Global markets continue to react to policy shifts from Washington. Initially, U.S. President Trump’s tariff policy reassured investors with a temporary truce with China, but concerns resurfaced as the administration proposed additional import taxes on the EU. Meanwhile, the U.S. Congress is advancing the budget reconciliation bill, which is expected to extend the 2017 Tax Cuts and Jobs Act (TCJA), while the federal deficit is projected to increase in the medium term. Uncertainty remains as the 90-day postponement of reciprocal tariffs nears its end in early July, leaving trade partners scrambling to reach agreements with Washington.

The U.S. President’s new deals

By the end of May, only two economies had reached tentative agreements with the U.S. on tariffs. The UK established a framework, though it lacked formal details. More significantly, the U.S. agreed to a 90-day truce with China on May 12 following negotiations in Geneva. U.S. tariffs on Chinese imports were reduced from 145% to 30%, while China reciprocated with matching cuts. This agreement was stronger than anticipated, providing some relief to markets by mitigating immediate supply chain disruptions. Both sides agreed to continue discussions, which remains crucial.

However, just as investors began to believe that the Trump administration had stabilized its stance on tariffs, the president floated the idea of imposing 50% tariffs on EU exports to the U.S., citing stalled negotiations. This proposal was subsequently postponed to July 9—the same date marking the end of the 90-day tariff pause. Other key trade partners, including Japan and South Korea, appear to be using the delay to negotiate terms that best serve their domestic political interests. Observing the U.S.-UK agreement, the 10% base tariff seems difficult to move, while potential levies on semiconductors, pharmaceuticals and other products remain uncertain.

Thus, tariffs will continue to pose risks into the summer months. Even if no new tariffs are introduced, the average rate on U.S. imports has already risen from 2.4% at the start of U.S. President Trump’s term to 12%, heightening the risk of higher consumer prices. Additionally, sporadic messaging from the administration may deter corporate investment in the near future.

U.S. Federal Reserve (Fed) Chair Jay Powell repeatedly cited uncertainty as a reason for maintaining current interest rates in his May FOMC press conference. The Federal Open Market Committee (FOMC) sees both inflationary pressures and risks to economic growth. However, given strong employment figures and other economic indicators, the Fed appears willing to wait. The futures market now fully prices in a 25 basis points (bps) rate cut only by October, rather than June, following Liberation Day.

Path to the BBB

Meanwhile, the White House and Congress are working to pass the reconciliation budget, or as U.S. President Trump called it, the Big Beautiful Bill. At the time of writing, the House has approved the bill, with the Senate vote pending. Research estimates suggest the legislation would add between USD 2.8trillion and USD 3.4trillion to deficits over the next decade—or up to USD 5trillion if temporary provisions become permanent.

The bill includes extensions to tax cuts from the 2017 TCJA, as expected. Additional measures include tax reductions on tips and overtime, as well as lifting the cap on state and local tax (SALT) deductions. To offset these tax cuts, proposed spending reductions include Medicaid cuts and the scaling back of clean energy tax credits. The bill also raises the debt ceiling by USD 4trillion.

The tax cuts are front-loaded, while spending reductions are deferred, considering the 2026 midterm and 2028 presidential elections. This could partly mitigate fiscal tightening resulting from tariff increases in 2025 and 2026.

However, long-term sustainability remains a concern. Moody’s downgrade of the U.S.’s sovereign rating from AAA to AA+ is frankly not a surprise. S&P and Fitch downgraded their U.S. rating in 2011 and 2017, respectively. Yet, this coincided with a period of high deficits in recent years, and the lack of determination by Congress to rein in this large fiscal shortfall. While U.S. government debt levels are comparable to other developed economies, the pace of debt growth raises red flags. The federal debt-to-gross domestic product (GDP) ratio currently stands at 98% and is projected to reach 130% by 2035. As a result, investors anticipate an elevated risk premium on U.S. Treasuries, particularly at the long end, unless Congress commits to addressing fiscal deficits more decisively.

Diversification and volatility management

U.S. trade, fiscal and foreign policies are expected to keep markets volatile through the summer. A key date to watch would be before July 9, when the 90-day tariff pause ends. While the U.S.-China truce has eased recession risks, economic slowdown remains likely. This suggests that consensus expectations of high single-digit earnings growth for the S&P 500, coupled with a 12-month forward valuation of 21 times, may be optimistic.

With global earnings poised for synchronized downgrades, the less demanding valuations in European and Asian markets present opportunities for international diversification in equity allocation. An active management strategy focusing on sectors with state support—such as defense in Europe and technology in China—could prove beneficial.

On fixed income, inflation and fiscal deficit risks in the U.S., combined with growth uncertainties, may keep the long end of the Treasury curve volatile. As a result, a short-to-neutral duration approach may offer a balanced strategy for income generation and volatility management.

