Beware calm markets. Smooth waters don’t always signal safety
As US markets proves remarkably resilient to tariff chaos, Fabio Bassi, head of cross-asset strategy at J.P. Morgan, pleads a note of caution. As seasoned sailors know, calm waters don’t always signal safety
In 2025, the global economic landscape is marked by fluidity and complexity.
Financial markets are navigating a sea of uncertainty, shaped by the interplay of trade policies, underlying resilience of the global economy, geopolitical tensions, uneven monetary policies and the broadening of the AI theme.
The narrative shifted dramatically from the optimism of US exceptionalism in January to fears of a US and global recession, induced by tariffs and trade wars around Liberation Day. However, a retreat from extreme tariff policies and the successful negotiation of trade deals have fuelled a sharp rebound in risk assets, currently hovering close to historical highs.
The long-term effects of tariffs
Initially perceived as negotiation tools, tariffs have evolved into a cornerstone of the US trade and fiscal policies. The Liberation Day shock, driven by unexpectedly high tariff levels sent ripples of alarms to investors triggering a large correction in risk assets. This was also reinforced by a momentum crash of crowded positions, which led to a stampede of liquidation.
Yet, the initial delay in tariffs implementation and the opening to trade negotiations triggered a sharp rebound in risk asset, surpassing previous highs.
As tariff rates are expected to settle at much higher levels than previously assumed, questions about the resilience of the economic outlook and financial markets have emerged.
Conventional models assess the impact of tariffs by estimating the tax equivalent shock of consumers and the sentiment channel on business spending. Concerns about retaliatory measures and potential declines in investment have added to these recession fears. However, a frontloading of activity occurred as companies increased inventories, contributing to the resilience in the economic data.
The shock has been partially absorbed by domestic importers or foreign exporters, resulting in a more muted impact that will unfold over a longer period.
As the year progresses, frictions from high tariffs are expected to become evident in the data.
Strong economic data have supported resiliency of financial markets. The “Trump put”, an implicit backstop for policy reversals, and the “Fed put,” expectations of Federal Reserve easing in response to weakening macro data, have bolstered market resilience. The abrupt softening in the US labour market data in the latest payrolls report has shifted monetary policy expectations with the first Fed rate cut now expected in September. Positive earnings in the first half of the year have further reinforced the bottom-up resilience to the tariff shocks, despite cautious forward guidance.
The interplay of policy reversal and monetary policy expectations underscores the backbone of current resilience.
US market resilience doesn’t mean all is well
Technological innovation, the broadening AI theme and the potential for productivity gains have been key forces behind the US relative outperformance.
While the theme of US exceptionalism has faded, the AI theme continues to support the U.S. equities. The democratization and broadening of AI, increased competition, and lower barriers to entry enhance investment opportunities, with the US maintaining a first-mover advantage.
The AI theme continues to broaden and remains a powerful force supporting risk assets, with an increasing focus on productivity gains and margin accretion both within and outside of the technology sector.
This momentum provides a counterbalance to economic uncertainties, offering positive drift to risk assets.
Macroeconomic resilience, the AI theme, policy reversals and potential Fed have led markets to price in a “Goldilocks scenario” – moderate growth with temporary inflation impacts, allowing the Fed to normalize policy rates to neutral.
Investors across assets classes are positioned for this scenario and are at risk of a pick-up in macro volatility. Risk assets are expected to exhibit a “frown” to macro volatility: resilient in the baseline scenario but with two-sided macro risks. Weaker data could trigger recession fears, while persistent inflation may challenge the Fed’s ability to cut rates.
Recent moderation in macro volatility has led to investor complacency, but growth and inflation surprises remain risks to monitor.
As seasoned sailors know, calm waters don’t always signal safety. While the economic outlook appears resilient to tariff shocks, timing is crucial.
A staggered implementation of tariffs has allowed companies to adapt, but impacts on hard data are widely expected by year end. Investors should hedge downside risk in equities and widening risk in credit spreads, even if a recession is not their baseline scenario.
Long in short-dated US Treasuries will provide an attractive hedge against recession fears and more aggressive policy easing. The path to Goldilocks seems narrow, and risks are skewed for a short-term correction in risk assets. We see value in implementing hedges although most likely this retracement will prove an opportunity to add.
Investors must remain vigilant, adopting flexible strategies to adapt to the evolving landscape, as they navigate the waters of a new global economy.
Fabio Bassi is head of cross-asset strategy at J.P. Morgan