Q2 2025: equities triumph, despite tensions and tariffs

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• US equities roar back from early jitters – S&P 500 and NASDAQ hit record highs
• Weaker dollar and trade optimism help emerging markets and Asia outperform
• Bond markets hold firm, even as Moody’s downgrades US debt

Despite geopolitical tensions and tariff tremors, global markets delivered a surprisingly strong performance in the second quarter. From a tech-fuelled rebound in the US to standout gains in emerging markets, investors found reasons to stay optimistic. Meanwhile, central banks navigated a shifting inflation landscape, and bond markets held steady amid fiscal policy changes.

Among global equity markets, growth and smaller company stocks performed particularly well. The MSCI World Index powered ahead with a total return of 11.5%, measured in US dollars.

US stocks shake off the bears

US stocks began the quarter on somewhat shaky footing, as President Trump’s ‘Liberation Day’ trade tariffs sparked heightened investor uncertainty and recession fears. In April, the S&P 500 Index of blue-chip companies slid briefly into bear-market territory. However, news that the majority of the tariff increases would be delayed helped to arrest the decline.

In the second half of the quarter, US share prices staged a remarkable recovery with both the S&P and the tech-focused NASDAQ touching record closing highs at the end of June. The rebound was driven first by a reassuring corporate earnings season, then latterly by investor positivity surrounding trade talks and towards the technology sector. Meanwhile, shares in healthcare and energy companies languished.

The recovery came in spite of US strikes on nuclear sites in Iran – a response to increased hostilities between the latter and Israel. Equity investors were relatively unperturbed by these events, perhaps because there was no sustained increase in the oil price, with little disruption to supply and the Strait of Hormuz staying open.

Overall, the S&P 500 gained 10.9% in US dollar terms over the three months.

Muted gains for the UK and Europe

While shares in large UK companies ended the quarter higher, gains for UK equities were more muted than in other regions. The FTSE All-Share Index generated a return of 4.4% in sterling terms. At the sector level, healthcare and energy stocks disappointed. By contrast, utilities and real estate were among the best performers.

It was a similar story in the Eurozone, which had enjoyed strong returns in the first three months of 2025. The MSCI Europe ex UK Index gained just 3.7% in euro terms, although weakness in the US currency meant that dollar returns were much more impressive.

Asian and emerging markets shine

The fall in the US dollar against a basket of other currencies also boosted share prices in emerging markets and Asia Pacific over the quarter. The MSCI Emerging Markets and MSCI AC Asia ex-Japan indices returned 12% and 12.5% in dollar terms respectively. Meanwhile, Japan’s broad-based Topix Index returned 7.5% in yen terms for the April to June period. Towards the end of the quarter, optimism surrounding trade negotiations between the US and China helped to push many emerging market and Asian indices higher, although China lagged other countries, with disappointing economic data acting as a drag.

Ten-year yields hold steady, credit outperforms

The falling value of the dollar, along with fiscal policy and other events in the US were among the key areas of focus for investors in government bonds in the second quarter. Early in the period, Trump’s ‘Liberation Day’ tariffs sparked fears of global recession, although these quickly faded when it became clear that introduction of the new import taxes would be postponed.

Later, the passing of the Trump administration’s new tax-and-spend legislation – the ‘One Big Beautiful Bill’ – in the House of Representatives raised concerns about its effect on the fiscal deficit. This prompted Moody’s, the credit rating agency, to downgrade its rating for US government debt for the first time in more than a century. Moody’s new rating is ‘Aa1’, one notch below the previously perfect ‘AAA’, but aligned with the other major credit rating agencies.

Throughout the quarter, the US Federal Reserve (the Fed) chose to leave the federal funds target range unchanged between 4.25% and 4.5%. Fed Chair Jerome Powell remained concerned that higher consumer prices as a result of import tariffs could foster “meaningful” inflation in the months to come. Despite a spike in response to the debt sustainability concerns, the yield on the US ten-year Treasury was relatively unchanged over the quarter as a whole (bond yields and prices have an inverse relationship).

In the UK, the Bank of England (BoE) cut its Bank Rate by 0.25 percentage points to 4.25% in May, then held it there in June, as inflation stayed above its 2% target rate. Andrew Bailey, the Bank’s Governor, described the Bank Rate as being on a “gradual downward path”, but added that the world is currently “highly unpredictable”. He also noted that there were signs of softening in the UK labour market. The yield on the UK ten-year Gilt was little moved over the three months.

