Markets ended Q2 close to or above where they began – and were still climbing as the quarter closed – despite a series of extraordinary economic and geopolitical events.
Have investors become inured to policy and political shocks which came thick and fast in Q2? Or were fundamental strengths buoying equity markets in the US and some other major markets?
Fears of a sharp increase in prices and a possible recession flared at the start of the second quarter, with President Trump’s “Liberation Day” announcement of unexpectedly high tariffs on all trading partners. By the end of the quarter, after successive retreats from the highest tariffs, equity markets had recovered – globally and in the US. But for the US, there was a twist. Interest rates are still high, notably at the long-end. And the dollar has dropped sharply.
Against this backdrop, RockCreek sees three key themes going into Q3:
Dollar weakness and international diversification.
Dollar weakness – after dropping 10% in the first half of 2025, will the dollar stabilize? A fundamental shift in investor views of the dollar was evident in April. Risk-off sentiment caused the dollar to fall, in contrast to the traditional pattern of a flight to safety. That phenomenon was evident again in mid-July. The dollar dropped in the brief period when markets feared that the Federal Reserve Chair was about to be fired. Evidence of US economic resilience has helped to stabilize the currency at around $1.17 to the Euro. But a strong rebound remains unlikely. Other developed markets, long seen as undervalued but also unattractive, are coming into their own. It is more likely given the potential for a more political Fed and the other economic shifts in the US for the dollar to continue weakening relative to the Euro, Yen, Swiss Franc and for gold to continue strengthening.
Interest rate moves as pressure builds on Fed Chair Jerome Powell
Interest rates – other major central banks have cut rates in 2025; when will the Fed follow? Obviously, economic dynamics in Europe, Japan and many emerging markets differ from the US. The Federal Reserve has held off cutting policy rates this year. It is unlikely to move until the end of Q3, in September. Louder calls from President Trump for an earlier cut will not move Chair Jerome Powell, even if he faces a split in the July meeting. There was an unusual public pushback from two Fed governors appointed by President Trump to Powell’s June message of continued “wait and see”. But the inflation data is not good enough, and the labor market data not bad enough, to justify moving.
Tariff and trade uncertainty
Tariffs – how will they impact the US and global economy? In Q2, the few signs of an impact from higher tariffs on prices and growth were smaller than economists expected. The White House has now pushed to August the deadline to reimpose the high “Liberation Day” April 2 tariffs. Markets expect further changes that will temper the impact on the economy. But even without further increases, the current effective tariff rate, estimated at 12-15% across all imports, is far higher than the 2-3% average of the past 50 years. That represents a tax increase on Americans likely to be felt in the second half of 2025.