Since President Trump assumed office on January 20th, there has been no dull moment. There has been a barrage of announcements, and the market is unsure how to evaluate the potential impact of these measures.
Since Trump’s return to the White House policy uncertainty has increased, especially in two areas: trade and fiscal policy. The Trump administration’s trade policies have damaged U.S. growth prospects in several ways. First, they have pushed up expected inflation, with near-term inflation expectations rising to the highest level since early 2023. Higher inflation will depress real wage growth, while constraining the Fed’s ability to cut rates. Secondly, tariffs will also increase business uncertainty. An IMF study has shown that uncertainty over tariffs can damage growth as much as the tariffs themselves.
Households, businesses, and state and local governments will have to tolerate at least a few months of uncertainty before they know tax rules, tax rates, tariff schedules, and the fate of existing subsidy programs. Markets hate uncertainty and businesses and consumers aren’t too keen on it either.
- U.S. Economic Growth is Softening
- Fiscal Spending Cuts
- Will Trump Make Europe Great Again?
- Germany’s Election & Debt Brake Policy
- Europe is No Longer a Value Trap
- Upside Risk for the Euro?
- China’s Outperformance
- Our Portfolio Positioning
U.S. Economic Growth is Softening
Recent data suggest growth is moderating at the start of the year. Global consumption appears to have slowed from its Q4 pace led by the U.S. This can be seen in the weaker data on retail sales, consumer confidence, services PMIs, and housing data.
The Atlanta Fed’s GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2025 is -2.8 percent on March 3. Real personal consumption expenditure growth and real private fixed investment growth fell from 1.3 percent and 3.5 percent, respectively, to 0.0 percent and 0.1 percent.
However, the negative reading is partly due to a massive spike in imports, as firms rushed to beat tariffs. And they have not yet allocated those imports to either consumption or inventories. Without the import issue, GDPNow would have fallen to 1.8%, down from 2.3%. The Citi US Economic Surprise Index has also dipped into negative territory. We don’t think this is the start of a recession, but the trend is concerning.
Data is often noisy around the turn of the year, and smoothing out the softer January and February data with the strong Q4 prints suggests still solid momentum in the expansion. Moreover, we take comfort in still-resilient consumer fundamentals, as well as an improvement in global manufacturing, especially in Germany and China. However, this supportive backdrop is facing an uncertain U.S. policy environment that is beginning to weigh on sentiment. We see sentiment as the key channel of transmission from policy impacts to the global expansion and will be watching closely for further developments on this front.
Fiscal Spending Cuts
The House of Representatives passed a Budget Resolution bill that adds $2.8tn to the deficit by 2034. The Senate is likely to modify it by increasing tax cuts and reducing spending cuts, increasing the budget deficit to $3.5tn. Republicans are likely to prioritize tax cuts to deliver a mild fiscal boost to offset the drag on growth from tariffs ahead of the 2026 midterm elections.
A concern remains the impending fiscal cliff at the end of the year when the Tax Cuts and Jobs Act (TCJA) expires. Congress is well aware, and so the House just passed a budget that would allow $4.5 trillion in tax cuts over the ten-year review window. The House proposal included increases for spending on defense, the border and judiciary of $300 billion, and spending cuts of $1.5 trillion mostly aimed at Medicaid, SNAP (food stamps), and student loans. However, an amendment states that if $2 trillion in savings are not found, the Ways and Means Committee must reduce the $4.5 trillion target. That could come through spending cuts or new taxes like tariffs. The House bill raises the debt ceiling $4 trillion, which is about 2 years at the current deficit run rate.
Interestingly, the estimated tariff revenues from a 25% across-the-board levy would be $3.7 trillion, which would be just enough to pay for TCJA. This is the world President Trump envisions, with an External Revenue Service replacing the IRS and the income tax. The U.S. has implemented a 25% tariff on two of our three largest sources of imports, Canada, and Mexico. China will be at 20%, and the EU, which collectively has a bigger import bill than any of these three, has been threatened with a 25% rate. Those four account for 60% of U.S. imports, and since trans-shipping would ensue, it seems like a universal tax would be needed. We understand these all look like negotiating points, but we are focused on the fact that the budget requires new revenues from somewhere or deep spending cuts.
Even if the House and Senate can get together behind one big, beautiful bill, it appears that the red line is a $2 trillion deficit in FY2025 and FY2026. That means no increase in fiscal stimulus in aggregate.
Right now, it looks like the Federal Reserve is sitting on its hands waiting to see both the effect on inflation and real growth from proposed policy. They will not rely on their models, which forecast a slowdown, but will watch for readings from the economy. That means they will likely be late in adjusting monetary policy.
While the U.S. fiscal situation will not improve significantly given political hurdles to cutting safety net programs, the bond market continues to assess whether the deficit will get significantly worse than was feared when Treasury yields jumped higher in late 2024. We believe Treasury yields will be lower on a 6-to-12-month horizon because of the slowing economy.
Will Trump Make Europe Great Again?
While the main Q1 2025 theme has been “America First”, the year-to-date market story has been more nuanced. “America First” would suggest an outperformance of US assets, but it is European assets that have started the year on a strong footing: The EURO STOXX 50 has outperformed the S&P 500, and EUR/USD has rebounded.
European economic positive surprises are picking up while the U.S. ones are moving toward negative territory. This dynamic is due to two main forces: Tighter financial conditions are weighing on U.S. activity, and sentiment toward Europe is becoming excessively negative, making it easier to surprise to the upside. Europe has been suffering from cyclical and structural headwinds, but these may be starting to dissipate. The difficult geopolitical backdrop for Europe could prove to be the necessary catalyst to implement structural reforms that the EU needs.
