Navigating a “watershed moment” for markets

• The market sell-offs in recent days reflect deteriorating prospects for the global economy: we think, in an extreme scenario, a full-blown trade war could shave up to 5.5% off global output over the medium term, while pushing inflation higher by 1.5% to 3%.
• The risk of a US recession and potentially “stagflation” have risen, though the eurozone could benefit from supportive tailwinds in the medium to long term.
• On China, the immediate tariff impact may be sufficient to wipe off 2% of GDP, with potentially larger implications as Beijing retaliates.
• Look for re-entry points in European equities, where the risk of a stagflationary environment is less acute.

US President Donald Trump’s “liberation day” marked a watershed moment for the global economic and trade system. The announcement of wide-ranging import tariffs – on top of existing tariff hikes – caused investors to reprice risky assets, leading to falls in stockmarkets around the world. The 13% fall in Hong Kong’s Hang Seng Index on 7 April was its biggest one-day decline since the Asian financial crisis of 1997.

Investors are now facing the prospect of a full-blown trade war, which, combined with stagnating or negative growth and rising inflation, could usher in a fundamental paradigm shift in the global economic order.

Here, we examine some of the key trends in this fast-moving environment:

Mr Trump’s economic and political approach can be described as US-centric with an isolationist and assertive stance. The events of the past few days indicate that his policy agenda has significant short-term costs for both the US and the rest of the world, which Mr Trump seems willing to accept in pursuit of his objectives. It is notable for us as investors that he also seems willing to accept high levels of financial market volatility – which was not necessarily the case during his first term in office.

The fallout from “liberation day” has not only pushed global trade policy uncertainty to historic highs but lifted expectations for US consumer inflation while lowering confidence in American business. These effects are likely to intensify over the coming quarters, potentially pushing US GDP growth toward stagnation – or even contraction. We assign a 40-45% probability to a US recession within the next year – a figure that would rise to above-even odds if elevated US tariff rates are sustained.

Mr Trump’s reciprocal tariffs have already prompted retaliatory action from countries such as China. If this trend were to develop into a full-blown trade war, the costs to global economic growth could be high – we estimate a full-blown trade war would shave 1.7% to 5.5% off global output over the medium term, while pushing inflation higher by 1.5% to 3%.¹

Our baseline outlook foresees uneven and, at best, lacklustre growth across countries and regions, with significantly rising risks of recession, renewed upward pressure on global inflation, and a persistent lack of macroeconomic coordination at both global and national levels.

On a more fundamental basis, we see the latest events as an unravelling of the global economic and trade framework of the past three decades – often referred to as “Chimerica” or “Bretton Woods 2”. Mr Trump seems to be pushing for an overhaul of the global financial order, which has been discussed under the label “Mar-a-Lago Accord” – a shift that could have far-reaching and disruptive consequences and spell further weakness for the US dollar.

While the eurozone will no doubt feel the negative effects of US protectionism, recent domestic developments have been more encouraging, not least the growing political openness for stronger pan-European cooperation across many areas. External risks may be partly offset over time by the prospect of a significant medium-term increase in public investment spending in Germany, higher defence spending across the region, a still-robust labour market and ongoing monetary easing.

Furthermore, the risk of a stagflationary environment is less acute than in the US – the euro is appreciating and falling energy prices will be supportive for European growth. And, while detrimental to some sectors, excess supply potentially redirected from China could provide a disinflationary tailwind for consumers. This environment could motivate the European Central Bank to continue lowering interest rates – particularly if growth tanks and labour markets starts to weaken more visibly.

So, despite the unfolding trade war and persistent structural impediments weighing on the European economy, there could be opportunities to re-enter positions at cheaper prices – especially for those longer-term institutions that had significant underweights in the region.

China is one of the hardest hit with tariffs. Mr Trump announced a reciprocal tariff rate for China of 34% on liberation day, which came on top of the previous 20% additional tariffs earlier in the year. That brings total additional tariffs this year to 54% – not far from the 60% figure that Mr Trump mentioned in his presidential campaign. There is little historical precedent for this scale of tariff increase, and early estimates suggest this could, in isolation, have a close to 2% impact on Chinese GDP.

We think China faces a delicate balancing act as it adjusts its economic model, transitioning to slower but likely more sustainable growth over the medium term.

Given the importance attached to achieving the annual growth target, which is again set at “around 5%” – it has been met or exceeded in each of the last 15 years with the exception of 2022, during the Covid pandemic – both monetary and fiscal policy in China should remain solidly in expansion mode.

Overall, the global economy faces a series of downside risks. These include the ongoing escalation of trade tensions, significant negative effects on labour supply from restrictive migration policies (particularly in the US) and a lack of macroeconomic policy coordination, which increases the likelihood of fiscal or monetary missteps.

Nevertheless, as we know from past experience, there is a tipping point where the US Federal Reserve will start intervening to avoid any kind of systemic risk. While we are not there yet, there are initial indications that we are entering an environment where central banks will want to calm down markets. This could provide some relief, at least in the short term.

In this environment, we maintain our cautious stance on global equity markets while continuing to prefer European over US equities – the latter being more at risk of retaliatory measures and stagflationary risks.

In Europe, our preference is for UK equities, which are less affected by US tariffs and exhibit attractive defensive characteristics. Swiss equities are also holding up well, although we will be watching in case the healthcare heavyweights find themselves in the line of fire of the US administration.

At the same time, we added to our positions in government bonds – which should continue to profit from tariff uncertainties – with a preference for Europe over US Treasuries. Critically, we have further reduced our underweight in US high yield bonds, which were already tightly priced and are vulnerable to retreating liquidity if difficult conditions persist. In terms of currencies, we believe that the Japanese yen could continue to provide good protection against falling markets.

In any case, diversification continues to be supportive for our broader portfolios, with gold remaining resilient in a tense geopolitical context, while volatility strategies have proven a good complement to gather premia from the rapidly rising volatility.

¹ Tariffs: could “liberation day” shackle the global economy? April 2025