Written by: Dong Jing, Wall Street Journal
In its latest research report, UBS addressed the 10 global economic issues that investors are most concerned about, covering core market worries from tariff impacts to dollar depreciation.
On July 8, according to reports from the Wind Trading Desk, UBS's research team released a major report addressing the top ten issues that investors are most concerned about. The report indicates that the current global economy faces a complex tapestry of challenges, with U.S. tariffs equivalent to a 1.5% GDP tax on importers and global growth tracking valuations at only a 1.3% annualized growth rate, sitting at an historically low 8th percentile.
UBS also stated in its report that the depreciation of the dollar and central bank policy adjustments in various countries have become the current market focus. Although UBS holds a cyclical bearish view on the dollar, it does not expect this to mark the beginning of a long-term depreciation trend for the dollar. The impact of tariffs on inflation is expected to manifest in the July CPI data, while the Federal Reserve faces dual pressures from inflation and employment.
UBS pointed out that European stock markets have a valuation advantage relative to U.S. stocks, with European stock market valuations showing an abnormal discount compared to U.S. stocks, with industry-adjusted price-to-earnings ratios 25% lower than those in the U.S., far exceeding the historical normal level of 7%. The bank maintains its strategy recommendation of a benchmark allocation to U.S. stocks and an overweight in European stocks.
UBS also mentioned in its report the impact of Trump's 'Great Beautiful Act' on the U.S. economy, the global central banks' general shift to easing policies in response to the growth slowdown caused by tariffs, and the outlook for economic stimulus policies in China in the second half of the year.
Question 1: The impact of tariffs on global growth has already manifested.
The report states that the tariffs currently implemented by the U.S. amount to roughly a 1.5% GDP tax on American importers, and even with trade agreements, there is no clear downward trend in tariffs.
Data from the U.S. Treasury Department indicates that based on June's tariff revenue, more than $300 billion in tariff revenue is collected annually. According to the Wind Trading Desk, Morgan Stanley previously reported that U.S. tariff revenue has reached an annualized $327 billion, accounting for 1.1% of GDP.
UBS stated that in April, following the announcement of tariffs, there was a sharp divergence between global hard data and soft data (reaching the highest gap in 27 years), with hard data showing an annualized growth of 3.6%, while soft data showed only 1.3%. However, in May, they began to converge, as the deterioration of hard data was faster than the improvement of soft data.
UBS stated that its global growth tracking composite data shows that global growth is only at a 1.3% annualized growth rate, which is only at the 8th percentile historically.
It is noteworthy that the decline in the U.S. confidence index has exceeded that of other regions, while European survey data remains largely stable, despite both regions facing similar levels of policy uncertainty. In the U.S., survey data is now 1.5 standard deviations lower than the level in December.
Question 2: How is this dollar sell-off different from previous ones?
UBS holds a cyclical bearish view on the dollar, but does not believe this marks the beginning of a long-term depreciation trend.
UBS analysts believe that the depreciation of the dollar is primarily driven by three factors: increased demand for hedging against dollar depreciation, cyclical slowdown in the U.S. economy, and improvement in trend growth in other parts of the world. Currently, the first factor is already at play, and the second factor is about to manifest.
Foreign investors hold $31.3 trillion in U.S. long-term securities, of which $6.3 trillion is held by official accounts. UBS estimates that if the foreign exchange hedging ratio increases by 5 percentage points, it will generate $1.25 trillion in dollar selling flow, far exceeding the U.S. annual external deficit.
However, UBS emphasizes that the current dollar sell-off does not have the necessary conditions for the long-term down cycle of the dollar seen in the past—improvement in growth in other parts of the world and a reduction in risk premiums. This will limit the scope and duration of the current dollar depreciation cycle.
Question 3: The lagging impact of tariffs on inflation
Despite the U.S. implementing large-scale tariffs, equivalent to a 1.1% increase in PCE prices, there has not been a significant reflection in the official CPI and PCE data.
UBS believes that this lag is mainly caused by four factors: exemptions for shipping dates, corporate inventory buffers, slow price transmission for intermediate and capital goods, and the bi-monthly sampling method of the CPI.
UBS expects to see a significant impact of tariffs on key inflation indicators only with the July CPI data (to be released in August).
The bank stated that during the Trump 1.0 era, the experience of a 20% tariff on washing machines in 2018-2019 indicated that it takes 2-3 months after the implementation of tariffs to see a clear impact in the CPI. The currently implemented 10% general tariff is the most inflationary, and its expected impact timing is similar to this.
Question 4: How do global exporters respond to U.S. tariffs?
The report states that the first quarter and the potential tariff front-loading effects in April/May indicate that a stable state due to price increases and quantity reductions has not yet been reached.
There is a persistent gap between the trade data reported by the U.S. and China, and there are also discrepancies between container shipping data and official trade data.
However, there is almost no evidence that foreign exporters are absorbing tariffs by lowering export prices. In April, U.S. import prices fell only 0.5%, and remained flat in May, suggesting that foreign exporters have hardly absorbed tariffs by lowering export prices.
UBS believes that foreign exporters may indeed absorb the impact of dollar depreciation on their profits, with American importers bearing the primary tariff costs. Currently, there are no clear signs of transshipment, but it is still too early to tell.
