CIO Digest
Outlook and Views
US tariffs and uncertainty around potential retaliation and government reorganization efforts have increased the risk of a US and global recession. In Q1, much of the weakness in the US was in soft data—business and consumer sentiment—due to high uncertainty. The biggest risk has now shifted to actual damage if tariffs are sustained. In Q2, we are focused on combining micro insights from company earnings with macro insights to assess the outlook for consumer spending, business investment, and employment. Europe's improved prospects from German fiscal and defense spending are unlikely to materialize soon, indicating downside risks in 2025.
We entered 2025 anticipating further declines in inflation. However, the implementation of faster, higher, and broader tariffs challenges this outlook in the near-term, making a return to 2% inflation in the US unlikely this year. Inflation expectations, corporate pricing power and wage demands will determine whether tariffs cause a one-time price increase or sustained inflation. In the Euro area and UK, fading wage catch-up effects and growth headwinds are expected to reinforce disinflation. Meanwhile, Asia looks set to continue to see divergent trends—rising inflation in Japan due to the fastest wage growth since the early 1990s, and deflation in China.
We expect the negative growth impact of US tariffs to outweigh inflation risks outside the US, strengthening the case for monetary easing in the Euro area, UK, and certain emerging markets. In the US, with inflation still above the Fed’s target, clearer evidence of labor market weakness will likely be needed for the Fed to act. But if the labor market weakens, there is a higher chance of deeper rate cuts. We expect the BoJ to raise rates again given the positive cycle between wages and prices, provided a global downturn is avoided. While domestic policy easing in China is anticipated, large-scale fiscal easing in major economies seems unlikely due to constrained starting fiscal positions, especially in the UK.
The lasting effects from announced or temporarily postponed tariffs on US and global growth and inflation remain highly uncertain, depending on negotiations, retaliation, and fiscal support. The ongoing uncertainty may undermine confidence, slowing down hiring, investment, and spending. We believe investors need to stay nimble to assess the evolving impact of deteriorating macro conditions, especially since identifying a potential circuit breaker to reverse the damage from tariffs is challenging.
For more see Market Brief: Taking Stock of the Tariff Shock.
We have turned defensive in light of elevated uncertainty over the global economic expansion despite healthy earnings growth and potential for central bank easing. We still see value in broadening equity exposures beyond the US "magnificent 7”1 to include small caps with attractive valuations. Regional diversification, including Japan (beneficiary of corporate governance reform), India (where valuations have improved), Europe, and emerging markets, also may offer value in an environment of growing dispersion. Diversification within technology is also crucial for capturing growth opportunities linked to AI adoption.
Within fixed income, we are tactically neutral on US rates due to near-term tariff inflation risks and the time needed for labor market weakness to prompt Fed cuts. However, the tariff shock is expected to create dispersion, offering relative value opportunities. We remain underweight Japanese rates as wage-price dynamics and prospects for fiscal support suggest further BoJ hikes later this year, barring a global recession. In contrast, limited fiscal room and weak growth prospects in the UK reinforce dovish policy expectations. In Europe, near-term growth risks are likely to overshadow medium-term fiscal prospects, potentially supporting a steeper yield curve positioning.
From a multi-asset perspective, we are cautious on credit compared to equities due to tight spreads, even after recent widening, despite healthy company balance sheets and a likely peak in defaults in the US and emerging markets. In fixed income portfolios, we hold moderate exposure to spread sectors, favoring securitized credit for its attractive valuations over investment grade credit. We have recently adopted a more defensive stance in anticipation of rising risk premiums amid growing recession concerns. However, we are prepared to capitalize on market corrections where we believe fundamentals will remain resilient.
We are neutral on the US dollar as its appreciation trend has stalled due to lower US rates and growth concerns, despite tariff risks. However, the dollar may strengthen if global growth weakens and financial conditions tighten sharply. We are constructive on the euro, given the improved medium-term growth outlook for the Euro area. We are underweight the Chinese yuan (CNY) versus the US dollar due to the positive carry in this exposure and see scope for CNY to weaken further in response to tariffs, with other Asian currencies likely to follow suit.
Topics in Focus
Unlocking Growth: European Equity Opportunities Beyond Defense
- Germany's fiscal rule reform, combined with a €500 billion off-budget infrastructure fund and increased region-wide defense spending, has the potential to significantly boost German and Euro area growth over the next decade. Our optimistic view on this growth uplift is informed by sustained efforts to address chronic underinvestment and a strong focus on domestic infrastructure, research, and development, which could catalyze innovation. For context, increased defense spending in the US, particularly through DARPA,2 has led to groundbreaking innovations like the internet, GPS, advanced robotics, and cybersecurity systems. Germany, with its biotechnology expertise demonstrated by developing one of the first COVID-19 vaccines, has the innovative capacity to drive similar advancements, especially as it repurposes its auto sector in response to competition from China and the shift to electric vehicles.
