This week we spoke to our consulting economist, Andrew Hunt, who has just returned from extensive meetings with U.S. investment banks and U.S. officials with an increasingly cautious assessment of global economic prospects. His message: the world may be on the cusp of a severe slowdown, with significant implications for Australian investors.

The U.S. Credit Cycle Has Turned

Hunt's central thesis is that the U.S. domestic credit cycle is over. U.S. banks are now shrinking their balance sheets, something he has only witnessed a handful of times in forty years. Investment banking arms are facing liquidity constraints for the first time since 2018, with head offices no longer willing to write unlimited cheques for client credit. Compliance departments have become energised amid concerns about private credit quality, covenant issues, and emerging fraud, drawing uncomfortable parallels with 2006 when domestic institutions began disengaging from the mortgage market before the Global Financial Crisis.

The critical question now becomes whether foreign capital flows will continue to fund American markets. Much as European banks perpetuated the U.S. credit cycle in 2006-2007 after domestic institutions retreated, Hunt sees recent U.S. market strength as dependent on massive foreign inflows, particularly from China. However, these flows are becoming erratic, with Chinese private sector capital outflows having fallen by a third to forty percent in recent months.

China: The Missing Catalyst

China's role in global capital markets has shifted dramatically. While running a massive current account surplus, the private sector is no longer recycling those proceeds into foreign assets. The People's Bank of China has stepped in with substantial foreign exchange intervention to prevent currency appreciation, but geopolitical tensions mean these flows are being directed away from U.S. Treasuries toward European and Japanese bonds. This circuitous funding mechanism, whereby Chinese purchases of European debt frees European investors to buy U.S. assets, is becoming increasingly fragile.

Meanwhile, China's domestic economy faces its own challenges. Fiscal policy, which provided support in early 2025, has now tightened. Local governments are reducing spending to facilitate debt repayment, creating a fiscal contraction that threatens corporate cash flows and the broader growth outlook.

Australia: Storm Clouds Gathering

For Australia, Hunt sees a choppy near-term outlook despite the economy appearing resilient through most of 2025. Looking backwards, there was no case for RBA rate cuts—capital inflows, China's fiscal expansion, and population growth had supported activity. Looking forward, however, a China slowdown coupled with disrupted capital flows could trigger a rapid deterioration. Rate expectations may fall dramatically as deflationary pressures emerge, though this would coincide with trade and balance of payments shocks.

On a longer horizon, Hunt is more constructive on Australia's prospects. The country has credible monetary and fiscal frameworks, population growth, and importantly, a policy conversation about productivity that is absent elsewhere. This positions Australia as a potential relative outperformer over the coming decade.

Investment Implications

Hunt's framework suggests all roads ultimately lead to inflation, but investors must first navigate a deflationary scare. His favoured scenario sees the U.S. credit cycle weakening, capital flows being interrupted, and a subsequent aggressive policy response including quantitative easing by 2026, becoming inflationary by late 2026 or 2027.

In this environment, Hunt counsels a more defensive near-term positioning while maintaining exposure to real assets for the inevitable inflationary phase. Traditional inflation hedges—index-linked bonds, property, and industrial commodities—become essential portfolio building blocks. Within equities, he favours under-owned companies with cash flow and cost control over crowded theme stocks, noting that buy-and-hold strategies in quality small companies historically survive inflationary periods better than active trading. Serendipitously, this very reflects our own positioning at present and some incremental changes  that we already started to make post an internal IC last week (we promise we didn’t put him up to it!)  

This doesn’t mean investors need to run for the hills, but maybe it is worth thinking about taking some chips off the table and keeping an eye out for a deterioration in monetary and credit conditions. The key signals to monitor include Chinese currency movements, foreign exchange reserves, European debt investor behaviour, and liquidity conditions at the fringes of financial markets. As Hunt notes, when the tide turns, it drains first from the creeks and estuaries before the main channel and those peripheral warning signs are starting to glow amber.