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As 2026 gets underway, it is still not clear which import tariffs have been authorised in the US – and the US Supreme Court is yet to rule on whether the tariffs are legal. The issue is that Congressional approval is required to sanction new tariffs and taxes but Trump has tried to circumvent this due process. Trump invoked old statutes to declare national emergencies so Congress could be by-passed.

Trump and his administration have stated that, if the tariffs are deemed to be illegal, they will use other methods to achieve the same aim.

All legitimate economic thinking reasons that import tariffs are nothing but a tax that will reduce consumption in the US and raise prices. Trump argues that tariffs will raise lots of revenue that can be used to good effect in the domestic economy. The problem that Trump’s thesis encounters is that the majority of revenue raised will have been paid for by consumers and US businesses.

Trump ‘negotiated’ trade policy using threats and penalties against those that did not comply with his position. The main protagonist in the trade war is China. China has retaliated by withholding exports of rare earths that it has a near monopoly over and which are essential for modern production of electronic vehicles (EV) among many other high-tech goods. It has also substituted the supply of some agricultural commodities from the US to South America. China has held firm in the face of Trump’s threats.

US farmers have suffered because of China’s actions. China stopped importing soybeans from the US. US farmers lost a major source of income while farm inputs – such as imports of fertilizer and farm machinery – have increased in price. Trump has moved to subsidise farmers using tariff revenue. Since the tariffs caused the problems, using tariff revenue to solve the problem is a less efficient way of running the economy. The US is ultimately worse off.

Trump is now partnering with some US firms by taking a share of export revenue of the likes of Nvidia. In other situations, he has ‘negotiated’ for foreign companies to invest vast sums in US manufacturing. It is far from clear that these investments will bear fruit. Neither is it clear that the US has the workforce willing and able to work in such industries.

Before Trump started this round of trade negotiations, the average tariff on US imports was 3%. That average has now lifted to near 18%.

Some commentators and politicians have stated that US inflation has not gone up as a result of the tariffs. Leading economists dispute that. Since importers and exporters around the world have been rescheduling trade to minimise the impact of the tariffs, and US companies are possibly cross-subsidising products within their portfolio, big jumps in inflation were not on the cards.

After separating out goods from the CPI basket, it can be shown that inflation of that subset has gone up from about 1.5% to just under 3%. US Federal Reserve (Fed) chair, Jerome Powell expects these one-off price changes to peak in the March quarter of 2026. Again, Trump has stated that he wants to give most US consumers the benefits of the tariffs. In other words, he took from consumers and businesses and now he wants to give it back!

Trump set Elon Musk up to run DOGE (Department of Government Efficiency). Lots of promises and initiatives were announced. A year down the track and reportedly nothing was saved and Musk retreated after his business interests seemed to suffer from his lack of focus.

The Fed paused its interest rate cutting cycle at the start of 2025 while it assessed what the impact on inflation of the new tariffs might be – and what impact they might have on the US economy. Trump threatened Powell with the sack and disparaged his performance as Fed chair. Powell held his ground and then brought in three successive interest rate cuts of 25 bps by the end of 2025.

Trump and his acolytes are bemoaning that yields of longer-term assets, like 10-year bonds and home mortgages, have not come down enough. It is well known by professional economists that Fed funds rate changes have little or no impact on long-term yields.

Powell’s term as chair of the Fed was set to end in May 2026. The incumbent can be re-appointed but Powell’s two terms mark a reasonable period of public service. He comes from investment banking and he possibly wishes to return to that world.

The government shutdown followed from the failure of Congress to agree on how to manage the deficit in time for the financing Bill to be passed. It turned out to be the longest shut-down in history – at 43 days. One important consequence of the shutdown was its impact on publishing official economic data such as employment data by the Bureau of Labour Statistics. Some publishing dates were delayed and some were cancelled.

Jobs data have become a major focus as the Fed has two goals – 1. stable prices and 2. full employment. Jobs growth has slowed down in recent months and Powell has stated that he believes there is a bias in the survey data – to the tune of overstating jobs growth by about 60,000 per month.

