You have to give credit to President Trump; no one was expecting at the start of the year that by summer, the U.S. effective tariff rate would be around 17% and that most countries would not retaliate. Yet, that is more or less what has happened. Apparently, most countries have decided that rather than poking the bear, they are better off waiting for Trump to leave office.
If you have Trump’s zero-sum view of trade policy, this lopsided victory is hugely positive for the U.S. The problem is that global trade is a positive-sum game where all sides gain from freer access to one another’s markets.
In his first six months in office, President Donald Trump clearly delivered on his campaign pledges to upend U.S. domestic and foreign policies with significant global ramifications.
To date, key macroeconomic and earnings indicators have given only early glimpses of the consequences of these policy changes but as we advance, the impacts on inflation, employment, GDP, and corporate profitability are likely to become more pronounced.
August, September, and October are historically the more volatile months of the year for markets, especially after a very calm market in July. And given the implementation of the new tariffs as of August 1st, combined with recently intensifying conflicts in Ukraine and Gaza, we expect to see increased volatility in the coming months across asset classes globally.
Markets should brace for potential disruptions in the second half of 2025, particularly from Russia, which could trigger a new tariff shock before any ceasefire materializes, as Trump promised secondary tariffs on countries that do business with Russia. The China trade deal also remains a risk, though its weak economy increases the likelihood of a trade deal over time.
Both Russia and China will ultimately de-escalate but before agreements are reached further volatility is likely. Even though these are risks, we are not negative on the economic cycle. We still think a major recession is unlikely in the near future, and market corrections could offer tactical entry points.
- Trade Deals
- Mixed Signals for the U.S. Economy
- Is Powell Too Late?
- Germany’s New Fiscal Era
- Where is China’s Domestic Consumption?
- Our Portfolio Positioning
Trade Deals
The Trump administration announced final tariffs for almost all countries in the world. This came after a deal with the EU was made. Only deals with China and Mexico are still being negotiated. However, these two countries are also America’s biggest goods trading partners.
The final average rate of tariffs is not known yet, but it is clearly going to be higher than it has been in decades. The impact of tariffs has started to become clear, as in June the U.S. Treasury reported an unexpected budget surplus because of the higher customs duties (i.e., tariffs) received. This could encourage President Trump to push for more fiscal spending, which would be good for the domestic economy.
However, an overlooked positive offset to the trade war is the reduction of tariff rates on U.S. exports. The direct benefits of opening of the world to U.S. exports will provide only a modest offset to the tariff drag on U.S. growth. But its interaction with the Most Favored Nation (MFN) principle under the WTO arrangement could generate broader benefits. MFN requires equal treatment among trading partners, such that any reduction in import tariffs a country provides to another must be extended to all MFN partners. Regional trade agreements, such as the USMCA, European Union, Mercosur, etc., are exempt, but not bilateral arrangements. A country can also lower tariffs solely for “developing” economies. The rule is asymmetric. A country can impose a higher tariff citing national security or anti-dumping reasons, but not the other way around.
Consequently, an economy lowering tariffs on goods imported from the U.S. will need to extend this reduction to all MFN countries. This is the unintended silver lining of the trade deals. The magnitude of the benefits is difficult to gauge as we await the finalization of the trade deals and see how quickly the lower tariffs are extended globally. But trade is a critical driver of global economic growth, especially for emerging markets. For example, a deal with the U.S. where the country lowers import tariffs on agricultural imports can benefit a third country much more than the U.S. These positive surprises are most likely to benefit emerging countries more than developed markets.
Mixed Signals for the U.S Economy
The United States entered 2025 on a strong footing with decelerating inflation, a resilient economy and labor market, and a lead in artificial intelligence. Looking forward, however, the U.S. economy is likely to see slower economic growth, with a clear deceleration visible in the job market.