- Investors have already benefited from diversifying into European equities this year, as the gap between US and European economic and earnings expectations has narrowed. Looking ahead, we believe attractive valuations, especially compared to the US, and earnings growth potential linked to German fiscal and region-wide defense spending will extend the strong performance in European equities, even in the face of near-term tariff risks. However, we believe it's crucial to look beyond defense and identify the opportunities presented by German fiscal stimulus which has potential to act as a cornerstone for earnings potential across a range of sectors like construction and industrial automation. Read more on the potential investment implications of fiscal transformation in Europe, led by Germany, in an upcoming edition of Asset Management Perspectives.
Deregulation in the Energy Sector—More Impactful for Gas Than Oil, In Our View
- Early 2025 has been marked by market-unfriendly actions like tariffs and federal worker layoffs. However, investors are hopeful for a sentiment boost from a shift in the Trump Administration towards market-friendly policies, including deregulation, in the coming months. One sector in focus is energy, and President Trump has signed executive orders to boost domestic energy supply.
- While the impact on oil production may be limited due to the US already achieving energy independence and becoming a net oil exporter, we think investment opportunity lies in liquefied natural gas (LNG). Oil companies are focused on capital discipline and shareholder returns, making them cautious about long-term projects.
- In contrast, LNG presents rising investment potential due to deregulatory efforts and structural demand needs. Measures to increase LNG production, including faster approvals for new projects, may help address the rising energy demand driven by AI ambitions and reshoring. Permits granted over the next four years are expected to drive the next wave of LNG export growth from 2029, potentially positioning the US as the world's leading natural gas supplier. We believe increasing LNG production and the necessary infrastructure creates investment opportunities in companies across the LNG supply chain including storage facilities and pipelines, making it a compelling focus for investors looking to capitalize on the evolving energy landscape.
- 1.5% Estimated boost to German GDP growth by 2026-2027— a significant uplift for an economy that has stagnated since 2022 and above consensus expectations of 0.8-0.9%. Eurozone is expected to be boosted by 0.5-0.6% by 2026-2027, a smaller boost than in Germany due to limited fiscal space in high-debt, high-deficit economies like France and Italy.3
- 50% Expected rise in global LNG demand by 2030, driven by Asia Pacific and Europe. With countries aiming for diversified supply streams after economic challenges created by Europe's reliance on Russia, and rising energy demand for AI, we believe the US has a chance to become a leading LNG supplier.4
- 7.5% Q1 2025 total return of European equities compared to a -4.3% decline in US equities and a -16% drop in the Magnificent 7. German equities rose over 11%, but lagged Asia Tech stocks (Hang Seng Tech Index), which returned 20.7%. In short, the potential benefits of regional equity diversification have been evident in 2025.5
What We’re Watching
- US Policy: US policy caused significant market uncertainty and volatility in Q1 but may improve investor sentiment in the future if the focus shifts towards deregulation and potential fiscal support. Tariffs are viewed as a strategic tool to address trade imbalances, geopolitical tensions, raise revenues, and stimulate domestic manufacturing. Therefore, we believe the baseline tariff imposed on all US trade partners, excluding Canada and Mexico, is likely to remain, even if additional tariffs are reduced.
- Corporate Earnings: In 2025, the market has shifted from the dominance of the Magnificent 7 to a more diversified landscape, with equity markets outside the US, including Europe and emerging markets, gaining ground. The latest wave of US tariffs has reinforced performance dispersion, with healthcare and certain domestically-oriented companies, such as leisure-related apparel and services, proving more resilient to recent market volatility. We will closely monitor the upcoming earnings season to assess the vulnerability or resilience of company earnings to the challenging macro backdrop, while also piecing together macro trends on investment and employment outlook.
- Fiscal Support: The response of governments to help manage the economic impact of tariffs through fiscal support, both in the US and globally, will be crucial for gauging the ultimate hit to growth and recession odds. US tariffs represent a significant hit to US consumer purchasing power, which may create political pressure for fiscal support. However, if this requires Congressional approval, the timeline may misalign with the peak economic impact.
1 Magnificent 7 is a list of large US tech companies including: Meta, Amazon, Apple, Microsoft, Alphabet, Tesla, NVIDIA
2 Defense Advanced Research Projects Agency (DARPA).
3 Goldman Sachs Asset Management Multi-Asset Solutions. As of March 27, 2025. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this document.
4 Bernstein Societe Generale Group Asia-Pacific Oil & Gas - Global LNG: An inflection point for the global cycle (March 20, 2025)
5 Bloomberg, Macrobond. As of March 31, 2025. Indexes used: EURO STOXX 600, S&P 500 Index, Bloomberg Magnificent 7, DAX Index, Hang Seng Tech Index.
