Introduction
In 2025 the global economy has been characterized by new governments, continuation of conflicts, escalations of new conflicts, global asset volatility, and unmeasurable uncertainty – how did we get to this point? More importantly, where do we go from here? The main catalyst of recent commotion was President Trump’s “liberation day”. Trump imposed tariffs on most global trading partners for the US, completely shifting the landscape of the global economy and disrupting global world order. The shocking magnitude of the somewhat expected restrictive policies spurred worldwide growth and inflation scares, putting a big question mark on corporate earnings and asset valuations worldwide. Coupled with continued conflicts in Russia and the Middle East, and an escalation of tensions in the India/ Pakistan border, supply chains and the state of the global economy are a crossroads which is proving difficult to navigate.
Tariff Mayhem
Since election day, getting an overall picture of market outlook amid Trump’s back and forth has proven to be next to impossible. We have come a long way from the beginning of the year when bets were placed on a new era of US exceptionalism to now tariffs threatening that post. April was a month of mixed market reactions, with overall mid May numbers paring those of early April. Following Trump’s introduction of tariffs on April 2nd, the S&P 500 saw a 12% decline through to April 9th when these tariffs were paused. Ensuing this week was a lot of market uncertainty and turmoil which was felt deeply by all asset classes. Equities in the US – most susceptible to drawbacks from tariffs – saw an especially shaky April with overall stock exposure tumbling to the lowest level since 2020. Overall, about $24.8 billion was redeemed from funds focused on American equities in the past 4 weeks, signalling a 2 year high.
Despite tariffs having the potential to reduce US GDP by 2-3% and increase inflation by 1.5%, we have seen somewhat of a recovery in May so far, following a positive slew of economic data from the US. NFP data printed 177,000 jobs were added in April, above forecasts of 120,000 and the Fed recently unanimously voted to hold rates – both signs pointing to a more stable environment going forward. Following this, trades that got crowded in April such as shorting the US dollar, betting against equities, and wagering on higher market volatility, are becoming vulnerable with the S&P 500 erasing the previous month’s losses and the dollar nudging up over the past weeks. Also, observing what happened in Trump’s first term, steel was hit very early on and the same has happened now. The US is now trying to protect what has now become a very strong steel industry, which has the potential to do well but this is a tiny part of the economy – there are way more parts of the economy that use steel in production than that produce steel.
In the diagram below, we see that the US is currently lagging behind the rest of the world, with the S&P 500 rally hitting a wall ahead of US-China talks beginning this weekend, showing the market remains extremely reactive to trade headlines.
Meanwhile in the credit market, after an initial slump from investors turning sour on risky credit, high yield US bonds have recouped their April losses and IG bonds have been little changed. Treasuries declined as investors became more risk tolerant due to job market data and the publication of a US-UK trade framework leading to higher yields on 2 to 10 year bonds with the yield curve slightly flatter amid dearth of catalysts. The number of rate cuts priced in fell from 4 at the end of April to 3 now.
The Pause
Implementation of reciprocal tariffs caused market turmoil and recession fears, leading to Trump coming under massive pressure to reverse course. One leading reason for originally implementing tariffs is to eliminate the US trade deficit, which Trump argues is a result of barriers to trade, though the 90 day pause gives countries the opportunity to negotiate trade agreements. Overall, renegotiating all trade agreements is improbable as such agreements usually take months/years to construct – currently, Trump’s team has set a list of roughly 20 partners as the focus of early negotiations (eg Japan, South Korea, Vietnam and Switzerland). These are all top sources of US imports where Trump wants to shrink the trade deficit. Also included are comparatively minor partners eg Fiji, Lesotho, Mauritius and Madagascar where, for example, the US imports more from Japan in 1 day than from Lesotho over the whole year.
The overarching goal is to establish templates for quick deals with other countries and prioritise lower profile countries to set an example for others. Countries are incentivised to strike a deal with the US since it is such a big & important partner both in trading and in defense.
