Shifting sands

The outlook for the US economy depends on how President Trump’s policy agenda plays out. Tariffs, taxes and interest rates will be closely watched by all.

A big policy shock

The tariffs announced by President Trump on “Liberation Day” sent financial markets into a tailspin in early April.

The peak in tariff uncertainty may have since passed, but the scale and scope of tariffs the United States will impose on its trading partners remains unclear.

The effective tariff rate on US imports is currently sitting at its highest level in almost 100 years.

Tariffs are likely to weigh on US businesses and consumers, putting a dent in American exceptionalism.

The One Big Beautiful Bill Act offers support to the US economy through front-loaded tax cuts and deferred cuts to government spending. This may offset some weakness caused by trade policy in late 2025 and 2026.

However, estimates by the independent Congressional Budget Office suggest this fiscal package could add US$3.3 trillion to the US deficit over the next decade. This would increase America’s total government debt to almost 130% of GDP.

Safe-haven status under pressure

Bond investors are dubious about the path taken by US officials and the potential for higher inflation. Treasury yields have increased and the US dollar has weakened.

Being the issuer of the world’s reserve currency usually affords the United States some flexibility. However, the US dollar isn’t behaving like a safe-haven asset in times of market stress.

This comes back to America’s economic and policy outlook, and implications for the US dollar’s role in global finance.

Although the US dollar is not behaving as history would suggest, it’s worth reminding ourselves of its importance.

56% of all global trade invoices are denominated in US dollars, which is well ahead of those expressed in the euro (30%) or Japanese yen (3%).

The US dollar also features in 87% of all foreign exchange trades.

Diversification into other currencies is happening, but 58% of all foreign currency reserves are still held in US dollars. Central banks build up reserves to provide liquidity during times of stress, and the market depth and liquidity of US assets remain unparalleled.

The US dollar is expected to remain under pressure due to both policy and market factors. However, its status as the world’s reserve currency will not change anytime soon.

We expect US economic growth to slow in the near term, but a recession to be narrowly
avoided. Lower immigration, larger fiscal deficits and higher inflation could challenge growth in the long run.

Rebalance America

Signs of fading US exceptionalism have led to “Sell America” headlines in the news.

However, investors have more likely been rebalancing their portfolios to address 0verallocation to US equities and take advantage of opportunities in other markets.

The US sharemarket staged a comeback in the second quarter, but investors must be mindful of elevated valuations.

A price-to-earnings ratio of 22x for the S&P 500 index is of some concern, as US companies may be impacted by weaker demand and higher costs due to tariffs.

Investors should balance these current headwinds with their long-run objectives.

The long-term prospects for US companies appear favourable. Many produce higher returns on equity and stronger earnings growth than businesses in other countries.

Furthermore, America’s technology companies are at the forefront of AI developments and seemingly have limitless potential. AI adoption is only at an early stage for many industries.

Diversification is your friend

The US sharemarket produced leading returns in three of the past four years (2021, 2023 and 2024).

Its exceptional performance may have led to overconcentration in US equities for many investors.

Other sharemarkets have fared better in 2025, as capital has flowed to regions where economic and political conditions are relatively stable and company valuations are
more attractive.

The Japanese, European and emerging markets are trading at reasonable valuation multiples
compared to both the US sharemarket and their own history.

In Europe, falling energy prices and a strong euro have allowed the European Central Bank
to proactively lower interest rates to spur economic growth. Furthermore, increased fiscal support is coming in the form of higher infrastructure and defence spending.

Perhaps more importantly, improved policy clarity and credibility are being valued by investors and supporting European shares.

This contrasts with the heightened uncertainty in America.

Corporate governance reforms are helping to transform companies in Japan and improve shareholder returns. We like the outlook for Japanese equities, although US tariffs remain a noteworthy risk.

A stronger yen may impact companies that rely on export revenues and benefit those leveraged to Japan’s domestic economy.

Diversification is your friend and especially during uncertain times.

Investors are likely to see better risk-adjusted returns by being well diversified across regions rather than having too much in US equities.

Although the rotation away from US equities and towards other sharemarkets has happened quickly this year, we think it can continue.

The implication is that investors with an overexposure to US shares can still benefit from rebalancing their portfolios.

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This is an excerpt of an article published in the latest edition of our flagship publication for clients only, News & Views. Craigs Investment Partners clients can view News & Views, including the full version of this article by logging in to the client portal.

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