Weekly market commentary

A stagflation scenario
Fed projections of GDP growth and inflation for end-2025, Sept. 2022-March 2025

The escalating trade conflict sparked the worst one-week selloff in the S&P 500 and U.S. high yield bonds since the 2020 pandemic shock – even as U.S. economic conditions remain solid, as seen in strong U.S. jobs data. We expected risk assets would remain under pressure until uncertainty starts to dissipate – and it’s now less clear over how long or short a period policy uncertainty could cloud the outlook. We now see a bigger growth drag and inflation boost. The Federal Reserve also expects a bigger impact than it did in March. See the chart. Many countries are preparing responses to U.S. tariffs. China has kicked off with 34% tariffs and other measures. Yet the full set of international responses and country-specific negotiations with the U.S. will take time, making it hard to have visibility on when and how this will settle. Major wealth destruction could hurt sentiment and consumer spending.

We still believe U.S. stocks will eventually reclaim global leadership due to mega forces – like the buildout and adoption of artificial intelligence. But for now, we shorten our tactical horizon to three months and reduce risk. A shorter tactical horizon means giving more weight to our early view that risk assets could stay under near-term pressure until uncertainty starts to dissipate. That’s why we reduce equity exposure, including to U.S. and Chinese stocks, and allocate more to short-term U.S. Treasuries that could benefit as investors seek refuge from volatility. If clarity comes quickly, we would up risk-taking again.

Getting selective

While we are more cautious about broad benchmarks, sharp selloffs are creating opportunities for security selection. U.S. policy shifts are spurring fiscal spending globally. In Europe, Germany’s €1 trillion package for defense and infrastructure investment is creating opportunities in the defense sector. We don’t think the growth and earnings outlook yet supports sustained European equity outperformance but a broader macro opportunity could emerge if the European Union finds a way to jointly issue bonds to fund investment across the bloc, as it did in the pandemic.

Overall, we think plans for a new wave of U.S. tariffs and responses from other countries reinforce that we will be in a world where interest rates – and long-term bond yields – stay higher than pre-pandemic. Tariffs and looser fiscal policy in some parts of the world will likely push up on inflation. We lean against market pricing of four to five quarter-point rate cuts by the Fed this year: U.S. core inflation is tracking well above the Fed’s 2% target, even before the impact of new tariffs.

We stay underweight long-term Treasuries given persistent U.S. deficits and sticky core inflation. We expect investors to demand more term premium, or compensation for holding long-term bonds given sticky inflation, higher-for-longer interest rates and a tough fiscal outlook. That could put upward pressure on long-term U.S. Treasury yields. We think gold can serve as a better return diversifier in this environment.

Our bottom line

Trade tensions have triggered a risk asset selloff. We see volatility persisting for some time, so we shorten our tactical horizon to three months and reduce risk-taking, turning neutral on U.S. equities and preferring short-term Treasuries.

Market backdrop

The S&P 500 slid 9% last week and shed 10.5% in just two days – the sharpest such move since the pandemic hit in 2020 – after the news of broad U.S. tariffs on global imports. Europe's Stoxx 600 closed down more than 8%, taking the index into negative territory for the year. U.S. 10-year Treasury yields fell to 4.00% but bounced from a six-month low of 3.86%, partly after Fed Chair Jerome Powell ruled out any near-term rate cuts. Two-year yields rose to 3.65% from a low of 3.47%.

U.S. CPI data for March will be the center of attention for further clues on how inflation is evolving before the new wave of tariffs and other U.S. policy changes take hold. Recent inflation data have been noisy and backward looking, not yet reflecting the impact of tariffs and other policy shifts. Core services inflation, excluding housing, is still running too high to be consistent with core inflation falling back to the Federal Reserve’s 2% target, in our view.

Big calls

Three-month views on selected assets vs. broad global asset classes by level of conviction, April 2025

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, April 2025

Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.

Euro-denominated tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, April 2025