Trade Tensions Ease
May saw a reversal in the performance trends of bonds and equities, underscoring the enduring benefits of portfolio diversification amidst prolonged market volatility.
This month, equities outperformed, driven by positive developments in trade negotiations between the US and its principal trade partners.
Conversely, bonds registered a modest decline, largely attributed to heightened scrutiny of fiscal deficit sustainability in the US and other developed economies.
Please click here to read our May 2025 markets report as a PDF.
Portfolio Diversification
Before delving into our May market report, we wanted to explain in more detail the importance of portfolio diversification. This year has been unusually volatile for investors, with bonds and equities experiencing sharp and frequent movements.
Data Source: S&P Global
In the adjacent visual, we have charted the monthly returns of two portfolios since the start of 2025: one invested in only Australian equities, and other evenly split between equities and government bonds. There are three main takeaways:
Similar overall returns: both portfolios achieved similar returns, with the equity-only portfolio returning 3.73% over the first five months of the year and the diversified portfolio returning 3.40.
Lower volatility for the diversified portfolio: The equity-only portfolio incurred greater swings, with the March decline return nearly triple that of the diversified portfolio, and two negative months compared to only one for the diversified option
Deeper drawdowns: While not shown in the graph, the equities-only investor would have experienced a peak-trough to decline of over 16%, before performance recovered in April and May
While this is a simplified illustration, the chart outlines a key investment principle: diversification can help reduce volatility and improve risk-adjusted returns over time.
Australian Economy
As forewarned in our April report, the Reserve Bank of Australia (RBA) moved to reduce interest rates for the second time this year, reducing the official cash rate by 25 basis points to 3.85%.
The RBA concluded that upside risks to inflation “appear to have diminished”. This was confirmed by the monthly CPI report, where underlying inflation – the bank’s preferred measure, fell within the 2-3% target band for the sixth consecutive month.
The Board did discuss a 50-basis point cut in response to “pronounced” trade uncertainties and their likely “adverse effect on economic activity”. Realistically, the likelihood of a supersized cut was low, however the discussion hints that the RBA’s attention shifted towards economic growth.
In the quarterly monetary policy statement, economic growth forecasts fell from 2.4% to 2.1% for the next year, while also warning that household demand has been slow to recover. To that end, borrowers should expect further monetary policy easing, with Governor Michelle Bullock acknowledging there is sufficient headroom for the central bank to lower interest rates further.
Future markets are predicting a further three rate cuts this year, totalling 75 basis points, which would bring the cash rate to 3.10%.
Equities
Global equities built on April's gains, bolstered by the US administration's reversal of several key trade policies.
The US announced it would lower tariffs on China from 145% down to 30% after the two nations met for trade talks. While the tariffs were suspended for 90 days rather than cancelled outright, President Donald Trump described the discussions as a “total reset” and said that “we’re not looking to hurt China”.
The S&P 500 led the gains, improving 6.3% for the month and bringing its 2025 returns marginally into the green. Returns were also aided by strong corporate results, with 78% of companies recording positive earnings surprises.
The US also announced a limited trade agreement with the United Kingdom, in addition to delaying 50% tariffs on European goods until July 9. The MSCI Europe Index finished the month 4.6% higher.
Closer to home, the S&P/ASX 200 added 4.2%, buoyed by the aforementioned tariff tailwinds and dovish rhetoric from the RBA.
Fixed Income
Fixed income yields increased in May, as investors sold off U.S. and other developed market debt.
Deepening fiscal concerns reared their head after ratings house Moody’s downgraded U.S. government treasuries, citing “over a decade” of growing debt and interest repayments. Combined with tepid demand at the May treasury auction, the S&P US Treasury Bond Index fell -0.85% for the month.
In a statement, the ratings agency said larger deficits will continue to increase the government’s total debt and thereby its interest burden. Per Moody’s estimates, interest repayments will absorb 30% of US tax revenue by 2035, up from 18% in 2024.
The ratings downgrade proved prescient when the US Congress narrowly passed a tax and spending bill that will add US$3.8 trillion to the existing US$36.2 trillion debt over the next decade.
The downgrade sent a ripple through indebted developed market borrowers, with bonds in Germany, the United Kingdom, and Japan also falling.
Labour Re-elected
At home, 10-year Australian Government bond yields increased 16 basis points to 4.27%, in line with global markets. The re-election of the incumbent Labour government to a second term also contributed to an uptick, as the result confirmed federal budget deficits for the foreseeable future.
Announced in March, the 2025 budget included $236 billion in cumulative deficits over the next four years. Total debt is expected to reach $1.22 trillion by 2029, which will need to be paid for by future generations through higher taxes or spending cuts.
Deficit Implications
Successive budget deficits with no prospect of returning to surplus are weakening the fiscal positions of Australia, the US and other developed nations. The net result will be bondholders demanding higher returns to compensate them for the increased credit risk that fiscal deterioration poses.
Governments can rectify this issue through three primary measures: raising taxes, reducing spending or growing the economy.
In Australia, at least, the latter is unlikely, given neither major party brought comprehensive tax reform to the election. Economic growth is also proving elusive.
The likely result will be higher taxes, such as the proposed legislation on superannuation balances above $3 million. Should this become law, we’ll provide an in-depth review of the changes.
Commodities
The RBA’s commodity price index fell for the fifth consecutive month in May, marking what has been a prolonged downturn for the sector. Over the past 12 months, Brent crude prices have fallen 23%, iron ore has declined 13%, in addition to negative returns for nickel, copper and gas.
Oil responded positively to trade talks; however, further supply increases from OPEC+ continue to place a handbrake on a sustained recovery.
Even the gold market cooled in May, as investors rotated into risk assets. Gold fell 0.7% to US$3,278 per ounce.
Currencies
The Australian dollar appreciated against most major currencies in May, supported by positive US-China trade dialogue. China is seen as a proxy for the Australian economy, given our reliance on exporting iron ore, natural gas and coal to the region. Notably, beef exports to the region are up 36% over the past year.
To finish the month, the AUD closed 1.2% higher against the Japanese Yen, with smaller gains against both the US dollar and Euro. It did however close 0.4% lower against the Chinese Yuan.
General Advice Disclaimer: The information and opinions within this document are of a general nature only and do not consider the particular needs or individual circumstances of investors. The Material does not constitute any investment recommendation or advice, nor does it constitute legal or taxation advice. Zuppe International Pty Ltd (ABN 12 628 405 952)
(The Licensee) does not give any warranty, whether express or implied, as to the accuracy, reliability or otherwise of the information and opinions contained herein and to the maximum extent permissible by law, accepts no liability in contract, tort (including negligence) or otherwise for any loss or damages suffered as a result of reliance on such information or opinions.
The Licensee does not endorse any third parties that may have provided information included in the Material. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. Therefore, any stated figures should not be relied upon. The investment return and principal value of an investment will fluctuate so that an investor’s investments, when redeemed, may be worth more or less than their original cost.
