Executive Summary
The US has kicked off a full-fledged trade war: On 2 April, US president Donald Trump announced “reciprocal” tariffs that exceeded expectations, with products imported from China set to be taxed at a staggering 130% from 10 April. The Liberation Day announcements included a universal minimum tariff of 10%, taking effect on 5 April at 12:01 a.m. EDT.1 President Trump also originally decided to impose individualized reciprocal higher tariffs on over 50 countries with which the US has the largest trade deficits, but ultimately announced a 90-day pause for all these countries except China. They are thus subject to only +10pps tariff hikes, while China is facing +125pps. Accounting for sectoral exclusions that were listed in the Executive Order (e.g. semiconductors, pharmaceuticals, copper, minerals), the US effective tariff rate on China now stands at 130%, while the EU faces 9%. All the tariff hikes bring the US global import tariff rate to 25.5%, the highest level since the 1890s. We assume bilateral deals could lower the US import tariff rate to 10.2% by Q4 2025.
In 2025, global GDP growth will slump to a mere +2.3%, the lowest level since the pandemic. Global economic growth is set to decelerate by -0.6pp from +2.9% in 2024 due to the US trade war. The current level of global uncertainty is as high as it was during the Covid-19 pandemic. The US will enter a mild recession (cumulative decline of -0.5% Q1-Q3), with a weak +0.8% in 2025, due to ongoing policy disruptions, import tariff hikes and retaliation tariffs from China. Europe will not escape lower growth due to higher trade restrictions and a weaker US economy, despite the German fiscal stimulus and higher defense spending. We have cut forecasts to +0.8% in 2025 and +1.5% in 2026. Increasingly worried households are likely to increase precautionary savings, dampening consumer demand.
Reflation risks make central banks cautious. Inflationary pressures, particularly in the US, are resurfacing, with headline inflation expected to peak at 4.3% by summer, driven by tariffs. Consequently, the Federal Reserve is expected to adopt a cautious approach, holding rates in place until October and then cutting them to 4% by end-2025 and 2.75% by mid-2026. Persistent stagflationary risks will reinforce the Fed’s focus on combating inflation above promoting growth. Europe’s continued disinflation contrasts sharply, suggesting divergent monetary policy responses between the two regions. The ECB is likely to bring rates down to 1.5%, -50bps more than expected.
Emerging markets are dealing with the (tariff) stick and gaining from the (diversification) carrot. Emerging markets are responding strategically by adjusting tariffs on American goods and diversifying imports. Israel, Vietnam, India and Thailand, to name a few, have opted for (resp.) cutting tariffs, seeking a trade agreement or increasing imports. Overall, countries which have the highest export dependency on the US and that are subject to the highest tariff hikes are likely to negotiate first, by committing to buy more US products, lowering import tariffs to close to 0 and increasing investments in the US when possible. Many nations in Asia (e.g. Cambodia, Vietnam, Taiwan, , Thailand and South Korea) and a few in Latin America (e.g. Mexico, Colombia) are likely to do so. Like a fog of war, it is unclear what the final tariff landscape will look like, but the cost of uncertainty is high as tariff arbitrage is now off the table for most companies – until the dust settles. China has taken a harsher tone, announcing retaliation of +84pps tariffs on all US imports, effective on 10 April, and potentially more to come. China demonstrated signs of economic recovery in Q1 and is proactively promoting consumption-focused reforms. Fiscal stimulus and monetary easing are expected to support GDP growth to reach +4.5% in 2025 and +4.2% in 2026, despite lingering downside risks.
Companies are adopting short-term strategies such as frontloading imports, diversifying supply chains and adjusting prices to mitigate tariff impacts, while policy uncertainty hampers investments, especially outside the US. US companies are expected to manage over the next few months with solid balance sheets and stockpiling covering six months of demand (especially for retailers and consumer electronics). However, two-thirds may pass tariff costs to consumers, varying by sector. Meanwhile, production is also shifting from China to Southeast Asia, Mexico and even the US to avoid tariffs. Companies have announced nearly USD1trn in investments in the US despite higher labor costs, which could affect profitability. Strong brands like luxury and tech can absorb costs without losing market share, while low-margin sectors like retail have fewer options. Overall, global uncertainty will suppress capital expenditures, particularly in Europe. Negotiating price cuts and selectively lowering selling prices are additional tactics. Global insolvencies are projected to rise by +7% in 2025 due to the slump in global demand and geopolitical issues, with the US seeing an +16% increase and Western Europe a +5% rise.
Capital markets have miscalculated Trump’s second term. Capital markets had already suffered from a more aggressive US policy stance before Liberation Day, reflected in lower US yields, falling equity prices, and a weaker dollar. Liberation day then reenforced those dynamics with markets sharply shifting into risk-off mode and only partially reversing after the subsequent announcement of a partial 90-day tariff pause. With a US recession now our baseline and lower central bank terminal rates than current market pricing, bond yields are expected to fall further from current levels. Equity markets continue to face heightened concentration risks. Nonetheless, our macroeconomic outlook suggests a bottoming out in risk-off moves. We expect both US and Eurozone equities to recover from current levels towards year-end, although downside risks remain and volatility will remain high amid a mixture of forthcoming trade deals and counter-tariffs.