The Monthly Pint - NOVEMBER EDITION

The Interplay Between Financial Markets and the Economy

A structured, evidence-based analysis of how financial conditions and economic behaviour influence each other across the cycle.

Financial markets and the real economy are often spoken about as if they operate independently. One is framed as speculative and expectations-driven; the other as grounded in production, employment, and consumption.

In reality, they function as a single ecosystem, where movements in either domain influence and shape the other. Understanding this two-way relationship is fundamental. It enables retail and institutional investors to interpret shifts in bond yields, currency movements, equity volatility, and economic data in a coherent way, rather than as isolated events. This Monthly Pint outlines how that interplay works, what it looks like today, and what it means for the period ahead.

MARKETS AS FORWARD-LOOKING INDICATORS

Financial markets adjust to expectations of future conditions, not current ones.

This is why:

• Equity markets often bottom months before recessions end

• Bond yields peak ahead of inflation peaks

• Credit spreads widen before unemployment rises

• Currency markets markets move well before trade data improves

• Crypto rises with expected liquidity, not current liquidity

  
  

Economic data is backward-looking - it tells you what has happened. Markets are anticipatory - they reflect what participants believe will happen.

This difference in timing explains why market movements often seem “out of sync” with the economy.

HOW THE ECONOMY PUSHES BACK

While markets anticipate, the economy provides the fundamentals.

Economic conditions ultimately determine:

• Corporate earnings

• Capital expenditure

• Household spending

• Wage and employment trends

• Business confidence

• Credit demand

• Housing activity

When the real economy slows, these 'fundamentals' weaken. Markets must then reprice to reflect that reality.

This forms the first half of the feedback loop.

Markets anticipate → Economy reacts → Markets reassess

Today, most developed markets sit in a phase of softening but still stable activity - not recessionary, but clearly past the peak of the cycle.

THE SIX FEEDBACK CHANNELS BETWEEN MARKETS & THE ECONOMY

There are six core mechanisms through which financial markets and the economy transmit signals to each other.

1. Wealth Effect (Markets → Consumption)

When asset prices rise - equities, property, crypto, super balances - households feel wealthier and spend more.

When prices fall, consumption tightens, especially discretionary spending.

This channel is immediate and powerful.

2. Borrowing Costs (Yields → Housing → Corporate Financing)

   
   

Bond yields determine the cost of borrowing across the economy.

Higher yields = higher mortgage rates, reduced credit activity, slower business investment, weaker housing turnover. Lower yields = the opposite.

This channel is visible in Australia now: higher rates have restrained housing affordability and borrowing.

3. Credit Conditions (Spreads → Hiring → Investment)

Credit spreads are a sensitive measure of risk sentiment. When spreads widen, firms freeze hiring and delay investment. When spreads tighten, economic expansion resumes.

Credit leads labour markets - often by months.

4. Currency Movements (FX → Trade → Inflation)

FX affects: export competitiveness, import prices, inflation dynamics, commodity revenues, travel and tourism flows

AUD–USD is tightly linked to global commodities, China’s growth profile, and relative interest rates.

5. Financial Conditions, Confidence & Real Activity

Equity prices, spreads, volatility, credit availability - all influence confidence and sentiment.

High confidence supports stronger hiring and spending. Low confidence suppresses activity and increases precautionary saving.

Sentiment is a legitimate economic input.

6. Liquidity (The unifying variable)

Liquidity — the flow of money and credit — acts as the bridge between markets and the economy.

High liquidity supports asset prices, risk appetite, consumption, and borrowing. Low liquidity tightens financial conditions and slows economic activity.

In 2025, liquidity is stabilising but has not yet swung into a strong expansionary phase. That remains a Q1–Q2 2026 theme.

WHERE WE ARE TODAY (LATE 2025 SNAPSHOT)

Growth: slowing but not contracting

Inflation: falling, but services sticky

Labour: cooling, not collapsing

Policy: at or near terminal rates globally

Liquidity: sideways, awaiting improvement

Equities: narrow leadership, still resilient

FX: USD firm; AUD range-bound

Crypto: constructive accumulation behaviour

This is a classic late-cycle environment trending toward a soft landing.

6. OUTLOOK FOR THE NEXT 6–12 MONTHS

The chart below is the S&P500 overlaid with the Manufacturing index (USBCOI - Institute for Supply Management). The ISM provides a monthly snapshot of whether the economy is growing or tracking where >50 = expansion, <50 = contraction but the change in direction is more important than the absolute level.

Base Case (Most Likely)

• Growth cools gradually

• Inflation continues to ease

• Yields stabilise and trend lower

• Liquidity improves in early–mid 2026

• Equity performance broadens beyond megacap tech

• Crypto remains constructive

• AUD strengthens modestly

This is a stable, low-volatility path.

Upside Scenario

• Faster disinflation

• Resilient labour markets

• Earlier policy easing

• Stronger liquidity flows

• Risk assets outperform

• AUD appreciation

• Accelerated crypto inflows

Downside Scenario

• Labour market deterioration

• Persistent services inflation

• China underperformance

• Credit spread widening

• Housing turnover slowdown

• AUD weakening

Not the base case, but worth monitoring.

SO IF YOU’RE

If you’re a long-term investor

market volatility doesn’t negate long-term positioning. Markets lead - data lags.

If you’re trying to decode headlines

distinguish between backward-looking data and forward-looking prices.

If you’re concerned about softer growth

late-cycle cooling is expected, not alarming.

If you’re Australia-focused

strong population growth, tight housing supply, and resilient employment continue to anchor domestic stability.

If you’re building crypto exposure

crypto is aligning with early-cycle positioning: constructive, orderly, liquidity-sensitive.

If you’re monitoring inflation and rates

policy relief is more realistic in 2026 than 2025.

(These are behavioural frameworks, not recommendations)

PINT-SIZED SUMMARY

The relationship between markets and the economy is not linear. It is a dynamic feedback loop in which expectations and fundamentals continuously shape each other. Markets look ahead; the economy responds; liquidity binds the connection.

Today’s environment reflects a late-cycle but stable equilibrium: slowing activity, moderating inflation, firm employment, and markets positioning for the next policy phase.

Understanding the interplay allows investors to interpret movements rationally, rather than react emotionally to lagged data or short-term noise.

Markets lead. The economy follows. Liquidity ties the two together.

Slow pours. Clear thinking.