Market and economic commentary - It has been a quarter to remember

It has been a quarter to remember

The second quarter of 2025 witnessed some of the most extraordinary market behaviour in decades. President Trump’s announcement of extreme tariff levels for countries with trade surpluses with the US was more severe and punitive than the market had anticipated. Many economists and strategists feared it would significantly disrupt global trade – and plunge the US into a recession that could, like a domino effect, lead to economic contractions elsewhere and, ultimately, a global recession.

Unsurprisingly, equity markets reacted poorly, with major global indices falling by around 14% over the following three days before staging a sharp recovery. This rebound included a day when the S&P 500 rallied by 9.5%, as some of President Trump’s key advisers sought to restore calm. However, this relative serenity quickly faded when Beijing chose to confront Washington directly, raising tariffs on US imports into China. This triggered a tit-for-tat escalation that reached a point where trade between the two nations began to unravel.

Doomsday economic scenarios followed, along with mounting pressure on President Trump both domestically and internationally. This led to a pause in hostilities, during which reciprocal tariff implementation dates were suspended for 90 days, allowing time for governments and industries to digest the announcements and negotiate potential agreements.

Powering up the rally

Investors viewed this pause as a positive and equity markets continued to rally from the lows. This upbeat sentiment was also fuelled by more constructive talks in Geneva between the US and China, which aimed to bring down tariff rates to more realistic levels.

However, to some, this was seen as a Trump reversal – and an indication that the extreme tariff rates were more of a negotiating tool than a likely outcome. Given the optimistic nature of markets, they quickly priced-in a favourable outcome of the 10% universal tariffs being implemented and those alone appeared to be priced in. Equity market support was also strengthened by the stronger March quarter earnings season, driven by tariff front running and stronger technology earnings.

Not even the significant escalation in the Middle East — with Israel launching an offensive on Iranian nuclear facilities and Iran retaliating with attacks on Israel — was enough to dampen market support for more than a few days. US equity markets continued their upward trajectory, reaching new all-time highs right up to the end of the quarter. The chart below illustrates the strong quarterly performance which, given the multitude of events during the period, represents a remarkable outcome

The US dollar has been a drag

Another notable development has been the continued weakness of the US dollar. During the first half of the calendar year, the US Dollar Index (DXY) — a weighted index of the major US cross-currency exchange rates — declined by more than 10%. This has been the worst performance in the first half of a year since 1973.

This trend reflects not only foreign investors withdrawing funds from the US due to risk concerns — particularly given the significant proportion of US assets now represented in global portfolios — but also a growing interest among US investors in opportunities abroad. Sterling appreciated by just under 10% in the first half of 2025, and the chart on the next page illustrates the impact this has had on various markets when foreign currency exposure is converted back into GBP.

The weakness in the US dollar runs counter to its traditional role as a safe-haven asset during periods of market uncertainty and geopolitical tension — both of which were prominent over the quarter. Furthermore, the fact that US cash rates remain elevated, with the Federal Reserve expected to maintain a restrictive stance on interest rates for some time, also appears inconsistent with the dollar’s recent decline. This suggests outflows from the US dollar must be substantial, and future growth differentials between the US and other regions are now perceived to be less favourable for the US — a notable shift from recent years. The key question is whether this trend will last over the medium term.

What to expect from here?

Many different factors can play a part in the market performance going forward, depending on their severity and impact on risk appetite. When we look at these factors individually, the picture forming is very clear: caution is still required. We can’t be too defensive, however, investors can quickly become desensitised to news that would normally be a shock to markets, particularly from the US administration. As a result, they are prepared to just hold tight and wait for any U-turn to happen.

Tariffs are a good example and, at the time writing, only the UK and Vietnam have come to any significant agreement on trade policy with the US. Many other regions are yet to make any headway. The fact the 9 July deadline on the pause in reciprocal tariffs has been extended to the beginning of August illustrates the fluid situation.

As discussed above, market expectations, given the recent rally, have an optimistic view on the tariff outcomes which leaves room for disappointment on this front as the details become evident as we move through July. The positive for markets is clarity, as companies and governments will adapt to any changes and investors can feel more confident when assessing the prospects, albeit challenging, for companies, industries and countries.

Geopolitical risks remain highly elevated, with Russia continuing to bombard Ukraine with increased firepower each week. The situation in the Middle East is far from resolved and is likely to escalate further over the months to come. However, markets are likely to take less notice, despite the human tragedy, unless global energy supplies are disrupted.

On the economic front, now President Trump has seen a watered-down version of his “One Big Beautiful Bill” pass through Congress, fiscal policy will be supportive for economic growth in the US – but at what cost?

Much of it will be funded by additional debt offset, in part, by the tariff revenues when they eventually come through. A substantial part of the latter will be borne by US consumers, as they pay a higher price for goods from overseas. This will be a negative for the US economy. Lots of interplay will occur over the next few months as actual economic indicators start to reflect the uncertainty that exists today, as well as the direct and indirect impacts of the policy decisions to date.

The other swing factor will be earnings – not just in the US, but across the globe – as the tariff front-running activity unwinds and real activity is impacted. This is particularly the case in relation to company supply chains and currency impacts. In the US, the latter will be a positive for earnings whereas elsewhere it will be a negative.

All these factors will continue to drive volatility over the short term, but with some clarity forming about how trade policy will end up, we can expect a more stable environment in the medium term, so long as we don’t get too many more surprises. Wishful thinking maybe, but companies adapt, consumers adapt and therefore economies adapt. This means it is important for investors to look for opportunities and not to extrapolate fearful news for a longer period than is strictly necessary. That’s because the market can be very quick to punish but, nowadays, even quicker to forgive and forget.