The Fed is predicting an end-of-2026 Fed funds rate of 3.4% against a market expectation of 3.07%. The current range is 3.5% to 3.75%. It seems quite likely that there will be two or more interest rate cuts this coming year.

With Trump due to appoint a new chair of the Fed – with the assent of the Senate – to start in May, there could be some additional friction around the transition in leadership of the Fed. The new chair will almost certainly be in favour of more interest rate cuts than less, but the chair only gets one vote out of 12.

It is important to acknowledge that there will be substantial government stimulus in the first half of 2026. Record tax refund cheques are due very soon and the so-called ‘Big Beautiful Bill’ will bring tax cuts and other benefits that will keep the economy ticking along. Growth for 2025 is likely to come in at around 2.5% for the year. That, and the stimulus to follow, means that a recession is unlikely unless Trump comes up with some unexpected action on the policy front.

With a modest economic growth scenario and falling interest rates, the US economy and, hence, stock markets are likely to do well for the first half of the year. What follows is highly dependent on what new actions Trump focuses on.

At home, Australia has had a data problem, but it was caused by the Australian Bureau of Statistics (ABS) trying to convert the energy subsidies into an electricity price change. It didn’t work out the way the government would have liked and, as the subsidies are ending, massive monthly contrived electricity price inflation data have entered the CPI calculations.

Because the RBA and the media do not seem to be aware of this issue, the market is now considering interest rate increases in 2026 to subdue inflation. Simple calculations show that CPI inflation is likely to start falling from the next data release on January 7th.

We think the next RBA board meeting at the start of February will pause while it considers the inflation problem in light of the most recent data. This has the potential to see a re-starting of the interest rate cutting cycle if the inflation data shows signs of moderating.

Besides all the usual policy changes that are designed to manage the economies, there has been a truly massive surge in the share prices of companies whose primarily business activity is directly in or related to Artificial Intelligence (AI). Presently, we do not see this as a bubble as the relevant companies have substantial revenue and earnings flows – unlike the start-up companies in the dot.com bubble of the early 2000’s. While each of the big tech firms seemingly have good strategies for expansion in place, it is less clear if all these companies together can fulfil expectations.

We see the Australian ASX 200 and the US S&P 500 share indexes performing well (long term average or slightly better) at least for the first half of 2026. The second half of 2026 should be re-assessed when it becomes clear what the political agenda and earnings profiles will be.

On top of the economic issues, there are many geo-political events that might cause increased market volatility: the Supreme Court’s ruling on tariffs; the Maduro court case and the Venezuela drugs blockade; the Russia-Ukraine conflict; Middle East unrest; and the management of the tariff problems with Canada, Mexico and China, amongst others.

ASSET CLASSES

AUSTRALIAN EQUITIES

After reaching an all-time high in October, the ASX 200 pulled back and finished up the year with +6.8% capital gains. Over December, the index grew a respectable +1.2%. Given the news that bombarded our market from the US, Ukraine-Russia and the Middle East, the index was resilient and made above-average returns in 2025.

When we include dividends (reinvested) the total return for 2025 was +10.3% this excludes the impact of franking credits.

INTERNATIONAL EQUITIES

Many thought the US markets would do well with Trump at the helm. He seems to like to judge his success as president by the performance of the market. The S&P 500 certainly took a pounding in April and May in the aftermath of the initiation of the ‘Reciprocal Tariffs’. That index recorded a capital gain of +16.4% for 2025 and it closed the year with a flat return of -0.1% in December after reaching a new all-time high during the month.

A key feature of Wall Street this year was the success of the so-called Magnificent 7 (‘Mag 7’) stocks. These businesses did particularly well on the back of massive pledges of investment in AI. However, towards the end of the year, these stocks tended to follow each other less closely than in the first half of the year as investors become more discerning as to the respective future propositions of each.

Some people are trying to equate the high performance of the Mag 7 with there being a bubble. A bubble does not exist if the fundamentals support the price movement. Unlike in the dot.com boom and bust, the Mag 7 stocks have strong revenue and earnings growth. While a pull-back is quite possible in some or all the component stocks, we think that would not just be due to a mispricing.

