Risk-off mood grips markets after Liberation Day tariffs
The S&P 500 fell 9.1% last week, its largest decline since the onset of the COVID-19 pandemic in spring 2020, after US President Donald Trump announced measures that will bring the effective tariff on imports into the US to their highest level in at least 100 years. This risk-off mood in markets was exacerbated by news that China planned to strike back with a 34% levy on US goods, along with restrictions on the export of rare earths—which are essential in the production of advanced technological products. China’s response raises the threat of a tit-for-tat conflict that drives tariffs even higher.
Finally, markets were concerned by comments from Federal Reserve Chair Jerome Powell that while tariffs were likely to produce only a transitory boost to inflation, there was a risk that the effects could be “more persistent”— implying that the central bank could be cautious in cutting rates to combat any economic slowdown resulting from a trade conflict.
The result was a broad risk-off trend. Along with the sell-off in stocks, the spread on US high yield credit over US Treasuries—a proxy for default risk- —-registered the fastest rise since 2020. Given the potential for tariffs to rise further before potential compromises come into sight, we downgraded US equities to Neutral from Attractive, and the US technology sector, AI, and Taiwanese equities to Attractive (from Most Attractive).
Takeaway: With uncertainty likely to remain elevated, investors should consider strategies to manage volatility. We believe gold will continue to offer portfolio diversification benefits, particularly in a downside scenario. Ensuring an adequate allocation to hedge funds can also help mitigate market swings. By dynamically adapting to macro shifts, hedge fund strategies like discretionary macro, equity market neutral, select relative-value or multistrategy can cushion portfolios in down markets.
Trade dispute could get worse before the outlook improves
Trade tensions look likely to intensify further as other nations follow China in responding to President Trump’s unexpectedly aggressive move. Investors will be watching for the response from the European Union, and we expect the zone to impose the equivalent of roughly 20% tariffs on US goods. This in turn could result in further measures from the Trump administration, including hiking tariffs on pharmaceuticals and semiconductors, which have so far been exempt.
Meanwhile, the most obvious off-ramps seem unlikely to be taken in the near term. Although it is possible that President Trump could bow to business and market pressure over the scale of tariffs, he appears to have a high level of conviction in the policy. On Sunday, President Trump likened tariffs to “medicine” and told reporters to “forget markets for a second.” Equally, legal challenges to the President’s authority to impose such sanctions may be made at an individual product or sector level, curtailing the broader market impact.
But we continue to see scope for more positive developments. News that President Trump had agreed to meet Vietnam’s leader to discuss a deal, likely presages a broader range of efforts in coming weeks and months to avoid the full implementation of the “Liberation Day” tariffs. Our base case remains that US effective tariffs should begin to come down from the third quarter as legal, business, and political pressures mount and the Trump administration strikes deals with various nations and industries.
Takeaway: While we hold a neutral tactical stance on equities, including the US, Europe, and China, periods of market stress have historically offered longterm rewards for diversified investors who look through volatility and stay the course or put fresh money to work.
Fed support for US economy likely amid tariff uncertainty
Ordinarily US jobs data might have provided reassurance over the economic outlook, dampening recent recesion worries. The economy generated 228,000 net jobs in March, compared to market expectations for a rise of just 140,000. The jobless rate ticked up only fractionally, from 4.1% to 4.2% —though this was due to a rounding up from 4.14% in February to 4.15% in March.
This positive news was overshadowed by concern that the trade conflict could lead to an abrupt slowdown in demand, causing US companies to cut back on hiring and even reducing headcount. In the near term, we believe unless President Trump takes active steps to reduce tariffs over the next three to six months, we are likely to enter a downside scenario, including a meaningful US recession.
But we also expect support from the Fed. Despite comments from Fed Chair Powell about the risk of more sustained inflation arising from tariffs, the markets are still assuming that price pressures would prove transitory—based on the 5- and 10-year US breakeven inflation rates, which fell sharply last week. Although higher inflation will present a challenge for the Federal Reserve, we believe much slower growth and likely weakness in the labor market will mean that the Fed will nonetheless deliver 75-100bps of rate cuts over the remainder of 2025.
Takeaway: We have been advising investors to seek durable income in quality bonds. The 10-year yield is slightly below our 4% year-end target at the time of writing. However, this still offers the potential for a solid total return. In a downside scenario, we expect the yield to fall to 2.5%, which would help cushion part of the downside in equity markets.