Transcript

<ul><li>Citi Research analyzes Europe's historic shift from an export-led growth model, driven by US tariff policies, towards one more reliant on domestic demand</li><li>Strategic significance lies in the fundamental challenge to Europe's mercantilist growth model, impacting inflation, real rates and financial markets, while compelling a shift towards domestic demand and advocating for continued ECB rate cuts</li><li>Listeners should anticipate continued ECB rate cuts and eventual long-term positive economic impacts for Europe from its rebalanced growth model, despite near-term headwinds and backloaded fiscal expansion</li></ul>

The U.S. tariffs are exerting an immediate impact on the financial markets, but they also have long-term consequences for economies — including a fundamental challenge to Europe’s longstanding export-led growth model. But as Chief European Economist Arnaud Marès argues in this episode, a shift toward domestic demand based growth had already been gaining momentum in the key economy of Germany. Join host Elise Badoy and Arnaud as they delve into the drivers and implications of Europe’s historic growth model shift. This podcast contains thematic content and is not intended to be investment research. Nor does it constitute financial, economic, legal, tax or accounting advice. This podcast is provided for information purposes only and does not constitute an offer or solicitation to purchase or sell any financial instruments. The contents of this podcast are not based on your individual circumstances and should not be relied upon as an assessment of suitability for you of a particular product, security, or transaction. The information in this podcast is based on generally available information and, although obtained from sources believed by Citi to be reliable, its accuracy and completeness are not guaranteed. Past performance is not a guarantee or indication of future results. This podcast may not be copied or distributed, in whole or in part, without the express written consent of Citi. © 2025 Citigroup Global Markets Inc. Member SIPC. All rights reserved. Citi and Citi and Arc Design are trademarks and service marks of Citigroup Inc. or its affiliates and are used and registered throughout the world.

Elise Badoy is a Managing Director and Head of Europe, UK, Middle East and Africa Research. Elise joined Citi in February 2010 and is a member of the Global Research Executive Committee. Prior to Citi, Elise worked at Goldman Sachs from 1999 to 2009, initially on the buy-side at GSAM and from 2001 in the Global Investment Research division covering the Consumer Staples sector. Prior to joining Goldman Sachs, she worked at Daiwa Securities in Equity Capital Markets and at ING Barings in Investment Banking. Elise was named in Financial News’ 100 Most Influential Women in European Finance 2018 and was a 2019 Women in Banking and Finance award for achievement finalist. Elise graduated from Ecole Superieure de Commerce de Paris (ESCP) and is a CFA Charterholder.

Elise Badoy, Head of Europe, UK, Middle East and Africa Research 

Arnaud Marès is a Managing Director and Citi's Chief European Economist. He is based in the London office and started with Citi Research in 2017. Arnaud served as Special Adviser to the President of the European Central Bank (ECB) from 2012 to 2017, and held various other positions in the private and public sector, including Head of Policy at the UK Debt Management Office from 2004 to 2007. Arnaud is a graduate from the Ecole Nationale de la Statistique et de l’Administration Economique (ENSAE) in Paris.

Arnaud Marès, Chief European Economist

The U.S. tariffs are exerting an immediate impact on the financial markets, but they also have long-term consequences for economies — including a fundamental challenge to Europe’s longstanding export-led growth model.&nbsp;&nbsp;

/rcs/citigpa/storage/public/Research_-_Citi_E29_final_transcript.pdf

E29: Europe’s Historic Growth Model Shift

<ul><li>U.S. tariffs are a stagflationary shock for the U.S., pushing up prices and constraining spending and real GDP, but an adverse demand shock for the rest of the world, depressing both real GDP and prices.</li><li>Downward pressures on U.S. growth could reach 1–2 pp over the next four quarters or so.</li><li>The tariffs pose a thorny policy challenge for the Fed, which is likely to “wait and see.”</li></ul>

In a new Citi Research note, a team led by Chief Economist Nathan Sheets explores key issues related to the White House’s raising of U.S. tariffs to historically high levels and the implications for U.S. and global economies through the year ahead.&nbsp;Since President Trump took office, the overall U.S. effective tariff rate has risen from roughly 2.5% to well over 20%. With further sectoral tariffs likely in the weeks ahead, we expect the tariff rate will likely peak at 25% or even higher. These are the highest tariffs faced by the U.S. economy since the early 1900s, larger even than the Smoot–Hawley tariffs of 1930. But they come at a time when the global economy is much more deeply integrated.There are few precedents to draw on in judging the likely effects of such policies. At best, they represent an ambitious effort to bring the U.S. increased benefits from its role as the world’s largest and most influential economy. But they also seem to threaten a range of unattractive lose-lose outcomes.<h2>Implications for growth and inflation</h2>One of our key findings is that the tariffs are a stagflationary shock for the U.S. They push up import prices and then pass through into higher prices for consumer goods and higher inflation. The tariffs act as a tax on spending, creating a corresponding drag on growth. For the rest of the world, tariffs are an adverse demand shock. They reduce demand for foreign products in the U.S., which puts downward pressure on both prices and real gross domestic product (GDP) abroad. Should other countries aggressively retaliate, the script is flipped, with a supply shock imposed on those countries’ economies and the U.S. experiencing a demand shock.We estimate that the tariffs could push up U.S. consumer price inflation by 1–2 percentage points (pp) over the next four quarters. Downward pressures on spending would be of similar magnitude, with U.S. growth roughly 2 pp lower over the next four quarters or so. We do note, however, that other estimates of the GDP effects yield assessments closer to 1 pp.We see a distinct risk that inflation could rise as high as 4% as the tariffs’ effects work their way through the economy. In tandem, we see plausible scenarios in which growth falls well below 1% and perhaps to zero. Even if the ultimate effects are less pronounced, this would create a challenging situation for Chair Powell and the Fed.For the rest of the world, our work suggests tariffs could push growth as much as 1 pp lower over the next four or five quarters. This would put global growth somewhere around 2%, down from nearly 3% in each of the last two years.<h2>Potential mitigating factors for the U.S. economy</h2>While tariffs will put upward pressure on U.S. prices and downward pressure on private spending, they are also likely to generate significant revenue for the U.S. government. A straight read-through of the tariffs suggests revenues could rise by $700 billion to $750 billion a year. But we suspect there’s likely to be significant slippage “from cup to lip.” Such slippages include:&nbsp;<ul style="list-style-type:disc;"><li>“layovers” in which exports from high-tariff jurisdictions go to low-tariff ones;</li><li>shifts in U.S. spending patterns to lower-tariff goods and toward services;</li><li>some production and sourcing moving to the U.S.;</li><li>increased government expenses needed for tariff implementation and enforcement; and</li><li>lower tax revenues due to the restraint on real GDP growth.&nbsp;</li></ul>&nbsp;The bottom line? We think net new annual revenues would likely be in the neighborhood of $500 billion, or 1.7% of GDP.A corresponding question is what the Trump administration would do with these revenues. Tax cuts are an option, and returning revenues to the income stream through tax cuts would offset the downward pressure on GDP. But this would also reinforce and exacerbate tariffs’ inflation effects, countering an adverse supply shock with a positive demand shock.We add a caveat: The effects of the tariffs should largely come online over the next four quarters, i.e. through the first quarter of 2026. But the effects of tax cuts may not be felt until much later this year or early in 2026, meaning the support to growth from tax cuts could meaningfully lag the downdrafts from tariffs.Another option would be to use these revenues to reduce the U.S. fiscal deficit. With the extension of President Trump’s 2017 tax cuts, we estimate deficits are likely to run in the ballpark of 6%–7% of GDP through the coming decade; tariff revenues could represent a significant down payment on deficit reduction. Markets would likely welcome such an action, which could be helpful in driving down longer-term Treasury yields.&nbsp;President Trump’s deregulation agenda is another important initiative that will likely provide support for the U.S. economy and help mitigate the drag from tariffs. We continue to expect a less restrictive regulatory stance for a range of sectors including energy, finance and healthcare, likely complemented by lighter-touch policies related to climate, labor relations and consumer protection. In the near term, deregulation is likely to bring increased output and help lower the costs of production, adding up to a positive supply shock for the economy. It’s reasonable to expect that tax cuts and deregulation together could lift U.S. GDP by roughly 0.5 pp and offset some of the drag from tariffs.We also note that in recent years the U.S. economy has shown notable resilience, with growth remaining near 3% and defying expectations that Fed rate hikes would push it into negative territory. The true upside scenario is that this resilience continues in the face of the tariffs, with pain spread in so many directions that no particular sector is unduly depressed. But this story could have been told more convincingly for a 10% tariff hike; with the actual increase much larger, there is a lot of pain that must be borne.<h2>Implications for central banks</h2>Central banks’ response will be a pivotal part of the story, but we note that as the central bank of the country imposing the tariffs, the Fed faces a thorny policy challenge, one that’s fundamentally different from those faced by central banks seeking to manage adverse demand shocks.<figure class="image image_resized" style="border-radius:10px;display:flex;overflow:hidden;width:fit-content;"><img style="aspect-ratio:1430/953;" src="/rcs/citigpa/storage/public/Research_Tariffs_Bank.jpg" width="1430" height="953"></figure>&nbsp;For the Fed, the upfront policy prescription is “wait and see.” The key question is which will dominate through the coming year: the negative GDP effects or the upside pressures on prices? Chair Powell recently noted that the Fed is currently in a good place: its policy stance is moderately restrictive, leaving the Fed well positioned should it need to counter inflation pressures, and it has significant dry powder to deploy should the economy weaken appreciably.In assessing inflation risks, the Fed will focus on several questions, including if longer-term inflation expectations are still well anchored and if tariff-related inflation is starting to bleed from goods into services inflation. With inflation still above target, we expect the Fed to take pains to protect its inflation-fighting credibility.On the growth side of its mandate, the Fed will be closely watching the labor market, though the inflation challenges create a high bar for cutting rates to provide support. The Fed would respond if the labor market started to crack, but that might require a couple of months of negative payroll prints alongside a rapid rise in the unemployment rate.Given the surprisingly large size of the U.S. tariffs, we see both the inflation risks and the growth risks facing the economy as first-order. For now, we lean more toward concerns about growth, noting the possibility that rising economic uncertainty could trigger a pause in spending and slower growth as households and firms also “wait and see.”The implications for monetary policy in the rest of the world look less complex. Countries are likely to face weaker export growth, which should put downward pressure on both their real GDP and inflation. The clear policy prescription in response is to cut rates more aggressively than had been envisioned; central-bank policy tools are well designed to manage demand shocks.To that we add an important caveat, however: The tariffs could bring appreciable downward pressures on exchange rates vs. the dollar. Developed-markets economies would generally be comfortable absorbing this, but some emerging-markets economies could fear the resulting pass-through to inflation or currency instabilities, possibly constraining their scope to cut rates.The bottom line is that central banks must be vigilant and prepared to act aggressively through this period of amplified economic uncertainty.<h2>Four open questions</h2>In analyzing U.S. tariff policies, four open questions stand out to us:<ol style="list-style-type:decimal;"><li>To what extent does the rest of the world retaliate? We anticipate responses from some countries but expect they’ll be far less than one-for-one, with most countries hesitant to put comparable tariffs on their own consumers and fearing escalation from the U.S.</li><li>How willing is President Trump to negotiate, and how quickly? While the president is clearly committed to his tariff agenda, he is also a dealmaker at heart, and has signaled willingness to engage in discussions.</li><li>How much economic and political pain is the White House willing to absorb? The baseline scenario we’ve described entails a significant disruption in U.S. economic activity, and tariffs have jolted markets. And unlike other recent major shocks, this episode has been entirely induced by Presidents Trump’s policy choices.</li><li>What is the eventual configuration of tariffs on Mexico and Canada? Those two countries represent nearly 30% of U.S. goods imports, making the landing zone with these economies important. Where these tariffs ultimately land will shed important light on the White House’s broader tariff strategy.</li></ol>

