Much has changed since our previous forecast round in late March. The U.S. administration announced an unexpected, steep rise in tariffs on April 2, 2025. Following the announcement and the aftermath, we are lowering our GDP growth forecasts. Global growth is 0.3 percentage points lower in 2025 and 2026 relative to our previous forecast round, and all regions are affected negatively.

Relative to our previous forecast round:

• U.S. GDP growth falls by about 60 basis points (bps) over 2025-2026, while Canada's and Mexico's GDP growth falls by a similar amount.
• Eurozone GDP growth is about 0.2 percentage points lower over the next two years, with Germany taking the biggest hit among the major economies.
• In Asia-Pacific's major economies, China sees growth drop by 0.7 percentage points in 2025-2026, while Japan and India see a reduction of 0.2-0.4 percentage points.
• In emerging markets (EM), more open Asia-Pacific economies (such as Malaysia, Vietnam, Thailand, and Singapore) see the biggest decline in GDP growth, falling by 0.5-1.0 percentage points per year.

U.S. Tariff Policy Continues To Shock The System

The announced higher tariffs on April 2 consisted of two parts: one fixed at 10% for all trading partners, and one variable. The variable part ranged from 0% to 50%. It was basically the U.S. trade deficit with a country divided by U.S. imports from that country (with a maximum value of 1 or 100%), times one-half.

The aftermath of this announcement was chaotic as trading partner responses varied. China took the hardest line, steadily escalating tariffs. After several quick rounds, the tariffs settled at 145% for the U.S. and 125% for China. Europe and Canada threatened retaliation but paused action after the U.S. put the reciprocal tariffs on hold for 90 days (excepting China).

Tariff actions appear to have settled for now. Nonetheless, the resulting level of U.S. tariffs has not been seen in over a century. We calculate that the April 2 actions and the subsequent fallout raised the U.S. effective tariff rate to about 24%. This surpasses the level of Smoot-Hawley tariffs reached in the late 1920s, widely considered to be a contributing factor to the Great Depression. U.S. effective tariffs are approaching the peak reached under the McKinley administration in the late 19th century (see chart 1).

Chart 1

Our best read is that U.S. tariff policy will fall into three buckets. China will be an individual case, reflecting the ongoing geopolitical rivalry, including long-standing tensions around the bilateral trade imbalance and "unfair competition."

Trade relations with the EU are likely to be complex and not necessarily limited to good trades. Measures could include lifting the suspension of its earlier retaliatory tariffs on U.S. steel and aluminum; targeting tariffs on politically sensitive U.S. exports such as jeans, motorcycles, and soybeans; and placing restrictions on intellectual property. The EU may later consider targeting U.S. services with non-tariff measures if negotiations fail. The U.S. administration rejected the EU's proposal of zero-for-zero tariff agreement.

Canada also looks to take a firm stance on trade talks with the U.S. following the recent mandate to the Liberal Party. We expect most remaining countries will try to negotiate a settlement rather than retaliate.

The Sharply Negative Market Reaction Has Somewhat Calmed

The initial market reaction to the April 2 tariffs was decidedly negative. Volatility, as measured by the VIX index, spiked to levels last seen in the 2007-2009 global financial crisis and the COVID-19 pandemic (see chart 2). The benchmark S&P 500 index fell sharply, recovered somewhat, but is still about 5% below the level of election day.

Chart 2

The U.S. dollar followed a similar pattern and has now returned all its gains from election day plus a few percentage points. Crude oil futures have fallen by $10 a barrel to about $60 over the same period, reflecting at least, in part, an expected drop in growth and therefore demand. Finally, yields on benchmark U.S. Treasury yields--which surprisingly rose following the tariff-induced volatility--have also now fallen below election-day levels.

Key markets have also de-risked as a result of recent U.S. tariff actions. Credit spreads have widened, particularly in the speculative-grade market, and parts of that market are currently closed to new issues. Also, financing for M&A and other deals has been paused, according to media reports. More generally, markets appear to be frozen as they await clarity on tariff policy. The price of gold is up by 25% year-to-date on safe-haven demand.

Chart 3

So far, the economic fallout from the tariff shock has been limited to drops in confidence indices and declines in nominal variables such as financial asset prices. It has yet to affect the real economy other than some front-running of imports to beat the tariffs. That may be starting to change as goods shipments from China have recently begun to decline.

The transmission to real variables could happen through several channels. Uncertainty could lower or pause intended investment, as would margin compression due to companies absorbing some of the costs of the tariffs. Uncertainty could also pause discretionary consumption as households worry about employment prospects. Higher import prices will lower U.S. purchasing power and crimp demand, and lower shipments to the U.S. from exporting countries will hurt their income and demand.

