Investors have been on tenterhooks ahead of news on the Trump administration’s latest tariff salvo. But looking beyond the headlines, the US macroeconomic picture remains encouraging.
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The primary driver of US equities at the beginning of this year was a modest slowdown in economic growth, in contrast to the continued ‘US exceptionalism’ many investors had anticipated. It’s worth remembering that, prior to last November’s election, the forecast for 2025 had been for a ‘soft landing’. That may be exactly what is occurring, independent of the changes in the political landscape. However, import tariffs may now accelerate the slowdown.
The two key data points that alerted investors to the new dynamic were purchasing managers’ indices (PMI) and retail sales. Encouragingly, both of these have steadied recently.
The initial shock came from the February flash US services PMI: it slipped to 49.7, indicating a contraction in the sector. Given the importance of services for the US economy, any fall-off in activity can be seen as a worry. The final reading for the month was revised upwards to 51, however, and March data showed robust expansion (see Exhibit 1).
In the manufacturing sector, the PMI had risen to above 50 beginning in January, suggesting that a barrage of tariffs on imported goods were not the primary driver of the change in economic activity. The March reading, though, fell back to just below the critical 50 threshold. It will likely be many months before any benefit of increased domestic production as a result of the tariffs can be seen.
So far, the latest PMIs for Europe have been mixed. Two out of the three countries reporting (Germany, France and the UK) have seen higher PMIs, though the level for manufacturing is still below 50. One would anticipate an improvement in Germany given the recent political agreement to increase infrastructure spending, although – as in the US – this may take many months before any impact is visible.
For China, the data was also marginally better. The levels, though, are below those in November/December, which is disappointing given the numerous stimulus initiatives announced by Beijing over the last several months.
Retail sales – US vs. Europe
PMIs are surveys, and hence a less precise measure of economic activity. Retail sales figures, however, are ‘hard data’. Hence the shock when US retail sales in January showed a decline. The US soft landing had been premised on modestly weaker consumer demand, but it was conceivable that the slowdown could occur much more rapidly and sharply than expected.
Encouragingly, sales rebounded in February, and not just in the US. Every country reporting so far has seen a gain, in contrast to the more hit-and-miss pattern in previous months (see Exhibit 2).
The improvement could be particularly important for Europe. The outperformance of European equities so far this year has been driven by a steepening yield curve benefiting the region’s banks, and expectations of greater infrastructure and defence spending boosting industrial companies.
These factors may already have been priced in, however, raising the question of what will drive performance from here. The consumer sector could be the answer. Demand has lagged since the Covid lockdowns ended, but consumer sentiment has held up better than in the US. Given the challenges exporters may face as the US imposes tariffs, more domestically-focused sectors could be a haven.
Tariff impact – US vs. trading partners
At the time of writing, we do not know the details of the Trump administration’s proposals, but one thing is relatively clear: it will hurt the US’s trading partners more than the US. While US companies and consumers will face costlier imports, there will likely be a shift in domestic demand towards US-produced goods.
There could also eventually be an increase in US investment as companies look to manufacture in the US to avoid the tariffs. Exporters to the US, by contrast, simply face a likely decline in either margins or sales.
Relative returns over the last week bear out this divergent impact. As tensions have ratcheted up ahead of the announcement, equities have declined, but the US outperformed most other markets (see Exhibit 3).
For all the market’s worries, earnings expectations for US companies have been relatively resilient, rising by 0.4% for the MSCI USA index over the last few weeks, while earnings forecasts for the rest of the world have declined. The difference is particularly notable in more tradeable sectors (see Exhibit 4).
While US economic growth remains steady, the outlook for other markets has improved relative to expectations at outset of 2025. Europe now seems destined to see significant infrastructure and defence spending, while China should benefit from the development of the DeepSeek artificial intelligence (AI) model. We expect this model to be adopted widely in the country, spreading the benefits of AI beyond the technology sector.
Our multi-asset team is thus cautiously optimistic on the outlook for equities following the declines we’ve seen so far this year. In contrast to the US-centric allocations immediately after the election, however, we see returns now coming from a broader range of markets.
