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The Trump administration’s recent tariff announcements, coupled with other countries’ efforts to strike back, have materially altered the US economic growth outlook for 2025 relative to expectations at the beginning of the year. Uncertainty around the ultimate implementation of tariffs has resulted in a broad range of possible near-term outcomes for growth and inflation. While this suggests more volatility ahead, we see a potential silver lining for insurers in the potential for enhanced yields.
For its part, the Fed is expected to maintain a reactionary stance, relying on hard data while preserving its independence. This approach may lag market dynamics, and the administration’s position on Fed independence and Chairman Powell’s role remains unclear. Meanwhile, lower-income US consumers show signs of financial stress, including rising delinquencies and defaults, while middle- and higher-income consumers remain resilient. The resumption of student loan payments is likely to pressure consumer balance sheets further.
Several of Trump’s policy priorities, including tax cuts and deregulation, are expected to support US growth in late 2025 and into 2026. Early deregulation efforts have focused on climate regulations affecting small businesses, while financial institutions are expecting reduced capital requirements to spur lending and competitiveness. Globally, geopolitical risks remain elevated, with the US-led trade war adding to the tensions.
At the end of the first quarter, valuations remained tight across most non-government sectors, with investment-grade corporate spreads hovering around their 20th percentile based on a 20-year lookback period. In the weeks since, spreads and rates have risen considerably as the market has reacted to increased tariffs and the greater risk of US and global recession, leaving valuations closer to median levels across most high-grade fixed income sectors. We believe this is an attractive time to marginally increase risk in reserve-backing portfolios, while maintaining an up-in-quality bias.
Given the moves wider in credit spreads broadly, we think investors should consider increasing exposure to investment-grade corporates. We remain most positive on more defensive names that may be able to withstand a prolonged period of market volatility, such as the big banks and pockets of industrials. On the fundamentals front, aggregate investment-grade credit metrics remain healthy, broadly speaking, and ratings momentum continues to be very strong. Forward-looking earnings expectations have begun to roll over, and the negative growth effects of tariffs are likely to accelerate this trend. Spreads are beginning to trade closer to median levels, partially pricing in the elevated risk of weaker growth and credit conditions over the next 6 – 12 months, while all-in corporate yields remain attractive. Demand is robust while supply has tracked ahead of expectations and volumes are strong. Investors have shifted from a “buy the dip” to “sell the rally” mentality in recent weeks, creating opportunities to act as a liquidity provider.
We remain positive on structured finance due to generally strong fundamentals and attractive income profiles:
Tax-exempt municipals used to be a meaningful allocation for taxable insurance companies that could take advantage of investing across both taxable and tax-exempt sectors. However, corporate tax code changes in the 2017 Tax Cuts and Jobs Act spurred a significant reduction in strategic tax-exempt targets for crossover buyers. This change in tax-exempt municipal targets was exacerbated by generally tight valuations in the market in recent years, driven by retail investors, and particularly in shorter maturities.
To put this tight valuation picture into perspective, as of year-end 2024, the muni/Treasury ratio at the 10-year portion of the curve, which is a snapshot of the relative value of 10-year AAA GO tax-exempts over US Treasury bonds, was at 67%, well below the 20-year average of 88%. This poor relative-value dynamic of tax-exempts relative to taxable fixed income led us to recommend to insurance crossover investors that they consider gradually reducing their municipal exposure in favor of other high-quality substitutes, such as Agency MBS and even US Treasuries.
However, year to date we have seen municipal valuations widen such that they are becoming more attractive relative to Treasuries and generally fair at the corporate tax rate versus corporate bonds, particularly relative to their recent history. As such, we think crossover investors should consider closing their underweights to tax-exempts at the margin to take advantage of more compelling after-tax valuations. In addition, given the increasingly uncertain macro outlook, we believe gradually rotating exposure into a more defensive asset class such as tax-exempt municipals is a strong proposition. One other potential benefit of allocating more to tax-exempts is that their buyer base is US-centric; in a period where rates are rising due to concerns about foreign capital outflows from other markets, we believe municipal bonds could present a safe haven and potentially outperform versus taxable sectors.
As a result of the tariff policy rollout and the subsequent sell-off across risk assets, high-yield corporate spreads widened above the trailing 10-year median in mid-April. While we are expecting an economic slowdown and further volatility, we do not believe defaults will spike past recessionary levels given good fundamentals and the higher-quality composition of the market. The growing role of private credit in providing financing for the lowest-quality borrowers provides added support. Overall, we think the high-yield spread widening has resulted in an attractive entry point for longer-term investors.
As noted, the risk of an economic slowdown has increased. Overall, we are expecting a modest uptick in default activity, with defaults increasing toward long-term averages (around 3% – 4%). We remain constructive on the high-yield market and think insurers with plus allocations should consider increasing risk on the margin as spreads have widened and provided more attractive income opportunities.
