Outlook Overview: Navigating the Turbulence

·       More tariffs will arrive from the U.S. from April with product (car, pharma, semiconductors and lumber) and reciprocal tariffs. President Trump has a 3-part approach to tariffs to raise (tax) revenue; bring production back to the U.S. and get fairer trade deals.  This means some of the implemented tariffs will be permanent.  Combined with the turbulence of tariff announcements, this means a moderate adverse hit to U.S. GDP and a boost to inflation. The impact could be larger if worsening business and consumer sentiment translates into a hit to growth. The 10yr U.S. budget bill will also likely be economically neutral to mildly negative rather than stimulative based on the House bill and the slim majority that the GOP enjoys. The Fed will likely be sensitive enough to the growth slowdown to cut rates in 2025, but we see only a cautious 25bps and then a further 50bps in 2026. 

·       The economic effects on other countries of tariffs are adverse to GDP and likely disinflationary.  Other countries will likely not match the scale or breadth of U.S. tariffs and this will mean a hit to their exports and trade impacting production/income and domestic demand.  It is also difficult to see a major quick shift in global trading patterns occurring, especially as China is seeing restrained growth. This has left us revising down 2025 GDP forecasts in a number of countries and increases our conviction about further interest rate cuts in most DM countries – except Japan where further slow normalization will be evident.

·       Geopolitically the U.S. is also drawing back from Ukraine and Europe, which has sparked a European commitment to increased defense spending (here).  However, most European[DS(1]  countries are more deficit constrained than Germany and Germany’s pace of defense and infrastructure spending is unlikely to be matched.  Meanwhile, our baseline still expects a Russia-friendly ceasefire followed by a peace deal, both as the Trump administration drives a hard bargain to get Ukraine to agree and also as Russia remains opposed to European peacekeepers in Ukraine – the alternative scenario is that the war continues, but without new U.S. support will be tough even if Europe steps up to support Ukraine.  Meanwhile, we still feel that the risk on an invasion of Taiwan in the next 2 years is very low, both as China military is not strong enough and President Xi would invade only if China was assured of success – with the U.S. strategic ambiguity support of Taiwan, invasion is currently a very high risk option.

·       For financial markets, short end government bond yields can see small to modest falls, as actual easing and an easing bias in most countries helps sentiment.  The outlook at the long-end of the curve is more volatile, with the prospect of a 6.5-7% U.S. budget deficit in 2026, though on balance the U.S. economic slowdown should cap yields and also produce a small yield decline.  This is all a tricky environment for U.S. equities and we look for an extended correction into mid-2025, due to the various trade wars and adverse economic hit.  The overvaluation of U.S. equities leaves it vulnerable, especially if any hard landing fears appear.  Other global equity markets will likely follow the U.S. on any selloff, but should outperform the U.S. for the remainder of 2025 – we prefer India equities.   

·       A weaker USD should also be evident against DM currencies, as the Trump administration is biased to a lower value for the USD and given the current overvaluation of the USD.  The USD trends against EM currencies will be more mixed, due to tariff hikes; starting point in currency valuation terms and inflation differentials versus the U.S.  However, we could see some recovery in the oversold Brazilian real that benefit from a high carry versus the U.S.

·       Risks to our views: A hard landing in the U.S. economy would spillover globally in GDP terms.  While this would likely trigger more aggressive Fed easing, it could still prompt a bear market in U.S. equities and a noticeable decline in the USD.