Trade negotiations beginning this weekend between the world’s two largest economies are highly anticipated by the market, though it is expected these are the first talks of many before an agreement may potentially be reached. China is the primary target of Trump tariffs because it engages in unfair trade practices, such as targeting favoured industries with huge state subsidies or forcing foreign companies to share intellectual property in exchange for access to its vast market. Despite this, the average member of S&P 500 made 6.1% of its revenue from selling to China in 2024, with trade between the two nations totalling $700 billion throughout the year, also representing the highest deficit of the US with any country at $295 billion in 2024 (probably bigger due to imports under the de minimis loophole not being counted). Last year, the 3 biggest US imports from China were smartphones, laptops and lithium-ion batteries while liquid petroleum gas, oil, soybeans, gas turbines and machines to make semiconductors were exported from the US to China. Up to 90% of such bilateral trade is susceptible to being erased if an agreement is not reached, following Chinese reciprocal tariffs of 125% against 145% from the US.
Tariffs were initially calculated by dividing a given country’s trade surplus with the US by its total exports to the US and halving that number.
In such an uncertain and changing environment, policymakers must balance recessionary risks while remaining cautious with inflation. The Bank of England lowered interest rates by a quarter percent this week while the Federal Reserve held steady due to uncertainty regarding tariffs with a unanimous vote. Meanwhile, central banks in several countries lowered interest rates, China being among them. This move could pump 2.1 trillion yuan into the economy by having also reduced the amount of cash lenders must keep in reserve. Other countries include the Czech Republic, Poland, Pakistan and Peru, while others such as Sweden and Norway kept them unchanged. Global economic data has shown mixed results: German industrial production has risen (3% gain in output largely driven by automotives, pharmaceuticals and machinery), US trade deficit has widened (driven by surge in pharmaceuticals, largely imported from Ireland ahead of tariffs) and Chinese exports are rising despite the decrease in shipments to the US. Chinese service expansion is also at the weakest level in 7 months.
The reciprocal baseline tariff has the most impact on trade restrictions worldwide and will be the aspect of incoming deals, like we saw with the UK, that investors most analyse.
Trade Renegotiations
On the 8th of May, the 80th anniversary of Victory in Europe, the US reached its first trade deal with another country following the 90-day tariff pause. The deal was described as “a historic trade deal, providing American companies unprecedented access to UK markets while bolstering US national security. This is a great deal for America.” More explicitly, the trade framework includes a significant tariff reduction: UK car exports to the US will face a 10% tariff (down from 27.5%) for up to 100,000 vehicles annually; tariffs on metals will be eliminated entirely (0%); the UK will remove tariffs on 1.4 billion litres of US ethanol and it will allow greater access for American beef exports. However, the 10% baseline tariff on most UK goods exported to the US will remain in place.
The UK finds itself in a unique position in negotiating with the US, especially in the absence of a dominant political figure from the European continent. Without Angela Merkel, leaders like Giorgia Meloni and Keir Starmer are left to step up in maintaining relations with the US, even as the UK remains more detached than ever from the EU. Furthermore, the UK’s unique economic relationship with the US including the absence of a US trade deficit helped fast-track the deal and made negotiation politically easier.
From the Trump administration’s perspective, the framework is being hailed as a “breakthrough,” promising to accelerate U.S. goods through UK customs and ease restrictions on billions of dollars’ worth of bilateral exports. As mentioned, this agreement may not serve as a template for deals with other nations, for example Japan and South Korea export far more vehicles to the US than the UK and are demanding full tariff elimination.
Another theory behind the current administration’s tariff policy beyond funding tax cuts is to create leverage for negotiation and align a coalition of countries to impose coordinated tariffs on China, thereby undermining its influence in global trade. This framework, however, makes no mention of the UK’s stance alongside the US on China or any other country. It will be interesting to see whether upcoming deals reportedly in progress according to Scott Bessent, United States Secretary of the Treasury include any provisions related to countering the People’s Republic.
The weight of a fractured $600 billion trade relationship hangs in the balance as US Scott Bessent and Chinese Vice Premier He Lifeng meet in Geneva this weekend, with US trade chief Jamieson Greer also expected to participate. Prior to the meeting, the US imposed tariffs as high as 145% on Chinese goods, provoking China to respond with 125% tariffs and new export controls on rare earth minerals. Already, China’s exports to the US have fallen by 21%, and factory output has slowed as supply chains are disrupted. Meanwhile, to compensate Beijing, has expanded trade with other markets which has led to shipments to the EU soaring by 8% last month.