All the major indexes that we pay close attention to had solid capital gains in 2025: S&P 500 (+16.4%), UK’s FTSE 100 (+21.5%), Germany’s DAX (+23.0%), Japan’s Nikkei (+26.2%), China’s Shanghai Composite (+18.4%); and Emerging Markets (+28.1%).

The greatest losses might have been when investors sold their indexes at the bottom of the market in the June quarter and were too slow in getting back in to the market. The S&P 500 gained +37.4% from the intra-year low in April. The Nikkei rose +61.7% since its low from this point.

BONDS AND INTEREST RATES

A number of central banks might be getting near the end of their interest rate cutting cycles. That could not be said of the US Fed and the RBA.

The Fed made three 25 bps interest rate cuts toward the end of the year and arguably will continue cutting in the first half of 2026. The RBA is awaiting clarity of inflation data potentially skewed by the electricity price component. With greater clarity we think the RBA could cut interest rates several times in 2026, assuming data indicates inflation is softening post the electricity subsidy impact being removed from the series.

OTHER ASSETS

Brent Crude (-2.0%) and West Texas Intermediate (WTI) (-1.0%) oil prices were down moderately in December.

The price of gold rose in December by +3.0% but ended the year slipping back a little.

The price of copper (+12.1%) grew strongly in December. The price of iron ore gained +1.9% over the month.

Despite the market gyrations over 2025, the US equity market volatility index (VIX) otherwise known as the ‘fear index’, returned to normal levels at the end of 2025. It closed the year at 15.0.

The Australian dollar appreciated by +2.4% against the US greenback in December.

REGIONAL REVIEW

AUSTRALIA

Jobs in Australia held up better than expected because of government spending. Even so, 21,300 jobs were lost in the last reported month (November) and the pain hit harder in full-time jobs since they lost 56,500 jobs. The unemployment rate might seem low at 4.3% but that is well up from the 3.4% low experienced near the end of 2022.

CPI inflation rose from 3.6% to 3.8% in October which surprised most – including the RBA. We pointed out earlier that the electricity price index has been corrupted by the ABS having tried to work the flat energy subsidies into price changes. That took electricity price inflation – as reported by the ABS – to 37.1% in October, from 33.9% in September. However, the ABS reported that the electricity price index without the questionable subsidy calculation would only have been 5.0%. That means there was 32.1% (= 37.1% – 5.0%) inflation in a significant component that has caused an upward bias in the data.

Since the annual inflation figure is a composite of the trailing 12 months readings, we can say that the next CPI figure should fall back to around the target rate. An unusually big reading will have fallen out of the 12-month window to be replaced by a more benign monthly reading for November. Of course, the ABS might try and overhaul the index to remove the problem – which we would welcome.

Since the next CPI read will be published on January 7th 2026, there will be plenty of time before the next RBA interest rate decision, which is due on February 3rd, to work out a new policy strategy. Unlike the RBA and the market, at this point, we do not see an interest rate hike being necessary in 2026 unless a new macro problem emerges.

Australian GDP growth came in for September quarter 2025 at 0.4% with the annual reading being 2.1%. In per capita terms, the September quarter growth figure was 0.0%. Based on this measure, more interest rate cuts are needed and we do not see inflation being a problem.

An interesting feature of the National Accounts, that contains a variety of indexes, is the major revision in the Household Savings Ratio. It had been languishing at historically low levels but jumped up to 6.4% for the September quarter – a very reasonable and welcome reading. The ABS reported that the 6.4% reading followed a 6.0% for the June quarter. While that is true, the June quarter reading was revised upwards to 6.0% from 4.2% the month before. Revisions of this magnitude are quite rare. No explanation has been provided by the ABS for the revision.

CHINA

China data are still underperforming expectations. Some of the problems likely stem from China having to rearrange its imports and exports to work around US tariffs.

Some China data have been quite strong. For example, exports rose 5.9% for the month but partially because the previous month had been soft. Exports from China to the US fell -2.9%.

