While we expect the tariff negotiations to remain fluid, our base case is that we now envision a steady state, with a 10% base rate across many countries, as well as flexible reciprocal tariffs and select sector-specific levies across autos, steel, semiconductors, pharmaceuticals, and critical minerals. All told, these considerations take our average aggregate tariff assumption up to 18% (with the severity of China’s tariffs pushing the average higher).
Our base case now has GDP growth in the U.S. running at 0.5-1.5%, compared to our quantitative GDP model of 2.9% (which does not include tariffs). DOGE likely drags down growth by 60 basis points, while tariffs reduce growth by 1.5-2.0%. As offsets to these headwinds, however, we do expect the Trump administration to push extremely hard on both tax reform and further deregulation in the near-term.
Importantly, with President Trump pursuing fiscal consolidation, the positive fiscal baton is now being handed from the U.S. to Europe and Asia. Specifically, as we detail below in Exhibit 6 , more fiscal stimulus in Germany and China is coming at a time when the U.S. — after being the lead spender immediately during and after COVID — is now embarking on fiscal tightening. For investors, this relative regional differential represents a notable reversal since 2020.
On trade negotiations, an approach that we think both executives and investors might reward with significant enthusiasm would be if the U.S. government signed a ‘deal’ with a like-minded country such as Japan. To review, Japan holds $1.1 trillion of U.S. debt, has similar national security preferences, and a consistent rule of law. The United Kingdom is the third largest holder of U.S. Treasuries, and it too has many of the same attributes as Japan. Separately, we also like the idea of reducing non-USMCA tariffs to 12.5% from 25% with Mexico and Canada, which we think would be well received by market participants and would help improve both future growth and inflation expectations.
In speaking with many CEOs and CIOs around the world, the biggest tension points are linked to the inability to quickly reconfigure supply chains, uncertainty around overall tariff policy (are tariffs a negotiating tool or revenue source and for how long?), and ongoing bond market/currency volatility (which makes it hard to determine one’s cost of capital). After fortifying supply chains following COVID, our engagement with the business community underscores the belief that they can handle most tariff scenarios if allowed time for proper planning. The same CEOs and CIOs also suggested that consistency of communication (akin to what we have seen from Secretary of the Treasury Scott Bessent) would help. Finally, there still remains a lot of CEO and CIO concern about a potential disorderly dollar or U.S. interest rate unwind, given a radically different view on U.S. exceptionalism/ cooperation from global investors following ‘Liberation Day.’
Markets are clearly trading at more attractive levels, and they are now pricing in a modest recession, we believe. However, positive price movements are also likely capped on the upside in the near-term. As we show below, Equities are likely pricing in low single digit EPS growth, while High Yield prices are suggesting defaults of around 3-4%, compared to 6-7% during the 2022 downturn. Interestingly, our Earnings Growth Lead Indicator (EGLI), compliments of lower global rates and lower oil prices, suggests positive, albeit quite mild, EPS growth during the next 12 months.
On the investing front, we believe that our Regime Change asset allocation framework, driven by larger fiscal deficits, heightened geopolitics, a messy energy transition, and sticky inflation, has become even more relevant under President Trump 2.0. See below for details, but we continue to think the traditional relationship between stocks and bonds is breaking down. If we are correct, then a different approach to asset allocation is warranted.
At KKR, we want to ‘make our own luck’ in this macro environment. As part of this mindset, we favor operational improvement stories, want to be higher up in the capital structure where we can, think prudently about leverage, and emphasize relative value in this market. As such, we favor European Credit, Capital Solutions, Asset-Based Finance, Infrastructure, control Private Equity, and certain parts of Real Estate, including Real Estate Credit.
We continue to feel quite positive about our key investment themes, including the Security of Everything, Productivity/Worker Retraining, Collateral-Based Cash Flows, Capital Heavy to Capital Light, and Intra-Asia Trade, which have only gained in significance since ‘Liberation Day.’
Acknowledgements
Miguel Montoya, Ezra Max, Brian Leung, Richard Bullock,
Bola Okunade, Asim Ali, Allen Liu, Rebecca Ramsey
