U.S. recession risks for the regions
The global economy faces a complex landscape as trade tensions between the United States and China persist, threatening economic stability. This week, Ric Deverell, the highly regarded Chief Economist at Macquarie, shared insights on the potential for a U.S. recession, the resilience of China’s economy, and the ripple effects on global markets, including Australia and Europe. Our interpretation of his comments follows, and where data is independently available, we have provided that data along with sources.
A mild U.S. recession on the horizon
The U.S. is likely to enter a recession, though it is expected to be mild. According to the National Bureau of Economic Research (NBER), a recession is defined as a significant decline in economic activity lasting more than a few months, typically visible in Gross Domestic Product (GDP), employment, and industrial production. The Conference Board’s Leading Economic Index (LEI) has shown persistent declines in 2024, signalling a heightened risk of recession in 2025, with a projected GDP growth slowdown to 1.5 per cent (down from 2.5 per cent in 2023).
The primary driver of this downturn is the ongoing U.S.-China trade dispute, which has escalated with new tariff threats under the Trump administration. Unlike China, which faces a demand shock from reduced export opportunities, the U.S. is grappling with a supply shock. We have seen what that does to economies during the COVID-19 pandemic. Prices rise and economic growth stalls.
Tariffs increase the cost of imported goods, driving up prices and reducing consumption, which can lead to stagflation – a combination of stagnant growth and rising inflation. Unfortunately, the Federal Reserve’s ability to respond is constrained, as rate cuts to stimulate growth could exacerbate inflation, while tightening could deepen the downturn. The Congressional Budget Office (CBO) estimates that a 10 per cent tariff increase on imports could raise U.S. consumer prices by 0.4 per cent annually, hitting lower-income households hardest.
However, there is some good news. President Trump has backed away from plans to replace Federal Reserve Chair Jerome Powell, providing continuity in monetary policy. The bond market has also remained stable, with 10-year Treasury yields holding steady at around 4.2 per cent. This stability suggests markets are cautiously optimistic about the Federal Reserve’s ability to navigate the challenges ahead.
U.S. Influence: capital markets vs. global trade
The U.S. wields disproportionate influence in global capital markets but plays a smaller role in trade. According to World Bank and International Monetary Fund (IMF) data, the U.S. accounts for 70 per cent of global market capitalisation, driven by the dominance of Wall Street and tech giants like Apple and Microsoft, yet only 25 per cent of global GDP and a relatively modest 11 per cent of global trade. This imbalance means that while U.S. trade policies can disrupt supply chains, their impact on global trade flows is less severe than their influence on investor sentiment and capital allocation.
Meanwhile, the recent rally in U.S. markets, which has brought indices close to pre-tariff levels, reflects backward-looking optimism based on strong corporate earnings from 2024. However, Deverell warns that softer economic data, such as rising unemployment (projected to hit 4.5 per cent by mid-2025 per the Federal Reserve’s estimates) and declining consumer confidence, will likely trigger renewed market declines.
Investors should brace for volatility as the reality of a recession sets in.
China’s resilience amid trade tensions
China is better positioned to weather the trade storm than the U.S. Its centrally planned economy allows for swift stimulus measures and trade redirection to mitigate the demand shock from U.S. tariffs. The People’s Bank of China (PBoC) has already implemented measures like cutting reserve requirements and injecting liquidity, with GDP growth projected at 4.8 per cent for 2025 by the IMF. China’s ability to redirect exports to markets in Southeast Asia and Africa, combined with domestic consumption growth, cushions the blow from reduced U.S. demand.
In contrast, the U.S. faces a supply shock that is harder to manage than a demand shock. Higher import costs increase production expenses, squeezing corporate margins and consumer budgets. The Federal Reserve’s limited room to manoeuvre – caught between inflation and growth concerns – complicates the response. A 2023 study by the Peterson Institute for International Economics found that U.S. tariffs imposed between 2018 and 2020 reduced economic output by 0.2 per cent and cost 142,000 jobs, underscoring the risks of escalating trade barriers.
Australia: well-positioned but not immune
Australia stands out as a bright spot in the global economy. Inflation has returned to the middle of the Reserve Bank of Australia’s (RBA) 2-3 per cent target band, and interest rates, at 4.35 per cent, are well above neutral, providing room for cuts if needed. The RBA’s proactive stance has bolstered confidence, as evidenced by the Australian dollar (AUD), which has also acted as a shock absorber during global volatility. The AUD’s flexibility helps cushion external shocks, maintaining export competitiveness.
Politically, Australia is stable, with the incumbent government increasing its majority in the 2025 election – a rare feat not seen since World War II. However, Australia’s business investment closely tracks U.S. GDP, and a U.S. recession could dampen capital expenditure. The Australian Bureau of Statistics (ABS) reports that business investment grew by 3.1 per cent in 2024, but a U.S. slowdown could halve this growth in 2025, particularly in mining and infrastructure.
My lunch today with a well-connected private equity investor who is also a successful multi-business owner confirmed that private equity deals have mostly dried up. And my meeting earlier this week with one of Australia’s biggest investment banks confirmed that a conga line of companies that wish to launch on the stock market for an initial public offering (IPO) are refusing to do so while markets remain volatile and demand for IPOs is muted.
Europe’s recovery at risk
Europe, which showed signs of recovery in 2024, now faces renewed recession risks due to the U.S.-China trade fallout. The European Central Bank (ECB) has been proactive, cutting rates to 2.5 per cent by early 2025 to stimulate growth. However, cheaper Chinese goods flooding European markets pose a headwind for local exporters, particularly in manufacturing-heavy economies like Germany. Eurostat data shows that Germany’s industrial production declined by 2.7 per cent in Q4 2024, a trend likely to worsen as Chinese competition intensifies.
On the flip side, other countries stand to benefit from redirected Chinese exports. Nations in Southeast Asia, Latin America, and Africa could see deflationary pressure from cheaper goods, supporting dovish monetary policies. The World Trade Organisation (WTO) estimates that global trade volumes could shift by 2-3 per cent as China redirects exports, creating winners and losers in the process.
A global rethink of trade and investment
The U.S.-China trade dispute has prompted a broader reassessment of global trade, investment, and risk management. Central banks, governments, and companies are diversifying supply chains and exploring alternative markets to reduce reliance on the U.S. dollar, which has weakened by more than eight per cent since the beginning of the year. This diversification may reflect a growing recognition that the global economic order is shifting.
The short-term damage from market readjustments to tariffs is unavoidable. The IMF warns that global growth could slow to 3.1 per cent in 2025, down from 3.2 per cent in 2024, if trade tensions escalate further. However, the long-term implications are profound, as businesses and policymakers adapt to a more fragmented world.
The global economy is at a crossroads, with the U.S. facing a mild recession, China demonstrating resilience, and regions like Australia and Europe navigating their own challenges. The U.S.-China trade dispute emphasises the interconnectedness of trade and markets and the need for strategic adaptation. While short-term volatility is likely, Deverell notes the bond market’s calm and central banks’ proactive measures provide some stability, but vigilance is essential as economic data catches up with reality.
Disclaimer
The Polen Capital Global Growth Fund owns shares in Microsoft (NASDAQ: MSFT). This article was prepared on 7 May 2025 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Microsoft, you should seek financial advice.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