Our new report US Tariffs – How Wrenching for the Global Economy? is available in full to existing Citi Research clients <a href="https://www.citivelocity.com/t/eppublic/3kL4J" target="_blank">here</a>.

With U.S. tariffs raised to the highest level in more than a century, we consider their implications for the U.S. and global economies. Our analysis addresses the nature of the shock, potential effects on growth, and the challenge for U.S. monetary policy, while spotlighting key questions that remain unanswered.

U.S. Tariffs – How Wrenching for the Global Economy?

The global economy has shown impressive resilience in recent years but current risks appear significant, ranging from tariffs in the near-term to longer-term risks such as public debt, aging demographics and economic and geopolitical fragmentation. We wrestle with these competing viewpoints in a new Citi Research report.

The Great Bifurcation — Resilient Performance vs. Still-Menacing Risks

Research on the impact of tariffs on economies, industries and consumers.

Tariffs

<ul><li>Given the escalating trade conflict sparked by U.S. tariffs, we’re lowering our forecasts for euro-zone growth to 0.8% in 2025 and 0.6% in 2026.</li><li>We continue to expect tariffs to bring disinflation to Europe, and lower our HICP forecasts accordingly.</li><li>The trade conflict looms as the third “once in a lifetime” shock to hit Europe’s economy in fewer&nbsp;</li></ul>

In a new Citi Research note, a team led by European Economist Giada Giani looks at the potential impacts of the escalating trade conflict for the euro area, revising forecasts for growth and inflation and considering the risks to those forecasts.We note that the trade conflict sparked by U.S. tariffs marks the third “once in a lifetime” shock experienced by the European economy in fewer than five years. Having started to slowly normalize following the energy shock, Europe’s economy now faces the prospects of falling back into a recession, leading us to formalize our new euro-area forecasts and lay out potential policy responses.<h4>Global tariffs, global shocks</h4>Our working assumption is that tariffs will remain in place around the levels announced. Some €310 billion in euro-zone exports (excluding energy, pharmaceuticals and cars) are subject to 20% U.S. tariffs, while cars and car parts (€42 billion) are subject to a 25% tariff. Using a midrange estimate for trade elasticity of U.S. import demand, we estimate exports to the U.S. may drop by nearly 50%, implying a hit to total euro-zone exports, including services, of around 4.5 percentage points (pp). That would shave roughly 0.6 pp off gross domestic product (GDP).But we note that the global nature of tariffs means the global negative demand shock may well amplify this estimated impact. Other EU trading partners would experience similar negative demand shocks if not bigger ones, impacting their own demand for European goods and services. Moreover, a period of prolonged uncertainty most likely awaits as firms try to figure out their new operating environments. Combined with tighter monetary conditions, this suggests investment will be deferred, further weighing on GDP.Therefore, we’re scaling up our estimate of the negative GDP hit to around 1 pp. This negative impact is likely to show in the data starting with second-quarter GDP, and should last for five or six quarters. We’re lowering our 2025 growth forecast to 0.8% from 1.0% and our 2026 forecast to 0.6% from 1.3%. In this new scenario, sequential growth hovers around 0% for three quarters.&nbsp;<h4>Inflation and monetary policy</h4>We continue to expect U.S. tariffs will bring disinflation to Europe. Besides reduced demand for European exports, an expected oversupply of tariffed Asian products will likely hit European markets, adding to disinflationary pressures on goods. EU counter-tariffs are unlikely to compensate for this effect. In addition, the recent drop in energy prices and the appreciation of the euro further contribute to lower our inflation profile. All in all, we lower our Harmonised Index of Consumer Prices (HICP) forecasts for 2025, 2026 and 2027 to 2.1%, 1.6% and 1.8%, respectively.A new economic shock would bring responses from policymakers, but the fiscal space within national budgets is more limited than it was during the pandemic or the energy shock, which we think explains the reluctance to make big fiscal announcements that we’ve seen so far. Fiscal space has been created in Germany but may not be immediately available, as a new government must be sworn in and a new budget law passed. Other policy countermeasures could include positive supply-side measures such as deregulation. But we believe that given weaker confidence, such moves may not fully offset near-term headwinds.This leaves monetary policy, which we continue to think will not only continue easing in the near term but also have to eventually go all the way to expansionary territory. But this is more reactive than proactive, and can cushion the shock to growth but not offset it.

Our new report, Euro Area: Back on the Verge of a Recession, is available in full to existing Citi Research clients <a href="https://www.citivelocity.com/t/eppublic/3kTDI" target="_blank">here.</a>

The escalating trade conflict looms as a negative demand shock for euro-area exports and potentially an even bigger positive supply shock from trade redirection.&nbsp;

Euro Area: Back on the Verge of a Recession

<ul><li>The announced pause in reciprocal tariffs, excluding China, doesn’t mean the U.S. economy has avoided slower growth or higher inflation.</li><li>The pause lowers the average effective tariff rate, but by less than meets the eye.</li><li>We continue to expect 125 basis points of Fed policy rate cuts this year.</li></ul>

