Commentary Corner - 1H 2025 Macro Outlook
The first half of 2025 has most certainly been a wild ride. From the expected 2025 M&A boom that never materialized, to the Liberation Day tariffs which sent all markets into freefall, to the crisis in the Middle East, to the stronger than expected US consumer, to the “more cuts in 2025” to “wait-and-see” and “higher for longer” from the Fed, and finally the One, Big, Beautiful Bill Act (“OBBBA”), the first half of 2025 has been anything but predictable. However, despite all the chaos in the markets and around the world, let us take a moment to analyze the latest economic data and insights in an effort to separate the signal from the noise.
The elephant in the room in 2025 is President Trump’s new tariff regime. There’s a new sheriff in town – and it marks a significant shift from decades-old free trade policy that dominated previous administrations. Liberation Day marked a significant turning point in US trade policy, and the subsequent comments from the Trump administration suggest that, whether you like it or not, the tariffs are here to stay. As of this writing, the average US tariff rate is 15.8% - the highest in nearly a century. The sustained impact of these tariffs will have long-term consequences for both the US and its trading partners. The present uncertainty around future expected trade policy has heightened volatility both at home and abroad, with businesses more hesitant to invest in new projects, hire employees, and pursue M&A without clear guidance from the administration regarding future expectations.
Tariffs are typically inflationary measures – after all, they are essentially a tax on products that is effectively passed down to the consumers. Despite the proposed benefit of “making foreign companies pay for the tariffs”, firms that do not wish for the tariffs to severely impact their operating margins will pass on the additional cost of the tariff to the consumers. Apollo Global Management’s Chief Economist Torsten Slok takes an even more aggressive view – he suggests that the tariffs are stagflationary shocks. Stagflation refers to the doomsday scenario where high inflation is concurrent with high unemployment rates, a nightmare scenario for any economic watchdog. Apollo argues that the tariff regime will simultaneously increase the possibility of an economic recession to 25% (up from 0% at the start of 2025), while being inflationary to price levels. At the same time, interest rates are expected to be higher for longer, with a year-end target range of 4-4.25%.
Meanwhile, there has been a divergence in the economic data between the ‘soft’ economic data (e.g., confidence levels, surveys, etc.) and ‘hard’ economic data (e.g., quantitative metrics such as spending, GDP, unemployment rate, etc.). The soft economic data suggest a deterioration in the state of the economy, while the quantitative metrics indicate that the economy is much more resilient than anticipated. This discrepancy further adds to the uncertainty surrounding interest rates – especially since the Fed considers both soft and hard economic data in its decision-making process. With the data pointing in two different directions, it makes it particularly difficult to discern the Fed’s next move with a high degree of confidence. On the bright side, trying to predict inflation and the Fed’s next cut is no longer the only issue anymore, given today’s market uncertainty.
The supply side of the economy continues to be disrupted by the new tariff regime, particularly those which rely heavily on foreign supply chains. The Israel/Iran conflict in June highlighted another risk – that higher oil prices would result in higher inflation and lower US GDP growth. Since the US is a major contributor to global aggregate demand, the tariffs will also result in lower global GDP growth. To quantify these insights, US GDP growth is expected to be 1.2% in 2025, while global GDP growth is expected to be 2.6% in 2025 (down from 3%+ at the start of the year).
Trump’s One, Big, Beautiful Bill Act (“OBBBA”) is characterized by massive tax cuts with some level of spending cuts. According to analysis by the Congressional Budget Office, the tax cuts are expected to increase the growing US deficit and worsen the country’s debt-to-GDP ratio. While the tax cuts may be stimulative to the economy in the short term, the increased interest expense and weaker fiscal position may prove to be a structural force keeping upward pressure on long-term rates in the future.
On the corporate side, many businesses were caught off guard by the impacts of the Liberation Day tariffs. Instead of a gradual increase in tariffs that would offer confidence, effectiveness, and predictability (e.g. an increase of 0.5% per month for the next 24 months), the immediate tariff across all countries sent supply chains (and ultimately, profit margins) into disarray. Companies are no longer sure of what to expect regarding trade policy in the immediate future, and the lack of predictability has caused earnings to be revised down across the board due to lower confidence.
Since tariffs aren’t going away anytime soon, it begs the question of when trade deals will be signed between the US and its trading partners to reignite collaboration between its closest allies. Before the optimists in the room can have a say, the fact of the matter is that trade deals take a long time to get signed, historically an average of 18 months from the start of negotiations to the actual signing date. After that, implementing the new trade deal takes even more time, an average of 45 months from the start of negotiations to actual implementation. Using April 2025 as a rough estimate, if historical trends hold, then we can assume a deal (Canada/US) sometime in October 2026, and the actual implementation starting in January 2029. Obviously, this will vary depending on the country, and Canada may be quicker to reach an agreement compared to others. But this is a gross generalization to illustrate that the tariffs may last longer than most expect.
