We think the regime of US growth and market exceptionalism will remain under pressure. Long-term potential growth will slow, the policy environment looks structurally less stable, and US corporate moats may be shallower than previously thought. Reserve currency status is unlikely to be overturned, but an accumulation of policy mistakes – such as following through on Section 899 of the One Big Beautiful Bill Act, which threatens retaliatory taxes on foreign investments – could put it at risk.
Looking to the next quarter, the global trade shock has moderated and the risks of a tariff spiral have receded. In response, we’ve upgraded some of our growth forecasts and reduced the probability of a US recession. But uncertainty has not dissipated and concerns over fiscal policy have grown, with long-dated developed market bonds a potential casualty.
The US average tariff rate now stands at 12%, and we are conditioning our forecasts on a slight increase from here. The courts have the potential to curtail Trump’s tariff-setting ability, but a raft of alternative legislation (Sections 122, 232, 301, 338) suggests that even if the administration loses its appeal against IEEPA being struck down, tariffs will remain an active policy lever. So US trade policy remains a source of deep uncertainty for the global economy, and there are still risks of big tariff re-escalation.
While the softening in trade actions and rhetoric has helped stabilise markets, the economic consequences are only just starting. The economic data is likely to be scrambled over coming months, with US Q1 GDP contracting due to tariff front-running, but an offsetting boost to inventories and sales likely to show up in a strong Q2.
But, looking through the noise, uncertainty will weigh on hiring, investment, and durable consumption, while weaker real income growth will also slow the economy. We are forecasting US GDP growth of 1.8% this year and next, a slowdown from 2.8% last year. We think 12-month recession risk is 30%, down from almost 50% previously.
While markets are less concerned about the tariff shock, they are increasingly on edge about fiscal policy. The fiscal reconciliation bill could be concluded by 4 July, and we expect this will push the fiscal deficit above 7% of GDP over coming years, even if most of the tariff revenue finds its way into government coffers.
Long-end bond yields have been under pressure worldwide, reflecting high debt loads and fewer natural buyers. A bond market rout is a growing risk, although in our base case it is likely too late for bond “vigilantes” to push policy to a more austere path. Indeed, the US deficit could be even larger than we forecast if a larger share of tariff revenue is spent rather than saved. We expect a continued loosening in European fiscal policy to boost defence spending, although the growth multipliers are modest.
Higher tariffs and large deficits will also prevent a return of US inflation to target, and we are forecasting 3% inflation this year. So there will be pressures on both sides of the Fed’s dual mandate, and we now expect the Fed to cut just once this year in December, as still uncertain fiscal and trade policy reinforce the “wait and see” approach.
Elsewhere, we continue to judge that the shock from US tariff policy will be disinflationary. In the Eurozone, we are forecasting 0.8% GDP growth and for inflation to be below the 2% target this year and therefore expect one further ECB rate cut. Cuts could be deeper and faster if a 50% US tariff is confirmed on 9 July. We expect Eurozone growth to improve again as fiscal easing occurs and have pencilled in an eventual rate hike later in our forecast horizon.
The US-China trade détente suggests China’s sequential growth slowdown will be more modest and begin later than we previously assumed. But bipartisan US support for a “tough on China” approach means we are conditioning our Chinese forecasts on US-China tariffs rising to around 40%, from the current 30%. So, after 5% GDP growth last year, we are forecasting 4.7% in 2025 and 3.9% in 2026. While this will tone down the urgency of further policy easing, we still expect the authorities to do more.
Emerging markets have at least escaped fairly unscathed from recent pressure on DM long-end yields; the EMBI sovereign spread is little changed, for example. Still, EM policymakers will have to contend with the uneven effects of US trade policy and market sensitivities to fiscal slippage.
Comment provided by Robert Gilhooly, Senior Emerging Markets Economist at Aberdeen.
