In this month’s Core Offerings, we discuss the emerging risk that President Trump will test his constraints by taking the economy to the edge of recession in “a period of transition”. This could manifest in a sharp weakening in the global economy and equity markets which could force the US Federal Reserve (Fed) to cut rates much more aggressively than it expects. For now, markets continue to price two to three Fed rate cuts but remain worried about rising inflation expectations. But this may be a ‘red herring’. Fed Chair Powell is talking tough on inflation and not flinching for now, but he ultimately has a jobs mandate too. And if Trump slows growth sharply on reduced fiscal spending and a tariff-induced confidence collapse, Powell knows he’s going to be cutting rates. We believe that the Fed’s dual mandate will force its hand. The end game of Trump’s tax cuts will then be in sight.
The first week of April is shaping up as a key pinch point for markets. A likely ‘hot’ inflation print will frame a week where Trump may well spray the world with reciprocal tariffs, further escalating the global trade war, ahead of key business confidence and US jobs indicators. Reflecting this, we are tactically adding some ‘defence’ to our portfolios, by trimming investment grade credit and moving overweight government bonds. With uncertainty heightened through April, tactical positioning may need further adjustment. As we’ve tirelessly stressed, 2025 is a year not to panic but to lean on well-diversified portfolios, amid this volatility. We believe markets can navigate modestly higher this year. There will be times to buy the dip, and one of those will likely be when a Fed pivot comes into view.
“We don’t know what’s going to be tariff. We don’t know for how long or how much, what countries. We don’t know about retaliation. We don’t know how it’s going to transmit through the economy. That’s, that really does remain to be seen…
Neither our lives, nor markets, are path independent. Monetary and fiscal policy matters, the geo-political framework in which we exist matters and the state of our psyche (confidence) matters. And like Fed Chair Powell commented in January, “we don’t know what’s going to be a tariff. We don’t know for how long or how much, what countries. We don’t know about retaliation. We don’t know how it’s going to transmit through the economy. Just so many variables. So, we’re just going to have to wait and see”.
Early April is shaping up as a key pinch point for markets, with some key signposts to watch for signs of just what path we might be on.
Of course, as at any time, there are other key developments, such as the seemingly failing ceasefire in Gaza, or partial ceasefire in Ukraine, which could also significantly lift volatility at a time of heightened uncertainty.
…You know, there are lots of places where that price increase from the tariff can show up between the manufacturer and a consumer. Just so many variables. So, we’re just going to have to wait and see”.
We remain comfortable with our key market themes for 2025, communicated regularly since our year-ahead piece, Outlook 2025 – Navigating disruption, discovering opportunity, published in early December last year. Within the frame of our 6–12-month tactical window, we continue to hold a constructive view on markets.
This is characterised within three key themes. Firstly, the macro backdrop remains relatively benign, with global growth slowing below trend (but not collapsing). Inflation is also continuing to moderate—although with work still to be done, its moderation opened the way for modest rate cuts in 2024 (and the likelihood of further modest cuts in 2025).
“The benefits of a tariff are visible. Union workers can see they are ‘protected". The harm which a tariff does is invisible. It spreads widely. There are people that don't have jobs because of tariffs but they don't know it."
Secondly, despite that constructive macro backdrop, this year is still going to embody greater volatility than we’ve seen for a number of years, as the new US administration out-works its agenda. This suggests a bumpier ride, and the risk of more meaningful (and more extended) drawdowns than we have experienced over the past two years.
And thirdly, after two years of around 20% equity market returns, that constructive view of markets still aligns with more ‘average-like’ returns for the year ahead. Yes, we still believe markets can deliver positive returns in 2025, but the ride will be bumpier, and while 2024 was a year to ‘lean into risk’, 2025 may be the ‘realm of the brave’ where we are prepared to ‘buy the dips’ through periods of volatility.
However, we also need to recognise when the facts change. By all accounts, as we wrote about last month in ‘Skate where the puck is going – key views for navigating noisy markets’, the cacophony of noise form the US administration, arguably to ‘flood the zone’ and create confusion – as well as the aggressiveness with which it’s pursued its fiscal (and related trade and tariff) agenda – has created some short-term risks to US and global growth (as discussed below) which we feel warrants some near-term portfolio protection.
