Global economic headwinds are intensifying as trade war fallout threatens worldwide growth, and the second half of 2025 will be defined by the themes of equity market leadership broadening beyond US mega-cap stocks, a bond market regime change favouring corporate credit over developed market sovereigns, and the need for active asset allocation strategies amid prolonged sub-par growth and elevated inflation, according to a recent report.

In the US, the economy faces downside risks to the growth outlook as rising input costs squeeze business margins, while tariffs on consumer goods will likely reduce real purchasing power, threatening the 70% of US gross domestic product driven by consumer spending, finds US-based asset manager T Rowe Price’s 2025 Mid-Year Investment Outlook for Asian Investors report.

As well, the US labour market has transitioned from exceptionally tight conditions to more balanced, the report highlights, providing less cushion against economic shocks than at any point in the post-pandemic period.

“The US administration’s tariffs – combined with retaliatory measures from trading partners – will deliver a supply shock to the US and a demand shock globally,” says Blerina Uruçi, chief US economist of T. Rowe Price. “Potential deregulation and fiscal measures, such as tax cuts, could also pose additional upside risks to both growth and inflation outlooks.

“[And] the Federal Reserve faces a difficult balancing act between inflation risks and supporting a weakening economy. This tension will likely persist through 2025.”

Equity markets continue to broaden

Market leadership continues broadening beyond US mega-cap concentration, the outlook notes, creating opportunities in value stocks and select emerging markets, including China, India, Argentina, Indonesia and Saudi Arabia.

European stocks are also likely to continue outperforming US markets this year.

“Tariff and trade tensions have accelerated the broadening of equity market opportunities both within the US and internationally,” states Rahul Ghosh, T. Rowe Price’s global equity portfolio specialist. “While this trend was already evident before last year’s US presidential election, recent actions by countries around the world to provide fiscal stimulus should provide ongoing momentum.

“We’re returning to an investing environment where more regions and sectors can generate meaningful returns, demanding diversification and favouring a flexible approach.”

Agnes Ng, T. Rowe Price’s equity portfolio specialist, adds: “[As] DeepSeek has highlighted China's advancements in artificial intelligence ( AI ), we anticipate that rapid technological progress will continue to accelerate in the coming years. While challenges in computing power persist, China remains well-positioned to leverage and commercialize AI technologies effectively.

“Concurrently, the Chinese consumer market is evolving, with emerging ‘new consumption patterns’ creating exciting opportunities in sectors like collectible brands, fresh beverages, snacks and music. This evolving consumer landscape signals a dynamic arena ripe for innovation and growth, offering investors compelling opportunities with low exposure to trade uncertainties.”

Fixed income to experience policy-driven regime change

German fiscal expansion and US tariff policies, the outlook points out, have ushered in a regime shift in global fixed income markets.

This transition, the report argues, is weakening the outlook for developed market sovereign bonds, as above-target inflation persists, while presenting opportunities in corporate credit and emerging markets.

In the near term, volatility is likely as markets adjust to this new environment.

The likelihood of a global recession – with the US leading the downturn – has increased. However, instead of a traditional recession, the world – especially in the US— may face a longer period of sub-par growth, marked by higher unemployment and inflation.

In this environment, corporate credit, the report suggests, becomes more attractive relative to sovereign bonds.

Corporate bonds are entering this cycle, the report points out, with significantly higher overall credit quality than in past downturns. Meanwhile, rising inflation is pushing sovereign bonds yields higher and eroding the value of developed market government debt.

“We are focused on diversifying into higher quality, resilient emerging market regions that are better positioned in trade, inflation and policy dynamics to mitigate risks from US currency and fiscal concerns,” shares Leonard Kwan, T. Rowe Price’s portfolio manager for dynamic emerging market bond strategy. “We favour a shorter-duration posture, which still offers attractive yields and income opportunities over spread compression.

“Maintaining liquidity and optionality will be key to navigating uncertainties from trade negotiations and tariff policies.”

Inflation protection, equity diversification to drive asset allocation

With tariff-driven inflation pressures likely preventing the Fed from cutting interest rates, T. Rowe Price’s asset allocation committee favours inflation-protected bonds and real assets to help offset inflation risk.

At the same time, the committee maintains an underweight position in longer-term US treasuries, which are more vulnerable in a higher-for-longer rate environment.

Although US equities have historically outperformed international stocks during economic downturns, the outlook states, the unique dynamics of this cycle have led the committee to favour non-US equities. 

“We remain cautious on equities, especially in the US, given extended valuations with better opportunities seen in European and emerging market equities due to competitive earnings prospects and potential fiscal boosts,” offers Thomas Poullaouec, T. Rowe Price's head of multi-asset solutions for Asia-Pacific. “We maintain underweight positions in bonds given upward pressure on US interest rates, but overweight higher yielding sectors given supportive fundamentals. Cash remains an overweight, as it provides attractive yields and liquidity amid expected market volatility.”