China is playing a long game in getting a trade deal with the US to work. They have the box seat on what are known as rare earths and critical minerals. The West is scrambling to find alternative supplies but the task is not easy. While reserves are plentiful around the globe, the by-products from mining and processing are problematic pollutants to deal with. That is most likely why China has been able to process while the West has struggled. These minerals are extremely important in the manufacture of high-tech goods like EVs and missile guidance systems.

We await a resolution to the China US tariff agreement.

UNITED STATES

The government shutdown prevented the normal flow of macroeconomic data. The jobs data were softening before the shutdown and Fed chair Powell has opined that there is a bias of about 60,000 jobs per month reported more than will be seen after the annual revision takes place. In the last two years, the aggregate downward revision for each year has been quite close to a million jobs.

This statement by Powell looks to us like he is gathering support for a consensus view within the Fed – and from the media and the markets – that more interest rate cuts are needed.

Inflation data reporting has been thrown into confusion. There is no doubt that inflation has been rising since the new tariffs started to be rolled out in June. However, the increase in inflation has not been as bad as some had feared. Trump cut many of the ridiculous tariffs before they had an effect and even removed some new tariffs completely. Powell expects tariff inflation to peak in the March quarter of 2026, unless, of course, there is a change in policy or new penalties for what are perceived as unfriendly behaviour by foreign countries.

Since Trump is prone to make up a new tariff in front of camera with seemingly little or no thought, volatility in equities, bonds and confidence have been buffeted.

Many of the so-called ‘tariff deals’ have been made with little detail. It is not clear if many of the foreign investment pledged by US trading partners will come to pass.

There is no doubt that there have been some US casualties from Trump’s tariffs. Farmers have suffered from increased fertilizer and agricultural machinery prices. They also suffered from China redirecting the sourcing of its imports from the US largely to South America, as a penalty.

Consumers are paying more for a whole range of goods such that Trump is putting subsidies in place. He is considering $2,000 per person, subject to some income limit; he has sent out cheques to servicemen and women, and farmers are also getting some of his largesse.

It has also just been revealed that US companies filing for bankruptcy is the highest in 15 years – and bankruptcies are up 14% in the last year.

US government debt has reached $38 trn and shows no signs of abating. At current rates, the US is spending one trillion dollars a year on interest payments alone – hence Trump’s desire to get interest rates down.

Since the Fed only really impacts the ‘short end’ of the yield curve – for terms up to about two years or so – Trump needs to win confidence from US and foreign powers that the future US economy will be stable. To date, he’s not winning many plaudits on that front.

The well-regarded University of Michigan Consumer Sentiment index is slightly above the reading recorded when ‘reciprocal tariffs’ were introduced in April 2025. However, the general level in this year is around that scored in the pandemic, the GFC and the 1970s oil crises.

Record tax refund cheques are going out in the March quarter and there are many disparate schemes that will provide fiscal stimulus to US households. The US economy seems safe from recession while there is an emphasis on stimulus. With US debt reaching problematic levels, stimulus is merely kicking the can down the road.

While Trump seems to be hopeful a new Fed chair will resolve US debt problems, this is very unlikely. The chair has the power to try and reach a consensus on interest rate decisions. He is only one vote in 12 (only 12 of the 19 committee members have a vote at any point in time). As much as Trump would like to be able to direct the Fed to do his bidding, this is unlikely to be a success.

EUROPE

The British unemployment rate climbed to a four-year high of 5.1%. Inflation in the latest report did fall from 3.5% to 3.2%. The Bank of England cut its interest rate by 25 bps to 3.75%.

The European Central Bank (ECB) kept its interest rate on hold but slightly increased its growth forecast to +1.4% for 2025 and +1.2% for 2026.

Europe is trying to work together to help resolve the Ukraine conflict.

REST OF THE WORLD

Japan reported inflation above its target for the 44th month in a row. The Bank of Japan raised its interest rate from 0.5% to 0.75%. Japan exports grew by +6.1% beating the expected +4.8%.

The Organisation of Economic Cooperation and Development (OECD) posted its list of member countries’ rates of productivity. Australia was positioned second last!