It remains unclear what some of the smallest economies could offer the US in exchange for more preferential treatment. For example, Lesotho, an African mountain kingdom with a population less than Chicago, has a substantial trade deficit to the US from exporting diamonds and apparel. Lesotho is one of the world’s poorest nations and faces a 50% reciprocal tariff if no deal is reached.
Trump and Xi Jinping both know the biggest asset of the US is the strongest and most resilient consumer in the world, and Trump is ready to use this as leverage when bargaining with China. They will be used to extract concessions and reshape trade balances, while China views the sweeping tariff campaign not just as economic pressure, but as part of a broader geopolitical effort to stall its technological and strategic ascent.
Conflicted Investors
The S&P 500 has surged $6 trillion from its lows, and according to the Trump administration, progress is being made on trade deals amid the tariff pause. Now, investors are weighing whether to chase the rally or remain in safe-haven assets. Many argue that the true economic impact of the tariffs has yet to materialize and when the time comes, risky assets will pay the price. Despite the recent rally seen across the board, some sectors such as travel/tourism remain deeply subdued.
Meanwhile, safe havens like gold (continuously being pushed to all time highs) and German & Japanese bonds continue to rally, even amid historic fiscal expansion in Germany. American policy could be much more hostile a year from now, but today, Europe is presenting a very individualistic country reaction instead of a group reaction. This has led to large discrepancies in performance of different European countries, for example it is much more difficult for France, which is politically divided and fiscally constrained. For now, a big leap into union is unlikely and countries will continue monitoring as and when trade agreements are reached/started.
But with the “Trump put” seemingly in effect, many institutional investors who moved too defensively are now adopting neutral stances. The market currently reflects a lack of strong consensus on US stocks or major currencies, but as Trump becomes open to amending trade agreements and data remains positive so far, we may see a resurgence in risk assets in the coming weeks.
Historical Perspective
As investors eagerly await clarity, many of them turn to history in search of insight into the present. There is a longstanding debate over whether the US dollar’s role as the global reserve currency is a privilege or a burden. While it has allowed the US to run a big fiscal deficit and borrow cheaply whilst simultaneously being at maximum employment and growing, the Trump administration’s view of the dollar as a burden, rather than a privilege, echoes past efforts to deliberately weaken the currency to improve trade competitiveness.
The Nixon Shock of 1971, when import surcharges and the end of dollar-gold convertibility forced other currencies to revalue, marked a pivotal shift in global monetary policy. Similarly, the Reagan era brought tight monetary policy, fiscal expansion, and floating exchange rates, a combination not unlike today’s environment, where a strong dollar, trade tensions, and aggressive U.S. fiscal moves are again reshaping global capital flows.
Other historical episodes offer warnings, too. After the Asian financial crisis, China fixed its currency to the dollar and amassed vast reserves, leading to persistent trade imbalances and swelling U.S. external debt imbalances that ultimately contributed to the 2008 financial crisis. Today’s policy environment may not mirror those conditions exactly, but familiar fault lines are emerging: a weakening dollar, retaliatory trade measures, and widening fiscal deficits. While lessons from the 1930s suggest we’re unlikely to see a full-scale collapse in trade, rising tariffs and fragmented political responses especially in Europe hint at growing structural risks. History doesn’t repeat itself, but it often rhymes, and for investors, those echoes are growing louder. In any case, fallout from these implementations is expected to be less impactful than back then, owing to the fact reciprocal tariffs will be placed only from each country to the US instead of on each other. Additionally, goods take up a lot less of our economy due to the growth of the services sector.
The role of Bond Vigilantes
Since Liberation Day, 2nd April 2025, when Trump announced reciprocal tariffs, we all thought about the bond vigilantes, how they would intervene and, if they did, how they would behave. We now know the answer, and we should probably thank them after what happened. Even Donald Trump himself said to watch the bond market closely, and now it’s pretty clear they played an important role, just as they have in the past.
So, what happened? As time passed, it became clear that Trump’s tariff move was more of a geopolitical opening gambit than a fully though out economic strategy. He likely wanted to send a message, that the tariffs were a real threat. But now, as time goes by, it’s becoming clearer that this was a first step aimed at strengthening his hand in future negotiations with other countries. Market sentiment has since turned around gradually, prompting us to consider a more probable scenario for peace in global trade relations.
