According to the RBA, Australia is reasonably well set up to absorb potential shockwaves from a volatile global economic environment. But best to fasten seatbelts, just in case.
Twice each year, Australia’s central bank publishes an assessment of the resilience of the domestic financial system and potential risks to financial stability. The good news, according to the October 2025 Financial Stability Review, is that the Reserve Bank sees our financial system as “well-positioned” to deal with negative shocks. It reckons Australia’s banking system is in “good shape” with our banks able to absorb large loan losses “supported by a long period of prudent lending standards, the high quality and quantity of bank capital and significant holdings of liquid assets”.
Risks posed by other financial institutions (including non-bank lenders, insurers and superannuation funds) “remain contained”. And further underpinning a largely positive assessment is the judgement that Australian households and businesses “display a high level of resilience overall, with many well-placed to weather a downturn should it occur”.
So far, so reassuring. However, where the Review sounds less sanguine is in its take on the prevailing global macro-financial position. Here, the RBA warns that while the international financial system has remained stable, it now faces elevated uncertainty due to a rapidly changing environment. As a result, it has become “increasingly vulnerable to potential disruptions”.
Global financial market volatility peaked in April this year, following the “Liberation Day” announcement of surprisingly large increases in US trade protection. The immediate market reaction included sudden and sharp falls in share and commodity prices, a parallel increase in market volatility, some abrupt exchange rate movements and a spike in concerns over market liquidity. Yet the disruption proved short-lived. The Trump administration paused the introduction of tariffs for a month and financial markets quickly stabilised. The RBA’s assessment of this period is that the Australian financial system “weathered the episode reasonably well”.
Since that early bout of market turbulence, global financial conditions have eased significantly. Despite persistently higher US tariffs and elevated trade policy uncertainty, the most recent Bank for International Settlements Quarterly Review notes that in the aftermath of the April shock, markets shifted to risk-on mode. Global equity markets soared, led by record high US share prices. Corporate credit spreads narrowed, with the past month seeing US spreads fall to their lowest since 2007. And crypto has been on a tear, with estimated crypto asset market capitalisation approaching record highs of around US$3.9 trillion, as of September this year. Other indicators of a robust market risk appetite include increased issuance of high-yield debt and a rise in private credit deals.
Volatility drivers
What has driven this extended bout of market exuberance? Several factors seem to have been at work.
First, there were likely initial elements of a relief rally, as the global economy proved surprisingly resilient through the first half of this year. Some of this seems to have reflected the front-loading of trade and production ahead of incoming tariffs. Some of it was the result of the limited degree (at least to date) of any trade policy retaliation beyond Beijing. And some of it was caused by the time taken for the full effects of trade disruption to work their way through the international system.
Second, broader economic activity has been reinforced by fiscal support in China, an AI-related investment boom in the US (on one count, the rapid rise in IT investment accounted for all of US GDP growth in H1 this year), and anticipated increases in defence spending — particularly European.
Third, markets are betting heavily on the transformative possibilities of AI. Last month, the Economist magazine calculated that since the release of ChatGPT in 2022, the value of the US share market has risen by US$21 trillion, with just 10 firms — all associated with AI-plays — accounting for 55 per cent of that gain.
Fourth, actual or anticipated monetary policy easing in response to easing inflationary pressures has provided additional support for risk-on sentiment.
Fifth, a now-typical risk-on crypto rally has been supercharged by the presence of a crypto-friendly US administration. This is evidenced, for example, by President Trump’s signing into law of the GENIUS Act in July, with its declared aim of making “America the undisputed leader in digital assets”.
Caution required
All of which has left international financial conditions in a very different place relative to the brief period of turbulence seen back in April. Yet as the RBA has now reminded us, there are good reasons to be cautious.
For a start, there is the sheer scale of the exuberance on display. International economy watchers, including in the latest OECD Economic Outlook, are highlighting the risks associated with stretched equity valuations and compressed credit spreads. With markets seemingly priced for near-perfect outcomes, the danger of a downside surprise looms large, threatening a significant re-pricing of financial risk and a brutal market reaction. Moreover, that possibility seems particularly relevant given that macro hazards have far from vanished. The risks associated with the shift to a very different global trading regime remain and will play out over an uncertain time horizon. The disinflation process — and the expectations of further rate cuts that hinge on it — face potential headwinds in the form of higher food prices and sticky services inflation. Geopolitical events could yet further complicate the picture, particularly if they were to involve adverse implications for energy prices. Sovereign fiscal risk also persists in an environment of large budget deficits and elevated debt stocks.
Another risk relates to that dramatic surge in share prices for technology stocks. Bubble-like conditions have generated increased market concentration risk. This is such that a negative development at the level of an individual firm could now threaten broader market disruption.
Finally, the growing connectivity between the still highly speculative crypto sphere and the traditional financial sector represents another important source of contemporary financial risk.
It is just as well then, that the RBA judges us to be “well-positioned” to deal with shocks. We may yet need to be.
This article first appeared as 'Shock treatment' in the November 2025 Issue of Company Director Magazine.
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