Key points

• The economic horizon has brightened after markets endured a wild ride following US tariff announcements.

• A volatility whiplash ceded attention to deficits and US government bonds.

• The economic outlook was buoyed by tariff reprieves and trade deals.

Market views: Volatility whiplash cedes attention to deficits and US Treasuries

In the early months of the year, we witnessed market and economic upheaval, especially in US equity and bond markets.

In an unlikely sequence of events, markets have just endured a dramatic rollercoaster ride; a sharp spike in volatility and a market sell-off, followed by an equally swift return to relative calm. 

Tariff announcements created a risk-off environment

Market volatility surged in early April after the US tariff announcements of 2 April. Markets reacted to three key concerns: the prospect of stagflation (potential recession and inflation at the same time), the threat of major global trade disruptions and a perceived willingness among US policymakers to tolerate short-term economic and market pain.

US equities, as measured by the S&P 500 Index, fell sharply, with highly valued “Magnificent 7” stocks and cyclical sectors (consumer discretionary and industrials) leading the decline. By contrast, defensive sectors, such as consumer staples, utilities and health care, held up better.

Mirror images: Stock prices and near-term expected market volatility

The levels of the S&P 500 Index and the CBOE Volatility Index (VIX)

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Notes: The chart reflects daily market data from 31 December 2024, through to 30 April 2025. The CBOE Volatility Index or VIX (see the right-hand side of the chart) is a proxy for the expected magnitude of US stock market price changes over the next 30 days. It is based on the prices of derivative contracts tied to expected increases and decreases in the S&P 500 Index (see the left-hand side of the chart). 

Source: Bloomberg.

While similar dynamics occurred in the corporate bond market, credit-spread widening was more measured. Spread widening was more acute for cyclical issuers and lower-quality bonds. In general, higher-quality corporate bonds outperformed. 

Starting on 9 April, sentiment began to shift dramatically following the US announcement that it would pause the bulk of its tariffs for 90 days. With the immediate downside risk receding, markets staged a robust recovery. Over the following month, this recovery was bolstered by IT and communication services companies reporting earnings growth ahead of market expectations and a notable tariff de-escalation between the US and China was on 12 May. Equities rebounded, led by high-beta and growth stocks, with credit spreads tightening to the historically low levels observed in late March.

What hasn’t changed - and what has

So where does that leave us? Two things stand out: First, the pricing of risk assets has not changed much. We have two sides of the same coin showing up in the equity and corporate bond markets. The US equity market, particularly, is supporting a historically high price-to-earnings ratio (21 times expected earnings for the next 12 months) on the strength of large US firms’ consistent earnings growth and their ability to expand profit margins. Meanwhile, corporate bond yields are highly attractive to many investors due to the current high risk-free rate, with historically low credit spreads supported by healthy corporate fundamentals. When it comes to pricing risk, the tension between strongcorporate fundamentals and historically rich valuations continues.

Second, two markets have not returned to their pre-April state: the yield curve for US Treasuries is higher and steeper, while the US dollar remains weaker. With the fog around tariff policymaking slowly lifting, attention is shifting towards the US fiscal outlook, with questions about the sustainability of its deficits. On 16 May, Moody’s became the last of the three major credit rating agencies to strip the US of its top credit rating. Markets took notice, sending the yield on the 30-year Treasury bond above the psychologically important 5% level. Increased scrutiny of fiscal sustainability, along with the impact of tariffs on the US economy, will likely remain a market focus in the months ahead.

Our economic outlooks: Tariff reprieves, trade deals brighten the economic horizon

United States

Positive trade developments with China have lowered our assessment of where the United States’ effective tariff rate on its trading partners will stand at year-end, to a range just above 10%. Although elevated compared with last year, it is significantly lower than our assessment of around 20% immediately after the broad US tariff announcement on 2 April.

We now expect GDP growth of around 1.5% this year or double our previous estimate.

We expect the pace of inflation to increase too, though not to the levels we had envisioned prior to the tariff truce.

The recent tariff developments should mitigate the severity of the challenges to the US Federal Reserve’s (Fed’s) dual mandate of ensuring price stability and supporting maximum sustainable employment. We continue to expect two quarter-point Fed rate cuts in the second half of the year.

United States economic forecasts

Euro area

Global trade developments have been positive for the euro area growth outlook. A US-China tariff truce boosts global growth prospects and eases financial conditions, while initial US agreements with the UK and China raise hopes for similar US-euro area progress. We have increased our 2025-euro area growth outlook to just above 1%.

We continue to foresee the deposit facility rate at 1.75% at year-end from its current 2.25%. 

Euro area economic forecasts

United Kingdom

An improved global outlook and greater-than-expected growth in the first quarter have led us to raise our forecast for full-year GDP growth to just above 1% from around 0.5%. Progress in US-UK and US-China trade relations underpin the more optimistic global view. We expect materially softer growth in the second quarter as an aftereffect of the frontloading and amid continued trade uncertainty.

Core inflation remains elevated, with little progress made on services inflation or wage growth in recent months. Expectations of further fiscal tightening and long-term inflation expectations that remain well anchored are likely to give the Bank of England (BoE) conviction that inflationary pressures will subside.

We continue to expect the BoE to cut the bank rate to 3.75% at year-end.

United Kingdom economic forecasts

Japan

The persistence of tariff challenges is likely to have a significant impact on Japanese exporters, leading to a more cautious approach by the Bank of Japan (BoJ) as it considers rate hikes.

Prices continue to rise, and a structural labour shortage has buoyed capital expenditures as firms seek to enhance productivity. The cycle is likely to strengthen, keeping core inflation above the BoJ’s 2% target throughout 2025.

We expect the BoJ to pause any rate hikes until the tariff situation stabilises. That said, the BoJ is likely to stick to its policy-normalisation cycle, given that domestic inflation momentum remains above target and wage-price dynamics are strengthening.

Japan economic forecasts

China

Positive US-China trade developments make us more optimistic about China’s growth prospects. We have increased our forecast for China’s 2025 economic growth to 4.6%. However, risks to the downside remain significant. 

We expect policymakers to adopt a more reactive stance to further stimulus. Such an approach is also reflected in our monetary policy view. We foresee China’s policy rate—the seven-day reverse repo rate—ending 2025 at 1.3%, higher than our previous forecast of 1.2%. We have lowered our forecast for headline inflation at year-end to just above zero as progress in trade talks eases pressure on prices of imported food. Our outlook for core inflation remains unchanged at 0.5%.

China economic forecasts

Asset-class return outlook

Vanguard has updated its 10-year annualised outlooks for broad asset class returns through the most recent running of the Vanguard Capital Markets Model® (VCMM), based on data as at 30 April 2025.

Our 10-year annualised nominal return projections, expressed for local investors in local currencies, are as follows¹.

¹ The figures are based on a 2-point range around the 50th percentile of the distribution of return outcomes for equities and a 1-point range around the 50th percentile for fixed income.