Q2 U.S. GDP beat expectations at 3.0% annualized, but the underlying data confirm that growth momentum is fading, reinforcing our defensive stance. Trade dynamics heavily distorted the second quarter as firms front-loaded imports in Q1 to avoid tariffs, depressing growth then and boosting Q2 net exports, which were the largest contributor to growth. With Q1 GDP growth at -0.5%, the first half of the year saw annualized growth of only 1.2%, below the potential growth rate of 2%. Near-term expectations are not much better, with consensus at only 1% U.S. GDP growth for the rest of the year.
While GDP growth was stronger than expected in Q2, the July employment report revealed large downward revisions and slowing payroll growth. Nonfarm payrolls rose by just 73,000 new jobs, and the prior two months were revised down by 258,000, bringing the 3-month average to 35,000, well below the previously reported numbers. The unemployment rate stayed stable at 4.2% but the risk is that if job creation falters, the unemployment rate can potentially rise quickly. At this moment, it is not yet clear what the full impact of the Trump administration’s immigration policies are on the supply of labor.
The economic impact of the tariffs on the U.S. and the rest of the world has not been fully felt. U.S. inflation has been surprisingly benign, but tariffs are making their presence felt, despite front-loading by importers and corporations are essentially absorbing the higher costs via reduced margins so far.
We expect the U.S. economy to continue to slow down but not to fall into a recession. Interest rate cuts and further fiscal spending could give a boost to economic growth in Q4. So, we are not turning negative on the economy and markets at this point, but we will keep a close eye on how the job market develops in the coming months.
Is Powell Too Late?
The Fed held rates steady for a fifth straight meeting this year, with a divided FOMC and a resilient growth outlook keeping policy on hold, supporting our long-duration stance. The target Fed funds rate range remains at 4.25%–4.50%, with the FMOC statement reflecting only a modest downgrade to the growth outlook. Two Governors dissented.
The divide is rooted in inflation views. Hawks prefer to wait, citing still-resilient growth and a concern over tariff-driven inflation. Doves favor cutting, pointing to slowing growth momentum and a willingness to look through near-term price pressures.
Just two days after the Fed decisions, the employment data turned a lot more negative than expected, showing that job creation has been weak for months. So, is President Trump right, and should the Fed have already cut rates to counter the weakening job market?
It does make a rate cut in September much more likely, mainly if inflation stays under control.
On top of that, Fed Governor Kugler resigned with immediate effect, offering President Trump the opportunity to appoint a new Fed governor in the coming weeks. This is important as the new Fed Chair will be selected from current Fed governors. This means Trump can now select his own candidate and effectively appoint a ‘shadow Chair’, undermining Jerome Powell’s authority. Depending on the person Trump appoints, it could rock the bond market or the U.S. dollar.
At the end of August, Powell will give a speech at the annual Jackson Hole conference, which will be scrutinized closely for any clues about upcoming monetary policy shifts.
Germany’s New Fiscal Era
The Eurozone appeared poised for better growth this year, but it will likely suffer marginally in the near term from the 15% tariffs the EU agreed to. Fortunately, U.S. security policy changes have triggered a German awakening, with Chancelor Merz stating that Europe has been freeloading and should take responsibility for its security. This has led to a significant fiscal inflection point in Germany, now suddenly willing to spend a lot more on defense and infrastructure. At the same time, the European Central Bank (ECB) has materially eased monetary policy, which should help to mitigate the impact of U.S. tariffs while also reducing financing costs across the region.
The fiscal policy reversal embraced by the new German government was unexpected and bold, and it could be transformative for the Eurozone’s prospects. The new coalition under Chancellor Friedrich Merz has enacted a plan to spend €1 trillion on infrastructure and defense over the next 12 years. The agreement adjusted the rules of the German “debt brake” to only count defense spending of up to 1% of GDP against fiscal deficit limits while exempting any additional spending. Merz has since indicated an intention to target defense spending of 5% of GDP by 2029 versus the 2.1% target in 2024.