Germany’s Election & Debt Brake Policy
Germany’s election delivered no major surprises but raised questions about whether Chancellor Friedrich Merz’s government will relax the “debt brake,” which caps budget deficits at 0.35% of GDP.
The new coalition, comprising the center-right CDU/CSU and the center-left SPD, controls 52% of the seats in the Bundestag. However, altering the constitution to ease the debt brake requires a two-thirds majority. Even with additional parliamentary backing from the Greens, who are also in favour of loosening the debt brake, the coalition will still fall short by 8 votes. They would need support from other lawmakers.
The right-wing AfD is now the second-largest party (24% of seats) but is excluded from government. The coalition may turn to left-wing Die Linke, which won 64 seats, for support. Die Linke favors higher government spending but opposes German rearmament and supports Russia, while Merz prioritizes defense spending and support for Ukraine. A deal could involve increased social spending in exchange for relaxing the debt brake, but an agreement is uncertain.
While the election outcome supports fiscal easing in the short term, it does not guarantee long-term reform.
Europe is No Longer a Value Trap
European equities are attracting interest primarily due to low valuations rather than strong growth expectations. But equity markets react more to potential growth surprises than the absolute level of growth. European valuations are depressed because of a misconception: Europe’s economic woes are entirely structural and will not go away. While Europe undeniably suffers from important structural headwinds, many of the cyclical headwinds are ebbing, giving Europe a chance to surprise investors positively.
Key challenges include low productivity from weak R&D and ICT investment, market fragmentation, shallow capital markets, and excessive regulation. Cyclical headwinds such as post-crisis deleveraging, a weak banking sector, fiscal austerity, and high energy costs have also weighed on performance.
However, Europe’s outlook is improving as the balance sheets of banks and the private sector strengthen, energy supply stabilizes with LNG expansion, and policy shifts support investment. With the U.S. facing fiscal tightening and Europe’s policy uncertainty set to narrow, European equities are becoming more attractive. While short-term risks remain, such as trade tensions and a potential 2025 recession, investors should gradually increase exposure to Eurozone equities.
Upside Risk for the Euro?
German election results were roughly as expected, but Europe’s biggest economy suddenly just got more interesting. While the details of the governing coalition have yet to be finalized, Chancellor Merz has floated options to ease the “debt brake,” which currently limits fiscal spending.
Markets have heard the message and are starting to price higher odds of fiscal stimulus. German swap spreads, the difference between swap and cash bonds yields, have historically been negative as the country has maintained a tight fiscal stance, thus diminishing issuance risk. Swap spreads have however recently drifted into positive territory, while U.S. swap spreads have declined as the Trump administration is more fiscally hawkish than expected. The changes are in line with the recent leadership change in economic surprises, where the Euro Area is starting to outperform the US.
There are risks to European growth, but they are well-known. An aggressive, stimulative German fiscal stance would be a buying signal for EUR/USD.
China’s Outperformance
China’s big tech stocks have outperformed strongly so far this year. The arrival of DeepSeek was a wake-up call to U.S. politicians that China has not been left out of the global technological upgrade despite Washington’s stringent export controls on AI-related chip products.
A strong conviction trade is being shaken. As international stocks are outperforming this year, global investors are asking if their faith in U.S exceptionalism has gone too far.
The contrast is most glaring when we look at China’s big tech. BYD Co., Alibaba Group Holding Ltd., Tencent Holdings Ltd., and Xiaomi Corp., the so-called BATX after their acronyms that span electric-vehicle manufacturing, e-commerce to social media and video gaming, have risen 46% on average. By comparison, the Magnificent Seven stocks are down year-to-date (-9.5%).
Chinese tech now offers an alternative. Generative AI is not the only field where export controls have failed. Sales at US-sanctioned telecom and smartphone giant Huawei Technologies Co., for instance, jumped by 22% last year, the fastest growth since 2016. It’s beating Apple Inc. in China.
For now, Beijing is trying to soften its image internationally. President Xi Jinping recently met with a group of tech titans, including Alibaba founder Jack Ma, China’s most high-profile tech billionaire. But while one staged photo alone is not enough to erase all the grievances investors have been feeling since the tech crackdown was first launched in late 2020, it’s a start to rebuild confidence in the market.
Our Portfolio Positioning
Despite the good start of the year for equity and bond markets, investors feel uncertain about what to do. The big question is, why are Markets ignoring the noise?
Because it is unclear which measures will be implemented and what their effects will be. The key driver of markets remains the economic cycle, and for now, the global economy is still expanding. We continue to favor a well-diversified portfolio across multiple asset classes. We also believe that it is likely that the outperformance of international markets will persist, and we will implement that view in portfolios.
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
The Citigroup US Economic Surprise Index (CESI) are objective and quantitative measures of economic news. They are defined as weighted historical standard deviations of data surprises. A positive reading of United States Economic Surprise Index suggests that economic releases have on balance [been] beating consensus. The indices are calculated daily in a rolling three-month window. The weights of economic indicators are derived from relative high-frequency spot FX impacts of 1 standard deviation data surprises. The indices also employ a time decay function to replicate the limited memory of markets.
The Dow Jones Euro Stoxx 50 is a market capitalization-weighted stock index of 50 large, blue-chip European companies operating within eurozone nations. The universe for selection is found within the 18 Dow Jones EURO STOXX Supersector indexes, from which members are ranked by size and placed on a selection list.
The Standard & Poor’s 500 (S&P 500) Index is a free-float weighted index that tracks the 500 most widely held stocks on the NYSE or NASDAQ and is representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.
