We see recent market moves overall as a healthy, if volatile, rebalancing of US asset prices towards their fundamentals. The S&P 500 has largely recovered its levels of before the 2 April ‘liberation day’ tariff announcements (-0.6% lower this year) and is still relatively more expensive than other regions, but earnings expectations have been adjusted downward. The US dollar has fallen 6% this year versus a basket of developed market currencies and is in our fair value range against the euro, Japanese yen and Swiss franc. US government and investment grade corporate bond yields remain among the most attractive within developed markets in real and nominal terms.
As accords between the US and the UK, and the US and China have demonstrated, stock markets are quick to respond to any indication that the Trump administration is rolling back its import tariffs. The China and UK deals confirm our base case of a transactional US approach to tariffs. We anticipate other deals will now follow with a 10% baseline tariff rate as the new standard. We may also see sectoral exceptions, as in the UK. While the US/China outline agreement was a positive surprise for investors, it only slightly reduces the effective applied tariff rate.
US equities short and long term
Historically, US equities have consistently outperformed other regions during economic slowdowns when short-term interest rates and oil prices are each below their 200-day moving averages, and falling, as now. First quarter corporate results have been strong, and markets now price expectations that earnings growth will decline as the US economy slows.
Nevertheless, after a strong recovery from 2025’s stock market lows in April, US equities are again at the upper end of their valuations. So as further progress is made on tariffs, consumer and market sentiment recovers, and any additional US corporate tax cuts eventually kick-in, we see US stocks extending gains in line with global stocks.
Despite the recent volatility in US markets, on a 10-year horizon, regional variations in expected annual returns have narrowed. Better valuations and higher expected returns for Europe, Japan, and emerging markets (EM) than for the US are balanced out by lower volatility, and underscore the need for investors to keep asset allocations regionally diversified. We have retained a neutral position in US stocks in our regional equity strategy.
Attractive sovereign and corporate bond yields
Are international investors losing their appetite for US Treasuries? Rather than a new trend, there has been a gradual decline in foreign ownership of US debt, and US investors have been the majority holders of US Treasuries for decades. In total, foreign- and domestically-owned US Treasuries have risen and the most recent issuance of 10-year Treasury bonds saw foreign investor participation consistent with 12-month averages.
In fact, US fixed income has become more attractive with rising yields, offering tactical opportunities to lock in high yields before the Federal Reserve cuts interest rates, perhaps starting in July. Currently, 10-year US Treasury bonds are yielding 4.4%, and 10-year TIPS (Treasury Inflation Protected Securities) 2%. In corporate credit, investment grade bonds offer 5% returns.
One measure of default risk and a form of insurance for perceived exposure, Credit Default Swaps or CDS, is informative. The recent widening of CDS spreads on US sovereign debt, from 36 basis points to 50 bps at the end of March, reflects a slightly higher risk premium linked to the US’s persistent budget deficits. With a 50 bps spread, an assumed standard 40% recovery rate and a one-year horizon, the implied probability of a US sovereign default in that timeframe is just 0.86%. That is hardly an indication that investors believe that US assets are losing their haven status. Nor should we see negative US swap spreads, where US government bond yields are higher than US swap rates, as a sign of mistrust in the US Treasuries market, as US swap spreads have been negative since 2012, the result of US Treasuries issued under the Fed’s Quantitative Easing (QE) programme.
The US dollar is now fairly valued
As the world’s reserve currency, central bank holdings of US dollars as a share of foreign currency holdings have declined from their highs of around 70% globally in 2000, to approximately 58%. That is still above the levels of the early 1990s, when this share was below 50%.
Following its April depreciation, the US dollar has approached its fair value against a number of currencies, including the euro, sterling, Swiss franc, Japanese yen and Chinese yuan, even after the US dollar’s rebound in the wake of the US-China trade talks. Using the close relation between real yield differentials with USD exchange rates, we still see some margin for the dollar to strengthen.
Further discussions between the US and its partners to lower tariffs may marginally support the dollar, and economic data may weaken in the second and third quarters of the year, although not by as much as suggested by recent sentiment survey data.
The dollar’s decline to within fair value ranges suggests that further movements may now depend more on fundamental interest rate differentials, and economic surprises. We keep our neutral outlook on the US currency.
The shock of US policy tripped international investors into re-evaluating their exposure to US markets. US assets have since experienced a healthy repricing, taking them towards more fundamentally justified valuations. From here, more typical patterns may return to drive the relative performance of US bonds and stocks, as well as the US dollar, versus other regional assets. The principle of portfolio diversification remains fundamental, and in this environment needs to be implemented geographically and across asset classes.
