Act, but don’t overreact

Newton’s Third Law states that for every action in nature, there is an equal and opposite reaction. This is often illustrated by a runner on a treadmill that is not going anywhere. However, the universe is more complex than this, and economics and politics do not follow such laws. This means the numerous policies from the Trump administration are generating a wide range of reactions from trade partners, allies and investors. Some of these are problematic for investors, but they also create opportunities in other areas.

Reaction 1: From businesses and consumers

There are two key points to note about U.S. President Trump’s tariff policies. First is the breadth of their reach. The 20% tariffs against China have already raised the U.S. average tariff rates on imports by two percentage points, from 2.4% at the end of the Biden administration. If the 25% tariffs against Canadian and Mexican exports to the U.S. are also implemented, this could push the overall tariff rate to 9%, the highest in several decades. The 25% tariffs on cars and car parts have also sent shockwaves through the global trade scene. At the time of writing, the administration is expected to announce more tariffs corresponding to the prevailing tariff rates against U.S. exports. This means the cost of imports for U.S. businesses and consumers could be at its highest in decades.

The second point is the uncertainty in implementation. Tariffs are often seen as part of the Trump administration's negotiation tactics to achieve its objectives, whether it’s restoring trade balances, tightening border security or stopping other markets from importing oil from Venezuela. However, these negotiations introduce uncertainties for businesses.

In addition to tariffs, the administration’s desire to cut government spending has led to rising job insecurity for some government employees. Some government departments have been shut down or experienced significant cutbacks on short notice. While government employees only make up a small percentage of the overall labor force, weaker corporate sentiment also raises the question of whether demand for labor in the private sector could be impacted too.

As a result, we have seen a dip in both business and consumer sentiment in the U.S. Consumers’ inflation expectations have also picked up due to tariff threats. While weaker sentiment does not automatically translate into softer capital expenditure and consumption, this early crack in weaker data has prompted a valuation de-rating in U.S. equities, especially in the more expensive tech sector.

Reaction 2: From trade partners

What is less clear is the reaction from trade partners following tariff implementation. For Canada, China and the European Union, retaliatory tariffs have been implemented, but these are applied to selective sectors, targeting the Republican voter base. Their objective is to respond, so as not to appear weak, but without escalating tensions. However, as U.S. President Trump continues to introduce more tariff threats, trade partners’ reactions could be dialed up. What is relatively certain is that inflation and growth could move in the wrong direction as the coverage of these measures broadens across the world. Businesses may also find it increasingly challenging to mitigate the impact of broader tariffs across product categories and markets. For example, tariffs against China could be addressed by moving some production to other locations. However, this supply chain reconfiguration would not work if a large number of emerging market economies are all facing higher tariffs, or at least the prospect of higher import taxes.

Reaction 3: From traditional allies

U.S. tariffs are not only targeted toward competitors, such as China, but also key trade partners and traditional allies. Mexico and Canada, with whom the U.S. has signed the United States-Mexico-Canada Agreement (USMCA) trade agreement, are good examples.

Additionally, the change in U.S. foreign policy direction is worrying allies, such as Europe. There are growing questions about whether the U.S. would provide security support to Europe (and by extension, to its allies in Asia). This has prompted European governments to urgently increase their spending on national defense. Germany has passed a EUR 1trillion defense spending package to boost its military capability for self-defense. It remains to be seen whether the rest of Europe has the fiscal space and political will for this increase in spending, but the desire to be more self-sufficient in maintaining regional security is clear. This has resulted in outperformance by European industrial stocks, helping European equity markets to outperform since the start of the year.

For investors: Don’t overreact and act accordingly

There continue to be short-term uncertainties from the White House on U.S. trade policy, and tariffs could be an ongoing tool that U.S. President Trump deploys to gain leverage against other markets on a range of demands. The March Federal Open Market Committee (FOMC) meeting by the Federal Reserve (Fed) was quite telling in terms of what to expect. Its forecast for the 2025 gross domestic product (GDP) growth was revised lower, but the inflation forecast was revised higher. This means more policy uncertainties, and as a result, the median forecast for the policy rate was unchanged, even though more FOMC members are predicting no change in the policy rate in 2025.

The recent market correction, especially in U.S. equities, reflects a more cautious view on the macroeconomic outlook. However, we still see plenty of opportunities for investors to generate returns that would outperform cash.

Starting with global diversification in equities, Europe and China are the surprising outperformers of 2025. China is helped by the potential boost from artificial intelligence evolution and a more business-friendly attitude from Beijing. Europe’s valuation re-rating is partly driven by banks and financials, given their decent profit margins and robust capital base. As mentioned above, greater determination by European governments to boost their defense also helped the industrial sector.

Then we have income-generating assets. Fixed income is the staple asset class and is able to deliver positive real yield in many cases, even for government bonds. High dividend stocks can also help. Alternative assets, such as transportation and infrastructure, have low correlation with public market risk assets while providing a consistent income stream. This consistency should be better appreciated during bouts of market volatility.

