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Tariff reprieves and the recent approval of sweeping multi-trillion-dollar fiscal tax breaks have significantly lowered the odds of recession in the US. Nevertheless, we remain cautious as risk assets continue to move higher, ignoring the early signs of slowing consumption and a weakening labor market (as measured by trends in aggregate income). At the same time, the Fed continues to remain on hold with less than two cuts priced in by 2025 year-end. In addition, core CPI is beginning to reflect rising inflation in the industries most impacted by tariffs, complicating matters for policymakers and potentially exposing markets to a short-term correction, should hard data worsen from here.

With tariff implementation well underway and dovish fiscal policy in place, we expect policymakers’ focus to shift towards deregulation, especially in the financial sector, which we believe should boost lending activity and risk taking. Accelerating existing home sales could also serve as another major engine for growth in 2026, tying into Trump’s desire for lower interest rates. While we expect the Fed to remain independent during the President’s tenure, lower mortgage rates and housing affordability will eventually come into focus for the administration.

In aggregate, it appears that current US policy is seeking to turbocharge the economy enough to “grow” America out of its mounting debt issues. Success is not guaranteed, and we believe execution risk remains elevated. Similarly, over in Germany, policymakers continue to surprise on the upside with economic stimulus, in terms of both magnitude and speed, potentially pushing the EU into a new era of fiscal largesse. On the other hand, China’s fiscal policy has been incremental and seems unlikely to generate the appropriate response in consumption to counter deflationary pressures.

Trading

Within Trading, we continue to favor discretionary approaches over systematic, and we maintain a healthy balance between EM and DM exposures.

We remain constructive on the opportunity set for DM global macro managers. In our view, there is still scope for tariff and policy-related opportunities in FX, and some equity themes are likely to continue. 

For EM macro managers, we believe the opportunity set over the near term has potentially improved due to somewhat less policy uncertainty and a weaker USD. Finally, we maintain high conviction in commodities, with our thesis focused on the supply / demand dynamics in the energy complex.

In commodities, we have a positive outlook on our commodity allocations with a primary focus on gas and power strategies, complemented by strategic long positions in the less correlated green transition materials theme.

Key DM policy rate path

Source: Morgan Stanley Research forecasts. Data illustrates Morgan Stanley’s forecast that the Fed will remain on pause through 2025 while some other DM central banks ease further. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

Equity Hedged

We believe that this current regime of global “fiscal dominance” should continue to support risk assets into next year. Yet, we assign a larger probability to a risk-off scenario and market “mishaps”. Furthermore, the impact of a government debt confidence crisis could be devastating as this would likely manifest with rising yields, thus compounding debt sustainability concerns. As such, we maintain a large allocation to discretionary macro to “hedge” our exposure to Equity Hedged strategies where we continue to see a positive alpha backdrop in both the US and Europe. TMT, financials and biotech continue to represent the lion’s share of our risk contribution in the strategy.

One thematic space we believe merits further exploration is the healthcare and biotechnology sector. Sentiment in this area appears overly washed out, and the consensus from speaking with managers is that the changes at the FDA are not as negative as being purported and should generally not hinder innovation and new drug approvals (with vaccines being a possible exception).

Changes in 2025 and 2026 EPS forecasts by sector relative to market

Source: Bloomberg; Weekly data; Dec 31, 2023 - Jun 30, 2025. The chart illustrates changes in 2025 and 2026 EPS forecasts by sector relative to market. The above data is a subset of the MSCI World index IT, telecom, utilities and healthcare sectors. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

Relative Value

Within Relative Value, we plan to maintain our current allocations to fixed income relative value strategies. The proposed relaxation of SLRs (supplementary leverage ratio) could be a net positive for balance sheet intermediation but potentially cause further compression in already tight spreads.

We continue to maintain a positive outlook for quantitative equity strategies. The strategy remains one of the top performers YTD, with both factor-driven models and more technical, liquidity provision strategies performing well.

In capital structure / vol arb, we plan to maintain our exposures. Looking ahead, we believe that corporate actions (refinancing and exchanges) will continue to benefit returns for managers with an established, leading presence in the convertible bond market.

Lastly, our outlook has improved for merger arbitrage strategies, but we plan on maintaining our current low exposure target for the strategy.

Move vs. VIX

Source: Bloomberg; Daily data; Jul 14, 2020 - Jul 11, 2025. Indices are for illustrative purposes only. Please see end notes for index descriptions. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

Credit / Income

We marginally reduced our Credit / Income allocations last quarter in response to compressing credit and liquidity risk premia across both corporate long / short and asset-backed strategies, regrouping around our best risk / reward opportunities. We are less focused on adding exposure to higher beta segments of the tradable ABS market given the current valuations for most assets.

We plan to keep an underweight allocation to long-biased and distressed strategies. Although overall yields in corporate credit are somewhat elevated due to the risk-free rate, spreads are very compressed relative to history and the entry point is unattractive. 

US high yield and investment grade corporate spreads

Source: Bank of America Merrill Lynch; Daily data; Jan 1, 2019 – Jul 1, 2025. Indices are for illustrative purposes only. Please see end notes for index descriptions.  PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

Index descriptions

The use of indices is for illustrative purposes only.