From the BlackRock Investment Institute
• We see more pressure on risk assets in the near term given the major escalation in global trade tensions. We trim our short-term tactical horizon and reduce risk.
• Last week saw a risk asset rout akin to major shocks like the pandemic. U.S. stocks plunged. U.S. 10-year Treasury yields fell, and two-year yields rebounded.
• We eye U.S. CPI this week to see how inflation is evolving before new tariffs take effect. Core inflation is running too hot to fall back to the Fed’s 2% target.
The sharp escalation in global trade tensions and extreme trade policy uncertainty has triggered a broad risk asset selloff. It is less clear if uncertainty will cloud the outlook for a little or a lot longer, so we reduce our tactical horizon to three months. That means giving more weight to our early view that risk assets could face more near-term pressure. We reduce equity exposure for now and allocate more to short-term U.S. Treasuries that could benefit as investors seek refuge from volatility.
The escalating trade conflict sparked the worst one-week selloff in the S&P 500 and U.S. high yield bonds since the 2020 pandemic shock – even as U.S. economic conditions remain solid, as seen in strong U.S. jobs data. We expected risk assets would remain under pressure until uncertainty starts to dissipate – and it’s now less clear over how long or short a period policy uncertainty could cloud the outlook. We now see a bigger growth drag and inflation boost. The Federal Reserve also expects a bigger impact than it did in March. See the chart. Many countries are preparing responses to U.S. tariffs. China has kicked off with 34% tariffs and other measures. Yet the full set of international responses and country-specific negotiations with the U.S. will take time, making it hard to have visibility on when and how this will settle. Major wealth destruction could hurt sentiment and consumer spending.
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We still believe U.S. stocks will eventually reclaim global leadership due to mega forces – like the buildout and adoption of artificial intelligence. But for now, we shorten our tactical horizon to three months and reduce risk. A shorter tactical horizon means giving more weight to our early view that risk assets could stay under near-term pressure until uncertainty starts to dissipate. That’s why we reduce equity exposure, including to U.S. and Chinese stocks, and allocate more to short-term U.S. Treasuries that could benefit as investors seek refuge from volatility. If clarity comes quickly, we would up risk-taking again.
While we are more cautious about broad benchmarks, sharp selloffs are creating opportunities for security selection. U.S. policy shifts are spurring fiscal spending globally. In Europe, Germany’s €1 trillion package for defense and infrastructure investment is creating opportunities in the defense sector. We don’t think the growth and earnings outlook yet supports sustained European equity outperformance but a broader macro opportunity could emerge if the European Union finds a way to jointly issue bonds to fund investment across the bloc, as it did in the pandemic.
Overall, we think plans for a new wave of U.S. tariffs and responses from other countries reinforce that we will be in a world where interest rates – and long-term bond yields – stay higher than pre-pandemic. Tariffs and looser fiscal policy in some parts of the world will likely push up on inflation. We lean against market pricing of four to five quarter-point rate cuts by the Fed this year: U.S. core inflation is tracking well above the Fed’s 2% target, even before the impact of new tariffs.
We stay underweight long-term Treasuries given persistent U.S. deficits and sticky core inflation. We expect investors to demand more term premium, or compensation for holding long-term bonds given sticky inflation, higher-for-longer interest rates and a tough fiscal outlook. That could put upward pressure on long-term U.S. Treasury yields. We think gold can serve as a better return diversifier in this environment.
Bottom line: Trade tensions have triggered a risk asset selloff. We see volatility persisting for some time, so we shorten our tactical horizon to three months and reduce risk-taking, turning neutral on U.S. equities and preferring short-term Treasuries.
Market Backdrop
The S&P 500 slid 9% last week and shed 10.5% in just two days – the sharpest such move since the pandemic hit in 2020 – after the news of broad U.S. tariffs on global imports. Europe’s Stoxx 600 closed down more than 8%, taking the index into negative territory for the year. U.S. 10-year Treasury yields fell to 4.00% but bounced from a six-month low of 3.86%, partly after Fed Chair Jerome Powell ruled out any near-term rate cuts. Two-year yields rose to 3.65% from a low of 3.47%.
