PERSPECTIVES

OUR CENTRAL SCENARIO

ÉRIC BERTRAND
Deputy Chief Executive Officer,
Chief Investment Officer
OFI INVEST ASSET MANAGEMENT

At a crossroads

On his “Liberation Day”⁽¹⁾ Donald Trump fulfilled his most symbolic campaign promise: imposing customs tariffs on almost all the planet’s countries. The euro zone as a whole was hit with 20% additional tariffs and China, with 34% (on top of those already imposed). The methodology for calculating the tariffs was debatable, to say the least, but its results still took the market by surprise. US equity markets dropped by almost 15%; Europe gave up its year-to-date gains, and sovereign bond yields fell significantly. In their expectations, the markets are moving beyond short-term inflation driven by increased tariffs and are now pricing in a risk of global recession.

Given the risk of a tit-for-tat (China has also already announced a 34% hike in its tariffs), the global economy is at serious risk of slipping into a dark scenario. However, we expect the Trump administration to use this as a starting point for broader negotiations with all countries affected, producing more manageable compromises. The risk of a tougher line by Donald Trump cannot be ruled out, but a steep drop on US equity markets, along with a US recession would hit voters in the run-up to mid-term elections. The outlook for planned US tax cuts and stimulus plans in Europe and China could then restore some lustre to the markets.

Central banks had been headed for the end of their rate-cut cycle with two additional cuts expected on each side of the Atlantic, but in a recessionary risk emerges, they may have to accelerate their monetary easing, as inflation is not being driven by shortages but by tariff shocks, albeit probably temporary ones. However, in this scenario, it would be important to keep an eye on the impacts of a disruption of global trade.

On the interest-rate front, yields fell very rapidly, leading us to take some profits on part of our overweight stance. This position nonetheless continues to serve as a good hedge against the recession scenario. On the credit market, we are lowering our stance to neutrality on high yield bonds in this low-visibility environment.

The period now beginning will bring with it lots of volatility on the equity markets, driven by statements by various governments. New dips may be used as opportunities to add to equity exposure in the run-up to negotiations with the potential outcome of reasonable agreements. That being said, in the event of an escalation towards a trade war, indices may have more room to drop. So, portfolio hedges are still in order.

OUR VIEWS AS OF 04/04/2025

After the stimulus plan announcements in Europe in early March, this time it was the announcements of US tariff hikes that triggered a correction in European and US bond yields. This sent the Bund yield back up to 2.50% following the US president’s announcements. After the rise in bond yields of early March, we had raised our cursor on euro zone duration to 7. In reaction to the recent correction, we are taking some profits and halving this exposure while remaining overweight, particularly on the euro zone. We are now taking a more cautious stance, given the uncertainties surrounding possible coming negotiations. While the markets are focused on recessionary risks, in particular in the US, inflationary risks could also affect bond yields. In corporate bonds, we are also lowering our high-yield weighting, but the carry trace offers protection that we believe makes it worth staying invested in the asset class. We continue to overweight investment grade corporate bonds, which are more defensive and should get a boost from a shift to less risky assets in this market context.

“Liberation Day”⁽¹⁾ was a violent event, sparing no one. Rising protectionism has never been good news for corporate earnings and, generally speaking, for equity markets, but some back-peddling (one of Trump’s specialities) is certainly possible. Nevertheless, while negotiations are still possible, there appears to be little chance of achieving meaningful concessions in the coming months. If we expect tariffs to be kept in place, we will have to revise earnings forecasts for European and Asian companies, as well as American ones, with all due respect to the Trump administration. That’s why we are making no change to the aligning of our weightings of European and US equities. With drops of 16% by the Nasdaq and Nikkei from their highs, of 11% by the S&P 500, and of 6% by the EuroStoxx, equity valuations are now less demanding. However, not until the release of first-quarter results and, even more so, guidance from visibility-deprived business leaders will we know if these are fair valuations. Uncertainties may go on and do require lots of humility. The only thing we can affirm at little risk of being proven wrong is that volatility will stay with us and will allow equity-underweighted investors to buy on the dips to boost their exposure.

The euro-dollar has benefited greatly from the sudden shift in fiscal paradigm in Germany, followed by the shift in the trade paradigm in the US. In reaction to this new context, we are moving to a neutral stance on the euro-dollar. True, the good euro zone macroeconomic news has now been priced in. But the additional tariffs announced are so extreme that they are likely to hit the US economy harder than the targeted economies, thus reining in the dollar, despite the prevailing uncertainty.

