Five key investor questions on US tariffs

Tariff announcements by US President Donald Trump on 2 April triggered strong market reactions. How should investors navigate such economic and political uncertainty and market volatility? We explore five key questions.

1. What is President Trump’s trade agenda? Protectionism or a transitory period leading to a new global trade environment?

President Trump is pursuing a shock therapy for the US economy. US Treasury Secretary Scott Bessent framed US trade in a context of economic “detoxification”. According to the Trump administration, this phase aims to halt the US government’s fiscal stimulus and reduce budget deficits, balance trade and current account deficits and impose deregulation across a number of sectors, including the financial, healthcare and housing sectors. Such a policy implies that the new US trade barriers may persist. How long, exactly, these new tariffs stay in place is difficult to estimate but it is a key factor for the economic outlook. Tariff levels will also be crucial. Much depends on trading partners’ reactions, as well as US trade deficit dynamics. Mr Bessent suggested that countries who retaliate with countermeasures will see their US tariffs rise further. Nations that seek to accommodate and actively reduce their trade surplus with the US in return for lower tariffs (for example through purchases of US defence goods) may see tariff rates fall. We expect Latin American economies to negotiate deals with the US, but for limited periods. Former US Trade Representative Robert Lighthizer recently indicated that agreements should only be put in place for five years given that the balance of trade inevitably evolves.

As the US retreats from an open trade policy to more limited agreements, China may fill the void

Free trade agreements are promoted by countries who dominate global manufacturing. Post World War Two, the US was the dominant global producer of goods, with a share of over 50% of global manufacturing. The US championed free trade through the 1947 General Agreement on Tariffs and Trade, and its successor, the World Trade Organization in 1995. Since accession to the WTO in 2001, China has become the world’s largest goods manufacturer. As the US retreats from an open trade policy to more limited agreements, China may fill the void beginning with its ties to the BRICS+¹ economies. US-China trading relations will likely remain frozen with tariff barriers for longer. Since 2016, China has worked to transform is economy by stimulating domestic demand and so make itself less reliant on exports. Next steps for China include measures that encourage private consumption: China’s private consumption only represents about 40% of gross domestic product, while for most other developed nations that number is around 60% of GDP.

2. Will the US dollar de-value?

The US dollar has dropped in response to the new US tariffs, but remains at the upper end of historic trading ranges against the euro. The narrative that an isolationist US may trigger capital outflows as investors sell US assets, including equities and Treasuries, has gained traction among market participants. This would suggest more substantial dollar weakening, supported by indications that the Trump administration plans to significantly weaken the US dollar in an effort to help rebalance its trade deficits. This is sometimes referred to as a “Mar-a-Lago accord”.

We do not expect a radical US dollar devaluation

We do not expect a radical US dollar devaluation. First, while markets are preoccupied with dollar weakening as foreign holdings of US assets decline, in a dollar-based financial system, global liabilities are far larger. If tariffs lead to a sharper global economic slowdown, the dollar would be expected to appreciate as these liabilities are unwound. Second, we do not think such a “Mar-a Lago” plan is relevant now that the 2 April tariffs are in place, and designed to correct the US trade imbalance. Moreover, adding a plan to devalue the US dollar would only reinforce US inflation and raise US Treasury risk premia. Both outcomes are contrary to the perceived US administration’s interests. Third, should the US trade and current account deficit improve as a result of US import tariffs, the dollar may gain. Structural account deficits like those run by the US for decades are the cause for long-term currency depreciation, as they deteriorate the cumulative net foreign position of the country. When these sources of currency weakening dissipate, currencies strengthen. Fourth, interest rate differentials with other currencies support the US dollar, and will continue to do so through 2025.

We expect the Federal Reserve to cut its policy rate to 3.75% this year, in response to slower US economic growth. The European Central Bank will likely need to ease its policy more, and we expect a terminal rate of 1.5% by end-2025. In this case, the US dollar will retain its interest rate support with a 225 basis point (bps) differential to the euro (EUR). We therefore expect the EURUSD to remain in a broad range of 1.06-1.12 for the remainder of the year.

We expect the SNB to cut interest rates to 0% to cushion some of the US tariff effects on the Swiss economy

Against the Japanese yen (JPY), or the Swiss franc (CHF), we see further dollar weakening. Both currencies are undervalued and act as havens in periods of uncertainty. We therefore see the USDJPY and USDCHF declining below our existing 12-month assumptions of 144 and 0.85 respectively. We expect the Swiss National Bank (SNB) to cut interest rates to 0% to cushion some of the US tariff effects on the Swiss economy. If Switzerland’s trade surplus declines following tariffs, we think Swiss franc strength will be more limited than Japanese yen strength.

3. What is the risk of negative rates again in Switzerland? What about Europe?

We expect the SNB to cut interest rates to 0%. Negative central bank rates might be avoided if the ECB ends its own rate cutting cycle well above Swiss rates, at 1.5%, as we expect. That leaves room for EURCHF to decline more gradually, without forcing the SNB to cut into negative territory again. This said, short- and medium-dated Swiss bond yields will probably continue to fall into negative territory, and there is a risk that 10-year Swiss government bonds approach the zero bound as well. Our 12-month forecast is 0.2%, with downside risks. In the euro area, negative interest rates are unlikely in our view.