Indeed, the elevated ‘noise’ is already weighing on business and consumer confidence. US consumer spending has slowed noticeably in early 2025, with Q1 growth on track for around 1%, a significant shift below trend after the 2.7% pace in H2 2024. Elsewhere globally, growth momentum continues to be positive in Japan, while Australia’s growth appears to have passed its worst. But China has lost momentum in early 2025, and the risk remains that US tariffs may weigh heavily on European and UK growth before the positive impacts of the recent significant fiscal stimulus has time to impact activity.
Reflecting this, and as discussed in our Tactical Asset Allocation section (page 18), while we remain moderately overweight equities (with a bias to non-US markets through a US dollar underweight and Japan equities overweight), we have added to global bonds, where we are now slightly overweight (while closing our overweight to investment grade credit). With a dovish Fed pivot a key signpost that our positioning is appropriate, a modest overweight to fixed income will protect portfolios in the shorter term if the current ‘risk-off’ period extends, while adding to our ‘insurance’ to engage equities more forcefully should the Fed cut faster, bonds rally or some resolution to the global trade dispute emerges.
While we remain moderately overweight equities with a bias to non-US markets through a US dollar underweight and Japan equities overweight— we have added to global bonds, where we are now slightly overweight (while closing our overweight to investment grade credit)
It’s almost like a game of prisoners’ dilemma. Both the accused end up pursuing their individual – arguably rational – goals (to be acquitted), but in the process deliver a worse outcome (a heavier sentence) than if they had mutually cooperated.
President Trump wants lower interest rates, but he is spraying the world with ‘reciprocal’ tariffs that could push inflation higher in the short-term. Jay Powell, Chair of the Fed wants lower inflation and appears in no rush to appease Trump with rate cuts until the evidence of such appears. It’s not exactly pistols at 12 paces, but lines have been drawn.
It’s almost like a game of prisoners’ dilemma. Both the accused end up pursuing their individual – arguably rational – goals (to be acquitted), but in the process deliver a worse outcome (a heavier sentence) than if they had mutually cooperated.
Yet unlike prisoners’ dilemma, we think one of these players will ultimately concede and (seemingly) cooperate. And while it could be Trump – worried by a falling equity market – we are guessing it will be the Fed. And it almost certainly won’t be due to political pressure, despite no shortage of pressure being applied by the Trump administration.
So, what are the goals each are pursuing? As we’ve written before, Trump’s fiscal strategy is ultimately driving the administration’s current actions. He currently needs to find between USD 1.5 and 2 trillion of fiscal savings (according to the House) to extend the 2017 tax cuts (and avoid significantly widening an already wide US deficit, at 6% of GDP).
“In short, the direction of US and global financial markets depends on the amount of fiscal tightening required to bring down US interest rates. Can the Trump administration cut fiscal spending just enough to bring down US bond yields but not cause a recession?”
Trump seemingly has three tools at his disposal to deliver the savings he needs.
“The Trump administration is flirting with high risk/low reward. Triggering a [US] recession may be the end goal of the White House, but borrowing costs are not declining as much as they ought to be while President Trump’s political capital is on thin ice. Most recessions are caused by a ‘murder weapon’. It is rare that this weapon can be holstered. This may be one of those times."
The Fed’s goals are simpler. They have a ‘legislated’ dual mandate of low unemployment and 2% inflation. Given the US jobs market is already tight, Powell’s focus is on reducing inflation, and he’s reluctant to further trim rates from their ‘restrictive’ position until inflation appears to be heading in that direction and not heading higher on tariff fears (as shown in the lower panel of the prior chart).
Interestingly, at the most recent meeting, the Fed’s forecasts reveal the expectations for a worsening growth and inflation trade-off for the period ahead, with growth revised lower and inflation revised higher. And while the widely followed ‘dot plot’ still showed a ‘median’ of two cuts for the rest of the year, there were four governors who moved to expecting only one cut, most likely due to growing inflation fears, with eight out of 19 now supporting only one cut this year, rather than two.
Still, there were early signs of Powell’s willingness to respond if required, with his post-meeting press conference including language that sounded ‘dovish’, noting that the Fed can ease should the jobs market weaken unexpectedly, or inflation fall more than expected.
“The trouble with tariffs, to be succinct, is that they raise prices, slow economic growth, cut profits, increase unemployment, worsen inequality, diminish productivity and increase global tensions. Other than that, they’re fine.”
And to use one last analogy, Trump and Powell are now playing ‘chicken’. Trump is moving forward with reciprocal tariffs, to be announced in the first week of April, and with the likelihood of more trade measures to come in the months ahead. For now, Trump is pushing forward despite an ‘around 10%’ correction in equity markets. Indeed, in recent media comments, Trump declined to rule out a recession, warned of a period of economic “transition” and cautioned “you can’t really watch the stock market”. It is always dangerous to taunt the equity market, which Trump now appears to have done.