MACROECONOMIC VIEW

HAVE ALL CARDS BEEN PLAYED?

OMBRETTA SIGNORI
Head of Macroeconomic Research
and Strategy
OFI INVEST ASSET MANAGEMENT

Fears of a trade war have been borne out with Donald Trump’s decisions to impose a 10% tariff on all US imports and additional tariffs on imports from about 60 countries. For the European Union, for example, they will amount to 20%. Will they last? While we expect there to be negotiations, this is an essential point in determining the ultimate impact, similar to the question of whether countries will retaliate or not.
Before the election, we had estimated that a severe protectionist scenario, with 10% across-theboard tariffs, would trigger a cumulative decline of about 1% of GDP between 2025-2026. However, as average additional tariffs on US imports amount to almost 20/25%, we estimate the impact at twice as much. If protectionist measures were to last, US growth could be closer to 1% than the 2% currently forecast. This downward impact is due to a shock to confidence and, most of all, to the loss of purchasing power caused by higher prices. Taking into account the announced taxes, temporary additional inflation would be 2%/2.5% (assuming no reprisals and assuming that all tariff hikes are passed on into final prices), although in the medium term, import tariffs are actually disinflationary.

A BACKWARD SWING IN US GROWTH IN THE FIRST QUARTER

Since the start of the year, households have begun to save more, in reaction to high levels of uncertainty. Companies are also worried, and this could weigh on their investment decisions. Meanwhile, while the main goal of the tariffs is to reduce the US trade deficit, the opposite is currently happening. Companies rushed to import massively before tariffs took effect, causing a collapse in the foreign trade balance. All these factors will weigh on US growth in the first quarter, which is likely to suffer a big swing in the opposite direction compared to the fourth quarter of 2024.

THE FED’S STARTING POINT GIVES IT SOME TIME TO WAIT AND SEE

Meanwhile, inflation as measured by the personal expenditure deflator stuck in place at 2.5% in February (while core inflation increased from 2.7% to 2.8%). The Fed is likely to wait a bit longer before lowering its rates, until it has a better view of the current uncertainty but could still lower its rates this year if the job market worsens.

EURO ZONE GROWTH TORN BETWEEN PROTECTIONISM AND STIMULUS

In the short term, growth is likely to take a hit from protectionism. We estimate that 10% tariffs are likely to lower euro zone GDP by about 0.5 percentage point between this year and next year, when also taking into account the shock to confidence. If 20% tariffs last long, the impact will be almost twice as much and the euro zone will experience flat growth this year. In the event of reprisals, European inflation could also rise, but less so than in the US. However, in the medium term, the €500 billion German infrastructure plan would boost growth by 0.3 to 0.4 percentage point of GDP in 2026, 2027 and 2028, or by 0.1 to 0.15 percentage point during this period in the euro zone. Regarding military spending in Germany and assuming a gradual deployment of the European Commission’s plan on a European scale, the boost to European GDP would be 0.15 percentage point each year in 2026, 2027 and 2028. In our initial scenario, we had assumed 10% tariffs on the EU and had lowered our growth forecasts for this year (from 1% to 0.7% on annual average), but this cut was offset by the upward revision in the 2026 growth forecast from 1.1% to 1.4%. If the 20% tariffs were to last, the risk would be on the downside for our 2025 and 2026 forecasts.

HOW MANY MORE EURO KEY RATE CUTS?

Euro zone inflation in euro zone is on a trajectory for returning to its target some time in 2025. Total inflation was on the right track in March (declining from 2.3% to 2.2%), and services inflation is beginning to moderate, probably driven by easing wage pressures. In its decision, the ECB must take into account the effects of both protectionism and stimulus, and the usual split between doves and hawks had already begun to re-emerge prior to the tariff announcements. Nevertheless, there is still some room for lowering rates before moving back into accommodative territory.

INTEREST RATES

THE US IS RETREATING FROM THE REST OF THE WORLD

GEOFFROY LENOIR
Co-CIO, Mutual Funds
OFI INVEST ASSET MANAGEMENT

The bond markets had been driven in recent weeks by expectations of tariffs on US goods imports. On 2 April, the US president ultimately announced an increase in tariffs for 185 countries and territories. This included a so-called “universal” tariff, which becomes effective on 5 April for about 100 countries or territories and special “reciprocal” tariffs, applied since 9 April to the others, with a single, 20% tariff targeting the 27 member-states of the European Union. So quite steep increases are expected to be imposed immediately. However, the extent of these increases has been anticipated in some adverse economic scenarios, and bilateral negotiations could very likely lower some of the tariffs.