The fiscal reforms also include €500 billion for infrastructure investments, of which €100 billion is dedicated to climate change. The federal government also adjusted the rules to allow states to run deficits of up to 0.35% of GDP versus the prior zero allowance, which will lead to incremental stimulus on top of federal spending. The changes agreed in Germany could lead to an increase in borrowing and spending of over €115 billion per year or circa 2.6% of GDP, which is significant.
The effects could be far-reaching, as Europe seeks to develop defense capabilities independent of the United States. Taken alongside the ReArm Europe Initiative, which will allow for common debt issuance of up to €150 billion and use of a fiscal escape clause to allow more defense spending across the EU, these measures could lead to sizable increases in European military spending.
Higher defense spending is a form of fiscal stimulus, and it is likely that much of the spend will be focused on technological innovation and capabilities, which can lead to other economic advances.
In the United States, the Defense Advanced Research Projects Agency (DARPA) has provided critical funding that led to the invention of the internet, Global Positioning System (GPS), semiconductors, voice recognition, autonomous vehicles, and more. In many areas where the United States is a technological leader, DARPA was involved in early-stage, high-risk funding. To the extent Europe can unify across national borders and create a peer to DARPA, higher defense spending could help narrow the innovation gap with the United States.
Defense spending will not only lead to potential innovation breakthroughs. It could also absorb excess manufacturing capacity, especially in Germany, France and Italy. This, combined with much lower valuations are the key reasons why we are long-term bullish on the European equity market.
Where is China’s Domestic Consumption?
China is in the fifth year of its real estate crisis, and without central fiscal stimulus, GDP growth is likely to slow further, with deflation becoming more entrenched, thereby creating longer-term systemic risks. To prevent this, China would need a combination of a large-scale fiscal stimulus program and major structural reforms, and the question remains whether these measures will be implemented.
In recent years, the central government has announced dozens of stimulus measures, but most have focused on monetary policy measures aimed at stimulating more borrowing. However, we believe fiscal stimulus focused on incentivizing consumption is needed. The only effective demand-stimulating measures in recent years have been subsidies for consumer durables and for electric vehicle purchases. Instead of one-off temporary incentives to spend, the central government needs to implement enduring policies that encourage households to consume more and save less on a sustained basis. That can likely only be achieved through structural reforms.
As part of the U.S.-China trade negotiation, U.S. Treasury Secretary Scott Bessent stated that the U.S. is focused on encouraging China to shift its economic model toward higher domestic consumption and to open its markets further. Meanwhile, China aims to limit U.S. tariffs and address export restrictions.
So far, China seems to have the upper hand in trade negotiations with the United States due in part to its dominance in critical rare earth minerals. The United States has been more anxious to reach a deal than China has, as U.S. companies face the prospect of idling manufacturing facilities in the absence of key inputs from China.
However, no matter where the final agreement ends up, Chinese exporters will face higher tariffs on exports to the U.S.
As the American market becomes less hospitable to Chinese exports, goods trade has been redirected to other countries. Some of these exports are likely to be shipped to the United States to avoid tariffs. Still, the ability of different economies to absorb excess supplies of goods produced in China is limited, both economically and politically.
Our Portfolio Positioning
July has been a remarkably calm month for markets as most markets continued to move higher, helped by relatively strong corporate earnings.
Portfolios have performed well since the start of the year. We are comfortable holding a balanced duration position, including a position in long-dated U.S. Treasuries as a hedge against further weakening economic data.
In stocks, we remain slightly defensively positioned for the coming months as we expect markets to be volatile and prone to swings. Given the recent sharp rise in equity markets and given that the coming months are historically more volatile, we could see some sharper up and down moves. However, despite this and the risk of a softer U.S. employment market, we are not bearish, but we will keep a close eye on future developments. Maintaining a globally diversified portfolio and staying invested is the right strategy in this type of market.
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.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
