After outpacing cautious expectations in the first half of the year, the global economy could face new challenges from trade policy uncertainty and inflation over the coming months.
September 3, 2025
By Joseph Wu, CFA
For all the disruptions caused by U.S. trade policy, the world economy has so far proved sturdier than anticipated. Growth has slowed but avoided the recessionary outcome many economists forecasted after the Trump administration’s “Liberation Day” tariff salvo in April. Several factors may explain this resilience.
Above-trend GDP expansion of 3.3 percent in 2024 put the global economy in a position of strength to start the year, and this helped buffer subsequent trade shocks. As 2025 got underway, a burst of “front-running” as firms and consumers brought forward purchases ahead of higher tariffs temporarily lifted output and trade volumes. Targeted government spending in several large economies added some ballast, while a U.S.-led surge in AI-related spending further bolstered demand. Steady wage gains also helped households weather economic uncertainty through the first half of the year.
The second half of 2025, however, may prove a sterner test of the economy’s mettle. As the U.S. concludes negotiations with trading partners and tariff rates settle at higher levels, the front-running boost will likely fade. An expected slowdown in U.S. imports over the coming months, as reflected in Bloomberg consensus forecasts, could be a drag on growth in the rest of the world. Meanwhile, higher inflation could chip away at U.S. households’ purchasing power and dampen consumption, while businesses – still wary of policy unpredictability and grappling with murky demand conditions – may defer investment until visibility improves.
Yet there are reasons for cautious optimism, in our view. As clarity on U.S. trade policy improves, governments deploy targeted stimulus, and supply chains adapt, we expect a modest recovery to unfold in 2026. Nevertheless, we believe the range of possible outcomes remains unusually wide, as these mitigating factors will soften but not completely offset the drag from more onerous U.S. tariffs.
The column chart shows quarter-over-quarter annualised GDP growth for the world, the United States, Canada, and the eurozone in the first half of 2025 and quarterly estimates for the second half of 2025 and the first half of 2026.
Source – RBC Wealth Management, Bloomberg (U.S., Canada, and Eurozone consensus forecasts), national research correspondent (global forecasts); data through 8/21/25.
The monetary policy outlook is clouded by persistent uncertainty around growth and inflation, but the bigger picture suggests major central banks will likely lean toward easier policy, with Bloomberg models suggesting interest rates are likely to fall over the next six to 12 months.
The scope for rate cuts varies from country to country, but it is worth noting that several major central banks have already trimmed rates this year, both to cushion the growth-sapping effects of trade frictions and because domestic inflation has settled near target levels. With global demand likely to weaken further in the near term, in our view, the bias towards monetary support seems likely to persist.
The column chart shows policy interest rates of the U.S. Federal Reserve, Bank of Canada, European Central Bank, and Bank of England in December 2024 and August 2025, and a projection based on Overnight Index Swaps for August 2026 as of August 21, 2025.
Source – RBC Wealth Management, Bloomberg; data through 8/21/25; expected policy rate sourced from Bloomberg interest rate models derived from the Overnight Index Swap market.
The U.S. presents a more complicated picture. Inflation remains above the Federal Reserve’s two percent target, and with some indicators suggesting that price pressures could flare up again, any shift toward rate cuts will likely be a careful balancing act. After a disappointing July jobs report and hefty downward revisions to the prior two months’ figures, markets have pulled forward their forecasts for a U.S. rate cut to as early as September. Still, the delicate balance between returning inflation to its target range and supporting growth underscores how data-dependent interest rate expectations have become.
While most central banks outside the U.S. appear inclined to cut interest rates further if conditions warrant, the Fed seems relatively more constrained amid firmer inflationary pressures. With global bond markets already discounting a series of rate cuts over the next 12 months, we believe the path of bond yields now hinges on whether these cuts materialise as expected.
Equity and corporate bond markets have so far absorbed the shocks generated by seismic shifts in U.S. trade policy with remarkable composure. The swift rebound from April’s sharp sell-off reflects two important changes in how investors view policy volatility.
The first is mounting skepticism about U.S. follow-through. Having watched the Trump administration repeatedly pull back from its most extreme tariff threats since April, markets are increasingly treating such announcements as posturing and are thus reacting in a more orderly way.
The second is corporate adaptability, as firms seem better able to handle supply chain disruptions than initially feared. Admittedly, the burden is unevenly distributed across industries, but the overall impact looks more manageable than the worst-case scenarios. In this respect, tariffs are no different from other uncertainties to which businesses must adapt – and the corporate sector has proven capable of navigating through shifting operating conditions over time.
While markets are often rattled by political and economic headlines, corporate fundamentals tend to matter more over the longer term. Macro developments are relevant mainly insofar as they are perceived to have implications for profitability. After stagnating in April and May, earnings estimates have stabilised and resumed an upward trend. Consensus estimates now point to global earnings growth of around nine percent this year and 11 percent in 2026 – an outlook that provides markets with a solid foundation, allowing investors to look past trade-policy bluster.
The line chart compares forward 12-month earnings-per-share estimates for the S&P 500, MSCI All Country World Index (ACWI) and the ACWI excluding the United States from January 1 through August 21, 2025. The estimates are indexed to 100 on January 1, 2025. All three estimates have risen overall. The S&P 500 estimate declined in the spring of 2025, and the MSCI ACWI declined in the summer of 2025, but all three have resumed an upward trajectory.
Source – RBC Wealth Management, Bloomberg consensus estimates; data through 8/21/25
Financial markets have managed to overcome a drumbeat of negative headlines in 2025, confounding pessimists. Much of this can be attributed to reality exceeding expectations, which has helped markets climb the proverbial “wall of worry.”
The recession fears that prevailed in the wake the U.S. tariff offensive in April was followed by relative resilience. Trade frictions have unquestionably eroded growth momentum in major economies. But policymakers have leaned against the drag with monetary and fiscal stimulus, helping ensure that growth, while slowing, has not tipped into contraction.
Companies, too, have shown a degree of adaptability in navigating supply-chain pressures, underscored by steady earnings delivery. While there may be some complacency on trade-related impacts, which are still unfolding, the outlook for profits remains constructive, in our view.
After a strong rally since April, however, asset valuations now appear to reflect a high level of optimism. The MSCI All Country World Index now trades at 19.1x forward 12-month earnings estimates, up from 15.6x at the worst of the correction in early April and well above the 10-year average of 16.5x. Meanwhile, the compensation for taking credit risk in corporate bonds has fallen to historically mediocre levels.
The line chart shows the forward price-to-earnings ratio of the MSCI All Country World Index from 2015 through August 21, 2025, along with the average over that period of 16.4x. The index has been above its average valuation since the beginning of 2024, except for a brief drop in early April.
Source – RBC Wealth Management, Bloomberg; data through 8/21/25
As long as the business cycle remains intact, earnings should continue to edge higher and provide support for asset prices. But with valuations leaving little margin for any disappointment, investors should prepare for occasional bouts of volatility. In this environment, leaning into a quality orientation and maintaining broad diversification across geographies and sectors remains a sensible basis for portfolio positioning, in our view.
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