In a new Citi Research note, U.S. economists Andrew Hollenhorst and Veronica Clark warn that pausing reciprocal tariffs, excluding China, doesn’t mean the U.S. economy has avoided a slowdown in growth and a rise in inflation.Our analysis comes on the heels of the Trump administration’s announcement that recently unveiled reciprocal tariffs will be paused for 90 days, allowing countries time to negotiate with the U.S. This lowers the average effective tariff rate, but by less than meets the eye. That’s for several reasons:<ol style="list-style-type:decimal;"><li>The baseline 10% tariff is being maintained against all countries, and amounts to a substantial increase in many cases. For now, we also assume this 10% rate applies to the European Union. We also assume no change to tariffs faced by Canada and Mexico.</li><li>The U.S. is imposing new tariffs of 105% on Chinese goods, in addition to the 20% related to the border and fentanyl and a 10% effective rate prior to the Trump administration.</li><li>Sector-specific tariffs on autos, aluminum and steel remain in place, with new tariffs on pharmaceuticals and semiconductors expected.</li></ol>Our calculations show the average effective tariff rate rising 21 percentage points from its level at the beginning of 2025. It wouldn’t be surprising to see at least some of the China tariffs reduced, but that could be offset by higher sector-specific tariffs or reciprocal tariffs that come back into effect after 90 days.In short, to a first-order approximation the rise in effective tariff rates isn’t that much less than what we’d been forecasting.The growth dynamics of a 90-day pause are complex. U.S. households and firms sourcing goods from overseas will now try to complete these purchases as soon as possible to avoid potential tariffs. That could lead to a surge in imports which mechanically would drag on second-quarter growth. Some of that might be offset by stronger consumer spending in the second quarter, followed by a slowdown in the third. Uncertainty for businesses will remain high, which could mean an extended pause in hiring and investment. Planned price increases due to tariffs may also be delayed.In our base case, signs of a slowdown in growth in coming months will be clear enough to allow the Fed to cut rates by May or June, despite core inflation running above target. Fed officials will be willing to look through tariff-related inflation confined to goods and lean dovishly toward growth and employment. We aren’t making major changes to our macroeconomic forecast because of this latest news and continue to expect 125 basis points of Fed policy rate cuts this year.

Our new report, U.S. Economics: 90-Day Tariff Pause Not As Helpful As It Sounds, is available in full to existing Citi Research clients <a href="https://www.citivelocity.com/t/eppublic/3kXLY">here</a>.

Pausing reciprocal tariffs excluding China doesn't mean the U.S. economy has avoided slower growth and higher inflation, as the average U.S. effective tariff rate remains about 21 percentage points above its level at the start of 2025. Uncertainty will persist; we still expect a Fed cut in May or June.

U.S. Economics: 90-Day Tariff Pause Not as Helpful as it Sounds

KEY TAKEAWAYS<ul style="list-style-type:disc;"><li>Markets are looking for signs of progress in tariffs talks or evidence of a “Fed put.”</li><li>With U.S.–China tensions high, we look to the rest of the world to find possible candidates for a first tariff deal.</li><li>The EU could make use of its anti-coercion instrument (ACI) to gain leverage in negotiations with the U.S. &nbsp;</li></ul>

In a new Citi Research note, global macro strategist Giammarco Miani and team look at what may lie ahead for U.S. tariff negotiations. With the U.S. effective tariff rate still at historic levels, China negotiations remain key for markets, but we look elsewhere given how high U.S. –China tensions are. We think Japan and South Korea are the best candidates for a first tariff deal; reaching a deal with the European Union (EU) may prove tougher, with the EU’s anti-coercion instrument (ACI) possibly used as leverage in negotiations.Markets are looking for evidence of signs of progress in tariff talks or evidence of a “Fed put.” The White House’s 90-day pause on reciprocal tariffs for countries that didn’t retaliate against U.S. tariffs gave markets a sigh of relief, but continued escalation between the U.S. and China has markets looking to the U.S. and the rest of the world for hopeful signals, as well as signs that tariff levels are heading lower. As the U.S. bond market struggles to fully normalize, the White House may need to announce some wins on the tariff front.The other thing markets are looking for is evidence of some sort of Fed put — the belief that the Fed will react to a steep drop in stock prices by taking measures to support markets. A rate cut isn’t seen as the most likely such measure; instead, the Fed could issue an exemption for the Supplementary Leverage Ratio, which is a capital requirement for banks, or make Treasury purchases. We doubt the Fed will step in on purchases, as several Fed policymakers have noted that funding stress isn’t apparent. That makes tariff negotiations the more likely development.<h2>Who might make a deal?</h2>We think China is the key factor. Even with the 90-day pause, the U.S. effective tariff rate on goods has only dropped by 3% to a rise of 21% year to date. This is because of the huge U.S. trade deficit with China. We don’t have confidence about timing of U.S. –China negotiations, as tensions are high. But we do think a Fed put and/or progress on trade deals would cause U.S. Treasurys and global equities to rally sharply, given the “dash for cash” and stagflation fears that seem to have been driving the idiosyncratic weakness for both.Japan and South Korea look to us like the best candidates for a first deal. The two countries seem to have been among the first to reach out, and the White House has expressed optimism on this front.&nbsp;Negotiations with the EU could be tougher, with the ACI coming into play. The EU has leverage over U.S. services exports, particularly digital services. This could mean tariffs are eventually lowered from the initially announced 20%.&nbsp;&nbsp;<figure class="image image_resized" style="border-radius:10px;display:flex;overflow:hidden;width:fit-content;"><img style="aspect-ratio:1430/754;" src="/rcs/citigpa/storage/public/research_tariffs_UN.jpg" width="1430" height="754"></figure>

The ACI is a three-phase EU legal framework introduced in 2023 to provide a tool for the EU to respond to coercion when a third country tries to force the EU or a member state to change policies via unjustified trade measures and/or financial tools. In the first of the three phases, examination, the EU Commission investigates any third-country measure to determine whether it meets conditions for use of the ACI. If conditions are met, the next phase is dialogue and de-escalation, with a nonbinding three-month deadline for talks. Should those talks fail, the Commission drafts countermeasures, which must be approved by 55% of EU countries representing 65% of the EU population. Numerous countermeasures are available, giving the ACI (which has never been used) its reputation as a “trade bazooka.”

ACI Basics

In negotiating, the EU is likely to feel emboldened by the White House’s recent U-turn on tariffs following bond-market jitters. But this raises the question of whether conditions for using the ACI would be met.The question of coercion is a legal one, but we note that while tariffs have been imposed simply to close the U.S. trade deficit, there’s been an implicit ask from the White House to scrap the EU’s value-added tax and adjust tech regulation. As for whether countermeasures would find a majority, we note that all EU member states stand to lose out economically by simply accepting the tariff status quo; we think reaching the 65% threshold is doable.The White House’s recent U-turn and the tools at the EU’s disposal leave us leaning toward thinking we’ll eventually see a deal. While tariffs remain very high and could be reimposed, we think the U-turn signals the possibility of more room for negotiations, at least for the rest of the world apart from China. And while the ACI is unlikely to be used, it gives the EU significant leverage, and room for more favorable outcomes.Our new report, Global Macro Strategy: US tariff negotiations – what to watch next? Views &amp; Trades, also includes investment strategies offered in conjunction with our analysis. It’s available in full to existing Citi Research clients <a href="https://www.citivelocity.com/t/eppublic/3nYJm" target="_blank">here</a>.

Markets are looking for evidence of tariff talk and/or some sort of Fed put, but so far there's nothing concrete. We look beyond China to consider negotiation possibilities, from potentially quick deals to tougher cases.

U.S. Tariff Negotiations: What to Watch Next?

<ul><li>The pause on imposing higher-than-expected U.S. tariffs has brought some respite for global markets, but uncertainty remains.</li><li>For European countries, tariffs could accelerate a shift away from traditional, export-led growth to a model that places more emphasis on domestic demand.</li><li>The tariffs pose a significant threat to “Factory Asia,” particularly export-led economies heavily reliant on U.S. trade.</li></ul>