4. Are global and US equities entering a bear market?

This year the S&P 500 has fallen 13.7% and the Nasdaq by 19.3%. This follows a year of exceptional returns in both, with the S&P 500 gaining 23.3% and the Nasdaq 28.6% in 2024. A good equity year in the US sees returns of 7% on average. We believe that the excesses in US equity markets have now been unwound, but that we are not in a bear market yet. The risk of a recession has increased following this trade shock. We now see a 50% chance of a US recession, but expect a slowdown rather than outright contraction of US GDP in 2025.

The excesses in US equity markets have now been unwound, but that we are not in a bear market yet

Consumer spending is what matters to the US economy and employment remains solid. The March labour market report was better than expected, adding 228,000 jobs, sharply higher than the 117,000 added in February. Of course this report pre-dates Mr Trump’s tariff announcements, and so we can expect some weakening from here. The US unemployment rate is 4.2%, and as long consumers have jobs, their spending will act as a stabilising force. If household spending power improves thanks to lower energy prices, falling mortgage expenses and tax cuts, consumption may hold up better than consumer sentiment indicators suggest. The state of the consumer will of course also depend on tariff-induced inflation and its persistence.

We now expect 1.2% real GDP growth in the US in 2025. This is materially slower expansion than we had anticipated at the end of 2024 under a different, and more transactional scenario for tariffs. But it is still far from a recession. Therefore we lean against the bear market expectation for now. Volatile dynamics in US equities are likely however. Currently, investor positioning suggests an oversold market in our view. The VIX index, a measure of US stock market volatility, is at a reading of 45 points, indicating high levels of nervousness. This is historically a trigger for a recovery.

The S&P 500 has a strong technical support around the 5,150-5,200 point level. We expect a rebound from here but a gradual approach is key as relief rallies tend to be tested. In the euro area or Switzerland, the US trade shock hits when there is lower growth to begin with. Domestic support mechanisms such as Germany’s public spending plan are only expected to fully unfold from 2026, which means that much depends on the ECB’s monetary policy stimulation in the near term for European markets.

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We expect 0.9% growth in the euro zone, and 0.8% in Switzerland in 2025, with risks to the downside, especially if the European Union decides to impose retaliatory measures on the US, which then triggers additional tariffs from the Trump administration. This may continue to put European and Swiss equities at risk of a sell-off.

There are likely to be rebounds and further sell-offs throughout the rest of the first half of 2025

Overall, we do not believe that global and US stocks have entered a bear market. We see potential upside from current levels, but expect sustained volatility over coming weeks and months, until these major shifts feed into corporate data. There are likely to be rebounds and further sell-offs throughout the rest of the first half of 2025, and a measured approach is key for long-term investors.

5. Are we heading towards another debt crisis?

In Europe, the spectre of unfavourable public debt dynamics is back since French credit spreads caught up with French public debt fundamentals, taking them to levels similar to Spain’s. Germany is using its fiscal headroom to engage in large public spending programmes. This raises Germany’s debt-to-GDP ratio closer to 80%.

German Bund yields have risen following this fiscal shift, increasing borrowing costs for every state in Europe. The French government has signalled that it will let its deficit goal slip if the trade war with the US hurts its economy. We expect that US tariffs will damage the EU’s economy since the bloc is preparing retaliatory tariffs and the US may escalate in response. Budget deficits should therefore rise in Europe, further deteriorating public debt ratios. Still, Italian sovereign five-year credit default swap (CDS) spreads, the cost of insurance against public debt risk, are only at 56 bps. In July 2024, CDS spreads were 80 bps and in 2022 they were above 100 bps. In short, we expect peripheral credit spreads in Europe to widen again. The ECB may act to contain this through purchases, but CDS are likely to respond. This is not to predict a debt crisis. Debt crises happen when there is no ability to fund debt domestically. Current account deficits of European countries are very small, so the ability to fund debt domestically is sound. Current accounts may now deteriorate if trade surpluses with the US shrink. But to reach a debt crisis would take current account deficits of more than 5% or 6% of GDP. We are far from such a scenario.

Volatility in equities looks likely… until the new trade rules feed more clearly into corporate data

The period of multilateral trade led by the US has ended. The BRICS+ countries may now take up the baton of promoting free trade while the US takes a self-centred approach to international trade. In Europe, we see deteriorating debt dynamics but do not anticipate a European debt crisis. Nor do we expect the US dollar to devalue dramatically, but see it remaining instead within broad ranges against the euro and sterling and weakening against the Swiss franc and Japanese yen. Negative policy rates in Switzerland remain unlikely but Swiss high grade bond yields in short and medium maturities will become negative. Volatility in US and global equities looks likely over coming weeks and months, until the new trade rules feed more clearly into corporate data.

For investors, we believe the best answer is to avoid panic and chasing market events (to not panic-sell equities in the eye of the current storm). Clients who have followed our recent strategy change have a cushion in their multi-asset portfolios through the overweight allocation to government bonds we have installed in addition to a reduction in risk exposure we carried out recently by reducing equity allocations from overweight to neutral levels. We see value in taking a long-term perspective when building new positions and look for the opportunities across asset classes that are now emerging in fundamentally solid firms that have experienced unjustifiable sell-offs. Market dislocations such as those seen in recent days offer opportunities, as uncomfortable as they appear now, they will eventually settle down.