Prepare for Trump 2.0

Since Donald Trump won the US presidential election and the Republicans gained control of Congress, long-end government bond yields have increased, the dollar has strengthened, and equity markets have become more volatile. The challenge for investors now is to understand the implications of potential changes in US policy.

Tariffs are top of mind for many investors. This is the area where the president has the most unilateral authority to alter the market consensus around continued growth and receding inflation.

In this letter we detail our latest tariff scenarios, consider how they may affect our broader investment scenarios for the year ahead, and address the implications for investors.

In short, we believe investors should prepare for the Trump administration to pursue aggressive tariffs. On his first day in office, the president announced and signed a flurry of executive orders and other actions. The most tangible trade-related action came in the form of a memorandum directing federal agencies to investigate and address “unfair” trade and currency policies by other countries. China’s adherence to the 2020 trade deal and the US-Mexico-Canada Agreement (USMCA) were singled out.

The scope and severity of possible tariff outcomes remains uncertain. Our base case, to which we assign a 50% probability, is for the US effective tariff rate on China to rise to 30%, and for China to retaliate. We also expect efforts to limit transshipments, protect US technology interests, and impose tariffs on some EU exports.

We are also monitoring for a risk case, which could include 10-20% universal tariffs on all US goods imports, a larger tariff of around 60% on China, or sustained, broad, and large tariffs against Mexico and Canada. This scenario would have a more negative impact on markets and the economy.

These tariff scenarios are a key determinant in our broader investment scenarios. We believe the most likely outcome (50% probability) is for growth despite tariffs. US growth momentum is currently strong, we continue to believe the Federal Reserve will cut interest rates by 50bps in 2025, and we see a limited overall macroeconomic impact from an effective tariff rate of 30% on direct imports from China.

What does all this mean for investors from here?

We believe that the risk-reward for equities is attractive, although investors should prepare for near-term tariff-related volatility. We expect around 10% upside for US stocks over the balance of 2025 thanks to solid economic growth, AI tailwinds, and gradually falling yields.

We also view the outlook for high grade and investment grade bonds as positive. In our base case, we expect the 10-year Treasury yield to fall to 4.0% by the end of 2025 as growth and inflation gradually slow, and as the Fed cuts rates.

We expect EURUSD to rise to 1.06 by the end of 2025, but given likely near-term volatility we like to harvest volatility in major currency pairs, rather than taking strong directional views. We see upside to gold both in our base case and in our bear case risk scenarios.

The coming weeks are likely to see volatility in markets, so we reemphasize the importance of diversification. But while the path ahead may be uncertain, we continue to see opportunities for investors who are well prepared and adaptable.

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      US trade policy in focus

      On his first day in office, President Trump reiterated his intention to take an aggressive stance on tariffs, and we believe that investors should prepare for this to be the case.

      Figure 1: Tariffs are top of mind for investors

      Number of mentions of tariffs in S&P 500 companies’ earnings transcripts

      A line chart showing a rise in the number of mentions of tariffs in S&P 500 companies’ earnings transcripts, revealing that tariffs are top of mind for investors
      Source: Bloomberg, UBS, as of January 2025

      Already, he has issued a memorandum directing federal agencies to investigate persistent trade deficits and address “unfair” trade and currency policies by other countries, reporting back by 1 April. The memo singled out China’s compliance with the 2020 trade deal and the USMCA. The president also told reporters that he was considering a 25% tariff on Mexico and Canada. On universal tariffs, he said “we may, but we’re not ready for that yet.”

      In our base case, we expect the effective tariff rate on China to rise to 30% (from 11% currently). We also expect measures to protect technological interests, rules limiting transshipments, and tariffs on EU autos. Possible retaliation by China includes imposing tariffs, weakening the Chinese yuan, and restricting critical mineral exports.

      At the same time, we do not believe that aggressive tariffs will necessarily lead to a major negative impact on the broader US economy. Up to a third of China’s exports to the US avoid tariffs by supply chain rerouting, and those that do not reroute currently account for just 12% of US imports by value, down from 18% in 2015. Non-tariff retaliations by China can still cause challenges in select areas, like critical minerals and agricultural supply chains, though currency actions and/or selling of Treasury bonds may not have as much of an impact as they once could have had. China’s official holdings of US Treasuries have fallen from USD 1.1tr to USD 768bn over the past three years and should be seen in the context of a total refinancing need of USD 10tr this year.

