Navigating tariffs

We reiterate our positive view on stocks and bonds. Earnings are coming in healthily, growth is solid, inflation is still trending lower, and global central banks continue to ease policy. We like to keep it simple.

But clearly the noise level has increased. The scale of tariffs President Trump announced last week would have been over four times the size of those seen in his first term, with meaningful effects on the US and global economy if sustained. Fortunately, the tariffs on Canada and Mexico were postponed and, while 10% tariffs on China have been implemented, they are no more than investors were generally expecting (and may be removed after a conversation between Presidents Trump and Xi).

Tariffs were always going to be on the agenda for President Trump, and he favors using them as leverage to achieve non-economic objectives (as in this case, where fentanyl and illegal immigration are in focus), as well as to address perceived economic unfairness (as in the China trade war). That Canada and Mexico were able to postpone tariffs with rather minor gestures, as well as Colombia on an immigration controversy a week earlier, suggests the non-economic objectives may be easier to address.

The issue of ‘trade fairness’ will be more difficult to remedy quickly, presenting a greater risk for the EU and China. Indeed, President Trump has been particularly vocal about tariffs on Europe of late, and given the challenge of getting 27 member states to negotiate as one unit, the region does appear uniquely vulnerable. The Trump administration will also unveil a more formal global trade approach in the America First Trade Policy review due on April 1. So despite the recent respite, investors must remain focused on tariff risk.

Exhibit 1: President Trump looks set to turn his attention to the EU trade relationship

US trade relationships, USD billions

Tariffs are difficult for investors to price because even when they are ‘known,’ the magnitude of economic outcomes is highly uncertain. Growth and inflation impacts depend on several factors, including trade elasticity, the ability of businesses to pass on higher costs, supply-chain integration and currency effects. It is also difficult to quantify indirect effects, such as business uncertainty which may ultimately on weigh investment and employment decisions.

In terms of growth, the US is less affected than its largest trade partners due to its trade deficit, and linking tariff revenue to fiscal spending could mitigate negative effects. However, inflation risks are higher for the US due to increased import prices and a stronger cyclical position compared to the rest of the world.

The Fed’s reaction function is also uncertain. Theoretically inflation from tariffs is akin to a regulated price increase, and should fade over the following year. This speaks to the Fed looking through the price effect, especially given downside risks tariffs pose to growth. But if tariff threats continue, then inflation expectations could become unanchored, which could force the Fed into a more hawkish stance. Tariffs thus raise the risk of a higher stock-bond correlation, with rising inflation risk premia undermining bonds and stocks together.

So despite our effort to ‘keep it simple,’ the reality is more complicated. We do maintain our current pro-risk stance based on underlying fundamentals, but have positioned our broader portfolios in ways to help mitigate tariff risk. First, we maintain a preference for US equities despite elevated valuations – we would like to have more clarity on Trump’s tariff policy this spring before diving more aggressively into cheaper international markets.

In fixed income, we have shifted some of our duration preference from the US into non-US bond markets. Since tariffs are likely to have a larger inflation impact in the US and a larger (negative) growth impact in tariffed countries, we prefer to take our duration risk in those trade-sensitive countries. If Trump hits Europe with aggressive tariffs, then bunds are more likely to cushion equity market drawdowns than Treasuries.

Our overall USD view is fairly neutral, but we do have underweights in the EUR and CNH with Europe and China in the crosshairs. Finally, we continue to favor exposure to gold. In addition to ongoing structural EM central bank buying, gold should perform well in an environment of broader policy uncertainty. 

The chart below shows the views of our Asset Allocation team on overall asset class attractiveness as of 5 February 2025. The colored circles provide our overall signal for global equities, rates, and credit. The rest of the ratings pertain to the relative attractiveness of certain regions within the asset classes of equities, bonds, credit and currencies. Because the Asset Class Views table does not include all asset classes, the net overall signal may be somewhat negative or positive.