Key Highlights

• Tariffs increase downside risk to growth, upside risk to inflation
• Fed bias will be to offset growth hit, as long as inflation expectations remain stable
• Possible retaliatory policy responses by Europe and China, domestic support also seems likely

Current macroeconomic forecasts

EXHIBIT #1: BNY MARKETS FORWARD LOOK 2025 Q4

^{Source: BNY Markets}

The announcement of universal and retaliatory tariffs yesterday has, not surprisingly, roiled markets. The average tariff rate for all U.S. imports is now somewhere between 20% and 30%, with most estimates at the higher end of that range. This would result in a higher tariff rate than the U.S. had under the Smoot-Hawley Act in 1930. Hopes that uncertainty would be alleviated on April 2 have turned into global fears of a protracted trade war and have not eliminated uncertainty, as the duration of the tariffs and the potential for negotiation or retaliation are still not clear.

United States

EXHIBIT #2: US EQUITY HOLDINGS FALLING, BUT MORE ROOM TO GO LOWER

^{Source: BNY Markets, iFlow}

BNY has raised its U.S. inflation forecasts by 1.5% to 4.4%, downgraded our GDP forecast to 0.9% from 1.6%, and increased our unemployment forecast from 4.7% to 4.9%. Our policy rate forecast still calls for two cuts by the end of 2025, while the market continues to price in more than three cuts.

We think the Fed will be more attuned to the growth risk than the short-term inflation moves due to tariff-induced price increases. However, we cannot be entirely sure that inflation expectations won’t rise in line with increasing goods prices, which would complicate the central bank’s position. Chair Powell is scheduled to speak on Friday morning and may reveal the Fed’s thinking about which side of its dual mandate is more at risk.

U.S. equities holdings, which have fallen since the election, are not underweight, but are closer to neutral compared to the previous five years, so there are still sufficient positions to shed as the market digests the obvious hits to growth. European and APAC equity positions, which have been rising in recent months as U.S. holdings have declined, are at risk of reversal, and we fully expect any sell-off to be indiscriminate across markets. As Exhibit #2 shows, holdings have already moved lower in the U.S. market across almost all sectors, except for defensive sectors like Consumer Staples and Utilities. Flows in March were also quite negative, but as the level of holdings is still somewhat elevated we believe more  U.S. stocks will experience shedding, with cyclical shares most at risk, but sectors most exposed to tariffs, such as Health Care (e.g., pharmaceutical companies), also at risk.

The dollar is likely to trend lower as U.S. assets become less attractive and rate expectations may continue to widen the 2y yield differential between the U.S. and the rest of the world. USD downside should be limited, however, given likely similar responses by central banks elsewhere.

Europe

Political and Policy Response

Certain European leaders have strongly condemned the new U.S. tariffs imposed by President Trump, with European Commission President Ursula von der Leyen warning of a “major blow” to the global economy and confirming that the EU is preparing retaliatory measures. ECB President Christine Lagarde echoed these concerns, stating the impact “will be felt the world over.” Spain has proposed a €14.1 billion support package, while U.K. Prime Minister Keir Starmer said the country’s response would respond in a “calm” manner while maintaining trade dialogue. Germany’s Economy Minister Robert Habeck said the country is leaning toward a “firm response,” but negotiation is still expected to be the EU’s first move. If push comes to shove, the bloc could activate the Anti-Coercion Instrument (ACI), potentially limiting U.S. firms’ access to European financial markets.

Spain’s fiscal package is likely a sign of things to come. With Europe already committed to expansionary fiscal policy, markets are unlikely to react negatively to further support aimed at boosting domestic demand. However, the more consequential response may come from monetary policy. The euro’s initial strengthening against the dollar suggests imported inflation is less of a concern than a demand shock. As a result, the ECB will need to focus on downside growth risks and persistent target undershooting. We reaffirm our view that the ECB will continue to cut rates at least once per quarter. Should the euro rise materially through 1.10 due to global de-dollarization, more aggressive easing may be needed to avoid deflation expectations.

iFlow

In iFlow, euro positioning remains neutral on both aggregate and cross-border levels, leaving room for investors to add euro longs. Such flows could test the ECB’s tolerance for currency strength in a weak growth environment. Even before the tariffs, the data showed a peaking in allocations to European equities; outright reductions are now possible. That said, sectors like Defense and Consumer Staples are likely to remain resilient on the back of stronger domestic demand. European asset managers may double down on home bias. A surge in cross-border flows into European assets would support the view that a structural rotation away from the U.S. is gaining momentum.

China

Political and Policy Response

China has strongly condemned the new U.S. tariffs, which raise levies on Chinese imports to over 50%. China’s Commerce Ministry urged the U.S. to “immediately cancel” the measures, warning they “endanger global economic development” and harm U.S. interests and supply chains. Beijing vowed to implement “resolute countermeasures” and is restricting its firms from investing in the U.S. to gain leverage in future negotiations. Other forms of strong tariff and non-tariff retaliation are likely, though a negotiated response cannot be ruled out.

China’s domestic policy response will likely focus on accelerating structural rebalancing. Additional fiscal support of 1-2% of GDP is possible, with positive spillovers for the region. At the same time, Beijing is positioning itself as a stable global trade partner. It immediately reached an agreement with the EU to fast-track resolution of their car industry dispute. Separately, it is advancing trilateral economic dialogue with Seoul and Tokyo. While the tariffs will have a material impact, we do not underestimate China’s resilience – a government priority in recent years. Policymakers are unlikely to resist asset price moves driven by fundamentals but will act to contain volatility. We expect guided weakness in the renminbi, consistent with broader inflation goals.

iFlow

In iFlow, cross-border positioning in Chinese assets remains light. The CNY is underheld, and equity inflows arrived quite late in Q1. The more significant opportunity lies in Chinese government bonds (CGBs). If fiscal stimulus pushes 10-year yields toward 2.50%-3.00%, we expect strong foreign inflows. Our data show the CGB market has not seen sustained cross-border demand since early 2021, but renewed participation could shift global asset allocation dynamics and add to term premia in U.S. Treasurys.