      We do not believe that tariffs would necessarily lead to persistently higher inflation. Using market-based gauges, there is little sign that inflation expectations have become unanchored. The Fed is likely to look through one-off price increases because of tariffs. And the central bank's own analysis of 2018-19 suggests that it is the potential impact on growth that would concern them more than the inflation impact.

      What could lead to a worse outcome for markets and the economy?

      Potential tariff outcomes

      We expect trade policy, including the use of tariffs, to play a central role in the Trump administration’s agenda. While the range of possible policy permutations is wide, we group the potential outcomes into the following four scenarios:

      House View scenarios

      Overall, we see the following scenarios for the remainder of the year:

      Scenario

      Scenario

      Bull case: strong growth

      Bull case: strong growth

      Base case: growth despite tariffs

      Base case: growth despite tariffs

      Bear case: tariff shock

      Bear case: tariff shock

      Bear case: hard landing

      Bear case: hard landing

      Scenario

      Probability

      Probability

      Bull case: strong growth

      25%

      Base case: growth despite tariffs

      50%

      Bear case: tariff shock

      15%

      Bear case: hard landing

      10%

      Scenario

      Market path

      Market path

      Bull case: strong growth

      Bond returns flat, equities up

      Equity markets rally amid strong US growth, accelerating consumption, and optimism about the impact of AI on earnings. Bond yields trend slightly up.

      Base case: growth despite tariffs

      Bond returns slightly up, equities up

      Equities rise owing to a stable and positive outlook for GDP and earnings growth. Bond yields fall slightly over the course of the year.

      Bear case: tariff shock

      Bond returns down slightly, equities down

      Equities and bonds suffer a correction due to fears of economic stagnation, a rising US fiscal deficit, and a longer period of tighter monetary policy.

      Bear case: hard landing

      Bond returns up, equities sharply down

      Global equities post double-digit losses, credit spreads widen. Valuations in AI stocks drop substantially. Safe-haven assets, such as high-quality bonds, gold, the US dollar, the Swiss franc, and the Japanese yen, appreciate.

      Scenario

      Economic growth

      Economic growth

      Bull case: strong growth

      The US economy continues to surprise positively, aided by policy support from deregulation and lower taxes. China’s economy turns the corner as policy stimulus proves more effective than expected and a US trade deal is reached quickly. European growth is lifted by improving global demand.

      Base case: growth despite tariffs

      The US economy continues to grow at a stable pace of around 2.0% over the next 12 months. Other Western economies experience weaker but positive growth in line with market expectations. Policy stimulus in China helps to stabilize economic activity.

      Bear case: tariff shock

      The disruption to global trade leads to lower US domestic demand and much weaker global economic growth, though likely falling short of a US or global recession.

      Bear case: hard landing

      Global growth falls over the next 12 months owing to weakness in consumer spending and labor markets and/or a fall in AI-related investments. GDP contracts for one or more quarters in the US and the Eurozone. Policy stimulus in China fails to stabilize the economy.

      Scenario

      Inflation

      Inflation

      Bull case: strong growth

      Continues to fall in Europe but stabilizes above target in the US as fiscal stimulus lifts consumption.

      Base case: growth despite tariffs

      Resumes its weakening trend in the developed world. Further softening in US core PCE opens door for more Fed rate cuts by mid-2025.

      Bear case: tariff shock

      Remains elevated in the US as each subsequent round of tariffs puts additional upward pressure on prices. Inflation in targeted countries normalizes less quickly as currencies weaken to offset the tariff impact.

      Bear case: hard landing

      Falls as demand for goods and services collapses.

      Scenario

      Central banks

      Central banks

      Bull case: strong growth

      The Fed pauses as inflation normalization stalls. Other central banks cut rates in line with expectations as inflation continues to normalize despite stronger-than-expected economic activity.

      Base case: growth despite tariffs

      All major central banks ease policy by mid-2025 with the exception of the Bank of Japan. The Fed cuts rates by 50bps in 2025. The ECB cuts rates by 25bps every meeting until mid-2025.

      Bear case: tariff shock

      Central banks adopt a more cautious approach to monetary easing for fear of a longer period of above-target inflation and dis-anchoring inflation expectations.

      Bear case: hard landing

      Major central banks cut rates swiftly at first signs of an economic downturn, bringing monetary policy back into accommodative territory. The Fed lowers its policy rate by at least 200bps over the next 12 months.

