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What happened?
Equity market volatility has picked up again after further twists and turns in trade talks between the US and Europe. Asian equity markets and US equity futures climbed early Monday after a late Sunday reversal in US-Europe trade headlines. US President Donald Trump on Sunday backed away from a threat to quickly impose 50% tariffs on European Union imports from 1 June following a “very nice call” with European Commission President Ursula Von der Leyen.

Trump is now suggesting a 9 July deadline for new 50% tariffs if negotiations with Europe fail to make progress, allowing several more weeks for talks. Von der Leyen in a statement vowed to “swiftly and decisively” advance talks with the US.

The prospect of renewed tariff escalation dampened the mood in equity markets last week, with the S&P 500 retreating 2.6% after gaining 5.3% in the prior week. Alongside the threat of higher EU tariffs, Trump separately threatened a 25% tariff on any Apple iPhones made outside the US and criticized the pace of trade talks with both Europe and China. Tensions also escalated last week when China accused the US of undermining negotiations by restricting Huawei’s access to AI chips.

Even before the Sunday turnaround in EU-US headlines, markets had already priced in some skepticism that the most severe tariff threats would be implemented. On Friday, the S&P 500 recovered from steeper losses early on to close only 0.7% lower. While US markets are closed today for the Memorial Day holiday, S&P 500 futures are up 1.2% at the time of writing.

Fixed income markets also saw notable swings, with Treasury yields rising sharply after the House passed a version of President Trump’s “One, Big, Beautiful Bill” and a 20-year auction saw weak demand, fueling concerns over US fiscal sustainability. In Japan, disappointing demand at a 20-year government bond auction pushed long-term yields to their highest level since 2000, prompting renewed warnings over the country’s fiscal position.

The renewed “will he, won’t he” tariff headlines are in line with our expectations for continued volatility, with sentiment remaining susceptible to shifting trade and fiscal narratives. While the latest reprieve for US-EU tariffs offers near-term relief, the risk of further escalation or volatility on new headlines remains clear.

What do we think?
While more time for EU-US negotiations is good news, the speed of the recent rebound in stocks suggests that investors may have become too optimistic on the path for trade discussions. At the start of last week, the S&P 500 had risen to within 3% of its all-time high and was up close to 20% from its low point on 8 April, when worries over the threat of a global trade war were at their most intense.

With high expectations already priced into markets, we recently downgraded our view on US equities to Neutral. President Trump’s most recent interjections underline that risks remain, and a successful outcome to discussions cannot be taken for granted.

However, the recent roll-back of tariffs with China supports our view that forceful rhetoric will most likely eventually give way to pragmatism. We are also encouraged that more moderate voices in the administration, such as Treasury Secretary Scott Bessent, have been playing a more prominent role. Our base case is for the effective US tariff rate to end the year around 15%, with the possibility of additional product-specific tariffs. However, with such high levels of policy uncertainty, we see equal odds that tariffs will be higher than this range or lower, depending on the outcome of talks with key trading partners and the outcome of legal challenges to the president's authority to impose blanket tariffs.

Notably, European markets that were open on Friday when Trump made his initial threat saw relatively modest moves, suggesting investors viewed the threat as more of a negotiating tactic. In addition, listed companies typically produce where they sell so actual exports to the US from European listed companies are relatively small.

We also expect the US Treasury market to stabilize after the recent volatility. Despite the decision earlier this month by Moody’s to strip the US of the country's last remaining AAA credit rating, the ability of the US to repay debt is not under question, in our view. While there is a risk that deficit fears lead to progressively higher yields in the weeks ahead, we believe that the Fed and/or Trump administration would likely make adjustments in the event of disorderly markets. In our view, this means high grade and investment grade bonds represent good value at current levels for investors seeking portfolio income.

How to invest?
Although in our base case we expect trade- and fiscal-related uncertainty to ease over the course of the year, the latest bout of trade-related volatility reinforces our view that investors should continue to strengthen and diversify portfolios amid uncertainty.

Phase into equities: We recently downgraded US equities to Neutral. Trade and fiscal uncertainty could continue to drive near-term volatility, but longer term, we see further upside in stocks amid structural earnings growth, Fed rate cuts, and greater policy stability. Investors should use the coming months to progressively address strategic portfolio gaps and position themselves for further upside in 2026 and beyond. Outside the US, our message remains to be selective in Europe, as outlined in “Six ways to invest in Europe.” We continue to recommend areas that are not overly exposed to tariff risks, offer structural growth, or benefit from Europe's monetary and fiscal policy, such as Eurozone small- and mid-caps, as well as the European IT, industrials, and real estate sectors.

Seek durable income: The uptick in yields in recent months reflects a combination of optimism about lower tariffs and fears about rising fiscal deficits. We believe that this presents an opportunity for investors to lock in attractive yields in high-quality bonds. At the same time, investors need to be mindful about non-domestic currency exposure in fixed income.

Sell dollar rallies: We anticipate continued dollar weakness in the months ahead as the US economy slows and as focus increases on rising fiscal deficits, and recently downgraded our view on the US dollar to Unattractive. We favor reducing excess US dollar cash by diversifying into other currencies such as the yen, euro, pound, and Australian dollar. For international investors, we would review strategic currency allocations and consider hedging US dollar exposure in US assets back into home currencies.

Navigate political risks: We expect gold to remain a valuable long-term portfolio diversifier, supported by persistent geopolitical risks, ongoing central bank demand, and our view that real interest rates will decline as the US dollar weakens. We maintain our USD 3,500/oz year-end target. While gold may consolidate after recent gains, price setbacks can be used to build exposure. To manage political risks, we like a mid-single-digit allocation to gold, alongside alternatives like hedge funds and capital preservation strategies on equities.

What to watch: 27 May 2025

• US durable goods orders for April
• US Case-Shiller home price index for March
• US consumer confidence for May
• GfK German consumer sentiment survey