As of now, market sentiment is improving. In recent days, we’ve seen a spike in the perceived probability of a resolution deal between the US and China. On Friday, Trump suggested the US could reduce its tariffs on Chinese goods to 80% from 145%, while calling on Beijing to open its markets to American products. However, he added that the final decision was up to Bessent (the US Secretary of the Treasury), who later said that the current tariff levels in both directions amounted to a de facto trade embargo that was “not sustainable.”
He also tempered expectations of a sweeping economic and trade agreement, saying the focus was now on reducing tariffs on both sides to create space for longer-term negotiations that would cover more than just the US trade deficit. As the Chinese saying goes, “to untie the bell, you need the person who tied the bell.” Trump refuses to reduce tariffs unilaterally, and his stance is unlikely to change. Beijing, for its part, is also concerned about a new US-UK trade deal that includes strict security rules, potentially setting a precedent for excluding China from
key supply chains. Despite the tariffs, China’s exports remained strong in April by rerouting goods through Southeast Asia.
Returning to the role of the bond vigilantes: we saw an immediate reaction after 2nd April, with yields rising, signalling concern and sending a strong message to the world. When you try to change things, you still have to face them, especially when they hold such power. They moved the market by selling bonds aggressively as a form of protest. Their behaviour served as a market signal, warning policymakers that geopolitical posturing comes with real financial costs. By raising the cost of government borrowing, they indirectly disciplined fiscal and trade policy.
We might even say that, although Trump played hardball with Powell, especially since two weeks ago, when people started pricing in the possibility that Trump could fire him (despite the obvious complications), the bond vigilantes stepped in to regulate Trump. Their unique strength lies in the fact that they are the ones who actually buy US debt. They can’t be fired like Powell, and they can react instantly, unlike the Fed, which operates with delays. Bond vigilantes aren’t political; they price risk. They are heavily invested in US bonds, and they know the power they hold and they used it, just as they did in 1994 with Bill Clinton.
India and Pakistan – what is happening?
India and Pakistan said on Saturday that they had agreed a ceasefire to end the worst fighting between the two nuclear-armed powers in more than two decades. “After a long night of talks mediated by the United States, I am pleased to announce that India and Pakistan have agreed to a full and immediate ceasefire,” Trump wrote on his social media portal Truth Social. India and Pakistan said on Saturday that they had agreed to a ceasefire to end the worst fighting between the two nuclear-armed powers in more than two decades. “After a long night of talks mediated by the United States, I am pleased to announce that India and Pakistan have agreed to a full and immediate ceasefire,” Trump wrote on his social media portal, Truth Social.
This is a very important announcement. The two parties started this fight a long while ago, and there are multiple reasons why they wanted it to start. First of all, there is the imbalance in religious populations. In India, most of the population is Hindu (79%), while a smaller portion is Muslim (14.2%). This generates problems when you go deeper and try to understand the role of religion in how the territory in the region of Kashmir was split between the countries.
Another problem is exactly Kashmir itself, the fact that this material (cashmere) is precious is another big component of the escalation. However, Trump now seems to have gained power in the conversation between the countries, especially by communicating the ceasefire in recent days. It may be that this is a strategic move by Trump, as an occasion to intervene, shine, and gain a better role in negotiations with countries, especially with India, which is becoming a very important partner for the US. Trump now is the biggest partner for India with a total of bilateral trade of $129 billion in 2024. The trade balance is currently in favour of India, which runs a $45.7 billion surplus with the U.S, whereas for Trump India is the 10th biggest partner.
Scenario Analysis
If the current scenario persists where the 10% banket tariff on all trading partners except China continue, we can expect a painful period of slow decline for the US economy and dollar denominated assets overall. Consumer confidence has declined and missed expectations for the fifth month in a row and is down at levels not seen since August of 2020. A continuing trend of this nature will hamper US growth in the coming quarters. However, the recent -0.3% GDP scare can be attributed to a number of factors but mainly the increase in imports as corporates brace for tariffs and is likely not representative of what is to come, however the outlook remains sluggish compared to pre liberation day. Atlanta Fed has it latest GDP growth estimate for 2025 at 2.4%.
If the US imports less goods and services, inflation will pick up or at the very least persist above the Fed’s 2% target, the latest reading being 2.4%. This will prevent rates from coming down and will hurt growth in the medium term.
