Ending with ‘Liberation Day’, a new tariff regime destined to send the world into an economic tailspin, Q1 2025 was a Trump-focused quarter – and presumably the US president would not have it any other way. If investors had hoped the announcement of tariffs would bring any clarity for businesses and policymakers, they would have been disappointed. This quarter is likely to be characterised by ongoing uncertainty.
Nobody has ever tried to impose tariffs on the scale Donald Trump has announced. At the same time, he has made it clear that tariff levels are open for negotiation – though, in keeping with the prevailing mood music, the terms of that negotiation are not entirely clear. This has left economists flailing: tariff levels are subject to change at a moment’s notice, how countries will retaliate is unclear and the ultimate impact on demand for goods and services is near-impossible to forecast.
Most agree it is unlikely to generate the speedy revival in US manufacturing Trump has promised and that the US economy is vulnerable in the near term. “In early February, we increased our stagflation probabilities, and in early March, we increased our ‘recession in the US probabilities’,” says Salman Ahmed, global head of macro, at Fidelity International. “The driver behind that is the tariff policy: with the uncertainty around implementation – one day in, one day out – we think that can produce a significant drag on both the business and the consumer sides of the economy.”
Ahmed concedes that ‘hard’ data in the US has been quite resilient- including the latest round of job numbers – but believes this is unlikely to last. “There is a lot of front-running happening – particularly in the transportation and equipment categories,” he continues. “The US will be fighting cyclical recession risk, if this uncertainty continues. This kind of sustained uncertainty, where tariffs are used as a negotiating tactic, will play more significantly in the months ahead. We think the US economic backdrop will take a significant hit as a result.”
There is also likely to be a tussle at the US Federal Reserve. The tariffs may create inflation – while consumer inflation expectations are already at highs not seen since the 1990s – but may also depress growth. The bond market appears to have decided the Fed will err on the side of the economy and drop interest rates but, at the risks of being repetitive, this is by no means a certainty.
And beyond the US?
The impact on the rest of the world is more difficult to judge. In general, no-one does well when the US economy starts to slide but, that said, there are reasons to be more enthusiastic about Europe. Inflationary pressures are not as acute. It is the one area with the economic might to stand up to the US, and countries have announced fiscal spending plans. In particular, Germany has relaxed its long-standing debt brake and announced a €500bn (£429bn) programme of spending.
“We are already seeing some pick-up in credit growth in Europe,” notes Ahmed. “Cuts by the ECB are starting to help. There are some initial signs of a turning point. All the tariff uncertainty has not affected Europe in the same way so far. European soft data remains quite resilient.”
For his part, William Davies, global chief investment officer at Columbia Threadneedle, is more cautious. “If you look at the potential fiscal boost in Germany, it could be over 2% of GDP going forward – half from defence spending and half from infrastructure,” he says.
“This is all great – but I remember when the Berlin Wall fell and people were talking about a peace dividend, saying military spending could be reinvested and would accelerate growth. Military spending may not provide the multiplier effect that other types of spending can deliver.”
And how vulnerable is Europe to a cyclical slowdown in the US? “We are already seeing this cycle shaping up differently,” says Ahmed. “The US is a big economic partner to Europe and the US consumer is important for the economy, but we think the European fiscal pivots are real and sustainable. The ECB is also cutting rates, which may not happen in the US.”
“The bond market appears to have decided the Fed will err on the side of the economy and drop interest rates but, at the risks of being repetitive, this is by no means a certainty.
Asian strength
China’s position will be important to watch – and the world’s second largest economy has reduced its dependency on US exports for the time being, which will have contributed to its decision to introduce retaliatory tariffs. Chinese policymakers are hoping the recently-announced fiscal stimulus measures will offset the impact of US tariffs. These measures have been designed to support consumption and shore up growth. The early signs are promising, with PMI data showing growing confidence among Chinese companies.
There are, as one might imagine, caveats – for example, Davies points to China’s ongoing flirtation with deflation, which can be “very tough to come out of”. On the other hand, he points to companies such as Deep Seek and BYD as a stark reminder of the technological prowess of China and the opportunities it offers to investors as a result.
Amundi believes this technological strength will power much of Asia from here, with Monica Defend, head of the group’s Investment Institute, noting: “Asia’s growth premium is likely to persist, fuelled by technological advancements that are reshaping economies and creating substantial investment opportunities. With a strong commitment to innovation and a young, tech-savvy population, the region is positioned as a leader in the global tech landscape.”
“Asia is a powerhouse in the technology sector, leading in various fields,” she continues, picking out China and Vietnam in manufacturing and supply-chain technology; South Korea and Taiwan in semiconductor production; India in fintech innovations and financial inclusion; and the continent more generally in e-commerce. “In 2023, Asia accounted for 76.6% of World IT Goods Exports and 33% of World IT Services Exports, with China and India respectively leading the two segments,” she adds.
Interest-rate cycle
The prevailing gloom on the impact of Trump’s tariffs on the global economy could be tempered by interest rate cuts. Although investors have feared higher rates, it is clear that bond markets are now expecting rates to fall in the longer-term. The US 10 year treasury yield has slipped below 4% for the first time since October of last year.
“The central banks of the US and UK have been reticent about cutting interest rates as inflation has remained higher than would be preferred,” says Neil Birrell, chief investment officer at Premier Miton. “In the Eurozone, however, inflation has been better behaved, and interest rates have fallen a bit faster.
“Therefore, if economic conditions do deteriorate, there is plenty of scope for rate cuts here and in the US to provide support and stimulus – and that would be taken well by investors. My view, for what it’s worth, is that this likelihood is increasing, and we will see more interest rate cuts than are currently expected this year and next – a case of ‘bad news equals good news’.”
It is difficult to see how markets can make significant progress against a difficult and uncertain backdrop – as Birrell says, “it is hard to see many winners, other than on a relative basis”. Moves from central banks may support markets temporarily, but any enduring clarity seems unlikely over the next quarter.
Nevertheless, there are still points of interest around the world – from defence and infrastructure spending in Europe, to technology strength in Asia. These areas may receive more attention from investors as the mega-cap technology trade unwinds. In the meantime, investors will be bracing themselves for a volatile few months.
