Summary
- Massive US tariff hike: this represents one of the biggest tariff increases in the history of the US. It will probably take the effective tariff rate from around 2.5% pre-Trump 2.0 to 22% currently. This is highest level since 1910. The announced tariffs are significantly larger than either we or the market had anticipated.
- Greater risk of a stagflation scenario for the US economy. The upcoming Q1 earnings season as well as business and consumer surveys will be important to monitor in view of the risks for employment and investments. This suggest a more cautious approach to asset allocation in the coming months.
- Elevated uncertainty supports US Treasury bond demand: the trend towards lower yields in the US is likely to persist. Investors will seek refuge in safe-haven assets. We are tactically turning Positive on US Treasuries and have revised our 3-month target for the US 10-year yield to 4%.
- More caution on stocks warranted: the result of yesterday’s tariff announcement is clearly negative for growth on a global basis and even carries the risk of stagflation for the US economy. We downgrade our Equities view from Overweight to Neutral.
- Pressure on US corporate earnings: the effects from the tariff announcements should have negative impacts on consumption while driving up companies’ input costs, pressuring profit margins. We downgrade our view on the US equity market from Neutral to Underweight.
The impact of new tariff measures
The new tariff measures
Our previous scenario incorporated higher US tariffs on Canada, Mexico and the EU (+12.5pp declining over time) as well as a permanent 30pp increase in the effective tariff rate on China (comprised of the 20pp already in place, and 10pp to come later this year). In addition, we expected a 4.5pp increase in the weighted average effective tariff rate on the rest of the world. This rather optimistic scenario was also reflected in asset prices as there was little risk premium observed.
Donald Trump’s announcement on April 2 brought major changes. It represents one of the biggest tariff increases in the history of the US. It will probably take the effective tariff rate from around 2.5% prior to the Trump presidency to 22% currently. This is highest level since around 1910. The announced tariffs are significantly larger than either we or the market had anticipated.
The economic impact of tariffs, retaliation and tariffs uncertainty
Higher tariffs impact economic growth and inflation via multiple channels:
- Higher prices of imported goods sold in the US leading to higher producer price and consumer price inflation.
- Falling purchasing power reducing consumer spending.
- In the event of retaliation, higher tariffs on US exports would hurt US economic activity.
- Sustained uncertainty regarding tariffs (time frame and possible new changes) weigh on both consumer and business sentiment.
We now see a greater risk of a stagflation scenario (low growth and high inflation) for the US economy. The upcoming Q1 earnings season as well as business and consumer surveys will be important to monitor in view of the risks for employment and investments. There is even room for tariffs to move higher in an environment in which other countries decide to retaliate. This suggests that uncertainty related to tariff policies should remain very high for the foreseeable future.
Changes to our investment strategy
The many uncertainties and recent announcements suggest a more cautious approach to asset allocation in the coming months. Our key assumption that tariffs would be used mainly as a negotiation tool is now much less likely to hold. The Trump administration seems determined to keep tariffs high for a long period and to see them as a recurrent source of government income and a means to force the repatriation of supply chains. We believe this will have a negative impact on global growth for at least the next few months. The tariff announcements are also having a negative impact on US inflation. We had initially expected a peak later this year, but that now looks much less likely.
We expect economic growth in the euro area to follow a J-shaped pattern. Indeed, the negative effects of higher tariffs and remaining uncertainties will not be offset by the positive effects of the large infrastructure and defence spending programmes recently announced.
Things are therefore likely to get worse before they get better, both in terms of sentiment and economic growth. The net effect of higher tariffs on euro area inflation expectations is likely to be negative, at least in the coming months. We have already considered a moderate acceleration in inflation over the next few years as a result of the economic stimulus. The negative impact of higher tariffs would more than offset this effect, at least in the coming months (we do not expect any major retaliation from Europe).
Rates, bonds and the US dollar: We do not change our outlook for the Fed and still expect two rate cuts, with a terminal rate at 4%. Inflation pressures will rise but should be temporary. The risks related to a stronger-than-expected fall in economic growth should convince the US central bank to continue cutting rates despite inflation remaining above 2%.