On the soft data, everything from consumer to business confidence is declining across the board. Consumers across all income groups are feeling the heat, with consumer sentiment declining even amongst those who earn 100k+/year. People are also worried about losing their jobs, holding a pessimistic view of the economy. Businesses don’t have it much better; CEOs are not any more confident than their consumer counterparts. To add insult to injury, US homebuilder traffic (buying/selling of US residential units) has been the slowest in years. Combine this with the fact that the US tourism industry (~10% of GDP) is in decline – the US is the only country expected to see a drop in international visitors in 2025.
Students aren’t faring any better in this economy. At the onset of COVID-19, students across the US enjoyed a moratorium on student loan repayments, allowing students to skip repaying their loans without negatively impacting their credit scores. It has now ended, with over 9 million students facing the mounting debt that they have accumulated over the years. There has been a huge spike in student loan delinquencies (loans that missed interest payments/principal payments). While this isn’t a huge issue in isolation, since students are some of the most vulnerable to economic shocks, it may become the canary in the coal mine for broader credit markets. While large corporations with robust balance sheets may be able to hide the impacts of a harsher economic regime with less difficulty, they are not less vulnerable to such changes. The broader implication of student loans defaulting is not just an issue in itself, but the billions of dollars of ABS tied to student loans will also take a significant hit. Since credit markets move in tandem (generally), the contagion could potentially spread to other credit-like assets, mortgages, auto loans, credit card receivables, etc. It then becomes a larger issue across credit markets, which may even lead to a rout in equity markets similar to what was observed in 2008.
Given all the uncertainty going on in the markets, capex spending is expected to be down, while inflation is expected to go up. These risks might send the US economy into a stagflation scenario, with runaway high inflation, along with high unemployment rates and low GDP growth. This may seem like a nightmarish outcome, but the consensus forecast is already projecting this to happen.
Capital markets were expected to be exuberant coming into 2025. An expected lax business environment spurred by President Trump’s proposed tax cuts was supposed to be a boon for IPO, M&A, and loan issuance activity. However, the policy uncertainty associated with the tariff regime cut deeply into the confidence of corporate management. While IPO transactions have stayed relatively strong, loan issuances and M&A activity have been quite underwhelming. This can be explained through the macro lens: with the uncertainty in interest rates based on the current economic data, businesses are less likely to borrow money today, if it means that they can wait until rate cuts happen later in the year (if it’s possible to wait until then). Similarly, with all the uncertainty surrounding trade policy, companies are hesitant to acquire new businesses – especially those that are subject to supply chain shocks. Exceptional businesses will continue to be purchased and sold regardless of the macro environment, but those are far and few between and do not comprise the bulk of M&A deals. As a result, the US IPO market has stayed relatively strong while the loan and M&A markets saw a drastic decline in activity.
The recent passage of the OBBBA adds further complications. An analysis performed by the non-partisan Congressional Budget Office estimates that the legislation will add $5 trillion to the US national debt over the next decade. This bill risks increasing the already burdensome existing deficit and further straining the country’s debt-to-GDP ratio. Currently, the US debt-to-GDP ratio is roughly 100%. Under the OBBBA, this ratio will rise to 130% by 2034. The fiscal problems we face at that point will be even more challenging than they already are today.
Finally, what does this all mean for investors going forward? If stagflation is the expectation of the short-term economy, then there are a couple of key factors we should consider in our investment process.
- Quality matters – during periods of recession, there will be a flight to quality. High-quality assets, such as equities of exceptional businesses with robust balance sheets, or safe-haven assets such as US treasuries or gold, will outperform.
- Sectors less affected by tariffs/macro – Telecom, Healthcare, Utilities, Tech, and Business Services are all sectors that are less affected by the macro environment. These might prove to be helpful if the recession lasts longer than expected.
- Other compelling investment themes – infrastructure, data centers, energy transition investments are all thematic trends that are disassociated with the current trade war. They may prove to be interesting and lucrative opportunities worth looking into.
While it is difficult to predict the macro environment ahead, it is important to understand the impact of today’s policy on tomorrow’s profits. However, volatility produces opportunity, and it requires investors to position themselves accordingly to effectively capture the dislocations when they eventually appear.
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