Weekly market commentary

U.S. policy shifts and AI advances have driven sharp market volatility so far this year. This volatility underscores the fact we are in a new macro environment, with a wider range of outcomes possible. We stick to our core risk-on framework yet fine-tune our views. We stay overweight U.S. equities on a solid macro outlook and the AI mega force – a big, structural shift. We go overweight government bonds in the euro area, where the potential growth hit from tariffs should reinforce rate cuts.

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A potentially historic shift
U.S. effective tariff rate, actual and potential, 1930-2025

We entered 2025 expecting the unexpected and for policy to add volatility. That has played out. Bond yields spiked on fiscal concerns, then fell on growth fears and the U.S. Treasury’s pledge to lower them. China startup DeepSeek’s seeming AI breakthrough and U.S. tariff news have also stoked volatility. We think tariffs will be a key U.S. policy tool. The U.S. could pursue universal tariffs as a tax this week, with reports suggesting they could come as reciprocal tariffs matching those placed by other countries. We eye potential universal tariffs on a reciprocal basis or at a flat rate, such as 10%, with tariff levels of 25% serving as a negotiating tool. That could push the U.S. effective tariff rate near 1930s levels. See the chart. The macro impact of tariffs depends on their level, scope, duration and any retaliation. The risk of higher inflation and lower growth likely keeps the Federal Reserve on hold for now.

U.S. equities have proved resilient this year, though escalating trade tensions could keep the pressure on in coming months. We think they can keep doing so, even with rolling tariff headlines and the potential for 10% blanket tariffs – provided growth holds up and inflation stays in check. Resilient growth, solid corporate earnings, potential deregulation and the AI theme keep us upbeat. Q4 earnings growth has broadened as we expected, with S&P 500 earnings excluding the “magnificent 7” stocks up about 5% from a year ago and the consensus eyeing a 10% rise this year, LSEG Datastream data show. We keep our tactical U.S. equity overweight yet watch for triggers for a change, such as earnings losing steam. We stay underweight long-term Treasuries. Even with the U.S. Treasury saying it aims to lower long-term yields, we see them rising anew as large fiscal deficits and persistent inflation cause investors to demand more compensation for the risk of holding bonds.

Evolving our fixed income views

Tariff risks reinforce our preference for euro area government bonds, so we go tactically overweight. U.S. President Donald Trump has signaled potential tariffs on Europe. Europe’s reliance on the U.S. as an export destination means tariffs – and any retaliation – would hurt euro area growth more than it boosts inflation, in our view. In the UK, we cut our gilt allocation to neutral. We had expected more Bank of England rate cuts than markets were pricing. Recent volatility, especially revived fiscal concerns, pushed yields to 17-year highs. Yields have since retreated as we expected, providing a better exit point. Markets have moved closer to our view on BOE policy rates – and we think concerns about the UK fiscal outlook will linger.

Emerging markets are especially vulnerable to the growth hit from tariffs and any worsening in global risk sentiment, we think. Mexico, with its heightened exposure to tariff impacts, is a key constituent in emerging market bond local currency indexes. We prefer to express heightened risks through fixed income, where we go underweight emerging market local currency debt. Tariff uncertainty could also drive volatility in currency markets and hurt returns in local currency EM debt.

Our bottom line

We stay overweight U.S. equities on a solid macro backdrop and the AI theme. We upgrade euro area government bonds, trim UK gilts to neutral and go underweight emerging market local currency debt.

Market backdrop

U.S. stocks were flat last week. Risk assets slid after the U.S. tariff plans before recovering by week’s end. Solid Q4 corporate earnings helped risk sentiment, with U.S. big tech companies reporting solid results and increasing their AI buildout spending. U.S. 10-year Treasury yields touched seven-week lows before settling near 4.50%. The U.S. jobs data showed a strong economy is keeping demand for workers high and leading to a renewed rise in wage pressures.

We get U.S. CPI for January this week. Even as December’s CPI report showed signs of inflation pressures easing, wage growth remains above the level that would allow inflation to recede back to the Federal Reserve’s 2% target, in our view. We see persistent services inflation forcing the Fed to keep rates higher for longer.

Read our past weekly market commentaries here.

Big calls

Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, February 2025

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, February 2025

Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.

Euro-denominated tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, February 2025