Wealth effects reflecting lower asset values could also constrain consumption. More directly, lower real wages from tariff-related inflation could crimp spending, as would lower employment or the prospect thereof.

We've Lowered Our Growth Forecasts Again

The April 2 tariffs and their aftermath have led us to lower our GDP growth forecasts relative to our latest credit conditions round in late March (see table 1). We reiterate that there are no winners in a scenario of escalating protectionist policies.

Our revised forecasts contain the following assumptions on tariffs:

• A 10% across-the-board tariff on imports from all U.S. trading partners as announced on April 2, but not the country-specific tariffs, which were paused for 90 days;
• A 25% U.S. import tariff on autos, steel, aluminum, pharmaceuticals, and semiconductors;
• Finally, the fully escalated tariffs between the U.S. (145% on Chinese imports) and China (125% on U.S. imports) are included, net of the carve-out for electronics imports into the U.S.

A note of caution about our latest revisions: we are in uncharted territory. Large-scale changes in tariffs have potentially non-linear effects on our forecasts. Estimates of the elasticity or sensitivity of key variables to tariff changes come with a warning sign. They are based on relatively small changes in tariffs and not the large changes implemented in recent months. We will continue to monitor developments and will provide forecast updates as needed.

Our revised numbers combine both direct and indirect effects of the tariffs. The direct effects comprise the size of the tariff and the exposure to the U.S. as a trading partner. The indirect effects comprise lower growth in all trading partners as well as the effects of confidence and uncertainty. In many cases, the indirect effects via the uncertainty channel are larger than the direct effects from the tariffs on profits and relative prices.

Table 1

Regional Macro Updates

This section provides further details on our regional macro updates. Other than for the U.S., we will not publish separate regional macro notes as part of this special credit conditions update. The detailed tables that usually appear in our macro updates appear in the Appendix below.

U.S.

We see the April 2 tariffs resulting in a faster decline in 2025 GDP growth compared with our previous forecast. Despite an improved base from the upward revision to the final quarter of 2024, we forecast U.S. GDP growth to fall to just 0.9% year on year in the final quarter of 2025. Domestic demand (GDP excluding net exports) is poised to expand at a sub-1% quarterly annualized pace the rest of the year.

Along this path, the U.S. economy would be flirting with a recession (two consecutive quarters of sequential negative growth). We calculate that the economy will lose about 60 bps of growth over the next two years compared with our March forecast, with roughly two-thirds of this coming in 2025. Core CPI inflation will jump to 4.0% at the end of 2025, with the U.S. Federal Reserve's preferred personal consumption expenditure (core PCE) inflation measure reaching 3.6%.

Regarding the Fed, we are forecasting 50 bps rate cut this year. We do not foresee a "Fed put" to bolster asset prices, but we do see the Fed being more cautious about upside inflation risks, given its experience with the post-pandemic inflation boom. Should the downside risks to growth materialize, the Fed will cut faster.

Eurozone

We have lowered our GDP growth forecasts for 2025 and 2026 by 0.2% each, due to harsher assumptions about U.S. tariffs and somewhat weaker foreign demand. Additional universal tariffs of 10% on European exports to the U.S., along with product-specific tariffs of 25% on steel, autos, and potentially pharmaceuticals, are estimated to reduce eurozone GDP by 0.4% cumulatively over the next two years through trade.

This will have an uneven impact across countries. France and Spain will be affected less than Germany and Italy, which are among the largest economies. We anticipate that robust German and European fiscal spending on infrastructure and defense will counteract the negative effects of U.S. tariffs and uncertainty. We anticipate eurozone growth will be above potential in 2027 and 2028.

Our revised baseline scenario incorporates lower inflation in 2025 and 2026 due to a stronger-than-expected appreciation of the euro and falling oil prices. However, we do not expect inflation to fall below the 2% target because fiscal stimulus will coincide with a tight labor market, which will support price pressures.

These updated growth and inflation projections have led us to adjust our outlook on monetary policy. We now expect the European Central Bank (ECB) to cut rates once more in June, followed by a pause until the end of 2026. If growth surpasses potential and labor market resilience persists, the ECB could raise rates again in the first half of 2027.

Asia-Pacific

Following the escalation of trade tariffs between the U.S. and China, and assuming for now these tariffs will stay, we lower our forecasts for China's GDP growth to 3.5% in 2025 and 3% in 2026, from 4.1% and 3.8% in the March baseline.

In response to U.S. tariffs of more than 100%, we expect a sharp decline in China's exports to the U.S. With exports to other countries also affected amid declining real world trade growth, we now expect overall export declines in China of more than 5% in 2025 and more than 6% in 2026.