      Scenario

      US politics / Geopolitics

      US politics / Geopolitics

      Bull case: strong growth

      US corporate tax cut to 20% or lower. A quick trade deal happens between the US and its main trading partners.

      Base case: growth despite tariffs

      President Trump extends the time frame of temporary tax relief policies in the US but stops short of lowering US corporate taxes. Selective tariffs are implemented on US imports, mainly targeting China, with some tariff retaliation by other countries. The chances of a cease fire deal in the Ukraine have increased.

      Bear case: tariff shock

      The Trump administration imposes large tariffs on imports from multiple countries, with proportionate retaliation by targeted trading partners.

      Bear case: hard landing

      The Trump administration imposes large tariffs on imports from multiple countries, with proportionate retaliation by targeted trading partners.

      Note: Each scenario narrative represents a non-exhaustive list of events that could lead to a market path outlined in our scenario targets. The probabilities represent CIO’s view on the overall probability of reaching the market targets for the given scenario, rather than the probability of a single event or chain of events materializing.

      Source: UBS, as of January 2025

      What are the key messages for investors?

      Here are our key messages for investors looking to navigate this backdrop of diverse potential outcomes:

      Key targets for December 2025

      Key targets for December 2025

      Spot*

      Spot*

      Bull case: strong growth

      Bull case: strong growth

      Base case: growth despite tariffs

      Base case: growth despite tariffs

      Bear case: tariff shock

      Bear case: tariff shock

      Bear case: hard landing

      Bear case: hard landing

      Key targets for December 2025

      MSCI AC World

      Spot*

      1,061

      Bull case: strong growth

      1,240 (+17%)

      Base case: growth despite tariffs

      1,140 (+7%)

      Bear case: tariff shock

      890 (–16%)

      Bear case: hard landing

      800 (–25%)

      Key targets for December 2025

      S&P 500

      Spot*

      6,086

      Bull case: strong growth

      7,000 (+15%)

      Base case: growth despite tariffs

      6,600 (+8%)

      Bear case: tariff shock

      5,100 (–16%)

      Bear case: hard landing

      4,500 (–26%)

      Key targets for December 2025

      EuroStoxx 50

      Spot*

      5,206

      Bull case: strong growth

      5,900 (+13%)

      Base case: growth despite tariffs

      4,900 (–6%)

      Bear case: tariff shock

      4,000 (–23%)

      Bear case: hard landing

      3,800 (–27%)

      Key targets for December 2025

      SMI

      Spot*

      12,208

      Bull case: strong growth

      14,200 (+16%)

      Base case: growth despite tariffs

      12,200 (–0%)

      Bear case: tariff shock

      10,500 (–14%)

      Bear case: hard landing

      10,200 (–16%)

      Key targets for December 2025

      MSCI EM

      Spot*

      1,082

      Bull case: strong growth

      1,250 (+15%)

      Base case: growth despite tariffs

      1,160 (+7%)

      Bear case: tariff shock

      870 (–20%)

      Bear case: hard landing

      850 (–21%)

      Key targets for December 2025

      Fed funds rate (upper bound)

      Spot*

      4.50

      Bull case: strong growth

      4.50

      Base case: growth despite tariffs

      4.00

      Bear case: tariff shock

      4.00

      Bear case: hard landing

      1.00

      Key targets for December 2025

      US 10y Treasury yield (%)

      Spot*

      4.61

      Bull case: strong growth

      5.25

      Base case: growth despite tariffs

      4.00

      Bear case: tariff shock

      5.00

      Bear case: hard landing

      2.50

      Key targets for December 2025

      US high yield spread**

      Spot*

      259bps

      Bull case: strong growth

      250bps

      Base case: growth despite tariffs

      300bps

      Bear case: tariff shock

      450bps

      Bear case: hard landing

      700bps

      Key targets for December 2025

      Euro high yield spread**

      Spot*

      301bps

      Bull case: strong growth

      300bps

      Base case: growth despite tariffs

      340bps

      Bear case: tariff shock

      500bps

      Bear case: hard landing

      700bps

      Key targets for December 2025

      US IG spread**

      Spot*

      70bps

      Bull case: strong growth

      55bps

      Base case: growth despite tariffs

      70bps

      Bear case: tariff shock

      120bps

      Bear case: hard landing

      180bps

      Key targets for December 2025

      Euro IG spread**

      Spot*

      96bps

      Bull case: strong growth

      90bps

      Base case: growth despite tariffs

      105bps

      Bear case: tariff shock

      160bps

      Bear case: hard landing

      200bps

      Key targets for December 2025

      EURUSD

      Spot*

      1.04

      Bull case: strong growth

      1.10 (+6%)