Turning to the Eurozone, the region’s central bank made two cuts to its deposit rate, which closed the quarter at 2%, while the Bank of Japan held steady. On the whole, steeper yield curves for government bond markets were evident, meaning longer-dated bonds cheapened in comparison to shorter maturities.

Corporate bonds did well over the quarter, with US high-yield among the top performers. The Bloomberg Global Aggregate Bond Index was up 4.9% over the three months/

Outlook

US: letters from America

Having pushed back the 9 July deadline for “reciprocal” tariffs to 1 August, President Trump began writing to a number of heads of state notifying them of the new tariff rates that would apply to their respective countries. Indicators show that if the rates announced so far were applied, they would raise the average US tariff rate by about 1.7 percentage points to 18.6%.

Higher tariff rates and the weaker US dollar present upside risks to inflation in the coming months, as they increase the likelihood that firms will pass on higher import costs to consumers. This poses a challenge for the Fed, which may need to maintain its cautious stance on monetary policy in the face of mounting pressure for rate cuts from the US President.

Market reaction to recent tariff-related announcements has been minimal, suggesting a certain level of scepticism about whether they’ll actually be imposed. Deadlines appear to be repeatedly pushed back, and are unlikely to be met if asset prices fall as a result.

UK: all eyes on the labour market

UK policymakers are also facing inflation-related challenges. In July, inflation reached 3.6% in the year to June, an 18-month high that was above economists’ predictions. However, most of the increase over the quarter came from expected sharp rises in regulated household energy and utility bills.

At the same time, there are signs of growing slack in the labour market. Coming in at 4.7% in the three months through May, the unemployment rate was higher than anticipated. This comes as labour-force participation continued to increase, helping labour supply, while job vacancies continued to decline. Meanwhile, private-sector wage growth is showing signs of slowing down, and barring a large increase next month, is still on track to undershoot the BoE’s estimate for Q2

The minutes from its last meeting in June (where its rate-setting committee voted to leave the Bank Rate unchanged at 4.25%) were relatively dovish in tone, emphasising these signs of loosening in the labour market. They also noted that underlying UK gross domestic product (GDP) growth is weak. Given this, our Policyholder Investment Office continue to expect a 25 basis-point cut to interest rates in August and an additional cut in November, followed by two further 25 basis-point reductions in the first half of next year.

Euro area: hoping for a trade deal

Higher tariffs remain the most notable uncertainty for European growth. President Trump's letter announced that a 30% tariff on EU goods will take effect on 1 August. While a trade agreement with the US is still possible, there is a prominent risk that the average tariff rate on EU goods settles above the current 10%. The market’s baseline tariff expectation appears close to the 10% level, which should have limited effect on profits and economic growth. A materially higher rate could therefore significantly alter the outlook, triggering a negative market response.

On the other hand, the case for higher future domestic demand has strengthened, as Germany unveiled its fiscal plans. In addition, the new NATO target of 5% of GDP defence spending will also contribute to higher domestic demand in other European countries, though not in the near term.

Emerging markets and Asia: navigating trade policy gyrations

US policy and political gyrations continue to create a high degree of macro uncertainty for emerging markets. Trade agreements are trickling in from the likes of Vietnam, Japan and the Philippines. Much uncertainty remains over reciprocal tariffs in China and Brazil, however. In addition, the Trump administration has raised the potential of applying secondary sanctions to countries importing oil from Russia if no Ukraine ceasefire agreement is reached by early September. These would affect major EM economies like China, India and Turkey.

In the background, the Chinese economy continues to face headwinds. Domestic demand is weak, fixed investment is falling below expectations and the property market continues to languish. Substantive future government stimulus is uncertain, leaving investors hoping for a comprehensive trade deal with the US.

Japan struck a deal with the US that lowered US reciprocal tariffs on Japan from a threatened 25% to 15%, as well as reducing auto tariffs for Japanese vehicles. While this reduces trade uncertainties, the political landscape remains fluid, as does the path for policy rates and the US dollar. Finally, Japanese exporters still face stiff competition from China for what looks to be a slowing US economic appetite.

The information in this article should not be regarded as financial advice and is based on our understanding in July 2025.

Money invested is at risk.