Liberation Day sell-off: Trump tariff blitz raises recession risk

US tariffs look set to hit their highest rate in more than a century following the Trump administration's series of attacks on global trade. Holding risky assets is a losing strategy in today’s unpredictable markets; investors should seek haven in defensive sectors and government bonds.

The risk of US recession and stagflation has risen sharply as Trump unveiled sweeping tariffs that went far beyond what many had expected.

The average tariff rate on US imports will rise from 4.8% to approximately 20% — reaching levels last seen during the Great Depression.

But the magnitude of these import levies does not fully capture the severity of the announcements. We’re particularly surprised by how the proposed tariffs are formed – focusing explicitly on closing deficits rather than on any notion of fairness of trade barriers. What is more, we see no plausible path for the situation to de-escalate quickly, as the administration provided scant detail on what the expected quid pro quo from trading partners would be.

China has already retaliated with reciprocal levies of 34% on all US goods, while Europe plans to put a united front in announcing possible countermeasures. This raises the spectre of a full-blown trade war, which significantly changes the outlook for global growth and inflation; the ensuing market rout also raises the risk of financial instability.

The likely economic fallout is hard to overstate.

Our analysis shows the economic damage on the US is three times bigger than the rest of the world. 

We expect announced tariffs mean consumers face an additional tax burden of over USD600 billion, equivalent to 2 per cent of GDP – the biggest since 1968. It will hit business and consumer confidence and significantly curtail their spending plans.

Our economists estimate that these tariffs could reduce US GDP growth this year by as much as 1.8 percentage points, while adding up to 2.6 percentage points to US inflation. This alone may be enough to push the US into recession.

Self-inflicted damage

US increase in tariffs as of 07.04.2025 and impact on growth and inflation

We now rate the probability of a US recession at 50% or higher — significantly more than we anticipated just a few months ago. This is either because tariffs at currently threatened levels stay on for longer, or because the second-round effects of the sentiment shock are worse in an already slowing economy.

Investors, therefore, should not expect just a technical recession but a proper, albeit shallow, contraction with higher unemployment.

What makes matters worse is that the US government will be hamstrung in both its monetary and fiscal response to a downturn.

If fully implemented, the tariffs could cut US corporate earnings by some 15% and compress US stocks’ price/earnings multiples by a further 10%. This is not accounting for other spillover effects, such as a possible boycott of US goods.

A fall in real interest rates may offer only partial relief. In a recession scenario, we could see the S&P 500 index dropping to around 4,500.

Given the heightened risk of a US recession, we believe it is prudent to reduce risk. That said, equity valuations are less stretched than they were in late 2024 (the 12-month forward price-earnings ratio has declined from 22.6x in early December to 18.5x currently), and investor sentiment is already quite negative, which should help limit downside.        

Our model shows US equities are now fully oversold on momentum and breadth measures, making a short-lived technical bounce likely.

In the coming days, negotiations may allow country-to-country solutions to emerge and there’s a small possibility that tariffs will drop. But the most likely scenario, in our view, is a messy and prolonged de-escalation after some further escalation. 

Atypical US-centric shock

The rest of the world is in a better position than the US, as countries in Europe and emerging markets have more countercyclical measures on both monetary and fiscal fronts in their toolkit.

We see relative strength in China, the UK, and potentially India. While China faces a steep import tariff rate of over 50%, it has considerable capacity to deliver monetary and fiscal stimulus thanks to ongoing price deflation and ample fiscal space. What is more, its reliance on US exports is often overstated as it stands at just 3% of GDP.  

Indian equities, meanwhile, benefit from a strong domestic demand and a services-heavy export market, suggesting they should be resilient. Japan and continental European markets, by comparison, look very vulnerable – not least because these economies are very trade-dependent.  

The UK, for its part, will be subject to a more modest tariff rate of 10%. This and the fact that its equity market offers high dividend yields and relatively high exposure to commodities and defensive sectors, indicate UK stocks could fare better than most.

When it comes to equity sectors, we expect utilities and telecoms to outperform given their defensive characteristics, services orientation and attractive valuations.

Conversely, consumer discretionary and tech stocks appear most vulnerable: the former due to reduced consumer spending power, and the latter due to high valuations, cyclical exposure, and the risk of targeted retaliation from countries that have suffered US tariffs.

In fixed income, government bonds should perform well, benefiting from safe-haven flows, fair valuations and expectations of further interest rate cuts. Markets are currently pricing in four cuts by the US Federal Reserve by the year-end. We see the best value in inflation-protected securities.

US 10-year TIPS yielding 1.8% look attractive, especially as real rates are likely to fall in a recessionary or stagflationary environment.

The most at-risk segment in fixed income is high-yield credit in the US, where spreads remain tight and a slowdown in growth will likely push default rates higher. European corporate bonds will come under pressure, but less than their US peers because the European Central Bank has more room than the Fed to cut interest rates.

Gold’s initial decline may have disappointed those who have invested in its safe-haven potential. The precious metal has already gained 40% over the past year, stretching its valuations. That said, falling real rates, US dollar weakness and rising economic uncertainty should support gold in the coming months.

Interestingly, the dollar dropped sharply on the tariff news — contrary to standard economic theory. In our view, this is justified: a growing risk of US recession will force the Fed to ease more aggressively, and the dollar remains about 15% overvalued based on our models.

Moreover, the US administration would likely welcome a weaker dollar to help shrink the trade deficit.

Alongside gold, the Swiss franc stands out as a rare true safe-haven asset in today’s environment and should appreciate amid falling global interest rates. The British pound may also benefit, given the relatively favourable tariff treatment for the UK.