The risk is that uncertainty about US policy causes firms and households to pause their spending plans, instead choosing to wait and see.
In his inaugural speech in 1933, US President Franklin D Roosevelt used the now famous phrase “the only thing we have to fear is fear itself”. He argued that it was merely fear that was crippling US demand in the aftermath of the Great Depression, rather than any structural issues buried in the foundations of the economy. This quote is relevant to the key risks facing the US, and global economy, today.
The global economy is structurally sound. For the last few years, it has defied calls for recession despite soaring inflation and interest rates, thanks to robust household and corporate balance sheets. The risk is that uncertainty about US policy causes firms and households to pause their spending plans, choosing to wait and see. The thing to fear is fear itself.
At the time of writing there is considerable uncertainty about the scale and scope of tariffs the US will enact on its trading partners. The shocking numbers announced on ‘Liberation Day’ have already retreated but the effective tariff rate on US imports still sits at its highest level since the 1940s (see Exhibit 1). A US trade court ruling against the president’s declaration of emergency to enact sweeping tariffs in late May has added to the uncertainty. With multiple other legal routes for the president to proceed if the reciprocal tariffs are ultimately revoked, we suspect the administration will find ways to keep pursuing their trade policy goals.
One reason for the administration to find a workaround to the current legal challenges is that it is already planning for how the revenue collected will be spent. The fiscal package making its way through both houses of Congress not only extends the tax cuts offered under the 2017 Tax Cuts and Jobs Act but adds further fiscal giveaways. This results in tax cuts and spending to the tune of $5.3tn based on CBO estimates. Although in theory these upfront tax cuts will be met with tariff revenue and spending reductions later down the line, the bond market is understandably dubious about the path the US authorities are on (see Exhibit 2).
Whether the benefits to the US economy from fiscal loosening are anyway outweighed by higher interest rates is an important question. As the issuer of the world’s reserve currency, the US Treasury can get away with more than countries such as the UK (see Be mindful of currency exposure), but the UK’s ‘Liz Truss episode’ does contain a lesson for the US administration: when the economy is at full employment, fiscal loosening will merely be met with higher borrowing costs.
The high levels of uncertainty about the outlook for trade and fiscal policy, and consequently growth and inflation, may make for a bumpy ride for markets in the second half of 2025, as investors react to incoming growth and inflation data.
The key data we will be tracking is as follows (all of which will, of course, be made accessible in our daily Guide to the Markets):
- Business capex and hiring intentions to gauge the damage of ‘wait and see behaviour’ by companies (see Exhibit 3).
- Consumer durable goods spending intentions to gauge the damage of ‘wait and see behaviour’ by households.
- Purchasing Managers’ Indices – specifically, the input and output price components – are key watch items for investors gauging how businesses are behaving, and the passthrough of tariffs.
- Consumer inflation expectations which may make the Federal Reserve (Fed) hesitant to cut interest rates.
We suspect the data will point to a US economy that is slowing rather than falling into recession. If anything, we see the risks being skewed towards inflation, rather than recession, concerns. Goldilocks’ recent encore was, in our view, largely thanks to a surge in US migration which helped quickly drag down wage growth and broader inflationary pressures in the US (see Exhibit 4). With migration now effectively halted after a very strong signal from the current administration, the risk of another 2022 supply shock that gets matched with a demand boosting fiscal shock would once again shock investors with a greater than expected pickup in inflation.
This balance of risks places the Fed in an uncomfortable position and in our view puts them in a reactive, rather than pre-emptive, mode. Investors have already scaled back their expectations for rate cuts by the Fed this year. In our view, inflation would have to rise fairly meaningfully for the Fed to openly start talking about raising rates, particularly given the president’s vocal opinions on US monetary policy. Our central expectation is that the Fed remains on hold through the remainder of 2025.
If we have misjudged the downside risks and unemployment were to start rising, we suspect the Fed would ignore inflation concerns and ease policy, perhaps significantly. In this scenario, investors should not forget the recession protection that core bonds afford (see Own bonds for bad weather, not all weather).
