What should investors make of US tariffs?

At the time of writing, markets have generally reacted negatively to President Trump’s announcement, with both equities and bond yields moving lower, reflecting growth fears. US risk assets are bearing the brunt of the impact, having markedly underperformed so far in 2025, and market volatility has risen sharply. Meanwhile, the US dollar is weakening, as are oil prices.

While there is some scope for negotiation, both we and the market now expect tariff levels to remain high for the rest of the year. A quick poll this morning from Goldman Sachs suggested over 90% of investors had increased their recession probabilities for the year ahead.

This year serves as a reminder of how difficult it is to predict both short-term economics and markets. The low implied volatility coming into the year, and strong positive equity returns to mid-February, highlight how quickly market narratives can turn around. 

Overall, our circumspect economic outlook and associated market positioning have been rewarded. But we continue to caution against having undue confidence in any single outcome.

What’s been announced?

Wednesday’s announcement by the US administration outlined a universal 10% tariff across all trading partners, starting imminently, with much higher rates on around 60 trading partners including China (34%), Japan (24%) and the EU (20%). The UK has fared well in a relative sense, facing just the baseline 10% tariff. 

Furthermore, some of the tariffs appear to be in addition to existing tariffs, although we await further details. For example, China looks to face an effective tariff rate of greater than 54% because of 20%+ pre-existing tariffs. 

With this much-anticipated announcement now made, the ‘event risk’ has passed and in theory the point of maximum uncertainty is behind us, with greater clarity around tariff levels. But in practice, we are not so sure that uncertainty will dissipate quickly.

What’s the economic impact?

Economists had already made some significant adjustments to their US growth forecasts in anticipation of these tariffs. Although recession probability forecasts had risen in recent weeks, we believe they are now likely to be revised even higher. 

Our economists now estimate a further increase in the probability of a US recession over the next 12 months, and are monitoring a wide range of signposts to assess this risk. The headwinds to growth from trade disruption, uncertainty and reduced confidence could all potentially combine to have a much larger impact than suggested by estimates based on the direct cost of tariffs alone.

That said, the reaction of businesses and consumers can be hard to predict. To avoid a US recession, we believe we would likely need to see a combination of tariff rollbacks, a limited response from trading partners, or domestic US fiscal stimulus that is passed quickly enough to mitigate the impact of the tariffs. There are also wider policy considerations weighing on potential growth, such as immigration restraint and job security threats for Federal workers. 

In terms of inflation, while there is still a chance that exporters absorb the costs of tariffs, we believe the blanket approach makes it more likely the cost is passed on as substitution as trade diversion becomes challenging in an environment when everyone is tariffed. Meanwhile, the value of the US dollar has fallen this year, balancing the argument that tariffs will not cause higher domestic US prices because the dollar will appreciate.

Is this the end of US exceptionalism?

Today’s falls in US equity prices follow the worst quarter of relative performance of US stocks versus the rest of the world since 2002. Of course, it’s too early to tell if these market moves spell the end of US exceptionalism. 

But US equities did start the year as investors’ favourite asset class, so some of the recent price action probably represents a clearing of very skewed investor positioning and relatively high starting valuations. Future returns will likely require more material changes to the earnings outlook, which will take longer to come through. 

On the positive side, tariff revenues could be recycled back into larger tax cuts. Fiscal stimulus through tax cuts and deregulation have taken a back seat in the macro narrative and may return to the foreground as a result, potentially providing support for the economy and markets.

What are we doing in portfolios?

In the Asset Allocation team, we believe diversification[1] can help to act as risk management by design, ensuring we are not overly exposed to any one asset class, region, or economic scenario. While in the past we have adjusted strategic asset allocations of the back of significant macro regime change (for example post-Brexit), we don’t see the uncertainty around future US policy as meeting the threshold for targeted changes yet.

Part of our more diversified approach extends to equity allocations, where we typically have a lower strategic allocation to US equities than concentrated market cap indices. The recent divergence in performance, away from the US, therefore, has acted as a natural relative tailwind for our approach this year, but follows a long period of US outperformance.

For portfolios with more dynamic positioning, we were positioned with a cautious bias ahead of the announcements. This was expressed with a negative view on credit and a positive view on sovereign bonds. With credit spreads at historically tight levels earlier this year, we saw the return potential from the asset class as asymmetric, with little upside potential and more significant losses possible in risk-off scenarios.  

For risk exposure, we prefer the potential upside of equities. For fixed income exposure, we prefer the potential safety of government bonds. That said, with yields moving lower on sovereign bonds today, and the possibility of inflationary scenarios rising, we are reassessing our positive duration view as we believe the asset class may be less well supported going forward.

In currency markets, we have been leaning against the strong US dollar narrative for a number of months, with a continued preference for the Canadian dollar and Mexican peso. At the start of the year, there was much love for the US dollar that we simply did not share. 

Focusing on delivering long-term value

While the market landscape is shifting, we believe our diversified approach and strategic positioning can provide a robust framework to navigate the uncertainties. We are committed to managing portfolios that aim to be well positioned for potential opportunities, regardless of the prevailing economic conditions. 

As always, our focus remains on delivering long-term value for our investors through careful management and strategic agility.

 

All information as at 3 April 2025, Source L&G.

Assumptions, opinions, and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass.
 
[1] It should be noted that diversification is no guarantee against a loss in a declining market.