US President Donald Trump’s “liberation day” tariff proposals have left the global financial markets shell-shocked at their severity, causing volatility to spike to levels synonymous with historic bear market events like the global financial crisis and the COVID-19 pandemic. As investors pause to consider the consequences of what seems like an abrupt and chaotic end to economic globalization, the only thing that is certain for now is uncertainty.

Should final tariff policy settle at the initially published rates, the structural damage to the global economy would be profound and warrant such extreme market moves. Since Trump holds unilateral power over US tariff policy, the tariffs can be reversed just as swiftly as they were imposed, without the need for legislation, if the US reaches agreements with its trade partners. 

While recession risk has materially risen, underlying global economic conditions prior to the escalation in the trade war were solid and many central banks, including the US Federal Reserve, were navigating soft landings. Despite high policy uncertainty, which has bruised this outlook, we believe as risk markets continue to price in the likelihood of a global recession, maintaining a slightly pro-risk stance may be prudent.

Figure 1

Investment implications

• Historically, spikes in the VIX above 30 have been associated with strong forward returns in global equities. The bottom chart in Figure 1 shows that, on average, equity market weakness tends to only last one month after a spike in the VIX and is followed by a strong recovery in the medium term.
• As fixed income spreads have widened and even US Treasuries have wavered as US-initiated tariffs have raised questions about their credibility as safe-haven assets, the traditional negative correlation between equities and bonds that made them reliable diversifiers might not be as consistent. Elevated macro volatility and stock dispersion could benefit alternative asset strategies and enhance their diversification potential.
• Although the dynamics of bond and equity correlation have been more complex in recent years, even prior to the current market volatility, we believe fixed income will continue to serve an important role in diversified portfolios. Higher yields offer an attractive entry point to produce income, which could facilitate compelling total returns over time for multi-asset portfolios.

What we are watching

• Countermeasures to US tariffs proposed by global trade partners, which are varied and evolving rapidly, and their willingness to negotiate terms or seek to retaliate. 
• Central bank policies faced with the potential conundrum of lowering rates to address weakening growth or raising rates should inflation accelerate; global fiscal policies as countries seek to fill the void from an isolationist US foreign policy.
• Trade policy crystallization versus ongoing volatility driving what may be short-term equity sector and regional dislocations or structurally more attractive long-term opportunities.