We revise China's domestic demand growth down only moderately, as we anticipate policy support will offset a sizable portion of the spillover impact from the export plunge on investment and consumption. In this setting, and with the policy support likely to be quite domestically oriented, with limited positive spillover on imports, we expect imports to decline significantly. Still, we project imports to fall less than exports.

We foresee the external impact leading to further downward pressure on prices and even larger policy rate cuts. Still, we do not expect a lot of additional currency weakness, compared with the March credit conditions outlook, given the apparent repricing on financial markets vis-a-vis U.S. assets.

For the rest of Asia-Pacific, we view the external environment as worse than in the March forecast, with higher direct U.S. tariffs and weaker demand from China and elsewhere.

Emerging markets

The effects of tariffs on GDP growth are relatively low outside of Asia-Pacific. This is because most countries run a trade deficit with the U.S. and the April 2 tariffs were therefore 10%. The main exception for non-Asia growth effects is Mexico, given its close relations with the U.S., despite no new tariffs.

As with other country groups, in most EMs the direct effects of the tariffs had a larger effect on growth than the indirect effects, which include weak global demand and general uncertainty.

We see EM central banks cutting policy rates more aggressively than in our March forecast. Central banks in Latin America are likely to cut more aggressively given that their current policy rates are above neutral. The recent appreciation of EM currencies against the U.S. dollar leaves central banks with more scope to cut rates across the countries we cover. The combination of stronger EM currencies and lower oil prices will help decrease inflation in most EMs, given most of those economies are net importers of energy.

Risks: Still On The Downside

Our top macro risk in the next 12 months is that higher tariffs, uncertainty, and financial market turbulence will lead to a sharp contraction in the real economy, in the U.S. and elsewhere. So far, the negative effects have mostly manifested in soft variables (surveys and confidence indicators) and nominal variables.

For signs of real economy stress, we are watching the nexus of consumer spending and the labor market. As our readers know, resilience in this nexus has been a feature of the advanced economies since central banks started their sharp increase in policy interest rates in 2022.

For the U.S., our baseline remains a slowdown in growth, but we believe the risk of a U.S. recession has risen to 35%, with upside bias. A sharp slowdown in U.S. growth and demand would almost certainly spill over to other economies.

A related risk from the recent market turbulence is a liquidity or credit event. Extremely elevated uncertainty and volatility have led to a flight to quality, de-risking, and closure of some markets. As investors have moved toward low-risk and more liquid positions, financing has dried up or become more expensive (via higher spreads), especially in markets with lower credit quality.

This raises the specter of companies being unable to meet their financial obligations under adverse market conditions, including the inability to access funding markets. Margin calls are also likely for leveraged investors, given the decline in collateral values. Higher-for-longer volatility raises this particular risk.

Escalation to a full-fledged trade war across an increasing number of economies, including reciprocal tariff hikes and an extension to tariffs on services, would exacerbate the factors contributing to these risks. This will come into focus when the 90-day pause on tariffs expires in early July.

The Road From Here: Thinking About Future Trade Balances

Where do we go from here? The implementation of U.S. import tariffs--in full or in part--is unlikely to substantially narrow the U.S. trade balance. This is because the trade balance--or, more accurately, the current account balance, which includes not only goods but also services--is by definition determined by the difference between savings and investment.

It follows that the U.S. current account will only narrow to the extent that the savings-investment difference narrows. This requires some combination of lower investment (and slower growth) and higher savings (and less consumption). If the tariffs do not materially move the U.S. savings rate, then they will simply shift the trade balance between partners as exports minus imports remain unchanged.

It's also hard to see the U.S. tariffs causing a wholesale return or reshoring of U.S. manufacturing. Decades of trade driven largely by comparative advantage means that production is currently located where it is most cost-effective. Taking the case of Asian supply chains, the cost of production there is often only a fraction of the cost of producing the same product in the U.S. (or Europe); the currently proposed tariff rates are unlikely to close that gap. To put it another way, relocating a large swath of goods back to the U.S. would likely involve a substantial increase in costs.

Chart 4

Finally, we need to consider imbalances in a global context (see chart 4). Even if the U.S. is successful at narrowing its deficits, it cannot unilaterally adjust. Since we do not trade with anyone from outer space (yet), the global trade balance must equal zero. Same for the current account. So, if the U.S. manages to narrow its trade and current account imbalance by lowering or eliminating its deficit, someone must take the other side, likely meaning a smaller surplus.

Germany has recently begun to move in this direction, with planned increases in fiscal spending, but a global rebalancing story needs to be comprehensive. We leave a fuller discussion of the rebalancing debate for future work.

Appendix

Table 2

Table 3

Table 4

Table 5

Table 6

Table 7

Table 8

Table 9

Table 10