Bright Spots Ahead as Markets Diverge
Jul 7, 2025
In its 3Q 2025 Outlook, PGIM Quantitative Solutions outlines the opportunities available in an evolving market.
TARIFFS, TRADE DEALS & TENSIONS
President Trump’s second term has been marked by a sharp focus on trade policy, with the early-April announcement of “Liberation Day” tariffs, coupled with threats of reciprocal measures, sparking widespread turmoil in stock, bond, and currency markets. Seeing the writing on the wall, the Trump administration partially walked back these measures, delaying the steepest tariffs and settling for a temporary 10% minimum tariff instead. Still, major trading partners like Mexico, Canada, and China have borne the brunt of Trump’s targeted policies.
The administration faces an uphill battle to keep tariffs in place, both at the Court of Appeals and potentially the Supreme Court. Even so, the process is lengthy, meaning tariffs are likely to remain in place until a final ruling is issued. Should the Supreme Court uphold the initial rulings rescinding the tariffs, the Trump administration may still have options. Other statutory authorities could enable the implementation of tariffs, although these are more limited in scope.
Despite higher inflation projections in the near-term as tariffs ripple through the U.S. economy, the Fed maintains its wait-and-see stance. Its Summary of Economic Projections suggest two rate cuts before the end of the year, consistent with messaging over recent quarters. Still, uncertainty lingers. While CPI remains contained for now, that the Fed’s stance could be tested if inflation spikes and unemployment creeps up. Central banks often talk about looking past supply shocks, but the Fed may be challenged by balancing its inflation fighting credibility with rising unemployment concerns.
The European Central Bank (ECB) has continued cutting rates, lowering the deposit rate to 2% in early June as inflation comes under control. ECB President Lagarde indicated the bank is nearing the end of its cutting cycle, while also flagging downside risks, suggesting additional room for cuts if needed.
Like the Fed, the Bank of Japan (BoJ) is in wait-and-see mode, but the relevant question for the BoJ is not when to cut, but when to hike. It must balance elevated inflation with negative trade impacts and the strengthening yen. Recent surveys of economists suggest a consensus is emerging that rate hikes will be delayed until 2026.
Internationally, geopolitics have further complicated the economic landscape. Tensions between Iran and Israel escalated into open conflict in mid-June as Israel launched strikes targeting Iranian military leaders and nuclear facilities. The U.S. joined in, deploying ‘bunker busters’ on Iranian nuclear enrichment sites, but is now actively working to broker a cease-fire. Oil futures initially surged amid fears that Iran would force the Strait of Hormuz closed, but prices have since pulled back on cease-fire hopes. Meanwhile, the Russia-Ukraine conflict persists, with significant casualties from ongoing attacks on both sides.
FROM HEADLINES TO HEADWINDS
Market volatility surged in early April following President Trump’s announcement of sweeping reciprocal tariffs targeting major trading partners. The news triggered a sharp sell-off in risk assets as fears of global retaliation and a potential recession intensified. Treasury yields spiked, with the 30-year yield jumping 21bps and the dollar index falling sharply, reviving worries about fiscal discipline among the debt vigilantes. While some relief came in the form of select exemptions and a tariff pause for non-retaliating countries, sentiment quickly soured again with new chip export restrictions and additional warnings from the Fed about inflation risks.
By mid-April tensions began to ease as President Trump signalled a willingness to negotiate a potential deal with China. Hopes for tariff relief spurred the S&P 500 to rally approximately 20% by mid-June from its lows following "Liberation Day," leaving it just 3% shy of February’s record high. Despite a recovery in equities, bond yields remained range-bound with the 10-year U.S. Treasury yield hovering at around 4.5%, pushed higher by concerns about tariffs and longer-term sustainability of U.S. debt. International equities and commodities emerged as standout performers during the first half of the year, while U.S. small-cap stocks and REITs lagged, reflecting divergent market dynamics into the middle of 2025.
Trade policy uncertainty is expected to persist in the coming months as negotiations continue, though likely with less intensity than in the first half of the year. The broader environment remains supportive for risk assets, supported by still-solid company fundamentals. The Q1 earnings season highlighted continued strength in company earnings prior to the escalation of tariff uncertainty. While forward one-year earnings expectations for U.S. companies peaked in February, they were quickly and intuitively revised lowered throughout Q2 as tariff uncertainty spiked. Approaching Q3, however, expectations appear to be stabilising. Even as global growth expectations have been revised lower since the start of the year, improved clarity around tariffs appears to provide some stability for growth expectations. The extent to which the Fed and other central banks remain measured in their responses to tariffs will be critical in mitigating potential market disruptions.
Outside the U.S., government yields are also under pressure. Longer-term Japanese Government Bond (JGB) yields are facing reduced demand from traditional buyers such as life insurance companies, prompting the BoJ to revisit its issuance plans. Meanwhile, in the Eurozone, government yields face prospects of stepped-up fiscal spending, particularly for defence. Commodities stand out as a relative bright spot amid the ongoing uncertainty, driven largely by a rising geopolitical risk premium in oil markets as of mid-June. Current conditions, including the prospect of higher tariffs, are supportive of strengthening commodity prices. However, while tariffs may boost prices in the short term, there is risk of second-round effects dampening demand. Gold continues to benefit from ongoing central bank purchases, inflation worries and its role as a safe-haven asset.
Source for all data points: PGIM Quantitative Solutions, July 2025.
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