Corporate earnings in the USA will also take a hit from tariffs due to supply chain complications and an increase in costs for businesses. These corporate earnings struggles will dampen US equities valuations slowly as they emerge. Further strain on US equities will be placed by the fact that less foreign capital deriving from US imports will be allocated to US assets. This problem is magnified for US treasuries. Inflows to other countries from us imports have been religiously allocated to US treasuries since our world trade order has been established. With higher rates and lower foreign purchases of Treasuries we can expect yields to rise in the medium term in the US, which will be of great concern for an administration focused on reducing its debt.
The big question mark remains the US’s biggest trading partner in terms of imports. Chinese tariffs have been set at 145% so far, but earlier this week Trump hinted at 80% being enough. This great volatility in policy magnitude will hurt investor confidence when it comes to US assets but a reduction from 145% to 80% will be happily greeted by a market fearful of the consequences of these never-before-seen measures. Potential trade deals being negotiated and other mitigations, similar to the recent UK deal or the exclusion of electronics from tariffs on China, will also be greeted with open arms by market participants.
For the US’s main trading partners inflation should not be that much of a concern, however this form of protectionism places grave growth concern on these economies. We can expect European and Canadian central banks to continue their rapid rate cutting throughout 2025 as their growth outlook appears to become sourer as the year progresses, in part due to Trump’s tariffs.
In our current scenario, a full adoption of the mar-a-lago accords becomes increasingly unlikely. Trump would like foreign countries to buy treasuries, and keep the dollar low, while the Fed cut interest rates rapidly in order to reduce the US’s trade deficit. This would be in exchange for higher safety and international cooperation.
If tariffs remain however, inflation will not come down causing the Fed to remain anchored to its current rate, furthermore, if the blow from tariffs is slightly alleviated, a rebound in dollar denominated assets would continue to spur the dollar rebound seen in the last 3 weeks, where a circa 3% recovery has already been seen. This three- legged puzzle is difficult to imagine as pulling the blanket from one side, exposes the other. This leads to our second main scenario: De-escalation or potential U-turn.
While much less likely we believe that a mass de-escalation is a possible scenario for what’s to come. ‘Going back to normality’ would have the consequences you might expect on US assets if it is done before any tangible economic damage has been done to the US’s corporates and inflation rate. However, it would place Trump’s image in a ridiculous place, having him be the face of one of the biggest foreign economic policy failures in our modern history, something that he clearly does not want. A more likely version of this scenario is somewhere in between full de-escalation and our current one. A series of trade deals, similar to the UK deal, can be signed with Europe and other major trading partners, where the bulk of the tariff burden is lifted, and a blanket 10% tariff remains on rather insignificant goods which will not move the needle in terms of trade balance. This way Trump can claim a ‘political victory’, without having to destroy the state of the economy which he inherited from the Biden administration: One with falling inflation and great growth despite having rates at levels not seen in decades.
This scenario will ultimately benefit the US trade partners in terms of alleviating the growth scares deriving from this form of protectionism.
A scenario where the US returns to “liberation day” tariffs seen on the infamous list, would be a complete disaster for the world economy and is not very likely at all. The mass selloff of US equities and treasuries that would ensue again, much like the first time around, is enough to pump the breaks on Trumps actions. Moreover, pressures from lobbyists and supporters would make this scenario truly hard to see through. Lastly, the supposed benefits from Trumps tariffs, for the USA, in the form of increased, jobs, increase in manufacturing and the resources to finance tax cuts, would take years and years to materialize and entire industries re-adjust to the new norm, meaning that a new administration would have to follow in Trump’s footsteps to fully ‘see this through’, something which is clearly not likely at all.
Conclusion
In conclusion, navigating the current and future macro scenery will prove tough due to the many moving parts in the global equation, and the inability to compare our current scenario to any in the past. It will be a gradual and rocky road as market practitioners continue to price a return to quasi-stability. Ultimately, a few key decisions, deals or data points could shape the US’s and the global economy in the medium term, especially in a time where fundamentals and narrative are so misaligned. The speed at which deals or decisions are taken will be equally important to the content of these deals or decisions. This concept will become more apparent over time as only in the coming quarters will we start to see the real consequences of what has unraveled in the last 6 weeks.
0 Comments