      Base case: growth despite tariffs

      1.06 (+2%)

      Bear case: tariff shock

      0.98 (–6%)

      Bear case: hard landing

      1.05 (+1%)

      Key targets for December 2025

      Commodities (CMCI Composite)

      Spot*

      1,853

      Bull case: strong growth

      2,000 (+8%)

      Base case: growth despite tariffs

      1,935 (+4%)

      Bear case: tariff shock

      1,725 (–7%)

      Bear case: hard landing

      1,600 (–14%)

      Key targets for December 2025

      Gold***

      Spot*

      USD 2,771/oz

      Bull case: strong growth

      USD 2,550/oz (–8%)

      Base case: growth despite tariffs

      USD 2,850/oz (+3%)

      Bear case: tariff shock

      USD 3,050/oz (+10%)

      Bear case: hard landing

      USD 3,150/oz (+14%)

      * Spot prices as of market close of 22 January 2025. Developed market constituents of the MSCI All Country (AC) World index display in the local currency. The MSCI EM index displays in US dollar. Values in brackets are expected percentage changes from the quoted spot levels. Dividends, share buybacks and other sources of carry are not included.

      ** During periods of market stress, credit bid-offer spreads tend to widen and result in larger ranges.

      *** Gold is a safe-haven asset whose price tends to rise when risk assets, such as equities, fall, and vice versa.

      Note: The asset class targets above refer to the respective macro scenarios. Individual asset prices can be influenced by factors not reflected in the macro scenarios.

      Disclaimer / Risk Information

      Nontraditional asset classes are alternative investments that include hedge funds, private equity, real estate, and managed futures (collectively, alternative investments). Interests of alternative investment funds are sold only to qualified investors, and only by means of offering documents that include information about the risks, performance and expenses of alternative investment funds, and which clients are urged to read carefully before subscribing and retain. An investment in an alternative investment fund is speculative and involves significant risks. Specifically, these investments (1) are not mutual funds and are not subject to the same regulatory requirements as mutual funds; (2) may have performance that is volatile, and investors may lose all or a substantial amount of their investment; (3) may engage in leverage and other speculative investment practices that may increase the risk of investment loss; (4) are long-term, illiquid investments; there is generally no secondary market for the interests of a fund, and none is expected to develop; (5) interests of alternative investment funds typically will be illiquid and subject to restrictions on transfer; (6) may not be required to provide periodic pricing or valuation information to investors; (7) generally involve complex tax strategies and there may be delays in distributing tax information to investors; (8) are subject to high fees, including management fees and other fees and expenses, all of which will reduce profits.

      Interests in alternative investment funds are not deposits or obligations of, or guaranteed or endorsed by, any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other governmental agency. Prospective investors should understand these risks and have the financial ability and willingness to accept them for an extended period of time before making an investment in an alternative investment fund, and should consider an alternative investment fund as a supplement to an overall investment program.

      In addition to the risks that apply to alternative investments generally, the following are additional risks related to an investment in these strategies:

      • Hedge Fund Risk: There are risks specifically associated with investing in hedge funds, which may include risks associated with investing in short sales, options, small-cap stocks, “junk bonds,” derivatives, distressed securities, non-US securities and illiquid investments.
      • Managed Futures: There are risks specifically associated with investing in managed futures programs. For example, not all managers focus on all strategies at all times, and managed futures strategies may have material directional elements.
      • Real Estate: There are risks specifically associated with investing in real estate products and real estate investment trusts. They involve risks associated with debt, adverse changes in general economic or local market conditions, changes in governmental, tax, real estate and zoning laws or regulations, risks associated with capital calls and, for some real estate products, the risks associated with the ability to qualify for favorable treatment under the federal tax laws.
      • Private Equity: There are risks specifically associated with investing in private equity. Capital calls can be made on short notice, and the failure to meet capital calls can result in significant adverse consequences including, but not limited to, a total loss of investment.
      • Foreign Exchange/Currency Risk: Investors in securities of issuers located outside of the United States should be aware that even for securities denominated in US dollars, changes in the exchange rate between the US dollar and the issuer’s “home” currency can have unexpected effects on the market value and liquidity of those securities. Those securities may also be affected by other risks (such as political, economic or regulatory changes) that may not be readily known to a US investor.

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