The ECB is still expected to cut rates twice, bringing the deposit rate down to 2%. In the short term, uncertainty remains elevated, and the trend towards lower yields in the US is likely to persist. Investors will seek refuge in safe-haven assets.
Against this backdrop, we are tactically turning Positive on US Treasuries and have revised our 3-month target for the US 10-year yield to 4%.
We see no reason to change our outlook for 10-year government bond yields. Our 12-month forecast remains 4.25% in the US and 2.50% in Germany. We keep our Positive stance on euro core government bonds and eurozone high-grade corporate bonds.
We see two reasons to expect the USD dollar to rebound after the recent weakness: i) Higher US inflation due to increased tariffs will probably lead to fewer rate cut expectations in the US while expectations of a J-curve pattern for the eurozone could lead to expectations of more rate cuts and ii) sustained uncertainty and risk aversion has historically been supportive for the USD. We expect the EUR/USD to fall back to 1.05 and hover around this level on a 12-month horizon.
Equities: As already mentioned, the result of yesterday’s tariff announcement is clearly negative for growth in a global basis and even carry the risk of stagflation for the US economy.
As a result, we revise our long held Positive stance on equites and downgrade our overall view from Overweight to Neutral.
Furthermore, we downgrade our view on the US equity market from Neutral to Underweight. The effects from the tariff announcements should have negative impacts on consumption while driving up companies’ input costs. Thus, profits may face pressure from two sides that does not appear to be reflected in analysts’ estimates.
The still high level on concentration in US mega-cap names is another reason for concern. Valuations are still well above historic turning points and companies could face regulatory pressures in the US while being an obvious target for European retaliatory measures. We stick to our preference for the equal-weighted S&P in the US. Outside the US, we keep our regional preferences but would advise reviewing high exposure to global trade and US tariff sensitivity.
The longer trade uncertainties persist, and these high levels of tariff are kept in place, the more negative the overall consequences will be. We need to monitor closely the recession probabilities, and our favourite indicators are initial jobless claims on the macro side and US high yield spreads (via credit default swaps) on the market side. In case of major changes, another review of the overall equity allocation could seem appropriate.
Q1 2025 Financial markets review
Stock markets: revenge of World ex-US
The rotation from US stocks to world ex-US exposure continued in March, with eurozone stocks registering a +10% return for the quarter while the S&P 500 was posted a 3% loss on the quarter by its mega-cap tech exposure (Magnificent 7 stocks -12% in Q1). The S&P 500 equal-weight index fared better due to its lack of tech bias, flat on Q1 overall.
Eurozone banks continue to lead the charge higher with a 30% Q1 return, while European insurers also impressed with +17%. Poland had the best performance amongst European countries, +31% in euro terms over the quarter as hopes grew for a potential Ukraine ceasefire.
The China tech trade continues apace, with the Hang Seng Technology index (+25% in Q1) driving a 20% quarterly gain for the Hong Kong China Enterprises index. Overall, the MSCI Emerging Markets index managed a 6% gain in US dollars from start-2025.
Lacklustre bonds post German yield reset
The fallout from the German stimulus plan announcement and ratification in parliament has weighed on eurozone sovereign and corporate bonds in March, with the 10-year benchmark German bund yield leaping 0.3% to 2.7%. Overall, Euro corporate bonds are flat for the year, while sovereigns have returned -1% for the year to date. Only Euro high yield credit (+1%) and emerging market sovereign bonds (+2% in US dollars) have eked out positive returns for 2025 so far.
Gold, silver and copper march ever higher
The standout performers across asset classes in Q1 2025 have undoubtedly been gold, silver and copper. Gold and silver have continued their longstanding bull run, with gold making a new all-time high (USD 3073/ounce as at 28 March) and driving a Q1 17% dollar return for gold and a 21% return for silver.
US-listed copper (on COMEX) has been even more impressive at +27% over the quarter, driven by US stockpiling over potential new tariffs on copper imports that has driven the US copper price to a near-15% premium over its London equivalent.
