CONTRIBUTORS
Sonal Desai, Ph.D.
Chief Investment Officer,
Portfolio Manager
It’s been a full three months since US President Trump’s “Liberation Day” tariff announcements sparked panic in financial markets, triggering a sudden plunge in equity valuations and a sharp rise in the recession probabilities printed by many economic models.
The aftermath so far has been remarkably benign—which, sadly, might now have encouraged Trump to double down on his threats.
Economic activity has kept humming along at a healthy pace. Looking through the volatility of import numbers, activity data have proved resilient. Household consumption has held up well, and the labor market remains tight. Job creation, with the nonfarm payrolls of 150,000 in June, is more than enough to maintain full employment, especially as a tighter immigration policy now restricts labor supply growth.
Domestic Demand Has Proved Resilient
2011–2025
Sources: BEA, Redbook Research Inc., US Treasury, Macrobond. Analysis by Franklin Templeton Fixed Income Research. As of July 9, 2025.
Corporate America has so far reacted to policy uncertainty with caution but not panic. Sentiment surveys remain subdued, but we have not seen the retrenchment and extensive layoffs that many feared. At this pace, I expect US gross domestic product (GDP) growth could comfortably exceed 2.0% for the full year 2025.
This is partly because, despite the customary media hype, US economic policymaking has delivered a fairly balanced mix of ugly, bad—and good. The recent passage of the Big Beautiful Bill has brought much-needed clarity to the fiscal outlook. While the budget deal entrenches sizable fiscal deficits for the coming years, the resulting fiscal outlook is not as loose as in the market’s worst fears. In fact, additional tariff revenue could well bring fiscal deficits somewhat below the levels estimated by the Congressional Budget Office.
Fiscal policy remains much too loose, but that’s neither news (the deficit averaged 6% of GDP over 2022-2024) nor unexpected. And the decision to make permanent the lower tax rates of the 2017 Tax Cuts and Jobs Act avoids what would have otherwise been a massive tax increase and validates hopes for a pro-business stance in this administration.
On the trade front, the fact that Treasury Secretary Bessent appears to have taken the leading role in negotiations temporarily reassured markets that we might be heading toward a set of sensible trade agreements, with tariffs settling at levels that would not completely disrupt global commerce and economic growth. This contributed to a more constructive tone in US equity markets, which as of last week had recovered their prior losses to reach new record valuations.
The resilience—and patience—of corporate executives and financial investors is now being tested again by a new series of social media pronouncements from the White House. This week marks the expiration of the grace period originally set by Trump after his Liberation Day announcements. Since almost no deals have been reached yet, he has extended the negotiation window to August 1, while at the same time unleashing a new volley of threatening letters to trading partners, renewing the prospect of double-digit levies (25% on Japan and South Korea, for example, which is added on top of tariffs on specific sectors such as steel). And, of course, pledging that there will be no further extensions beyond August 1.
Equities weakened on the news, but it was a moderate drop, not a panic. The novelty of these tariff threats is wearing off. Markets tend not to remain in a state of panic for long, at least not without increasingly intense fodder for fear. It’s human nature.
On the face of it, this should be good news for the macro outlook. To the extent that corporate leaders and financial investors have taken the measure of policy uncertainty and learned to discount some of the hype in White House announcements and the subsequent media coverage, there is a strong chance that growth will remain on an even keel. The fact that low tax rates have been made permanent should support both business and consumer confidence; and the budget deal provides additional fiscal stimulus in the short term, which should also lift GDP growth. And the global rhetoric about the US dollar and US assets losing their global leadership role has faded—as I have argued in previous articles, this leadership was never really in question.
Against this background, the risk is that Trump might feel emboldened to take more extreme and disruptive actions. So far, economic developments appear to have vindicated his moves: Tariff revenue has increased significantly without lifting inflation, and the economy has continued expanding at a steady pace. But this is because corporates and markets have come to terms with the prospect of tariffs around 10% across the board—which, as I wrote in a previous On My Mind, would be equivalent to a relatively modest 2% sales tax on all goods and services. Should trade negotiations break down, and the administration impose tariffs of 25% or more on major trading partners, the impact on the economy and markets would likely be far less benign, I believe.
My baseline scenario is that the White House understands this—but there is a huge element of uncertainty here.
Tariff Revenue Collections Have Soared in the First Five Months
2012–2025
Sources: BEA, Redbook Research Inc., US Treasury, Macrobond. Analysis by Franklin Templeton Fixed Income Research. As of July 9, 2025.
For the time being, therefore, I am also sticking to my Federal Reserve (Fed) forecast: Given what we’re seeing on activity and inflation, I don’t see the need for any further rate cuts, but the Fed could still see scope for one more cut of 25-basis points. And with resilient growth and large fiscal deficits keeping pressure on yields, I still expect 10-year US Treasuries to end the year in a 4.50%‒5.00% range.
Trump has stepped up the pressure on the Fed and investors have begun to anticipate that when Fed Chair Jerome Powell’s term expires next May, he might be replaced by someone more willing to heed the President’s call for lower rates. A more dovish Fed might well cut rates beyond my current forecast in the second half of next year. In that scenario, however, I would expect the yield curve to steepen, with 10-year bond yields still above 4.50%—assuming we do not enter a recession scenario.
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