In a new Macro-to-Micro note from Citi Research, quantitative global macro strategist Alex Saunders and a team of analysts and economists look at the uncertainty that remains following the U.S. pause on higher-than-expected tariffs, exploring the economic implications of those tariffs and what may lie ahead. We addressed the U.S. economics implications <a href="https://www.citigroup.com/global/insights/us-economics-90-day-tariff-pause-not-as-helpful-as-it-sounds">in a previous article</a> and now highlight implications for the European Union (EU) and emerging markets.Regarding the EU, we find it useful to step back and try to identify whether the volatility of current events can have lasting consequences by itself, providing perspective for policy announcements.<h2>Economic impacts for the European Union</h2>In the case of Europe, we expect U.S. tariff announcements to have several interwoven consequences. We see a meaningful probability that European countries attempt to move away from their traditional, export-led growth model in favor of more emphasis on domestic demand. We see the growing debate about defense spending as providing the motive and opportunity for this rotation. But while we expect this to lift European nominal growth rates over time, our fear is that in the near term, it could contribute to downward pressure on activity through a tightening of financial conditions, which would compound other negative consequences of U.S. tariffs for Europe. This suggests a form of J-curve in which growth, inflation and interest rates must first come down before all rising again (and more) in a couple of years.&nbsp;Underlying this conclusion is our observation that the trade and current account surpluses of the euro area and economies in Asia may not have been entirely fortuitous but in part the consequence of policy choices. In recent decades a number of countries have shown a preference for generating trade and current account surpluses to improve their net external position and reduce perceived vulnerability to external funding. In doing so, they’ve generated downward pressure on inflation, because a trade surplus is by construction an excess of supply over domestic demand, and put downward pressure on real rates because a current account surplus is an excess of savings over domestic investment. &nbsp; To the extent that U.S. tariff policy is intended to rebalance global trade, it creates pressure to move away from policies that maintained this downward pressure. From this perspective, we think it’s correct to suggest that U.S. policy will likely push us away from the “lowflation” environment of the 2010s.It seems to us that this shift in the global economic order will accelerate a recognition in Europe that was already under way: that a growth model overly driven by exports wasn’t sustainable. We saw recent relatively generous wage settlements in Germany as an early sign that the political consensus was evolving toward greater emphasis on supporting domestic income.<h2>Stronger intra-Europe links?</h2>We also note that rising obstacles to European exports to the U.S. may strengthen links between European countries. While those countries favored export as a growth engine, they paid comparatively little attention to the economic performance of their peers. While committed to the political stability of the EU, Germany’s economic performance was arguably affected more by China’s economic performance than that of its neighbors. With China becoming more competitor to Germany than client, and the U.S. not a viable destination for net exports, it seems to us that Germany and other European countries will likely be more interested in refocusing policy toward boosting domestic demand, including via fiscal expansion. This is one reason we’re skeptical that the EU will escalate trade tensions with the U.S. or retaliate in a substantial way. The response is more likely to take the form of a shift in policy priorities.This rotation will likely be reinforced by Europe’s potential defense challenges, which would leave European countries with no choice but substantial fiscal investment to fill the gaps in the European defense system. This suggests to us that Europe could witness an acceleration of growth, but we think increased demand won’t materialize for a couple of years, as much of the investment must follow political decisions, leaving the impact of new pro-growth initiatives backloaded.On the other hand, the headwinds generated by U.S. tariffs and their consequences won’t be backloaded. Those consequences could include tighter financial conditions, a direct negative demand shock, an indirect uncertainty shock and the appreciation of the euro. All contribute to our downward revision of euro-area growth projections by 1 percentage point of GDP in 2025 and 2026. Those consequences should also contribute to bringing down inflation dynamics.Given the above, we think the European Central Bank will have to cut rates to try and cushion the shock, leading us to expect that J-shaped profile for growth, inflation and policy rates. We see all of them coming down in the near term, but as Europe is pushed further toward a more robust growth model emphasizing domestic demand over external demand, all should rise eventually. (Listen to our related podcast <a href="https://www.citigroup.com/global/insights/e29-europes-historic-growth-model-shift" target="_blank">here</a>.)<h2>A threat to emerging markets and “Factory Asia”</h2>The Trump administration’s April 2 tariff announcement hit China, the countries of “Factory Asia” and the associated supply chain network particularly hard. We estimated a “crisis-level” growth shock on Vietnam that’s three times larger than the growth shock to the U.S. and China, along with meaningful growth shocks for Thailand, South Korea, Taiwan, Malaysia and Singapore. Even with the 90-day pause and product exemptions, the broad-based 10% reciprocal tariff remains in place, the threat of tariffs being dialed up again post-pause still looms, and exemptions are still under review.&nbsp;We see the latest U.S. tariffs as a significant tax imposed on U.S. consumers and businesses; as the U.S. economy is hit by this “tax,” it will have ramifications for the emerging-markets economies most exposed to the U.S. market. We see Mexico as the most exposed to a sharp U.S. slowdown, followed by Vietnam, Cambodia, Thailand, Costa Rica, Malaysia and South Korea. Beyond direct exposure, the asymmetry of the tariff incidence by sector introduced by reciprocal tariffs, most dramatically in the case of China, adds further divergence in growth impact.<img class="image_resized" style="aspect-ratio:1430/954;border-radius:10px;width:95%;" src="/rcs/citigpa/storage/public/research_tariffrisk_Asia.jpg" width="1430" height="954"> Our analysis shows that while the initial hit to growth is largest in the U.S., over time the cumulative growth shock becomes larger for the more U.S.-trade-exposed emerging-markets economies of Vietnam, Mexico and South Korea, alongside China where tariff asymmetry is more extreme. Frontier African economies, Pakistan, Argentina, India, Romania, South Africa and Israel are relatively less affected.&nbsp;The CPI inflation impact of these tariffs up to 2026 is also expected to be asymmetric, with the U.S. likely facing a stagflationary shock, with CPI inflation about 0.9 percentage point higher than the baseline by 2025 but dissipating toward a disinflation path by 2026 as the slowdown advances. But our model sees a disinflationary shock vs. the baseline in emerging markets.We have started to make significant adjustments to our macro forecasts in Asia. We’ve noted a downside risk of 140 basis points (bps) to our Vietnam growth forecast this year and downgraded our Thailand GDP growth forecast by 80 bps, China by 50 bps, South Korea by 40 bps and India by 30 bps. We’ve increasingly front-loaded and added monetary easing calls across Asian central banks; over time we see the need to move policy rates below the neutral rate to buffer a potentially large external demand shock. Fiscal support from Asian governments will likely be extended, but probably with some delay after governments get a sense of the economic impact’s severity and assess how tariff negotiations are progressing.&nbsp;Our new report, Tariff Risk Rally: The Pause Is the Cause But Macro Risk Hasn’t Thawed, offers further economic analysis and recommendations for equities, FX, rates and commodities. It’s available in full to existing Citi Research clients <a href="https://www.citivelocity.com/t/eppublic/3nfhi" target="_blank">here</a>.

We explore the implications of now-paused U.S. tariffs for global trade and what may lie ahead, highlighting potential impacts on the European Union and the emerging markets that make up “Factory Asia.”

Tariff Risk Rally: The Pause is the Cause but Macro Risk Hasn’t Thawed

<ul><li>U.S. tariff rates’ rise to historically high levels is creating challenging headwinds for the global economy.</li><li>We are lowering our 2025 and 2026 forecasts for global growth, with the risks in our forecasts strongly skewed to the downside.</li><li>While the U.S. and China are in a full-blown trade war, most U.S. imports from Mexico and Canada continue to enjoy privileged market access. Elsewhere, trade partners are scrambling to strike deals with the White House.</li></ul>

