Markets are pricing in a 30 per cent chance of a fifth rate cut this year at the RBA’s December board meeting, which has resulted in a probability-weighted year-end cash rate that is circa 3.23 per cent (or bang-on Hauser’s neutral number).

Confidence in the need to normalise interest rates has been underpinned by the recent jump in the jobless rate from 4.1 per cent to 4.3 per cent, which implies that the tightness in the labour market may be abating somewhat.

This has doubtless been facilitated by robust immigration-led population growth that is continuously expanding the supply of skilled labour. Population growth is running at 1.5 per cent on an annual basis, which is a bit above its trend in the 1990s and 2000s.

An interest rate cut from the Fed in September is a much more line-ball call with market pricing implying a 43 per cent probability that it pulls the trigger at the central bank’s next meeting.

There are about 33 basis points of cuts priced by the end of the year, which is slightly more than one standard 25-basis-point move. During the week, the Fed held its July board meeting and resolved to keep its cash rate unchanged at the 4.25 per cent to 4.50 per cent range.

The event was not, however, without considerable controversy. For the first time since the early 1990s, two governors dissented and instead voted to reduce rates. The dissidents in question were both appointed by President Donald Trump.

One, Christopher Waller, is also a candidate to replace the current chair, Jerome Powell. He has won some credibility for correctly predicting that the pandemic-induced spike in inflation would dissipate without precipitating a large increase in unemployment.

It is important to note here that both the Fed and the RBA are set for very shallow cutting cycles that would take their policy rates to a more normal footing.

In both countries, there are grounds to be cautious about securing sustainably low inflation.

In the US, there has been a slight pick-up in core inflation, driven by tariff-led goods price increases, although it is tracking below the Fed’s forecasts. Underlying services inflation has also been well-behaved.

While the market is unsure about whether the Fed will lower rates in September, we believe it will do so due to a stagnation in consumer spending.

In inflation-adjusted terms, US consumer spending has not increased at all in the first half of 2025, which is a dynamic that ordinarily only prevails during a recession or sharp downturn.

“Core inflation undershooting the Fed’s forecast combined with the pronounced weakness in consumer spending suggests that the central bank should resume cutting rates in September,” argues Kieran Davies, Coolabah Capital Investments’ chief macro strategist.

“The Fed would also be comforted that most measures of inflation expectations remain contained,” Davies says.

Having said that, the US unemployment rate remains very low at 4.1 per cent and is actually inside the Fed’s estimates of the level of joblessness that corresponds with sustainably low inflation.

And wages growth remains a touch above its pre-pandemic pulse. With population growth in the US slumping to its weakest pace in the history of the republic, care of Trump’s war on illegal migrants, the risk is that labour costs start inflating at an excessively strong rate.

Here in Australia, we may benefit from disinflation as global exporters dump cheap goods on our shores. And plentiful labour supply is keeping a lid on wage growth. Yet the rampant crowding-out of private activity by never-ending public spending is creating a productivity crisis that could ultimately spawn a very high-cost economy.

The trade war also threatens extraordinarily stretched US equity valuations that afford historically very skinny excess returns over the risk-free rate. Our analysis of Trump’s tariffs finds that US consumers and businesses have borne almost all of the brunt of these taxes.

“To date, US trading partners appear to have absorbed none of the cost of Trump’s tariffs based on observed movements in import prices, although that does vary by country,” Davies warns.

“If trading partners had absorbed some of the impact of tariffs by cutting prices, it should be reflected in lower US import prices, where published import prices are measured excluding customs duties,” Davies continues.

“However, the total US import price index, excluding energy, is basically unchanged from January, which suggests that US firms and/or households have paid the full cost of the new tariffs.”

We estimate that the effective tariff rate in the US, which measures the ratio of tariff revenue to the value of imported goods, has climbed from 2.5 per cent to 10 per cent.

If Trump implements all announced tariffs, that will increase to 20 per cent based on the generous assumption that US trading partners (rather than US consumers/businesses) absorb one-tenth of the cost of these duties.

That would generate roughly US$600 billion ($932 billion) in annual tariff revenue, which represents one-third of the annual US budget deficit. It’s a big deal. (Of course, there may be some substitution effects away from tariffed goods that erodes these revenues.)

“To put this in perspective, the new effective tariff rate would be close to the 24 per cent peak briefly reached during the Great Depression of the 1930s on the back of the disastrous Smoot-Hawley tariffs,” Davies says.

It is, therefore, tantamount to a chunky tax increase: on our figuring, tariff revenue will rise from one-quarter of a per cent of US GDP to about 2.25 per cent of GDP.

What equities investors appear to be overlooking at present is how this could hammer US business profits. Since goods prices have only appreciated modestly, we believe that it is businesses (rather than consumers) that are wearing the cost of these levies.

And as the effective tariff rate escalates towards 20 per cent, it could reduce small business and corporate profits by as much as 10 per cent a year.

“For its part, the US stockmarket appears to be assuming that firms will eventually pass on the cost of tariffs to households,” Davies comments.

“Equity analysts do not think that tariffs will dent forecast strong growth in earnings – at least over the next year or so – although they do tend to be inherently optimistic.”

We’ve extended the usual equity risk premium model to Aussie bank stocks. And the news is not pretty. On our numbers, major bank equities normally pay a 6.2 per cent premium in terms of their expected one-year forward earnings over the real yield on their bonds.

This has plunged by about half to just 3.3 per cent at the time of writing. That in turn implies major bank stocks are 44 per cent overvalued relative to the yields offered on their bonds.