A potential watershed moment for European stocks and bonds

Global security considerations came to the fore this week with news the US would suspend military aid and intelligence to Ukraine. The response from European governments was as swift as it was unprecedented, with German chancellor-in-waiting Friedrich Merz announcing a vast increase in defense spending, causing yields on German bunds to rise at their fastest pace in three decades. In a similar vein, the European Union proposed a €150 billion borrowing facility for military spending. In the UK, Prime Minister Keir Starmer proposed an increase in defense spending to 2.5% of GDP by 2027. European defense stocks were the main beneficiaries as investors responded to what European Commission President Ursula von der Leyen described as a “watershed moment.”

Flurry of tariffs

US stocks, which had rallied midweek, fell on Thursday, partly in response to weakening economic data but also because of confusion around the possible impact of President Donald Trump’s tariff proposals. These proposals include a 25% tariff on imports into the US from Mexico and Canada, an overall 20% on goods from China and reciprocal actions on goods and services from a wide range of additional countries starting in April. On Thursday, however, Trump abruptly reversed some of the tariffs on Canada and Mexico.

Against the trade-policy uncertainty, Louise Dudley, Portfolio Manager, Global Equities, Federated Hermes Limited, highlights the opportunity in defensive and dividend-paying stocks.

“With the US exceptionalism trade fading, defensive sectors such as telecoms and healthcare are now in favor, with investors looking to avoid market volatility stemming from planned tariff changes. Dividend-paying stocks and value names have been seeing positive flows as a result,” she says.

“Diversification globally is key, considering a diverging interest rate environment and uncertainty facing US companies being impacted by a strong dollar, rising inflation and weaker consumer sentiment,” she adds. “Overall, we’re seeing a weaker growth outlook given the geopolitical tensions, but there remain opportunities for companies and investors focusing on longer-term pragmatic, disciplined strategies.”

What it might mean for emerging markets

Jason DeVito, Senior Portfolio Manager for Emerging Market Debt at Federated Hermes, highlights the impact an aggressive tariff policy could have on the Mexican economy.   

“In our view, in unlikely event the US administration does insist on 25% tariffs, this would almost invariably shock the Mexican economy into recession,” he says. “External buffers in Mexico are strong and the debt-to-GDP ratio is moderate. We expect limited default risk, but the next 12 months may present something of an economic malaise.”