In a new Global Economic Outlook &amp; Strategy report from Citi Research, a team of analysts and economists led by Chief Economist Nathan Sheets looks at the challenging headwinds for the global economy created by U.S. tariff rates’ rise to historically high levels. In the face of these headwinds, we see global growth softening to 2.1% this year, down from just under 3% in 2024. This forecast is 0.5 percentage point weaker than what we expected in March, with lower growth projections for a broad set of countries. We see 2026 global growth rebounding to just 2.3%, down 0.3 percentage point from our forecast in March. And the risks to our forecast are strongly skewed to the downside.Since President Trump took office, the U.S. effective tariff rate has surged from 2.5% to just under 25%, the highest level in more than a century. These tariffs come after decades of intense global integration and are likely to require a significant and potentially disruptive reprofiling of the global goods sectors, including broad patterns of sourcing and production. This gives us few precedents to draw on in judging the likely effects of these policies.Another complication is that the composition of the tariffs continues to evolve, with recent action from the White House including pausing reciprocal tariffs for 90 days, significantly hiking duties on China, exempting broad swathes of electronics and then clarifying that this exemption is only temporary. And the jury is still out on the White House’s willingness to negotiate down tariffs, or potential retaliation from U.S. trading partners.This has left markets to handicap two distinctly different types of uncertainty. The first is how a given configuration of tariffs will affect global trade and economic performance. The second is even more fundamental: What will the U.S. tariff policies ultimately look like? Stated bluntly, heightened policy uncertainties are greatly exacerbating the underlying economic uncertainties.&nbsp;This has left financial markets facing amplified pressures, with market moves arguably signaling reduced foreign appetite for U.S. assets. As the U.S. strikes a more aggressive economic posture vis-à-vis the rest of the world, it would be naïve to think this will have no effect on how attractively U.S. assets are perceived and how willing foreign investors are to hold these assets. The accompanying uncertainty about U.S. economic policies further amplifies these pressures. We think it’s too soon to conclude that foreign investors are poised to leave the U.S. in an appreciable and sustained way, but it’s an issue we’re watching closely.&nbsp;Some have argued that President Trump’s administration has already done permanent structural damage to the U.S. and global economic performance through its realignment of U.S. economic policies. We think it’s too early to reach such a judgment with any confidence, while noting that it’s clearly a risk. President Trump has only been in office for three months; for now, it behooves us to wait and see how his administration’s initiatives play through.&nbsp;<h2>Implications for global growth</h2>The global economy is increasingly feeling the effects of the tariff shock and its associated uncertainties. We see global growth as likely to slow, with the stepdown in developed markets especially pronounced and lower projections for countries including the U.S., euro area, Canada, Japan, China, Mexico, India and South Korea. We emphasize that our forecast is necessarily fluid as we respond to evolving news about the tariffs, but risks are clearly skewed to the downside.The U.S. has seen economic-sentiment measures continuing to retreat; though the “hard” data have held up comparatively well, we think the broader economy is likely to feel the pinch soon. That said, the ultimate slowdown in spending may still be a few months down the road. Consumers and firms are likely to bring their spending forward during the next few months to front-run the tariffs, but the second half of the year looks likely to be weak. As this softness becomes apparent, the White House may seek to accelerate its tax cuts and deregulatory efforts.<img style="border-radius:10px;" src="/rcs/v1/media/citigpa/akpublic/storage/retrieveMediaFile/6807a33c59d4ab32ab39a6c6.jpg" alt="image of a cargo ship in port">For the euro area, a more positive narrative that had taken hold during the first quarter has been largely squelched. These downward pressures were strikingly captured by the sharp drop in April’s expectations component of the German ZEW, a key sentiment gauge. We see euro-area growth over the next four quarters running just slightly above zero, down from a 1% projected pace in our March forecast.China is now embroiled in a full-blown trade war with the U.S., and its sizable exports to the U.S. are likely to contract sharply. With triple-digit tariff rates, only Chinese goods that are essential and can’t be sourced elsewhere will be competitive in U.S. markets. We’ve cut our forecast for Chinese growth this year to 4.2% from 4.7% and for next year to 4.4% from 4.8%. We do expect the Chinese authorities to dial up stimulus efforts, forestalling an even steeper decline in growth.How central banks respond is an important part of this story, with the U.S. Federal Reserve facing a fundamentally different policy challenge than other central banks. For more, we direct you to <a href="https://www.citigroup.com/global/insights/us-tariffs-how-wrenching-for-the-global-economy">our early April note</a>.<h2>How tariff effects might vary for trade partners</h2>With the recent shifts in the contours of U.S. tariffs, it’s helpful to think about U.S. trade policies across three distinct global corridors:<ul style="list-style-type:disc;"><li>U.S. trade with China (about 13% of goods imports), now in the throes of a full-blown trade war;</li><li>U.S. trade with Mexico and Canada (about 28% of U.S. imports); and</li><li>U.S. trade with the rest of the world, including Europe, Japan and emerging Asia.</li></ul>We consider these corridors one by one:U.S.–China Trade: The escalation in tariff rates between the U.S. and China has been breathtaking. Broad swathes of U.S. imports from China currently face a tariff of 145%, with the current carve-out for electronic goods promised to be swept up in forthcoming sectorial tariffs, which are likely to run at 25%.&nbsp;In response, China has raised its tariff rate on the U.S. to 125% and announced a global suspension of exports of rare-earth minerals to the auto, aerospace and defense manufacturing sectors, a move that looks particularly directed at the U.S.We note that with U.S. imports from China roughly three times as large as its exports ($440 billion vs. $140 billion), the U.S. market is clearly the principal theater for this confrontation. Tariffs of this magnitude are likely to be prohibitive, with China’s price competitiveness in U.S. markets greatly diminished or reversed. And we remain especially concerned about the implications of the tariffs for global production chains. Since the pandemic, many firms have diversified their supply chains away from China, but China remains a key source of inputs.We’re also struck by the rapid and apparently unpremeditated escalation in tariff rates. We don’t think either side anticipated or desired this outcome as recently as a month ago. This raises questions about the commitment to these policies; while we aren’t anticipating a near-term rapprochement, the table could be set for meaningful negotiations within the next year or so.U.S. Trade With Mexico and Canada: Imports compliant with the 2020 U.S.–Mexico–Canada Agreement (USMCA) remain entirely duty free, with most trade that isn’t USMCA-compliant facing 25% tariffs. To be USMCA-compliant, goods must meet “rules of origin” standards regarding their North American content. Clearly, a goal of the White House is to vigorously screen out re-exports from other countries, especially China.The share of U.S. imports that is and isn’t USMCA-compliant is an open issue; we envision that 85% to 90% of U.S. imports from Mexico and Canada will ultimately prove compliant, with the clear implication that broad swathes of trade within the USMCA corridor should continue to enjoy privileged access to the U.S. market.Could these tariffs rise further? We see reasons for cautious optimism, as there looks to be sufficient U.S. political support for USMCA that the White House will seek to renegotiate it rather than scrap it. But we see few concrete signals of what such a renegotiation process might look like.Given the full-blown trade war with China, Mexican firms appear to have a unique opportunity to expand their footprint as suppliers to the U.S. market. Relative to China, they offer attractive geographic proximity and cost competitiveness, as well as a more stable geopolitical setting, with Mexico’s President Sheinbaum proving effective in her interactions with President Trump. We see the stage as set for an upsurge in nearshoring activity.The Rest of the World: Many of the remaining U.S. trade partners are benefiting from the 90-day pause capping reciprocal tariffs at 10%, as well as the temporary exemption on electronics. As such, these countries are scrambling to strike deals with the U.S. to avoid a snapback in reciprocal tariffs. The White House has signaled increased openness to negotiations, but it’s unclear what concessions will be demanded and how quickly these negotiations could be completed.As a baseline, we expect some countries to strike deals over the next 90 days, potentially including Japan, South Korea and India. But we expect these agreements will hew to a minimum reciprocal tariff of 10%, and won’t offer exemptions to the sectoral tariffs. Over time, we expect other countries to reach similar deals. We also judge that most U.S. trading partners will be hesitant to pursue meaningful retaliation against the U.S., given the importance of U.S. markets and President Trump’s vigorous response to China’s retaliatory tariffs. Moreover, with the U.S. running a large goods deficit with many countries, the White House simply has more imports to tariff.That said, the U.S. trading partner we’re most concerned about is the European Union (EU). The EU broadly sees itself as a counterpart to the U.S. in terms of global size and stature, and European countries’ patience appears increasingly frayed. EU leaders may conclude that a muscular response is a better approach than meeting U.S. demands, and domestic politics may make it more difficult for the EU to make concessions.&nbsp;

Our new report, Global Economic Outlook &amp; Strategy: Global Headwinds From U.S. Tariffs, also includes country-by-country economic discussions and notes on investment strategy. It’s available in full to existing Citi Research clients <a href="https://www.citivelocity.com/t/eppublic/3ngc5">here</a>.

Global Economic Outlook & Strategy

Challenging headwinds for the global economy go beyond the direct effects of historically high U.S. tariff rates to include increased policy uncertainty and sharply declining sentiment. We explore these headwinds in a new Citi Research note and offer revised forecasts for global growth.

 Global Headwinds From U.S. Tariffs

<ul><li>We expect global growth of 2.3% in 2025, edging up to 2.4% in 2026. That’s below the 2.8% growth seen in 2024.</li><li>While the global economy has been resilient, we think U.S. tariffs’ effects are being felt only gradually and we’re in the “calm before the storm.”</li><li>The policy prescription for the U.S. Federal Reserve looks different from the likely course of action for other central banks. &nbsp;</li></ul>

