Understanding the Impact of Tariffs on Global Markets

Looking at the reciprocal tariffs that had been announced, it appears that the calculation of tariffs have been based on a simplistic formula where the trade balance is divided by two times imports. This method, however, is based on rather naive assumptions that do not hold up in reality, such as the absence of retaliation and changes in other underlying economic parameters. It also fails to consider the broader context of global trade and excludes services, making it an unrealistic approach and method of calculation.

The future impact of tariffs on the global economy is challenging to predict due to the unprecedented nature of the situation. Estimates vary widely, with potential effects on U.S. GDP ranging from a 0.5% to 2.5% dent, and inflation also likely to tick up. This uncertainty complicates the global economic picture, as the final state of tariffs remains unknown, and their effects on growth and inflation are difficult to quantify.

To help understand the potential outcomes of the tariff situation three scenarios are outlined:

• Peak Tariffs: This scenario, which we currently view as the most likely, suggests that tariffs will not worsen, and some countries may renegotiate with the Trump administration, leading to a gradual de-escalation. Growth is expected to be slower, and inflation slightly higher in the US, but most countries are likely to avoid recession.
• Retaliation: In this scenario, the US enters a full-blown trade war with China and possibly Europe, leading to higher tariffs, increased inflation, and a likely recession in the US. Policy responses would initially involve central bank rate hikes followed by aggressive loosening, potentially including quantitative easing.
• Détente: A less likely scenario where Trump rolls back tariffs significantly, leading to positive market sentiment and improved economic conditions.

Rate expectations have been mixed, with the Federal Reserve's outlook becoming more dovish, pricing in up to four rate cuts this year. In our view this seems overestimated unless a recession occurs. Other central banks have seen less of a shift in expectations. The yield curve in the US has steepened recently, indicating short-term problems but a positive long-term growth outlook. This steepening is usually a positive macro signal, suggesting that while immediate challenges exist, the long-term prognosis remains favourable.

Market outlook
Turning to markets, EFG’s valuation methodology indicates that Europe has become cheaper relative to levels seen in December, and the region has also seen upwards earnings revisions. Japan, which was previously expensive, has also become much cheaper, presenting a potential for rebounds. The United States, while not outright cheap, has moved from being overvalued to a neutral zone.

Earnings growth expectations for 2025 are starting at a reasonable 11.5% year-on-year for the MSCI All Countries World Index. However, these figures may face downward revisions due to ongoing concerns about trade tariffs and potential recession. Interestingly, while US earnings are being revised downward, Europe and Asia are experiencing upward revisions, driven by fiscal policies and economic measures.

In the short-term technical environment, investor positioning has shifted dramatically. A Bank of America survey indicates that over the past few months investors have moved from overweight positions in US equities to overweight positions in eurozone equities, reflective of changes in market sentiment and valuation. Elevated cash levels in money market mutual funds further suggest that markets could be nearing a bottom. Furthermore, currency markets show that investors are predominantly short on the US dollar, suggesting stabilisation in the short term.

The market environment is currently challenging and is likely to remain volatile until there is greater clarity on country responses and President Trump’s tariff stance. This underscores the need to maintain a long-term perspective. Staying informed and adaptable in response to ongoing geopolitical and economic developments is crucial for navigating these turbulent times.