The U.S. dollar (USD) is expected to face continued pressure in the medium term as investors focus on the twin deficits—current account and fiscal. While currency depreciation typically helps restore balance, strong U.S. equity and fixed-income outperformance relative to global markets has delayed this adjustment. However, as international markets catch up, the USD could see further downside, potentially creating openings for emerging market fixed income, including local currency options.

Global economy

• The U.S.-China negotiations in Geneva resulted in a surprisingly large bilateral tariff reduction, bringing U.S. average tariff rates down to 13.7%. This 90-day trade truce reduced recession risks materially, but has not eliminated them, as the average tariff rate is still significantly higher than the 2.4% in end-2024, posing material risks to inflation and growth. April non-farm payroll growth totaled 177K, beating expectations despite uncertainties. In the May FOMC meeting, the Fed decided to keep interest rates unchanged, continuing its “wait and see” approach. Moody’s also downgraded the U.S. sovereign credit rating from AAA to AA+, citing concerns over growing debt and fiscal outlook.
  (GTMA P. 28, 29, 30)
• Eurozone business activity disappointed. HCOB composite PMI contracted at 49.5 in the May flash print, down from 50.4 previously and below the 50.7 expected. The services sector deteriorated at 48.9, hitting its lowest level since January, while manufacturing improved marginally but remained in contraction territory. Japan’s economy contracted by 0.2%, the first quarterly drop since early 2024, largely due to a fall in exports. The ongoing U.S.-Japan negotiations remain key to the economy’s outlook.
  (GTMA P. 18, 19, 20, 21)
• The People’s Bank of China announced a package of monetary support measures for the China economy, including rate cuts, reserve requirement ratios cuts and expansion of lending facilities. April headline consumer price index (CPI) contracted by 0.1%, similar to March. Credit data also disappointed due to local government debt swap programs and weak demand. April activity data was also mixed, with industrial production beating expectations, while retail sales disappointed.
  (GTMA P. 5, 6, 7, 8)

Equities

• The MSCI AC World gained 5.7% in May, with most developed markets delivering positive returns in local currency total return terms. U.S. markets logged the strongest return over the month, with the S&P 500 up 6.3%, followed by European markets with MSCI Europe up 4.6%, and then the Japanese markets with MSCI Japan up 5.3%.
  (GTMA P. 33, 34)
• In the U.S., broad-based strong 1Q earnings, artificial intelligence advancement remaining still intact, optimism around lower U.S. tariff rates and renewed hope for a soft-landing outlook aided markets. Nasdaq returned 9.7% over the month, outperforming the S&P 500, while small caps lagged with a 5.3% return, with reference to the Russell 2000 index. In year-to-date terms, both the Nasdaq and small caps remain underwater, with only the S&P 500 in positive return territory by the end of May.
• Most sectors delivered positive returns in May, led by cyclical sectors as risk-on sentiment revived. The top performing sector was information technology (+10.9%), followed by consumer discretionary (+9.4%). The only sector with negative performance over the month was health care (-5.6%).
• Emerging markets rose 3.2% over the month, with APAC ex-Japan up 4.0% in local currency total return terms, as China rallied on the de-escalation in trade tensions after the Geneva meeting with the U.S. Most other Asian markets were also resilient as trade deal negotiations with the U.S. continues.

Fixed income

• Government bond yields in developed markets increased sharply over the month. 10-year yields on U.S. Treasuries were up 24 bps to 4.39%, with 30-year yields testing the 5%-mark, as markets are increasingly concerned about significant fiscal deterioration induced by the reconciliation bill’s tax cuts and extensions, alongside Moody’s rating downgrade.
• Japanese government bond yields also rose over the month, with the 10-year yield at 1.50% and the 30-year yield at a record high of 2.96%, as domestic pressure to loosen fiscal policy was met with the Bank of Japan’s purchase tapering and weak auctions. Fiscal pressure also led 30-year yields on UK Gilts and German Bunds to decade level highs, on top of the hotter-than-expected inflation print and the Dutch pension reform, respectively.
  (GTMA P. 55)
• Spreads on U.S. high yield bonds narrowed more than on investment grade bonds, thus returning 1.7% and 0.0% over the month, respectively.
  (GTMA P. 60)

Other financial assets

• Gold prices edged down by 0.7% in May to USD 3,278/oz, while silver and copper prices rose 2.7% and 4.9%, respectively. Crude oil prices increased 2.4% to USD 61.0/bbl despite the potential Organization of the Petroleum Exporting Countries (OPEC+) production hike.
  (GTMA P. 71, 72, 73)
• The USD was mostly unchanged over the month, with the DXY index steady at 99.3 by the end of May. While the Euro and Japanese yen weakened, most other Asian currencies, such as the Chinese yuan, Australian dollar, Korean won and Taiwanese dollar, had all appreciated against the USD.
  (GTMA P. 69, 70)

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