Moreover, to Chair Powell’s likely annoyance – after his near-success at reducing inflation over the past year – we are now seeing some signs of inflationary pressure, through rising consumer inflation expectations (bottom panel of the prior chart) as well as rising upstream materials prices for businesses (reflected in business surveys).
Of course, neither Trump nor Powell want a recession. For Trump, a recession will almost certainly scuttle any hoped-for fiscal improvement as rising unemployment and falling economic activity will almost certainly reduce tax revenue across corporate and personal income tax. Expenses would also balloon on rising welfare payments. It would also threaten Trump’s slim majority at next year’s mid-terms.
Nor does Chair Powell want a recession, not least because he would be slashing rates (and delivering what Trump wants), but the Fed may wear more of the blame for any rise in unemployment, given they will have ‘held onto’ 4.5% of interest rate firepower which many would perceive could have been utilised earlier. And lastly, Powell will miss his ‘full employment’ mandate if unemployment starts rising and then the Fed could be confronted by sub-target inflation, which proved difficult to rectify in the 2010s. Recessions are devilishly hard to reverse. Powell’s term also expires mid-2026, and he’s likely keen to exit with the economy expanding, unemployment low and inflation near the target. Who will blink first?
Powell’s term also expires mid-2026, and he’s likely keen to exit with the economy expanding, unemployment low and inflation near the target. Who will blink first?
But economists know that that’s not how the game of tariffs plays out. Tariffs have almost always been deflationary as far as underlying or core inflation is concerned which is what most central banks’ target, once the initial ‘headline’ inflation shock has passed through.
As noted in The Economist (2019), during the first trade war of 2018–2020, “In theory, tariffs should boost inflation in the country that sets them. However, the recent trade war between America and China sparked fears about global growth, leading to a rush into safe assets and a deflationary impact on the global economy”. Tariffs have always been deflationary. That was true with the Smoot Hawley tariffs in the 1930s, Nixon’s tariffs in the 1970s (see the chart below). Growth slows and unemployment rises.
Indeed, recent ‘soft data’, including business and consumer confidence, new order and capital investment intentions, both in the US and globally have weakened materially during Q1 2025. Near-term, there is the risk that the ‘muzzle velocity’ with which tariffs are being implemented and fiscal policy being tightened that businesses and consumers may just react by doing nothing. The global economy could rapidly approach ‘stall speed’ in H1 2025, rapidly changing the ‘tariffs are inflationary’ narrative impacting markets.
Time will tell which ‘gentleman’, prisoner or chicken flinches first. We believe that the greater constraints on the Fed will force its hand…as such, in a scenario that is weaker than our central case of a ‘constructive macro backdrop’, rapidly falling rates (that improve the forecast growth outlook), should at the very least, stabilise risk markets.
And this is where the odds are more in favour of the Fed acquiescing. Sure, inflation at a headline level may still be above the target. While Trump may sweat a few bullets if recession seems imminent and equity markets collapse, he also knows bond yields will fall making his fiscal financing task easier. Trump also knows that Powell knows that he’s got 450bp of rate cuts and society expects him to use it (even if he’s being forced to do it by Trump’s growth-reckless policies).
Time will tell which ‘gentleman’, prisoner or chicken flinches first. We believe that the greater constraints on the Fed will force its hand. As such, in a scenario that is weaker than our central case of a ‘constructive macro backdrop’, rapidly falling interest rates (that improve the forecast growth outlook), should at the very least, stabilise risk markets. And there would still be some prospect that markets end the year modestly higher. Nearer-term, as noted, we have added some defence via an overweight to government bonds to hedge portfolios against the risk of this weaker than expected near-term outcome.
How markets respond to a period of weaker-than-anticipated growth rate in H1 2025 will also depend on events surrounding any Fed pivot. There is great uncertainty over where things will land in terms of the Ukraine war, a ‘grand deal’ between Trump and Xi, a ceasefire in Gaza or rising concerns about Iran’s nuclear stockpile.
For markets, we want to skate where the puck is going over the next year, which is likely moderately higher given our constructive macro backdrop. However, a more meaningful Fed pivot on weaker growth may still deliver a similar outcome in time, though the volatility may be greater, as could the opportunity to buy the dips.
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