VOLATILITY AND REVISED EXPECTATIONS

The market continues to regard this trade war through a recessionary, and not inflationary, prism. Hence, after the early March sell-off⁽²⁾, which saw the Bund yield rise to 2.90%, nominal yields receded, with the 10-year German hitting 2.50% in intraday trading on 4 April.

US and European yield curves steepened as the markets are now pricing in more rate cuts by the US Federal Reserve (about four in 2025) and by the ECB (three), or more than one additional cut by each central bank compared to expectations of a few years ago.
A further illustration that the market’s risk perception is on the recessionary, rather than the inflationary, side can be seen in the euro inflation break-even points. These have fallen by about 20 basis points from their March highs. The 1-year, 1-year inflation rate is now just 1.8% for the euro zone. The picture is more contrasted in the United States, with 5-year breakevens up and 10-year ones down. However, the 5-year, 5-year inflation swap⁽³⁾, which is often tracked by central banks has fallen further than in Europe, to just 2.29% on 4 April.
As we are rather heavily overweighted on rates, these market movements are in line with our expectations. But caution is in order. There are many unknowns and the bond markets are likely to remain volatile in the coming weeks. We believe that rate-cut expectations, particularly regarding the ECB, are currently a little overdone.
That’s why we are taking advantage of this bond rally to halve our overweighting of duration on European and US rates.

THE ‘CCC’ WIDENING IS INCREASING WITH TARIFFS

The announcement of a steep rise in US tariffs also hit credit market valuations. The most cyclical sectors targeted by these decisions, such as automakers and auto parts makers, were on the front lines. Given the uncertainty over the economic impact of these decisions and the response of targeted countries or regions, we are shifting to a more cautious stance on the credit market, particularly in high yield. The many technical factors that have been supporting this market for several months could fade in the coming weeks. Even so, carry, which is still at historically high levels, continues to offer some protection for the asset class’s performance. With this in mind, we are overweighting the highest-rated issuers in both investment grade, with issuers rated ‘A’ or above, and high-yield, with issuers rated ‘BB’ instead of ‘B’ or ‘CCC’, whose spreads have widened by about 100 basis points.

EQUITIES

"MAKE AMERICA GREEDY AGAIN!"

ÉRIC TURJEMAN
Co-CIO, Mutual Funds
OFI INVEST ASSET MANAGEMENT

Libération Day⁽⁴⁾ came with new tariff barriers in the US, and very little consideration by the Trump administration for its historical trade partners. On top of justifications based on strange and even stranger calculations having no economic foundation, tariffs set to take effect on US imports in a few hours are far greater than in the most pessimistic forecasts.
Not since the start of the 20th century have US tariffs been so high. True, these were meant to be a ceiling for opening up bilateral negotiations, but the damage has clearly been done. President Trump and his administration have just run roughshod over almost 30 years of globalisation. At this writing, the consequences are still hypothetical. We don’t doubt that companies will be able to adjust to this new environment. They have always been able to do so and are likely to show once again their resiliency to this pitfall. Leaders of large global groups are already reviewing the various available options. That being said, the impact on US consumers and growth are harder to determine.

CUSTOMS DUTIES… FOR HOUSEHOLDS

$5,000 per year. That’s the average additional cost to consumption that would be caused each year to the 130 million US households by the tariffs announced on 2 April. With all due respect to the Trump administration, we are indeed dealing with a tax on US consumption, with companies having said for several months that they would pass on the tariffs as much as possible into sale prices. In an economy more than 70% of whose GDP is based on household consumption, the Republicans’ gamble looks risky. The risk of recession is rising, tracking uncertainty that is likely to persist.
And US equity markets have expressed these doubts for several weeks now. Companies that are less sensitive to shifts in economic cycles have outperformed, while household consumer discretionaries have dropped steeply. Hotel and cruise operators and airlines have recently borne the brunt. It is also very likely that companies will postpone their investment decisions at least until the dust settles.