Question 5: Does the U.S. fiscal outlook push up global yields?
Currently, the vast majority of changes in the U.S. budget deficit stem from the extension of the 2017 tax cut policy, which had been anticipated after the elections.
UBS is very concerned about the long-term supply of U.S. Treasuries, but historically, demand fluctuations have often far exceeded supply fluctuations.
If concerns about an economic slowdown continue to rise, domestic demand for U.S. Treasuries should increase to a level sufficient to easily absorb this supply.
UBS believes that the bottom for the 10-year government bond yield should be around 2.75%, even in a highly stressed environment.
Question 6: What is the evidence of capital outflow from the U.S.?
The view that foreign investors are reducing exposure to U.S. assets has spread widely among market participants.
UBS stated that the April U.S. TIC data provided evidence of a sell-off of U.S. assets, but it is unclear whether this rotation continued beyond April. The data showed that foreign investors net sold $50.6 billion in U.S. long-term securities, including $18.8 billion in stocks and $40.8 billion in government bonds.
UBS believes that the continued depreciation of the dollar may reflect that global investors have increased their foreign exchange hedging ratio for U.S. assets. Data from Australian and Canadian pension funds show that the current hedging ratio remains at a historically low level, with further room for increase.
UBS stated that so far, there has been no clear evidence in merger and acquisition announcement data to validate the federal government's claim of a $10 trillion FDI investment commitment flowing into the U.S.
Question 7: How 'exceptional' is the U.S. stock market compared to Europe?
When global GDP slows down, the U.S. typically performs well, but this time the GDP slowdown is centered on the U.S., with the Eurozone unexpectedly performing much better than the U.S., although this has not been fully reflected in market trends.
The areas where the U.S. is performing exceptionally poorly relative to the Eurozone include: valuation (abnormally expensive compared to the EU), fiscal situation, and household excess savings, as detailed below:
The adjusted price-to-earnings ratio of U.S. stock sectors relative to Europe is 25% higher after adjustment, while the historical average is only 7%.
The total yield in Europe (dividend plus buyback) is currently 4.4%, while in the U.S. it is 2.8%.
Europe's fiscal situation and household excess savings are significantly better than those in the U.S., with Europe's excess savings at about 10% of GDP, while the U.S. only has 2%.
UBS stated that the aspects in which the U.S. is no longer 'exceptional' compared to the Eurozone include: buyback (as a percentage of market capitalization) and GDP growth (slightly lower than the EU in 2026).
Question 8: Does the 'Great Beautiful Act' help or harm U.S. growth?
UBS stated that the act increases the deficit before 2026 and then shifts to narrowing, with a total reduction of $400 billion in the deficit over the next 10 years.
The bank anticipates that the 'Great Beautiful Act' will contribute approximately 45 basis points to growth before 2026, after which fiscal drag will begin to manifest.
The act expands the business provisions of the 2017 tax reform, including full expensing, research and development tax credits, and changes to deductions, with student loan reductions being an important recent source of funding.
Question 9: How do central banks respond to the escalation of global tariffs?
The actual impact of tariff shocks significantly differs from expectations, mainly reflected in the depreciation of the dollar and the lack of retaliatory measures. This fundamentally alters economic outcomes, including the orientation of central bank policies.
For central banks outside the Federal Reserve, the current situation is much simpler than the previously feared stagflation scenario. The tariff shock clearly constitutes a negative growth shock and could still be a deflationary shock. Since April 2, the average one-year interest rate in developed markets has fallen by 30 basis points, while in emerging markets it has decreased by about 50 basis points.
UBS's deep analysis model shows that among G3 central banks, the European Central Bank has shifted to the most dovish stance, while the Bank of Japan is starting to worry about growth. The Federal Reserve, on the other hand, faces a dilemma.
If inflation rises faster than the unemployment rate, the Federal Reserve's policy rules suggest that it should raise interest rates. However, if the tariffs are primarily a one-time price level shock, the Fed may choose to prioritize addressing higher unemployment. Current signs indicate that the Fed leans towards supporting the labor market.
Question 10: How many stimulus measures has China implemented, and how many are still to come?
China set a GDP growth target of about 5% at the National People's Congress in March and announced moderate policy stimulus measures. The general fiscal deficit has expanded to 1.5-2% of GDP, and monetary and credit policies are set to be 'moderately loose.' UBS expects a 30-40 basis point reduction in policy rates.
In terms of policy implementation, the central bank lowered the policy rate by 10 basis points in May, reduced the reserve requirement ratio by 50 basis points, and announced new relending tools to support consumption and innovation. The net issuance of government bonds was strong in the first half of the year, driving credit growth in June to an annual growth rate of 8.8%.
UBS estimates that China's general fiscal deficit in the first half of the year expanded to 1.1% of GDP year-on-year. It is expected that the remaining planned fiscal stimulus (0.5-1% of GDP) will be delivered in the second half of the year, and additional fiscal stimulus exceeding 0.5% of GDP may be introduced, possibly in the third quarter.
Additionally, UBS expects a further reduction of 20-30 basis points in policy rates.
