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What happened?

The US and the European Union have struck a deal over tariffs in a development that is likely to reinforce the market narrative that the worst of the trade conflict has passed. The agreement will cap levies on most EU exports to the US at 15%, half the 30% level that the US administration had threatened to impose if an agreement was not reached prior to a 1 August deadline.

As part of the agreement, the US president said the EU has committed to buying USD 750bn of US energy, investing USD 600bn in the US in addition to existing investment, and purchasing “vast amounts” of US military equipment. Although specific details are lacking, and questions remain on the feasibility and mechanisms of purchase and investment agreements, as well as on how the 15% rate might interact with potentially higher Section 232 tariffs (for example on pharmaceuticals), the agreement is seen as a short-term positive for both economies and investors. The S&P 500 gained 1.5% last week to close on an all-time high, encouraged by optimism over trade following a deal between the US and Japan. Futures in the index are up 0.3% at the time of writing. The Euro Stoxx 50 index opened 0.9% higher.

In other encouraging news for markets, the South China Morning Post reported on Sunday that the US and China have agreed to extend their tariff truce for another three months, as officials meet in Stockholm this week for their third round of negotiations.

What’s the context?

The S&P 500 index has climbed by close to 30% since the April lows, when worries over US tariff policy were at their most intense. This has reflected a growing conviction among investors that the US would reach a compromise with leading trading partners. Trade deals with the UK, Vietnam, Indonesia, the Philippines, and Japan, a tariff truce with China, and a relaxation of AI chip restrictions have reinforced that narrative. Recent data have also suggested that the US economy has remained resilient, while market sentiment has also been bolstered by top tech companies continuing to step up AI capital spending.

A US-EU deal was seen as among the most complex to negotiate, given the variety of internal constituencies within the EU, the multitude of issues that could create complexity in negotiations, and harsh rhetoric in recent months. The deal is therefore likely to be viewed as a significant step forward in the trade conflict, and we believe the immediate market reaction is likely to be positive.

At the same time, we believe that the substantial equity rally in recent weeks has already priced in a lot of potential good news, and that investors should prepare for potential market volatility in the weeks ahead. While markets will be encouraged by the greater degree of certainty on US-EU trade, the level of US tariffs has still increased roughly sixfold from prevailing levels before "Liberation Day." The economic impact of these tariffs is currently feeding through, and uncertainty remains about the scale, distribution, and second-order effects. In the days and weeks ahead, US payrolls, inflation, and retail sales data will be closely scrutinized.

Additionally, various Section 232 sector-level tariffs are still under discussion. Visibility on the potential outcomes remains low, and it is unclear how such tariffs may interact with country-level deals. Yet the economic ramifications of sector-level tariffs could prove to be even larger than country-level tariffs.

Sectoral tariffs could become especially important if US courts ultimately reject the authority of the administration to impose tariffs under the International Emergency Economic Powers Act, which provided the justification for the reciprocal levies announced by the president during his 2 April “Liberation Day” announcement.

Investors also should not rule out the possibility that the Trump administration could revisit agreed trade deals and continue to use tariff threats as a negotiating tool.

Elsewhere, investors will be watching for the announcement of the Federal Reserve’s interest rate decision this week, commentary on the impact of tariffs, the ongoing second-quarter earnings season, announcements on AI capex spending, and for further details of trade negotiations with China.

How to invest?

Prepare for market volatility. We expect equity market gains over the coming 12 months, and greater tariff certainty will help support that. At the same time, after a strong rally and with good news now well-priced, we believe that markets may be vulnerable to volatility in the near term. Investors who are already allocated to equities in line with their strategic benchmarks should consider implementing short-term hedges and those underallocated should prepare to add exposure on potential market dips in the weeks ahead.

Invest in transformational innovation. We believe potential volatility could be a good opportunity for investors to build exposure to structural growth ideas, including AI, power and resources, and longevity, which we expect to deliver attractive returns in the years ahead. In AI, diversified exposure across infrastructure, semiconductors, and applications should capture accelerating adoption and monetization. We expect power and resources to continue to benefit from surging electricity demand. Meanwhile, the longevity opportunity is supported by demographic shifts and rapid innovation in health care, medtech, and wellness.

Buy quality bonds. We see an attractive risk-reward profile in quality investment grade bonds. Yields remain relatively high, and in our view, the risk-return for high yield bonds and senior loans looks less appealing at this stage owing to tight spreads. We favor medium duration bonds (five to seven years), given the risk of higher volatility at the long end of the curve.

Navigate political risks. We believe an allocation to gold remains an effective hedge against residual geopolitical and political uncertainty, including potential fears about Fed independence. We maintain our USD 3,500/oz target and do not rule out the potential for prices to exceed this level if risks escalate.

Reduce excess dollar exposure. We continue to expect the US dollar to weaken by the end of the year, given the US’s significant fiscal and current account deficits and an ongoing trend of overseas investors re-evaluating US dollar exposure. While high US interest rates make hedging dollar exposure expensive, we believe investors should review their currency allocations and align them with those required to meet liabilities and long-term spending and investment plans.