How trade wars could impact personal portfolios and businesses?

He also issued executive orders to freeze foreign aid and federal funding (it was rescinded but may be rewritten and could cause a demand shock). Meanwhile, internal political convulsions for the world’s largest economy were amplified. With so many things happening, each with significant geo-economic ramifications, it will likely affect most portfolios, in one way or another. 

At the same time, DeepSeek, a Chinese Large Language Model that rivalled ChatGPT, threatened investment in AI due to its open-source nature and lower cost and threw Nvidia off its supposedly unassailable perch. This tactic is not too dissimilar to the “dumping” of physical goods at very low prices. To be sure, there was no spillover, and Nvidia is now trading at more palatable valuations.

We are entering a new era of global de-synchronisation. Market and economic de-synchronisation during the pandemic gave us a glimpse of what it looks like: higher inflation, less efficiencies (so larger output gaps), far less predictability which meant bigger inventories and an advantage for larger corporations who would place larger orders, and widely diverging economies and monetary policies. A word starkly different from 2009-2017 when central bankers worked in coordination to make sure the global economy didn’t spin off its axis.

Decisions by the US Federal Reserve and the European Central Bank tell us not just a story of interest rates but how different regions see their futures diverging. The thinking is that, over the short and medium term, trade wars and a crackdown on immigration will likely result in upward inflation pressures in the US. While the IMF and various institutions also see a real GDP acceleration, we would be a bit more reserved on the economic growth side of things.

Yes, drumming up domestic production, deregulation and lower corporate taxes may spur growth enough to counterbalance the disturbance, but this will take time to play out. Bond markets are not pricing significantly higher inflation, so yields could climb further, reducing fiscal space more immediately, while higher inflation may eat into nominal growth. So, for the short-term, we see likely higher inflation, despite last week’s benign core Personal Consumption Expenditure (PCE) number which, however, reflects a previous economic paradigm, and we have questions over medium-term growth in the world’s largest economy. 

Over the short term, this could boost domestic demand, but it will likely cause issues for US large caps who have 41% of earnings from abroad. Not only will manufacturing likely face serious importing issues and margin pressures, but it is not inconceivable that US companies will find themselves in a more hostile environment abroad if tariffs are already imposed. A threat carried out or repeated on every subject is not an effective deterrent. This is not likely reflected in present valuations which, for US large caps, trade at the top 10% of their historic valuations, despite last week’s Nvidia correction.

The EU is going a different way. Disinflationary pressures are stronger, with wages not nearly as adaptable as in Anglo-Saxon economies, and China finding more fertile ground to sell goods at lower prices.

Meanwhile, tariffs on US exports will likely reduce demand for goods, political uncertainty in France and Germany and persistent centrifugal EU forces are not conducive to growth, which the IMF has consistently downgraded over the past year.

Tariffs may increase EU inflation over the longer term, as global supply chains are disrupted again. However, it is a different sort of disruption at the origin (China) and at the endpoint (US) so we could see a very different situation than during the pandemic.  

Thus, it is no wonder why central banks diverged, with the Fed taking a hawkish stance and maintaining rates (over the President’s vocal objections) while the ECB dovishly chose to support the beleaguered single currency area and may well do so again.

If anything is holding it back, it is the potential for capital flight if interest rates widen too much, but Christine Lagarde seems to prioritise shielding the EU and the Euro at the current juncture. 

As for the BoE? The UK’s central bank is in a bind. On the one hand, it faces persistent wage inflation. On the other, growth has been lacklustre, and with its main trading partner, the EU, in the doldrums and the other boarding up the trade gates, as well as higher inflation reducing fiscal space, GDP upside is limited.

As political and economic rifts widen, the global economy diverges. The US is on a path to inflationary expansion, the EU on a disinflationary slowdown, and the UK on a stagflation one. Yet if inflation pulls up globally, stagflation could become a reality for all developed markets. Monetary and even fiscal policy can only do so much in the face of such a megatrend as the reordering of globalisation and the post-WWII world order and the uncertainty this brings. Such a reordering may not happen in the space of months but could take years to complete, on a road with many twists and turns. 

What should investors do?

It’s difficult to see where the chips may land. Portfolio managers need to look beyond the benign picture of global equity and bond markets and recognise that systemic risks are on the rise. We live in a different world than we did a decade ago, even three weeks ago. So, steps can be taken to manage risks within portfolios. We recommend taking good advice where you can find it and being resilient.

The week ahead

It is shaping up to be another interesting one. Markets will be waiting for the US President to issue new executive orders, and to further explain his tariff strategy with Europe. It is also interesting to see the sort of response coming out of the countries where tariffs have already been imposed. Will they take their complaints to the (defanged) WTO? Will they respond in kind? Will they seek to export somewhere else? From a macro perspective, markets will be focusing on PMI numbers (although they are historic by now, and don’t yet tell the story of what’s ahead), and US payroll data at the end of the week.

It will be a bumpy ride, and we are merely in the beginning. 

George Lagarias – Chief Economist

Market update

In the US, corporate earnings and concerns over AI competition led to a turbulent week for stocks. The introduction of DeepSeek, a Chinese low-cost AI model, triggered a significant sell-off in tech stocks, notably affecting NVIDIA, which saw a nearly 17% drop on Monday (27th January). Despite some positive earnings reports from major tech companies such as Meta Platforms and Apple, overall market sentiment remained cautious. However, on the whole, the US equities saw only a slight decline of -0.3%.

Global equity markets showed mixed results. Japan equities led the way with a +2.2% increase, followed closely by the UK at +2.0%, the EU at +1.1% - with strong earnings results and the European Central Bank's (ECB) decision to cut interest rates boosting investor sentiment. EM equities rose by +0.8%. On the whole, global equities remained flat at 0.0%.

In the currency markets, the GBP/USD rate fell by -0.7%, while the GBP/EUR rate rose by +0.7%. Both the GBP/JPY and EUR/USD rates saw a significant drop of -1.2% and the USD/JPY rate decreased by 0.5%. These movements reflect broader market volatility and the impact of geopolitical developments, such as the Federal Reserve's decision to maintain its policy rate, citing solid economic activity and labour market conditions, but noting that inflation remains somewhat elevated.

Bond yields generally fell, with the US and German 10-year yields both decreasing by 8 basis points (bps), while the UK 10-year yield fell by 10 bps to 4.53%.

Commodities showed varied movements, with gold prices increasing by 1.8%, while oil prices dropped by 2.1%, mainly attributed to worries regarding a potential decrease in demand in China - the world's top oil importer.

Macro news

The US Federal Reserve kept its policy interest rate unchanged at the 4.25-5% range. Fed chair Jerome Powell stated that US rate-setters “do not need to be in a hurry to adjust our policy stance”. Donald Trump sharply criticised the Federal Reserve just hours after the US central bank defied the president’s calls for deep reductions in borrowing costs and left interest rates on hold.  Robust activity, a solid jobs market and sticky inflation justify the Fed's decision to hold interest rates steady. Currently, the market is pricing two 0.25% cuts in 2025.

Europe's two largest economies contracted at the end of last year as the collapse of their governments hit business and consumer confidence. In the fourth quarter, Germany's GDP fell by a larger-than-expected 0.2% quarter on quarter, while France's GDP decreased by 0.1% quarter on quarter. German Bund yields and the euro fell following the data releases. The ECB is expected to cut interest rates on Thursday to support economic growth.