PRUDENCE ON QUARTERLY NUMBERS

Against this backdrop, it is hard to imagine much optimism from company executives in their firstquarter releases, and even fewer upward revisions of earnings guidance at this stage of the year.
The near-term risk to earnings is very clearly on the downside, with forecasts having already begun to fall in the US. Central banks’ announcements will be the next thing that investors focus on, particularly to determine whether there does exist a reassuring “Fed put”⁽⁵⁾.
Tariffs imposed on emerging Southeast Asian emerging market countries are significant and target the entire “supply chain of corporate America”. Here again, the US administration’s message is clear: “produce locally!”, although it’s hard to imagine labour-intensive industries offshoring back to the US. So, some countries may be very tempted to manipulate their currencies to counter the impact of tariffs, at the risk of drawing renewed condemnation from the US authorities.
As we have seen, rising protectionism has never been good news for companies. That being said, for once we don’t see any reason for US companies – even though they tend to outperform European companies on domestic growth – to emerge as winners from this confrontation. That’s why, a few weeks ago, we neutralised the positive bias in favour of US equities by raising our weighting of European equities to the same level. Recent events do not give us any reason to change these weightings. Volatility will, of course, persist as the Trump administration continues to blow hot and cold. And this will offer opportunities to buy on the dips to add to equity market exposure, which could pay off once the dust has settled.

EMERGING MARKETS

CHINA IS ONCE AGAIN A CREDIBLE ALTERNATIVE FOR INVESTORS

JEAN-MARIE MERCADAL
Chief Executive Officer
SYNCICAP ASSET MANAGEMENT

In reaction to the Trump administration’s unpredictable governance and fears of a US recession, international investors are turning increasingly towards Europe and, even more so, Asia, where China is emerging as a pillar of stability.

Just one year ago, China was regarded as uninvestable, bogged down in an endless real-estate crisis and uncertainty over politics, domestic governance and its closeness to Russia. Now, several major international banks have a buy rating on Chinese equities, raising their forecast returns to 10% to 15% by yearend.

There are three main reasons for this turnabout:
1. Renewed credibility: among recent policy decisions, China unveiled a full economic stimulus plan in September, including fiscal and monetary measures, support targeted at banks and the real-estate market, as well as consumption vouchers for certain products.
President Xi Jinping has also voiced his support for the private sector – a turnabout in comparison with the 2021 measures. GDP growth is looking strong so far this year, at an annualised 5.5% in the first two months, above the government’s 5% target.

2. Technological advance: the world now acknowledges the competitiveness of Chinese technology in key sectors such as artificial intelligence, electric vehicles, robotics, drones and solar power. Investors are finding that some Chinese companies are credible competitors to US giants.
3. Valuations deemed attractive: Chinese equities look undervalued, especially compared to US equities. Despite a spectacular rally since mid-January, valuations, in our view, remain attractive, with a 2025 P/E of the MSCI China of about 12.5 and projected earnings growth between 7% and 8%, with momentum likely to remain positive.

The announcement of a 20% to 54% hike in tariffs on imports of all Chinese goods into the US could, as things now stand, subtract 1.5% to 2.0% from GDP. We don’t know at this point whether this is a decision aiming to trigger negotiations. But it is highly likely that the Chinese government will respond with measures of retorsion and with an increase in fiscal support for growth. Meanwhile, the diversification of Chinese exports towards the global south, which began in 2018, will continue and regional cooperation will intensify.

Elsewhere in Asia, Indian equities rallied by 5% in March after having dropped by almost 20% since September – the steepest monthly gain since June 2024. Investors are gradually returning to India, drawn by its huge medium-/long-term potential and by positive indicators such as inflation at a seven-month low and a smaller trade deficit. Valuations, moreover, appear to be once again fair, with a 2025 P/E of almost 20 and projected earnings growth of about 12%.
Other Asian markets have been hit harder by the US tariff measures and the correction in US tech stocks, Taiwan in particular as it is closely correlated to the US artificial intelligence cycle, along with Korea, Malaysia and Thailand, which are closely dependent on exports to the US.

To sum up, a draconian tariff policy and a disconcerting geopolitical stance are sowing doubt and stoking volatility. US investors had overweighted domestic stocks heavily (and justifiably so) for about a decade, but they are now rediscovering the benefits of international diversification. In our view, Asian equities, Chinese ones in particular, have much to offer in this environment.

FIGURE OF THE MONTH

5.5%

Estimated annualised Chinese GDP growth for the first two months of 2025 – above the government’s 5% full-year target. The main components improved, with the exception of the real-estate sector, which nonetheless did stabilise.

AVERAGE EXPOSURE IS CURRENTLY 27%, WHICH IS STILL BELOW THE ALMOST 31% WEIGHTING OF CHINESE EQUITIES IN THE MSCI EMERGING INDEX.

Source: Morningstar, HSBC March 2025

Document completed on 04/04/2025