Investors’ Outlook: Stitching fraying seams

Stitching fraying seams

Markets have surprised many by defying what had appeared to be a fraying economic outlook. A policy patch between the US and China – a 90-day trade truce – helped calm immediate tensions. Washington temporarily slashed tariffs on Chinese goods from a staggering 145 percent to 30 percent, while Beijing lowered its levies to 10 percent. Soon thereafter, US President Donald Trump was in full dealmaker mode, signing large commitments in the Middle East.

This exceeded investors’ expectations and improved sentiment. Markets responded with optimism that the worst of the tariff damage might be mended, boosting hopes that the US economy could regain some traction after a sluggish start to the year, dragged down by surging imports ahead of Liberation Day. From trade talks to the Russia-Ukraine war, diplomatic efforts are positive but not yet a reversion to stability and still susceptible to strain, in our view. Nevertheless, we believe markets have been too quick to price in the positives. And when optimism becomes consensus, it can leave little room for market upside.

One big question is whether a temporary policy reprieve can restore confidence before more fundamental tears emerge in the economic fabric. In the US, hiring and consumer spending have slowed, and the labor market seems to be at a tipping point: Companies aren’t hiring aggressively, but they also haven’t starting laying off in large numbers.

The US Federal Reserve is in a similar holding pattern. Unlike past cycles that triggered emergency intervention, the market stress following Liberation Day didn’t reach that level. And the Fed has signaled no rush to cut interest rates, preferring to wait for clearer data, citing the risk of higher inflation and unemployment from Trump’s tariff policy. We believe investors may need to be more patient for the Fed’s next rate cut.

In the meantime, Moody’s recent downgrade of the US credit rating has also refocused the spotlight on other topics of concern, such as the ballooning budget deficit, driven in part by the prospect of unfunded tax cuts and the effects of Trump's spending bill.

The past few months have underscored the importance of diversification across geographies and asset classes. And despite a weaker US dollar and louder talk of de-dollarization, it’s worth noting that not all dollar-denominated assets have suffered equally. While US Treasuries have seen selling pressure, US equities and US corporate debt have held up quite well.

In this Investors’ Outlook, we analyze the US dollar and put the currency’s bear markets under the magnifying glass, explore the current macroeconomic environment, and share our thoughts on asset classes.

The road ahead is unlikely to be seamless. But as active managers, we don’t pull at every loose thread.