation of the Australian dollar in trade-weighted terms. While tariff concerns do not appear to have materially weighed on overall equity prices in the United States, valuations have declined modestly around some tariff announcements, with the largest moves for highly trade-exposed companies such as car manufacturers dependent on cross-border supply chains. Despite brief periods of volatility, markets have overall continued to function well.

Trade and immigration policies have the potential to lead to a noticeable decline in prices of riskier assets if tariffs prove larger, more broadly based or more persistent than currently anticipated by market participants. Such a fall could be amplified if it causes a reassessment of the positive risk sentiment underpinning historically low equity and credit risk premia. This could sharply tighten global financial conditions, with potential spillovers to the functioning of key global funding markets. The overall effect on financial conditions in Australia would depend, in part, on the extent to which the Australian dollar depreciates further to offset any such spillovers; all else equal, a depreciation of the Australian dollar represents a loosening of financial conditions in Australia. A repricing of riskier assets could also occur if restrictive immigration policies have a larger-than-expected effect on US population growth, labour supply and inflation, given the potential to affect the outlook for US interest rates.

Expected tax cuts and deregulation have boosted prices of riskier assets while supporting higher yields.

Market participants anticipate that the new administration’s fiscal and deregulatory policies will support near-term growth in the United States, while modestly raising near-term inflationary pressures. Fiscal policy is expected to be expansionary overall, with the effect of anticipated declines in individual and corporate taxes outweighing potential higher tariff revenues and spending cuts. The strength in equity prices in recent months in part reflects this anticipated boost to growth as well as expectations of higher after-tax earnings from corporate tax cuts. Financial corporations’ equity prices have risen particularly strongly, in part due to expectations of decreased regulation under the new administration. For equity markets outside the United States, the positive effects of spillovers from expectations of stronger US growth and risk sentiment, and the effect of a stronger US dollar on earnings of exporters and multinationals in local currency terms, appear to have outweighed concerns about tariff risks. In Australia, lower interest rate expectations owing to domestic factors have also supported equity prices.

The uncertainty around fiscal policy poses risks to US inflation and growth expectations.

Concerns about the inflationary impact of fiscal policy could be contributing to a rise in shorter term market measures of inflation compensation in the United States. Concerns about the implications of higher government debt for future fiscal settings, interest rates and inflation have contributed to an increase in measures of the term premium, though the still-low level of term premia suggest these concerns are only modest at present. The full details of changes to taxes, which require congressional approval, and spending proposals are likely to take several months to emerge. This poses risks in both directions – a more stimulatory-than-expected fiscal policy could provoke a sharp upward move in yields, while an outcome in which tax cuts are more modest, or spending cuts more severe, than anticipated could weigh on riskier asset prices, particularly if coupled with trade or immigration developments that are also perceived to be negative for growth.