Our September Investment Quarterly (IQ) was held in London, coincidentally during President Trump’s state visit. While the official trip was accompanied by considerable pomp and pageantry, our meeting had much less grandeur, with the focus on the impact of the administration’s policies across economies and markets. Monetary policy was also in the spotlight, as the Federal Reserve (Fed) cut rates for the first time since December 2024.

Despite the recent swirl of global fiscal and monetary policies, financial markets have enjoyed considerable returns with surprisingly little volatility. Against this backdrop, IQ members debated whether these favorable market conditions would continue or if something out there could potentially derail them.

Macro backdrop

The group acknowledged that markets had calmed down since Liberation Day in April. U.S. tariffs have been deployed and governments, businesses and households spent the last quarter adjusting to them. We estimate that the average U.S. tariff rate is close to 16%. So far, businesses have absorbed a fair share of the tariff costs while maintaining their operating margins; consumers have paid the remainder.

The U.S. fiscal balance is benefiting from greater revenue. Meanwhile, governments around the world are deploying policies to offset the impact. We recognize that global trade involves many moving parts, and there may come a point when businesses feel compelled to pass a greater share of the tariffs on to the consumer, causing demand destruction. Already, we are seeing corporate America in a hiring pause that has led to a slowdown in the labor markets.

The Fed is responding to this with rate cuts, but fiscal stimulus is also on the way globally. In the U.S., the impacts of the One Big Beautiful Bill Act (OBBBA) will hit at the start of 2026; in Germany there are plans for a sizable spend on defense and infrastructure and in China, policymakers are focused on fixed asset investment. We expect the European Central Bank to pause at 2%, having already cut rates substantially. The Bank of England will resume rate cuts in the spring.

Despite tariffs, the group was impressed that inflation expectations have remained contained. Market participants remain comfortable that the impact will be temporary. While inflation is likely to stay above developed economy central banks’ 2% targets through the middle of next year (running now around 3%), the overshoot is concentrated in goods prices and not services. In China, there is deflation in intermediate and finished goods.

The metric the group is most focused on is wage growth. For now, it is stable, but if wage growth were to weaken further, it would imply less labor demand and a greater probability of economic contraction. Firmer wage growth would tell us that businesses have been able to navigate tariff policy and are hiring again and investing in capex on the expectation of higher revenue growth. Firmer growth would be a validation that the fiscal and monetary responses have worked to offset the tax of tariffs.

We appreciate that markets may see further fiscal and monetary developments. Lack of a trade agreement between the U.S. and China could be destabilizing. Midterm elections in the U.S. are only a year away, and we could see more policy change from the U.S. administration in the form of deregulation or additional fiscal stimulus. But for now, the surprising calm should continue through year-end and as we roll into 2026, the stimulative impact of the OBBBA should more than offset the drag of tariffs.

Scenario expectations

We reduced by 5% each the likelihood of Crisis (now 5%) and Recession (now 10%). With policymakers globally focused on providing monetary and fiscal accommodation to cushion the impact of trade policies, an orderly or disorderly contraction is far less likely to occur. We shifted that cumulative 10% into Above Trend Growth (20%). We can envision, as global fiscal stimulus hits next year, business profitability triggering a meaningful resumption of hiring and capex. We left Sub-Trend Growth (65%) unchanged. Businesses and households seem to be gliding into year-end despite slower hiring and spending.

It will likely take some time for the global economy to adjust to the new paradigm of trade negotiation and reshoring, but we have confidence that policymakers will stand by ready to assist.

Risks

The greatest risk is that inflation settles in at a structurally high rate, given that inflation has persistently run well above the central bank’s 2% target. Despite this, the Fed is focused on ensuring the labor market remains firm, and is willing to ease policy to guarantee that. Further, the next Fed chair and Federal Open Market Committee (FOMC) appointees are likely to be supporters of the administration’s view that lower policy rates will lead to stronger growth. The “next Paul Volcker,” an inflation vanquisher using dramatic interest rate hikes, is not on any administration’s short list of candidates. 

It does not seem entirely improbable that looser monetary policy, combined with an influx of global fiscal stimulus, could lead to a wage-price spiral. Sovereign borrowing and spending seem to have become business as usual, while debt brakes and austerity have become outdated concepts. We should also be mindful that an awful lot of money is still sloshing around the system from pandemic-era policies.

A lesser risk is that the highest rate of tariffs in a century proves to be a bigger tax on the global economy, and a contraction ensues. Businesses pulling back on their tech capex could also contribute to a slowdown in growth. Separately, if central banks renew their fight against inflation, a key support for markets will evaporate.

Strategy implications

The group was focused on opportunities that would outperform in a moderate expansion. The risk-on bias led us to global hybrid capital notes, emerging market debt (local sovereigns and corporate debt) and leveraged credit (high yield, broadly syndicated loans and direct lending). There was some preference to maintain a modest long duration bias expressed through U.S. Treasuries and an ongoing view that the U.S. dollar would continue to weaken, perhaps another 5%. We think the fed funds rate will settle at 3.375% by Q1 2026, with the 10-year Treasury in a range of 3.75%-4.25%.

While the low volatility, high return environment should continue over the next couple of quarters, the group had hoped we would see a “Buy the rumor, sell the news” market consolidation following the FOMC meeting. We acknowledge there is still a considerable amount of cash on the sidelines looking to get into these markets and any sell-off should be a buying opportunity.

Closing thoughts

While policymakers and the markets are enjoying an extended soft landing, the question is what comes next. In the U.S., tariff policy has yet to be fully shaped and implemented, the OBBBA has yet to take full effect, and the future leadership of the Fed and its longer-term rate path are unknown. Outside of the U.S., the impact of fiscal spend across Europe has yet to be realized. China has to execute on a bold plan to bolster fixed asset investment and consumption. And lastly, conflicts are still ongoing in Ukraine and the Middle East. Nonetheless, the resilience of businesses and households has been impressive, and policymakers are in an accommodating mood. Despite some skepticism that the good times in markets can roll on, we remain focused on harvesting yield and return from an array of global bond markets.

¹Additional Tier 1 bonds are assets that, among others, are part of the capital banks are required to hold against possible stress.

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