In a new Global Economic Outlook &amp; Strategy report from Citi Research, a team of analysts and economists led by Chief Economist Nathan Sheets looks at how U.S. tariffs continue to leave an imprint on our forecast for the global economy. We now see global growth at 2.3% in 2025, down from 2.8% last year. Developed-markets economies are hit particularly hard, with growth falling to just above 1%; the slowdown for emerging markets is more limited. We see growth rebounding only anemically in 2026, edging up to 2.4%.But we also note that so far the global economy has absorbed the tariff uncertainties and shown continued resilience, with the pace of activity looking to have slowed by only a notch. Recent global data have generally matched or even exceeded expectations, and global Purchasing Managers Indexes (PMIs) have remained solid. Global equity markets are now well off their post-Liberation Day lows and moving back toward recent peaks.But part of this resilience reflects that U.S. tariffs are being phased in only gradually, with their full restraining effects not yet felt, and households and firms have spent earlier to get ahead of the tariffs. For households, this has meant increased consumption of autos and electronics; for firms this front-loading has shown up as accelerated accumulation of inventory.The upshot is that U.S. imports have soared, rising nearly 30% in March from October levels. Rather than restraining U.S. demand for foreign goods, the tariffs appear to have stimulated it, providing an important engine of support for the global economy in recent months.&nbsp;The implication, however, is that once the full effects of the tariffs are felt (likely over the next few months), spending could face a double blow: The tariffs should reduce real purchasing power, and those front-loaded purchases will need to be “paid back.”We see another encouraging development in the pragmatism shown by the White House in moving to implement the tariffs. Such steps include the 90-day pause on reciprocal tariffs, carve-outs for electronics, and an agreement with China to ease the trade war. The White House also looks poised to sign a broad set of trade deals before the pause on reciprocal tariffs expires in early July.Given these recent developments, we’ve marked up our global growth forecast; in aggregate, our projection for 2025 is up 0.2 percentage point (pp) from its April trough, with our 2026 projection up 0.1 pp. But we’re not inclined to upgrade the outlook more aggressively, as we’re likely still in the “calm before the storm.” We continue to expect a significant slowdown in second-half growth, and we remain concerned about downside risks.In this environment, global inflation has stayed on a downward trajectory. Headline inflation has now returned to 2%. Core inflation has also fallen, but is still running a bit higher than before the pandemic. Going forward, we expect global inflation to remain contained because of below-trend global growth, as well as our expectation that oil prices will remain flat and low. As the tariffs hit, inflation should notably rise in the U.S., but could move lower elsewhere.<h2>Tariff uncertainties</h2>In recent months the global economy and financial markets have felt the effects of two kinds of uncertainty: policy uncertainty due to the numerous zigs and zags in the implementation of tariffs, and economic uncertainty that’s also been elevated. Tariffs under the Trump administration are slated to be the most aggressive in decades, and come after many years of global integration, arguably leaving the global economy more sensitive to such shocks. As such, markets have also struggled with uncertainty about how a given set of tariffs will pass through into growth, inflation and other key economic variables.If there’s any good news, it’s that recent trade deals have seemingly diminished the level of policy uncertainty on tariffs. The White House appears to have pivoted into negotiation mode: In coming weeks we expect a truckload of further trade deals, with countries near the front of the line including Japan, South Korea, India, Saudi Arabia, Australia and potentially Vietnam. We see the U.S. seeking concessions from trading partners in five major buckets: (1) reduced tariffs on U.S. exports; (2) increased purchases of U.S.-produced goods; (3) exchange rate policies; (4) rules of origin and limiting re-exports from China; and (5) non-tariff barriers. We’re also awaiting announcements about sectoral tariffs on pharmaceuticals, electronics, copper and lumber.We now expect the U.S. tariff regime to broadly converge to 10% reciprocal tariffs and 25% sectoral tariffs, with an additional continuing penalty on Chinese goods. Currently this has taken the form of 20% fentanyl tariffs, but this could change over time. Finally, the United States–Mexico–Canada (USMCA) agreement is likely to remain a favored corridor for U.S. trade, with the lion’s share of imports entering with tariffs at or near zero.&nbsp;These assumptions imply an effective U.S. tariff rate of roughly 15%, compared with just 2.5% when President Trump took office in January. Such tariffs are likely to take 1 pp off the level of U.S. GDP during the coming four to six quarters, and would raise U.S. prices by a similar quantum. For the global economy, the GDP effects would be roughly half as large, at around 0.5 pp.<h2>Implications for central banks</h2>This discussion highlights an important observation: The tariffs are a different kind of shock in the U.S. from the rest of the world. For the U.S., the tariffs will likely be stagflationary, pushing up prices and constraining spending. But for the rest of the world, the tariffs will be an external demand shock, constraining exports; the result will likely be weaker growth and lower prices. Recent readings on the “input prices” component of manufacturing PMIs hint at this divergence: For the U.S., the measure has risen sharply in recent months, but it’s been flat or even declined slightly for the rest of the world.<figure class="image image_resized image-style-align-center" style="border-radius:10px;display:flex;overflow:hidden;width:fit-content;"><img style="aspect-ratio:1430/953;" src="/rcs/citigpa/storage/public/federal-reserve-washington-dc-united-states.jpg" width="1430" height="953"></figure> Accordingly, the policy prescription for the U.S. Federal Reserve is different from that for other central banks. For the Fed, the tariffs are pushing the economy away from both objectives of its dual mandate: Hike to fight inflation, or cut to support growth and employment?We see the Fed as likely to be patient and “wait and see.” Only after the economy slows will there be a good case for rate cuts. Such conditions should prevail by the fourth quarter, but under other scenarios (including our U.S. team’s baseline), it could happen even more rapidly.For other central banks, the prescription is clearer: The tariffs should prompt them to ease policy relative to their pre-tariff baselines. Central-bank tools are well designed to counter adverse demand shocks. To date, the European Central Bank has led the cutting parade with 175 basis points (bp) of cumulative cuts, and we expect another 75 bp in cuts this year. The Bank of England began an easing cycle earlier this month and we expect the pace of cuts to gain steam. Similarly, since the year began we’ve trimmed expectations for forthcoming rate hikes from the Bank of Japan and Brazil’s central bank.More broadly, there’s debate about why central banks other than the Fed aren’t moving more aggressively to cut rates. Even with the prevailing uncertainties, the direction of the shock for these economies is clear.Several factors appear to be in play. First, a natural response to the greater uncertainty is to “wait and see” where tariff rates ultimately land and get a better sense of the economic effects. Second, activity in many countries has remained relatively firm, and banks are hesitant to cut rates pre-emptively with the inflation shock of 2021 still fresh in mind. Third, while the dollar has fallen in the wake of the tariffs, some central banks no doubt worry that cuts could drive a weakening of their currencies, which could boost inflation. Fourth, some central banks have gauged their policies relative to the Fed’s, and may hesitate to begin easing while the Fed is still emphasizing patience. We expect that over time, these central banks will see the need to go their own way.

Our new report, Global Economic Outlook &amp; Strategy: The Global Imprint of U.S. Tariffs — Calm Before the Storm, also includes country-by-country economic discussions and notes on investment strategy. It’s available in full to existing Citi Research clients <a href="https://www.citivelocity.com/t/eppublic/3u7Sz" target="_blank">here</a>.

Global Economic Outlook & Strategy Report

We analyze how U.S. tariffs continue to leave an imprint on our forecast for the global economy.&nbsp;

The Global Imprint of U.S. Tariffs: Calm Before the Storm

<ul><li>The White House has announced a broader set of country-specific tariffs, with some higher than expected, such as the 39% tariff on imports from Switzerland.</li><li>We see announced tariffs as possibly resulting in a 4-percentage-point (pp) drag on 2025 MSCI AC World earnings growth.</li><li>Combined with signs of economic slowdown, the tariffs could raise questions about how sustainable continued near-term upside is for equity markets. &nbsp;</li></ul>

In a new report from Citi Research, a team of equity strategists led by David Groman explores the potential impacts of the Trump administration’s latest tariffs. We estimate that announced tariffs could result in a ~4 pp drag on global earnings growth this year vs. a pre-Liberation Day baseline, though impacts would vary among regions.In terms of equity market impacts, we note that Europe has seen the largest downgrades to earnings per share (EPS) growth among major regions so far this year. We’ve made the case that current European EPS growth forecasts of 1% for 2025 are consistent with U.S. tariffs of ~20%, meaning some upgrades are possible from here. Sector-specific tariff risks will vary.The 39% tariff imposed on Switzerland strikes us as surprisingly high, and could result in a 4 pp to 7 pp drag on 2025 EPS growth, with much depending on the final level of pharmaceutical tariffs. Healthcare makes up some 35% of MSCI Switzerland market cap and some 40% of earnings. But these risks are potentially offset by the announcements coming against the backdrop of a 5 pp cut to 2025 EPS forecasts since April, and market pricing for below-consensus 12-month forward EPS growth outcomes.We see the announced 15% tariff on imports from Japan as a positive development, especially the significantly reduced levy on autos. We think U.S. tariffs could be a 4 pp drag on Japan’s fiscal 2025 EPS growth, with some more positive offset likely from gross domestic product and foreign exchange assumptions.Substantial uncertainty remains around tariff rates for emerging markets, but we’ve estimated that U.S. tariffs could directly reduce MSCI emerging-markets EPS growth by 5 pp to 6 pp this year. With EPS growth forecasts only revised down modestly so far this year to 12%, more downgrades are possible from here.For the U.S., we see a 15%+ effective tariff rate as possibly driving a ~5% hit to S&amp;P 500 earnings, though the overall tariff impact should be manageable, and must be weighed against the broader backdrop of U.S. policy. Tariff impacts are more likely to be sector-specific, with potential risks to margins.Turning to market views, we remain overweight on the UK as the least tariff-exposed region and on continental Europe, where forecasts already embed the largest amount of tariff risks. We’re underweight on emerging markets, given relatively small EPS downgrades year-to-date despite lingering tariff risks. Within Europe, we’re underweight on Switzerland.&nbsp;The recent rally in global equities has left market pricing for EPS growth looking extended, especially in the U.S. Combined with signs of economic slowdown, tariffs could raise questions about the sustainability of continued near-term upside for equity markets. That said, our market targets still see upside to the middle of 2026. &nbsp;

Our new report, European Equity Strategy: Read-Through From Latest Tariff Announcements, is available in full to existing Citi Research clients <a href="https://www.citivelocity.com/rendition/eppublic/documentService/ZG9jX2lkPTMwMzU2Nzk0JnBsYXRmb3JtPTEwMCZ2ZW5kb3I9Q2l0aSBWZWxvY2l0eSZjaGFubmVsPUNvcHkgVVJMIExIUyZzdWItY2hhbm5lbD1JbnRlcm5hbA==">here.</a>

The Trump administration has announced a broader set of country-specific tariffs, with some levies higher than expected, such as the 39% tariff on Switzerland. Effective U.S. tariff rates look likely to rise above 15%, with lingering uncertainty around particular sectors. We estimate that announced tariffs could result in a 4-percentage-point drag on 2025 MSCI AC World earnings growth, implying additional downgrades and adding to questions about the sustainability of continued near-term equity market upside.

