Recession Fears Resurface as Tariff Uncertainty Lingers

While President Donald Trump repeatedly stated his global trade views on the campaign trail, the trade policy he ultimately implemented triggered an unexpected firestorm. The sweeping tariffs Trump announced in early April sent financial markets tumbling and upended global economic and inflation outlooks.

Still reeling from the initial tariff rollout, markets flipped course a week later, when Trump paused most reciprocal tariffs for 90 days. Others remained in place, including a steep 145% tax on goods from China and a blanket 10% import tax. By April 14, the average effective U.S. tariff rate was 22.8%, the highest level since 1938 and up from 2.5% in 2024.¹

Meanwhile, the nation’s gross domestic product (GDP) dropped at an annual rate of 0.3% in the first quarter. A surge in imports as businesses stocked up on goods ahead of the tariff announcements weighed on GDP. Despite healthy consumer and business spending, the first-quarter data presented a mixed bag and no clear economic path.

In our view, this unpredictable, highly volatile backdrop underscores the importance of maintaining a high-quality, well-diversified investment portfolio.

A Slowing Economy Is a Growing Probability

We believe economic pressures from tariffs, still-high interest rates and persistent above-target inflation will stall the U.S. economy over the next several months. For these reasons, we put the odds of a slowdown sharply higher than other possible economic scenarios.

• Slowdown/Recession: Although we continue to believe below-trend growth (flat to slightly positive) is a likely near-term outcome, we also think recession is a growing possibility. We remain concerned about mounting consumer headwinds, including rising auto loan and credit card delinquencies, and sagging consumer sentiment.

• Stagflation: The potential for higher inflation and weak economic growth has slipped back into our forecast. However, we think stagflation is much less likely than a slowdown or a recession.

• Growth Surprise: We believe the chance of growth surprising to the upside has decreased significantly in recent weeks. We gauge this scenario, including above-trend economic growth, above-target inflation and tight financial conditions, as less likely than stagflation.

What Would a Slowdown/Recession Scenario Mean for Investors?

As the economy slows, U.S. Treasury yields will likely fall. We also expect credit spreads to widen.

While inflation should slowly moderate, we still expect tariffs to create temporary price bumps in the road. Overall, we believe the slowing economy will outweigh temporary price hikes, prompting the Federal Reserve (Fed) to resume its easing program by mid-year. We estimate the Fed will cut rates three or four times by year-end.

What Would Stagflation Mean for Investors?

In our view, stagflation would push the 10-year Treasury yield higher amid significant volatility as slow growth and high inflation collide. We also believe the two-year Treasury yield could increase as the Fed maintains tight financial conditions. Meanwhile, credit spreads may widen amid weak economic growth, particularly in the high-yield sector.

What Would a Growth Surprise Mean for Investors?

If economic growth surprises to the upside, inflation would likely remain above the Fed’s target. A growth surprise scenario could keep financial conditions tight and trigger renewed Fed rate hikes.

Tariffs: Long-Term Goals vs. Short-Term Economic Effects

The Trump administration’s trade policy overhaul seeks three key longer-term goals:

• Seeking economic security by reducing the nation’s dependence on foreign goods and promoting domestic production.

• Establishing fair trade through policies that protect American industry and employees from unjust practices, including currency manipulation and bans on U.S. goods.

• Reducing taxes and paying down the nation’s record-high debt by generating revenue through tariffs.

While these goals seem reasonable, some economists remain skeptical that the plan for achieving them will work. And many worry about the broader implications, including reduced imports and retaliation from trading partners.

In our view, even a relatively low level of tariffs could flatten U.S. economic growth and inflate prices. We also believe other aspects of Trump’s policy agenda, including tax cuts and deregulation, may not be enough to counteract the recessionary effects of tariffs.

Given the scenario that’s unfolded so far, Trump may back off some tariffs. He could also strike deals with key trading partners to lower tariffs, secure free trade and relocate more manufacturing to the U.S.

Meanwhile, speculation, economic uncertainty and market volatility will likely persist as tariff negotiations continue. But we believe it’s still possible to get through this upheaval without a major trade war.

What a Stalling Economy May Mean for Portfolio Allocations

We believe maintaining a broadly diversified portfolio is a prudent policy as the economy slows or potentially contracts. In our experience, investors who maintain their long-term strategies may persevere as markets gyrate. However, we also believe specific investment characteristics deserve consideration in this environment.

For example, given mounting recession worries, we believe overweighting duration relative to market benchmarks may deliver advantages if interest rates fall and a flight to quality ensues. Additionally, select agency mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs) offer defensive characteristics and attractive yields.

Among stocks, rather than focusing on growth versus value, we generally favor quality, such as dividend-paying companies in defensive sectors (health care, utilities, consumer staples). Additionally, sustainable growth companies with stable earnings and strong competitive advantages will likely be more resilient to trade disruptions and tariffs.