Diversified commodity funds have also performed well as a result – the BNP Paribas Energy & Metals Enhanced Roll index has delivered a near-10% Q1 return in euros, even accounting for the drag from a weaker dollar.
Steady improvement in commercial real estate
The commercial real estate market continues to follow a slow and steady recovery from the valuation reset triggered by the 2022-23 surge in long-term interest rates. According to the European real estate fund association INREV, European unlisted property funds registered a +3% total return in calendar 2024 with a 1.2% return over Q4 2024 alone, boosted by a stabilisation of net asset values and rising rental yields. Residential-focused funds performed best, with a +2.3% Q4 return.
Risk review: what to watch for
US high yield spread flags rising risk
One of our favourite financial market risk indicators, the US high yield credit spread, has widened by over 0.8% to 3.4% since mid-February. There are two ways to look at this spread widening.
The half-empty glass interpretation would highlight that this spread is now at its highest since mid-2024, underlining greater financial risk. This tallies with the US Economic Policy Uncertainty index, which has risen to its highest level since 2020.
But not so high compared to history
The half-full glass interpretation would argue that even at 3.4%, the spread remains very low by historical standards when comparing today’s level to the last 25 years, when the credit spread has averaged over 5%. During periods of real economic stress, such as in mid-2022, the US high yield credit spread has frequently exceeded 5%. By these standards, the current spread is not at all extreme, but rather still well below long-term average.
Other measures of financial stress, such as the Citi Macro Risk index, have also risen since February but remain well below levels that we would consider alarming.
When we look at our composite risk radar of 9 different financial market and economic indicators, we do not see a worrying combination of warning signals at this point. We will watch these closely going forwards, but we do not yet flag the need to reduce exposure to risk assets such as stocks and corporate bonds.
US consumer sentiment is concerning…
The March reading for the University of Michigan’s consumer sentiment survey was worrying, with an aggregate reading as low as the one seen during the 2008 financial crisis and immediately after the 2022 outbreak of war in Ukraine. This reflects a pessimistic outlook from the bulk of US households, who are worried that the avalanche of tariffs will drive prices higher and erode domestic purchasing power.
…but not confirmed by other US economic measures
In contrast, composite measures of US economic momentum such as the Citi US Economic Surprise index are nowhere near recession territory but rather indicate at worst a modest slowdown in US GDP growth to somewhere in the 1%-2% range. The latest US composite PMI (combining readings for both manufacturing and services) calculated by S&P Global, sits in healthy expansion territory at 53.5, well above the 50 break-even level.
Most importantly, it is important to distinguish between “soft” data from surveys and “hard” economic data which measure actual economic activity such as retail sales. If in doubt, one should always lean towards the hard data over survey readings. In this case, March US retail sales ex-gasoline continue to grow at a healthy +3.1% year-on-year pace, not signalling any worrying slowdown in domestic consumption. Clearly, should consumer sentiment remain this depressed for a continued period, then it may well translate into slowing economic activity. But this is not yet the case.
A US and global regime change?
Take Trump at his word
Investors, particularly those in Europe, should heed what Trump supporters say when asked why they like the president:
“He tells it like it is and says what he means”.
Uncomfortable as this might be for a global investor, this is perhaps an appropriate mantra to remember when trying to decode the president’s latest moves on the geopolitical front.
So, when Trump talks about taking control of Greenland and the Panama Canal, and annexing Canada, he likely means what he says. Of course, this doesn’t mean that he will get what he wants. But I believe that investors should take President Trump at his word, rather than trying to find some deeper reasons behind his daily pronouncements.
Why Trump is so focused on tariffs
The blunt truth is that as of 2023, the US maintained a lower level of global import tariffs than virtually any other G20 country. In addition, US manufacturing employment has declined since 2001 (when China joined the World Trade Organisation) from 17.3 million to 12.8 million today, while total US industrial production has not grown since 2014.