Global Equity Strategy: Read-Through From Latest Tariff Announcements

<ul><li>Citi Research expects global growth to slow to below 2% in the second half of the year before rebounding to nearly 3% in the first half of 2026. Upside and downside risks to this forecast are roughly balanced.</li><li>President Trump continues to aggressively implement tariffs. We judge that the effective tariff rate is likely to remain above 15%, the highest level in decades.</li><li>The cost of tariffs is being borne by three groups: foreign exporters, importing U.S. firms and U.S. consumers. So far U.S. firms have borne the lion’s share, apparently absorbing 60% to 70% of the cost.</li></ul>

In a new report from Citi Research, Chief Economist Nathan Sheets and a team of analysts and economists offer their expectations for global growth and consider the upside and downside risks to their forecast. They also look at the effects of U.S. tariffs and how these costs are being borne.The global economy has kept moving forward. During the year’s first half, growth slowed to around 2.5%, down from near 3% in 2024. But consumers and firms have absorbed tariff-related uncertainties surprisingly well, leaving our narratives for global inflation, monetary policy and markets broadly in place.For example, global purchasing managers’ indices (PMIs) have generally moved in line with what we saw last year, with services outperforming manufacturing. The services PMI retreated through the spring, but in recent months it’s bounced back to the favorable levels seen during last year’s second half. Meanwhile, the manufacturing PMI has remained around the 50 breakpoint between expansion and contraction.Similarly the Citi surprise index for the global economy has also performed well, with recent months’ readings running higher than in the second half of last year. While this doesn’t necessarily signal outright strength in the data, it does at least indicate that performance has surpassed expectations.So far, the effects of U.S. tariffs — and the associated challenges for the global economy — have mainly shown up in indicators of international trade. For example, the PMI for global export orders fell through the spring. This series has climbed back up more recently, but remains below the 50 breakpoints.Tariffs were expected to weigh on the global economy primarily by reducing U.S. demand for foreign products. But foreign exports have actually been strong relative to trend, as we saw a surge in U.S. imports in late 2024 and early 2025 due to U.S. households and firms looking to front-run the tariffs. So this mechanism of tariff transmission has been slow to emerge.During the first half of 2025, many countries saw their exports to the U.S. expand more rapidly than to the rest of the world. Notable exceptions were countries front and center in the Trump administration’s tariff initiatives: China, Canada, South Korea, Japan and Mexico. China has been hit particularly hard, with its first-half exports to the U.S. down more than 10% from a year earlier.In recent months, however, U.S. imports have retreated to levels at or even slightly below what we saw last year, with foreign exports moving down roughly in tandem. As such, the tariffs’ restraining effects are now starting to be felt. We anticipate that the tariffs will take a bite out of the real spending of households and firms through the second half of this year, and note that front-loaded purchases that were pulled forward will need to be paid back.As these effects play through, we see global growth slowing to below 2% in the second half before rebounding to nearly 3% in the first half of 2026. We judge that the risks to our forecast are roughly balanced. On the upside, the global economy has shown resilience over the past few years, and may shake off any further softening from the tariffs. On the downside, more powerful downdrafts from the tariffs may yet emerge. Even so, the likelihood of severe downside risks strikes us as diminishing with each passing month.<h1>How will U.S. tariffs’ effects be distributed?</h1>A key question is how the tariffs’ effects are likely to be distributed across key sectors, including foreign exporters, U.S. firms, and U.S. consumers.President Trump continues to aggressively implement tariffs. By our reckoning, currently announced tariffs imply an overall U.S. tariff rate of around 18%. We envision that the tariff rate could top 20% once further sectoral tariffs are fully implemented, including ones on pharmaceuticals and electronics. Additional trade deals may bring tariff rates down from these levels, but the scope of negotiations looks to have narrowed. We judge that the effective tariff rate is likely to remain above 15%, the highest level in decades.It's also clear that a sizable portion of these tariffs is already being collected. Tariff revenues have surged from $75 billion last year to an annual rate above $330 billion in July, corresponding to an ex post effective tariff rate of 11%. Given the revised reciprocal tariffs announced in July, as well as forthcoming sectoral tariffs, we expect that tariff revenues will keep rising through the coming months.The incidence of these tariffs is necessarily distributed across three groups: foreign exporters, importing U.S. firms, and U.S. consumers.Faced with rising U.S. tariffs, foreign exporters may choose to absorb the tariffs into their margins. This would manifest itself as a decline in U.S. import prices, as such prices are reported at the foreign dock before tariffs are assessed. So far, we see only limited evidence of such behavior; the level of U.S. import prices has been generally flat over the past couple of years.Considering disaggregated data for import price inflation in capital goods, autos and consumer goods, autos show the clearest signs that exporters are squeezing their prices, which fits with other reports indicating Japanese auto exporters, in particular, have cut their prices in response to the tariffs. Even so, the decline is small relative to the 25% tariff imposed by the U.S., as well as the run-up in import prices for autos since the pandemic.An alternative to foreign exporters is that U.S. consumers could bear the tariffs in the form of higher prices. Some evidence of this has emerged in recent months: Since February, U.S. core goods inflation has risen to 1.2%, with observed price increases particularly large for product categories such as audio equipment, window and floor coverings, furniture and bedding, and toys. In tandem, the number of goods subsectors experiencing large monthly price gains has risen.These data suggest a simple back-of-the-envelope estimate for the share of the tariffs being borne by consumers. With the collection of tariff revenues pointing to an ex post tariff rate of 11%, along with the fact that 30% to 40% of goods are imported, the recent rise in core goods inflation suggests consumers have borne roughly 30% to 40% of the cost of tariffs to date.Going forward, we see scope for core goods inflation to rise further as reciprocal and sectoral tariffs come online. And the U.S. corporate sector appears to be absorbing a large share of the tariffs, which may not prove sustainable.This points us to the margins of U.S. firms. To date, U.S. firms have borne the lion’s share of the tariffs, apparently absorbing 60% to 70% of the cost. Consistent with anecdotal reports, a number of factors have likely contributed to this outcome.First, with consumers still reeling from COVID-era price increases, the scope to pass along further price increases may be limited.Second, given uncertainties, firms may have preferred to hold their prices to see where tariffs ultimately land.Third, some goods have natural product cycles, which may entail seasonal (or even annual) price changes. For example, many apparel and leisure products are introduced and priced according to shifting seasonal needs.Fourth, and more broadly, firms may prefer to increase their prices gradually to maintain goodwill with customers, gauge the robustness of demand, and observe competitors’ responses.Even so, absorbing such a large share of the tariffs is likely unsustainable for the corporate sector as a longer-term strategy. As such, we expect U.S. firms will increasingly seek to shift the cost of tariffs to U.S. consumers and their foreign suppliers. That said, so far signs of pressure have been limited. While firms have pointed to tariffs as squeezing margins, the overall tone of earnings reports has been generally positive, and explicit measures of firms’ margins have remained solid.

Our new report, Global Economic Outlook &amp; Strategy: Tariffs Remain Front and Center, also includes a discussion of the path for the Fed and other central banks. It’s available in full to existing Citi Research clients <a href="https://www.citivelocity.com/t/eppublic/42asB" target="_blank">here.</a>

Consumers and firms have absorbed tariff pressures surprisingly well, and our narratives for global inflation, monetary policy and markets have remained broadly intact. In a new Citi Research note, Chief Economist Nathan Sheets and a team of analysts and economists offer their expectations for global growth and consider the risks to our forecast, which they see as roughly balanced. They also look at which groups appear to be bearing the cost of tariffs so far.

