Global Markets Hold Their Breath as Risks Multiply

Archive edition · Market data and company circumstances reflect 26 April 2025, when this newsletter was sent.

Market on the Knife’s Edge

As we head deeper into Q2 of 2025, the financial markets remain perched on an uncomfortably narrow ledge — neither in the clear nor completely tumbling into crisis. The relief from the April 9 pause in reciprocal tariffs was swift but short-lived. Federal Reserve leadership, and Treasury markets have swiftly renewed volatility.

Let’s unpack what investors need to brace for next. Because if the last few weeks have shown us anything, it’s this: The path ahead for markets is fragile, and much could still go wrong.

Markets Holding On — Barely

When reciprocal tariffs between major economies were temporarily paused on April 9, there was a notable relaxation in financial conditions. Markets rallied, Treasury yields initially dropped, and hopes of sidestepping a near-term US recession rekindled. But optimism faded fast.

Markets price weaker growth, constrained policy

The underlying drivers of market unease — trade uncertainty, political risks, inflationary pressures, and a constrained Federal Reserve — remain deeply entrenched.

Goldman Sachs still pegs the probability of a US recession at 45% over the next 12 months.

That’s dangerously high by historical standards and implies markets are nowhere near fully pricing in the potential economic fallout.

Markets Are Still Underpricing Recession Risks

After the initial tariff announcements on April 2, cross-asset pricing sharply downgraded U.S. growth expectations. Volatility spiked, credit spreads widened, and cyclical stocks sold off relative to defensives. However, with the announcement of a 90-day tariff pause, a significant part of this pricing reversed.

Analysts warn that markets now again look complacent relative to the real risks. Equity volatility and credit spreads never reached levels typically associated with deep recessions, and Treasury yields have not moved enough to reflect a potential sharp deterioration in economic activity.

If a full-blown recession scenario materializes, Goldman Sachs estimates:

Markets may rally on intermittent good news — a data beat here, a deal headline there — but structurally, they remain exposed. The risk is that negative surprises hit when pricing offers little cushion.

• The S&P 500 could slide to around 4600.
• High-yield credit spreads could blow out to 600 basis points.
• Shorter-term Treasury yields could fall below 3%.

Treasury Market Dysfunction

One of the clearest signs of fragility surfaced in early April when Treasury markets failed to act as a reliable hedge during an equity selloff.

Traditionally, during risk-off moves, Treasury yields drop as investors seek safety. But this time, yields initially fell only modestly, then sharply reversed higher on April 7-8.

This dysfunction in the world’s deepest bond market is troubling. It suggests that liquidity is thinner than it appears and that financial markets may struggle to absorb shocks. Analysts expect this sensitivity to persist, especially with upcoming Treasury auctions and sustained concerns about U.S. fiscal sustainability.

• Worries about inflation from tariff-induced price hikes
• Reduced foreign demand for US Treasuries
• Leveraged position unwinds, particularly in the swap market

The Fed Is Cornered — And That’s a Problem

The Federal Reserve faces one of its most difficult dilemmas in years. The economy is slowing, but inflation risks remain elevated due to trade disruptions. Political interference — including proposals to replace Chair Jerome Powell — adds another destabilizing layer.

Recession would bring deeper Fed cuts and is not sufficiently reflected in current pricing.

Goldman Sachs’ base case assumes the Fed stays cautious but remains ready to cut if unemployment ticks higher. In a recession scenario, rates could drop by 200 basis points in short order — far deeper than markets currently price in.

However, the Fed’s credibility is under threat. Consumer inflation expectations have risen sharply, while market-based measures are mixed. The risk is that the Fed either acts too late or too timidly, exacerbating market volatility and worsening the economic downturn.

A Weakening Dollar

The U.S. Dollar, long a safe-haven in times of stress, has shown unusual vulnerability. Recent weakness has outpaced what can be explained by interest rate differentials alone. This can be due to a deeper global reallocation away from U.S. assets.

Investors are questioning U.S. governance, fiscal discipline, and institutional credibility — not just in Washington, but on the global reserve currency stage. Though the Dollar remains dominant, its share of global reserves has been slipping for years.

Even without foreign investors dumping U.S. assets, the risk is that hedge ratios rise and inflows slow. With U.S. assets historically overweighted in global portfolios, there’s room for further weakness in both the Dollar and U.S. markets.

What Can Go Wrong Next?

Goldman Sachs outlines several key vulnerabilities that could trigger a deeper selloff:

1.6.1 Breakdown in Trade Negotiations

While a 90-day tariff pause is in place, talks remain fragile. If negotiations falter, markets could rapidly reprice recession risk. The baseline tariff rate remains elevated at 10%, and any escalation would hit consumer spending, corporate margins, and business investment hard.

1.6.2 Policy Missteps at the Fed

The Fed is walking a tightrope between growth risks and inflation management. A miscalculation — tightening too much or easing too little — could tip the economy into contraction. Political pressure adds a layer of unpredictability.

1.6.3 Treasury Market Illiquidity

Recent dysfunction in Treasury markets is a warning sign. A disorderly bond market could amplify equity and credit market stress, particularly if foreign demand weakens further or fiscal concerns rise.

1.6.4 Inflation Resurgence

Tariffs are inherently inflationary. While we expect headline inflation to moderate due to falling energy prices, tariff-induced goods inflation could persist, limiting the Fed’s ability to ease aggressively in a downturn.

1.6.5 Further De-Dollarization

While no single currency is ready to replace the Dollar, shifts in investor behavior matter. Rising risk premiums for U.S. assets and growing hedge ratios could weaken U.S. financial markets, raising funding costs and weighing on equities.

1.6.6 Foreign Central Bank Policy Divergence

Unlike in the U.S., where tariff-driven inflation limits policy space, central banks elsewhere can cut rates to support growth. This policy divergence could pressure the Dollar further and increase capital outflows from U.S. assets.

Positioning for a Fragile Market

Given these risks, Goldman Sachs recommends a defensive, diversified stance:

Goldman Sachs emphasizes remaining on ‘recession watch’ for at least the next two to three months, with risks skewed to the downside.

• Favor defensive equity sectors over cyclicals
• Maintain exposure to high-quality credit
• Look for steepening opportunities in the 2-5 year Treasury curve
• Prepare for a potential USD downtrend by diversifying into G9 currencies like the Yen, Swiss Franc, and Euro
• Stay alert to signs of market dysfunction — especially in bond markets and swap spreads

Archive note

This article preserves the analysis in our weekly newsletter sent 26 April 2025. Market prices, forecasts and company circumstances reflect the time of publication and may have changed.

This material is general information, not personal financial advice or a recommendation to trade. Investing and trading involve risk, including loss of capital.