With the US current account deficit (value of goods & services imported minus those exported) growing from zero in 1991 to 4.2% of GDP as of Q3 2024, President Trump feels that other exporting nations, such as China have “taken advantage” of US demand in recent years. He thus wishes to redress this trade balance, using tariffs as his main weapon of choice.
Potentially undermining American exceptionalism
If we examine the fundamental reasons for American exceptionalism, we can point to several important facts:
- The US is the largest economy in the world, with dominant industries in technology/internet, consumer-related, health care and energy.
- It possesses the world’s de facto reserve currency in the form of the US dollar, which gives it the benefit of a lower interest rate on Treasury debt as central banks hold the majority of their foreign currency reserves in US dollars.
- It has unparalleled “hard power” through its military might, far outspending any other country. At nearly USD 1 trillion in defence spending, the US spent 6.6 times more than Russia and 3 times more than China on defence in 2024.
- It also has dominant “soft power” through its global consumer and technology brands, cultural exports (films, music) and overseas aid.
To be clear, Donald Trump will not undo all of these unparalleled advantages for the US overnight. But we should ask ourselves whether the US has peaked in terms of the US exceptionalism narrative that has powered the US stock market and the dollar to strong performance in recent years, culminating in stretched valuations.
In terms of the military contribution to NATO, Trump has already been clear in obliging European NATO members to step up their defence spending to exceed 2% of GDP, undermining the US’s hard power.
Arguments for a global rebalancing
Trump wants lower interest rates, a lower dollar
Both President Trump and Treasury Secretary Scott Bessent have underlined their desire for lower interest rates, to reduce the cost of financing the ever-expanding US federal debt burden and to reduce the cost of borrowing for the private sector, thus incentivising investment and growth.
They have already enjoyed some early success in this endeavour, with the benchmark 10-year US Treasury bond yield falling from 4.8% in mid-January to 4.0% currently. However, to encourage a further fall in financing costs, the Federal Reserve would need to reduce the Fed Funds rate from the present 4.25-4.50% range. In our view, this is likely to happen with 2 cuts expected in H2 2025 against a backdrop of softening economic growth.
President Trump has also highlighted his preference for a lower US dollar, which would help in rebalancing US trade and encouraging the relocalisation of manufacturing to the US – one of Trump’s key goals. Since mid-2011, the Broad US Dollar index has appreciated by 39%, presenting an increasing headwind for US exports and cheapening goods imports from low-cost trade partners such as China, Vietnam and Mexico.
The end-February value of the Federal Reserve’s Trade-weighted Real Broad Dollar index sits 20% above its 25-year average. The only time this broad dollar index has ever been higher than today was back in 1985, just before the Plaza Accord was signed in a bid to depreciate the US dollar (which it did eventually by 33% to 1992) against other major currencies.
Investment flows have supported a stronger dollar
Aside from the usual fundamental arguments looking at inflation, growth or interest rate differentials between the US and the eurozone in determining the direction of the EUR/USD exchange rate, we should also consider the substantial influence of investment flows from Europe to the US.
Since the beginning of 2021, USD 1.3 trillion in gross capital has flown from European investors to be channelled into US stocks according to Bloomberg (they now hold over USD 8 trillion in US stocks in total), particularly in mega-cap tech stocks. This involves huge constant selling of euros to purchase US dollars, strengthening the greenback at the expense of the euro. While the Magnificent 7 continued to power outperformance of the US stock market versus the rest of the world, this momentum encouraged even more capital flows out of Europe and into the US, thus strengthening the US dollar versus the euro.
This reflexive momentum can continue until the mega-cap tech stocks stop outperforming, which may already have happened. Over 2025 to date, the Nasdaq 100 has lost 17% and the Magnificent Seven 24% in euro terms, while in contrast, the MSCI World ex-US has gained 2% over the same period, led by a 9% return from the Euro STOXX 50 index. Given the huge buying of US stocks by European institutional investors over the last 4 years, any reversal of this trend can only have begun and could still have a long way to run. Investment bank UBS recently warned that “fading US exceptionalism” could put USD 14 trillion of unhedged US assets held by non-US investors at risk.
Global Chief Investment Officer