Tariffs Remain Front and Center

<ul><li>We expect global growth to slow below 2% in the second half of 2025 before rebounding to 2.5% in 2026.</li><li>We anticipate that tariffs will increasingly bite, driving prices higher, reducing real incomes and causing real spending to decline.</li><li>Despite that, we see the tariff-related divot in global economic activity as smaller and more short-lived than feared as 2025 began. &nbsp;</li></ul>

In a new report from Citi Research, Chief Economist Nathan Sheets and a team of analysts and economists outline their expectations for global growth. While noting the global economy’s surprising resilience, they warn that there’s another shoe still to drop: Tariffs are increasingly biting, which is likely to bring further softening in U.S. consumption and import demand.&nbsp;The economy cooled a notch during the year’s first half, as tariff-related uncertainty restrained spending, but activity held up better than expected. Growth looks to have run at 2.6% during the first half, compared with 2.8% last year, and monthly data such as the global services purchasing managers’ index (PMI) indicate this solid performance has continued into the third quarter.&nbsp;We see several factors behind this resilience. For one, the expectation of rising tariffs prompted U.S. households and firms to front-load purchases of imported goods, causing U.S. imports to run on average well above 2024 levels. And we note that over the last five years, the global economy has shaken off a series of shocks; global growth hasn’t been rapid, but it has been solid. Clearly, the global economy has shown remarkable flexibility and a capacity to adjust to even sizable economic shocks.But we continue to believe there’s another shoe to drop. The tariffs are increasingly biting: In August, monthly tariff collections reached $30 billion, or $360 billion annualized, up from $75 billion last year. We’re also seeing some notable effects on inflation: Since early this year, core goods prices in the Consumer Price Index (CPI) have accelerated by more than 1.5 percentage points, with large increases in a range of imported goods.We also expect significantly more inflation pass-through ahead. We estimate that to date, consumers have borne 30% to 40% of the cost of the tariffs, with the corporate sector absorbing the remainder. Firms aggressively accumulated inventory as part of the front-loading seen in the first half, giving themselves room to delay price increases. But that process is now likely playing through. We also hypothesize that firms have held off on price increases, awaiting visibility about where tariffs would ultimately land and harboring concerns about consumers’ willingness to absorb further price increases.Over time, we anticipate firms will find ways to shift the costs of the tariffs onto consumers. As this occurs, U.S. consumers are likely to pull back on spending. The first-half front-loading was moving expenditure from the future into the present; it presumably must be “paid back.” In addition, as tariffs drive prices higher, real incomes will be reduced and real spending should decline.Accordingly, we expect a softening of U.S. consumption and imports through the next couple of quarters, and note that recent U.S. labor-market weakening is broadly consistent with this view. In tandem, our forecast sees global growth slowing to below 2% in the second half of the year before bounding back to 2.5% next year. This tariff-related divot in global economy activity, while notable, is now smaller and more short-lived than we’d feared as 2025 began.U.S. tariffs are at their highest levels in decades, and we remain on a steep learning curve about the implications for economic performance. A major surprise is that the process of pass-through into price, and the accompanying restraint on spending, has been more prolonged than we’d expected — which, in turn, has provided a buffer for the effects on the economy.&nbsp;Part of this slower pass-through reflects that tariffs have come online gradually, with more likely ahead. But it also reflects the many ways the economy can adapt to tariffs. Besides raising prices, firms can reduce their margins, adjust production plans, cut costs (including wages and employment) and deploy inventories. Similarly, households can shift the timing of purchases, rotate spending to other goods and services, and adjust savings. Another surprise is that to date, foreign exporters have absorbed only a negligible share of the tariffs. We continue to expect firms will price for concessions from their foreign suppliers, but even so, the share of the tariffs paid by foreign exporters is likely to be relatively small, perhaps in the neighborhood of 10%.

Our new report, Global Economic Outlook &amp; Strategy: Tariffs &amp; Global Resilience — Waiting for Another Shoe to Drop, also includes discussions of the global inflation outlook and what may lie ahead for central banks. It’s available in full to existing Citi Research clients <a href="https://www.citivelocity.com/t/eppublic/45zRb">here</a>.

Global growth remains on a solid trajectory, with activity holding up surprisingly well despite tariff-related uncertainty. But in a new Citi Research note, Chief Economist Nathan Sheets and a team of analysts and economists warn there's still another shoe to drop as tariffs increasingly bite. We see global growth slowing to below 2% during the second half before bouncing back to 2.5% next year.&nbsp;

Tariffs & Global Resilience — Waiting for Another Shoe to Drop

<ul><li>We expect global growth of 2.7% for 2025, nearly equal to last year’s 2.8% pace, with an easing to 2.5% in 2026</li><li>The global economy faces multiple downside risks, from tariffs in the near term to longer-term issues such as public debt, aging demographics and the possibility of economic and geopolitical fragmentation</li><li>These risks are cause for considerable concern, but must be balanced against the remarkable resilience shown by the global economy despite recent years’ sizable shocks, as well as the prospect of AI-driven productivity gains ahead &nbsp;</li></ul>

In a new report from Citi Research, Chief Economist Nathan Sheets and a team of analysts and economists explore what they see as a “gaping bifurcation” between the global economy’s continued resilience and downside risks that remain menacing. What is clear to the team is that global growth has kept motoring forward; we now expect global growth of 2.7% in 2025, nearly equal to last year’s 2.8% pace. This resilience poses intriguing questions, but the global outlook also faces risks that appear outsized. In the near-term, the possibility of a further bite from tariffs stands front and center; looking longer-term, we’re concerned about high levels of public debt, rapidly aging demographics, and the increased likelihood of economic and geopolitical fragmentation.Growth in developed markets remains much weaker than in emerging markets, but has dipped only modestly in both sets of economies. We expect global growth to ease in 2026, but only to 2.5%. Across individual economies, growth in the euro area looks to have accelerated this year, and we also judge the pace of expansion as having picked up in Japan, Australia, India and Poland. Growth has also looked solid in China and Indonesia, with ongoing 5% gains. U.S. growth appears to be moderating to a near-trend 2% rate, a slight cooling from 2024’s unsustainably rapid pace.&nbsp;Meanwhile, global purchasing managers’ indices (PMIs) continue to highlight relative strength in services, which are running in strongly expansionary territory. But these measures haven’t shown any meaningful deterioration this year, and highlight the economy’s generally solid performance.The largest near-term risks we see are the possibility that tariffs will deliver a further, more painful bite. We’re also concerned about political and geopolitical tensions, with the U.S. government shutdown, French political dysfunction, and policy uncertainties about Japan’s new prime minister all in play even as the Russia-Ukraine conflict drags on. And the longer-term risks noted above all threaten to slow or disrupt the global economy in the years ahead.But those cautions must be balanced against the resilience shown by the global economy despite a run of sizable shocks, all of which were expected to derail growth: the onset of the Russia-Ukraine conflict (2022), headwinds from aggressive central-bank rate hikes (2023 and 2024), and challenges from the Trump administration’s tariff campaign (2025). In each instance, global growth has shrugged off the pressures and continued expanding at a near-trend pace.Part of this resilience has flowed from the willingness shown by central banks and governments to provide aggressive monetary and fiscal support. But this doesn’t explain the entirety of what we’ve seen. Rather, it seems that the global economy is showing increased flexibility and more capacity to respond to shocks than we’ve seen in the past. Adjustments to supply chains and production techniques now seem to happen more smoothly, fueling solid ongoing global growth and labor-market performance. Indeed, we note that labor markets have stayed tight, which in turn has supported consumer spending; we judge that the global unemployment rate has been about flat at just over 5% in recent years.And looking medium-term, we see other reasons for optimism. As explored in <a href="https://www.citigroup.com/global/insights/productivity-the-ai-revolution-implications-for-the-economy-and-markets">our September Must C report</a>, the potential economic effects of artificial intelligence (AI) develop the case for a forthcoming rise in productivity. Those gains are yet to be seen, with the global economy currently supported by a surge in AI-related investment, but our expectation is that these gains will come, and we note that the adoption of AI looks to be proceeding at a historically rapid pace.Bullishness about AI has been a key driver of strength in U.S. equity markets. Looking ahead, we expect efficiency gains and profits from AI will be increasingly felt among “AI adopters,” rather than concentrated among “AI producers.” Such a dissemination across sectors will allow countries that aren’t AI producers to also notch meaningful productivity gains.These disparate and offsetting factors leave us to wrestle with what they mean for the global outlook: The challenges and risks we note mandate caution, but the experience of the last four years highlights the economy’s sustained and ongoing momentum. Hunkering down hasn’t been a winning strategy; the prescription instead seems to be tactical flexibility and paying attention to both the range of challenges and the continuing opportunities.

Our new report, Global Economic Outlook &amp; Strategy: The Great Bifurcation — Resilient Performance Vs. Still-Menacing Risks, also updates our thinking about tariffs, global inflation and central banks. It’s available in full to existing Citi Research clients <a href="https://www.citivelocity.com/t/eppublic/48kQG">here</a>.

Tariffs

IN THIS SERIES

The Great Bifurcation — Resilient Performance vs. Still-Menacing Risks

Tariffs & Global Resilience — Waiting for Another Shoe to Drop

Tariffs Remain Front and Center

Sign up to receive the latest insights from Citi.