Identifying opportunities in the midst of policy-driven market uncertainty

By Raj Singh
Portfolio Manager, Multi-Asset

Trade policy uncertainty is anticipated to remain high despite recently announced trade deals, with Trump administration utilizing tariffs as a negotiation tactic. This ongoing "tariff noise" will likely become a fixture in the economic landscape. While the impact of tariffs on China is projected to be mild, tariffs is likely to affect Mexico and Canada significantly. In Europe, tariffs are likely to stabilize around 15% based upon the latest trade deal announced but will also be influenced by sector-specific tariffs.

We expect that the introduction of tariffs will cause a one-time inflation shock , primarily impacting core goods prices. Although the Fed believes these effects won't trigger second-round impacts, it acknowledges the risk of persistent inflation pressures. Near-term inflation expectations are gaining attention as the Fed navigates trade uncertainties alongside resilient employment data.

On other hand, Trump’s recent remarks have raised alarms about the Fed's independence. The Fed’s autonomy in setting interest rates is crucial for bond market investors, ensuring market credibility and a stable foundation for inflation expectations. If trust in the Fed erodes, Treasury buyers may seek alternatives, leading to higher U.S. interest rates. The Fed's credibility enhances the effectiveness of its conventional policy toolkit and permits unconventional measures, such as forward guidance. Increased market volatility, a weaker dollar, and rising long-end yields could arise from perceived threats to Fed independence.

Given the potential fallout, it seems unlikely that Trump will fire Chair Powell, but he may expedite his selection for a new Fed Chair as Powell's term ends in May 2026. The Fed will likely maintain a data-dependent approach; however, current data is muddled due to significant structural forces in the labor market and uncertain tariff policies. Holding rates steady may amplify political noise, while future rate cuts could invite suspicions of politicization. This dynamic may drive bond market volatility and hinder the Fed’s monetary transmission effectiveness. If credibility continues to decline, any future rate cuts may see muted drops in longer-end bond yields, countering Trump’s objectives.

China's robust growth in the first half of 2025, along with favorable policy conditions, has led to optimistic forecasts. European fiscal measures are also boosting growth predictions for 2026. These shifting global dynamics have prompted investors to question U.S. exceptionalism, evidenced by a recent three-year low for the dollar.

Anticipated near-term volatility underscores the importance of diversification—both geographically and across asset classes. U.S. equity markets have fully rebounded, with the S&P 500 achieving a new record high, largely driven by technology stocks, particularly the "Magnificent Seven". Continued gains in the S&P 500 are expected, supported by strong earnings amid resilient economic growth. While large-cap valuations look stretched, they are underpinned by solid fundamentals, on the other hand US small caps valuations are relatively attractive but the economic uncertainty and higher interest rate backdrop remain challenging for small caps. Beyond trade developments, the renewed momentum in AI theme will continue to benefit US Large Cap Tech companies along with Asian markets such as Korea, China and Taiwan which are exposed to AI theme.

In fixed income, recent volatility may create buying opportunities if fundamentals remain strong.  After the spread widening following Liberation Day, it may have been tempting to reduce risk; however, that would have been a misstep, as spreads have returned close to cycle lows. In this uncertain environment, fixed income is well-positioned to yield favorable outcomes across asset classes. Investors should prioritize quality, exercise selectivity, and remain agile to adapt as policy developments unfold.