In short, investors will need to act and position their portfolios for volatility due to policies from Washington, and the potential reactions from businesses, consumers and trade partners. However, they should not overreact since many investment principles, such as diversification and a focus on the longer term, can help to counter these volatilities.

Global economy:

• The Fed kept rates steady at 4.25%-4.50%, noting “unusually elevated” uncertainty with policy in the U.S. In the economic forecasts, the Fed lowered growth projections and adjusted unemployment and inflation higher, maintaining two cuts in the dot plot for this year. In terms of purchasing managers’ index (PMI), the U.S. services sector showed resilience at 53.5 in February, but manufacturing PMI fell below 50 to 49.8 due to fading front-running from manufacturers. Another notable change was a record high trade deficit in January, with elevated imports likely feeding into weaker 1Q25 GDP data. The job market remained stable, with 151,000 jobs added in February, although the unemployment rate ticked up slightly to 4.1%. Layoffs of federal workers remain a key concern for the labor market.
  (GTMA P. 28, 29, 30)
• Europe saw a major shift in Germany’s fiscal policy, where the government approved a historic spending plan, especially on infrastructure and defense, moving away from decades of fiscal conservatism. Business activity in the eurozone also recovered at its fastest pace in seven months as pressure on the manufacturing sector eased. However, services grew at a slower pace and export orders remained under pressure amidst trade tensions. The European Central Bank cut rates as expected amidst growth concerns.
  (GTMA P. 18, 19, 20, 21)
• China held its “Two Sessions” in early March, where policymakers reiterated their supportive growth stance, expanded fiscal deficit by one percentage point to 4% of GDP, increased central and local government bond issuances and provided forward guidance on more rate cuts to come. Policymakers also emphasized the importance of technology and consumption and expanded the scale of trade-in subsidies.
  (GTMA P. 5, 6, 7, 8)

Equities:

• The MSCI AC World continued its decline in March, falling by 4.1%. Developed markets underperformed with a -4.6% return, dragged lower mainly by the U.S. market. Europe’s STOXX 600 also gave back earlier gains, falling by 4.2%, putting year-to-date returns at 5.2%.
  (GTMA P. 33, 34)
• Both the S&P 500 and NASDAQ experienced corrections in mid-March, falling over 10% since the mid-February peak, logging monthly returns of -5.8% and -8.2%, respectively, in March. On March 11, the NASDAQ fell 4% due to growth fears, logging its largest single day drop since September 2022. Markets recovered some of the losses in late March, driven by slight dovishness from the Fed, but on March 31, markets fell further in anticipation of tariffs in early April. Sector-wise, tech was the main underperformer, falling by 9.0%, while energy was resilient, with a 3.7% return.
• Emerging markets outperformed developed markets in March, returning 0.4% in U.S. dollar terms. Asian markets also slid in early March from U.S. recession fears and tariff policies, but were buoyed in mid-March by the prospect of continued rate cuts by the Fed. MSCI China rose 1.9%, driven by improving macro data and positive messaging from the Two Sessions, although tech stocks experienced some profit-taking. Japan outperformed for most of March, touching an 8-month high on March 21, mainly buoyed by stronger-than-expected inflation data and the expectations of rate hikes by the Bank of Japan. However, Japanese markets tanked when U.S. auto tariffs were announced, resulting in a TOPIX monthly return at -0.9%. 

Fixed income:

• U.S. 10-year Treasury yields rose 2 basis points to 4.21%, with the yield curve reaching its steepest level in three years, as markets continue to digest the on-and-off tariff threats and firmer inflation data, while the Fed views inflation risk as transitory and focuses more attention on growth concerns. The Japanese government bond 10-year yield rose to 1.52%, a decade-high level, due to promising developments at the Shunto wage negotiations.
  (GTMA P. 60)
• Spreads remained tight on U.S. investment grade bonds but widened on U.S. high yield bonds, which returned -0.3% and -1.0%, respectively, over the month, as all-in yields rose.
  (GTMA P. 55)

Other financial assets:

• Commodities were broadly higher in March, with the DJ/UBS Commodity Index rising 3.6%. Gold prices reached a record high, surpassing USD 3000 per ounce on March 14, driven by policy and economic uncertainties that increased demand for safe-haven assets, ending the month 9.9% higher. Copper also reached multi-month highs, rising 5.0% in March, due to expectations of tariffs on copper imports leading to speculative buying. Crude oil saw some fluctuations, with Brent crude ending the month 2.7% higher, impacted by factors such as energy tariffs on Canada and Mexico, as well as the Organization of the Petroleum Exporting Countries’ (OPEC+’s) decision to increase output.
  (GTMA P. 71, 72, 73)
• The USD dropped sharply in early March on Trump’s confirmation of one-month tariff reliefs, with the DXY index ending the month down 3.2%. On the other hand, the euro surged on Germany’s agreement to increase defense and infrastructure spending, up 3.9% over March.
  (GTMA P. 69, 70)

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