16 May 2025: Weekly Update – US-China Tariff Pause and Market Fragility

The reduction in tariffs has had a ripple effect across the economic landscape. In the US, GDP forecasts have been modestly upgraded, and inflation expectations have been revised downward, reducing fears of a stagflationary scenario. The Federal Reserve has adopted a cautious, wait-and-see approach, contrasting with the European Central Bank’s anticipated proactive policy stance. Despite the strong equity performance, our concerns linger about the sustainability of these gains, especially in light of stretched US equity valuations.

On the geopolitical front, US economic ties with Saudi Arabia have deepened through a record-breaking $142 billion arms deal and expanded collaboration in technology sectors, notably artificial intelligence, with companies like Nvidia poised to benefit.

However, despite the recent market buoyancy, risks remain. The temporary nature of the current US-China trade agreements presents uncertainty, with deadlines that could reignite volatility if substantive progress isn’t made. Structural issues, such as industrial policy disputes and global imbalances, are unlikely to be resolved soon. Meanwhile, in Europe, whilst Germany’s fiscal loosening offers a modest lift, longstanding challenges to economic growth could limit its potential.

Overall, while the immediate threat of a global trade war has receded, the path ahead remains uncertain. Market optimism is buoyed by recent developments, yet it is fragile, with potential for renewed instability should fundamental disagreements between key global players persist.

That fragility will be tested this week following Friday’s after close announcement by Moody’s, the credit rating agency, that it was lowering its credit rating for the US. This further adds to the pressure for capital to continue to flow away from the US and into Europe and Asia. Pricing in a higher term premium for the US is a further manifestation of the risks facing US equities and the dollar.