Looking beyond the US, it is once again apparent that Europe is often at its best when faced with a common adversary or crisis. We are encouraged by meaningfully more positive domestic policy. Germany is now using the considerable fiscal space it has guarded in recent years. The new government's proposed fiscal stimulus is huge, with the key question for Germany’s growth outlook being how quickly such a large volume of money can be deployed.
The backdrop for the European consumer is also improving. Real wages continue to rise, labour markets broadly remain firm, and falling interest rates might finally encourage the region to deploy some of the sizeable savings that were accumulated during the Covid pandemic (see Exhibit 5).
Europe’s domestic recovery could be derailed if tensions with the US spike higher once again. Late May provided a clear example of how quickly things can change, with the US administration threatening to introduce additional tariffs of up to 50% on the European Union (EU) as early as 1 June, before deescalating just two days later. President Trump cited the goods trade deficit that the US has with the EU, as well as slow progress on trade talks, as rationales for these potentially higher tariffs. We suspect, as with other regions, there is a deal to be done as a lengthy retaliatory trade battle doesn’t appear in the interests of either side. If Europe can maintain its domestic recovery there may well be scope for European stocks to narrow their outsized valuation gap with the US (see Use regional stock diversification and income strategies).
The UK shares many of continental Europe's potential tailwinds, including a sizeable pot of savings built up during the pandemic. The trade backdrop is arguably also improving for the UK. A trade deal with the US has already been secured, but – more importantly for UK exporters – relations with the EU have also markedly improved.
The key challenge facing the UK in the remainder of 2025 is the Autumn Budget, where the chancellor is once again facing difficult decisions if she wishes to stick to her fiscal rules. Last autumn, Chancellor Reeves hiked one of the few taxes that was not ruled out in her party's election manifesto – employers’ national insurance contributions – to fund a boost to public spending. As the 2025 Autumn Budget approaches, higher global interest rates may well leave the UK government deciding between cutting spending or raising taxes.
Given the public backlash against last autumn’s tax hike, as well as the need to support growth, we suspect any fiscal decisions will focus on restraining medium-term spending. If, however, the Office for Budget Responsibility – the UK’s fiscal watchdog – marks down its perennially optimistic productivity forecasts, the fiscal outlook is likely to look worse come autumn, potentially forcing the chancellor to reconsider increases to the ‘big’ taxes.
The Bank of England (BoE) may also be forced to pause its easing cycle unless UK inflation pressures dissipate quickly (see Exhibit 6). Core inflation remains stubbornly elevated in the UK, defying the Bank’s ongoing optimism about inflation drifting back to 2% within the target horizon.
Over in Asia, China appears to be continuing to largely evade problems in sending goods to the US by using intermediate trading partners (see Exhibit 7). Should the US clamp down on this in upcoming negotiations with other regions, then China, like Germany, must decide whether to stimulate domestic demand to compensate for weaker export demand. However, unlike Germany, China has shown little inclination towards a meaningful domestic stimulus package.
Beijing does seem to have managed to stem the decline in property prices and its efforts to encourage domestic equity investment have helped boost stock prices, making consumer wealth effects more favourable. But we are yet to see Beijing’s actions translate into a meaningful rise in consumer confidence or consumer spending, which will be crucial if China is to weather external trade pressures.
However, January’s DeepSeek announcement was a symbolic reminder of what China’s government has done right, which many emerging economies fail to (see Exhibit 8). China focused on education, and thus each year churns out a large number of highly skilled graduates. If the government promotes entrepreneurship – and engineers are confident they will profit from the fruits of their labour – then China could be at the leading edge of tech innovation.
Overall, despite the noise, we expect a reasonably benign outlook with a transition over the next year to slower and more geographically dispersed growth. But there are considerable risks in both directions (see Global market scenarios and risks). Risks to the downside would result from fear caused by policy uncertainty leading to a more meaningful retrenchment in corporate hiring and capex plans. And perhaps even more disruptive, the risk of a more vengeful return of inflation (see Use alternative investments for alternative risks).
Having a stable strategy to cope with an unstable world will be critical to being able to switch off from the tedious continual political noise, safe in the knowledge that even should that noise become a destabilising cacophony, there are capital preservation strategies in place.