We retain a slight overweight view on global equities. One of the key questions today is whether the recent sell-off signaled the end of the bull market or simply a correction driven by tariffs. We don’t see evidence of an earnings or economic recession, which are usually associated with a bear market. However, we do think US exceptionalism is being tested and that higher tariffs could be harmful to US growth. That said, we think the recent market sell-off was more likely a correction driven by a repricing of growth expectations given tariff concerns and policy disruption, and that we are likely to see further adjustments in headline EPS growth as expectations evolve.
Thus, we are watching for better entry points amid near-term volatility, while also remaining mindful of the fact that missing the early stage of a rebound can be costly. Over the next 12 months, we expect mid to high single-digit earnings growth and flat valuations in global equities — based on our probability-weighted approach and assuming a reasonable likelihood of higher tariffs with negative growth/inflation trade-offs.
Another key question occupying allocators recently was whether equity market leadership would finally broaden. At the start of the year, we expected some broadening, both regionally and within the US, which led us to neutralize our regional overweight/underweight views (we previously had an overweight view on the US versus Europe). The unusually asynchronous moves we’ve seen between regions through the first few months of the year have exceeded our expectations.
The upending of the consensus on US outperformance is reflected in investor surveys and equity flows, where we have seen some historically large shifts out of the US and largely into Europe, where earnings revisions have risen sharply. Both cyclical indicators and signs of a sea change in fiscal dynamics give us some indication of the potential bull case for Europe. However, the abrupt gains in the market have pushed valuations to more expensive levels, and we will need to see EPS improve further to gain confidence that we’ve entered a sustained period of outperformance. In addition, we think neither US tariffs nor implementation risk (e.g., borrowing for defense spending) have been adequately reflected in valuations.
In the US, it seems reasonable to expect that perceptions of heightened policy risk will pressure valuations lower from record levels (i.e., economic policy uncertainty may continue to weigh on the US equity risk premium). Taking this and weaker earnings breadth into account, we are not tempted to move to an overweight view on US equities despite the sell-off.
Japan has underperformed despite solid earnings growth, modest valuations, and continued bottom-up progress on shareholder return and governance. Policy has been a headwind, with the Bank of Japan still in tightening mode. We maintain our neutral view but are still constructive on the structural story.
In emerging markets, recent gains have been driven mainly by a repricing of China, where housing indicators appear to have bottomed out and private-sector sentiment has improved, particularly in the technology sector. We maintain a neutral stance on emerging markets broadly.
Within sectors, we have an overweight view on utilities, financials, industrials, and technology, against an underweight view on telecoms, energy, and staples. Utilities and industrials are our highest-conviction views, driven by fundamental tailwinds including infrastructure and defense spending.
We have moved to a neutral view on commodities from an overweight view last quarter. Following the extreme gains in gold, we have shifted to a smaller overweight view. We think the geopolitical environment remains favorable for gold, with both EM central banks and retail investors (via gold ETFs) participating and the impact of tariff risk on physical flows of gold providing an additional kicker. But while we acknowledge the strong uptrend (albeit with some volatility), we think it’s worth waiting for a more favorable entry point for a long position.
We remain positive on the outlook for private credit, even in the face of elevated market volatility. The private credit market has demonstrated resilience and adaptability, including during periods of economic uncertainty, such as the COVID-19 pandemic.
During the pandemic, the private credit market saw a significant increase in issuance driven by the need for companies to secure financing amidst the economic disruptions. The strong issuance during this period highlighted the market's potential to provide essential liquidity and support to businesses when traditional financing avenues may be constrained. It also underscored investors’ confidence in the market's structural protections and potential for attractive risk-adjusted returns.
The presence of downside protection covenants played a crucial role in attracting investors to private credit during the pandemic. These covenants typically include provisions such as prepayment protections, make-whole provisions, and senior positions in the capital structure. Such features may offer investors a higher degree of security and potential for better recovery rates compared to public debt. Additionally, we think diversification across sectors, geographies, and tenors can enhance the resilience of private credit portfolios.
In today’s environment, prior to the heightened market volatility we have experienced recently, the private placement debt spread premium was well above historical averages — it was 70 bps at the end of the first quarter, compared to an average of about 50 bps over the past decade.1 We expect this spread premium to move closer to the historical average given the moves wider in the public market recently, especially since the private market experiences a lag. With that said, we believe managers with the ability to source deals across both agented and direct sources should still be able to identify pockets of opportunity above the market average.
Downside risks include an expanded tariff war, which could drive growth and inflation expectations higher, raise the risk of a US recession, and move markets to a risk-off stance. Geopolitical risk is also a concern.
Upside risks include a more measured approach to tariffs and progress on the US administration’s plan to reduce taxes and regulation. A jump in US productivity that increases growth potential without higher inflation would also improve the outlook.
Consider maintaining a slight pro-risk stance — Despite high policy uncertainty, our economic base case is not a US recession. As such, we think insurers should still own some risk in both their reserve assets and in surplus portfolios. In global equities, we favor utilities and industrials, given fundamental tailwinds including infrastructure and defense spending, along with financials and technology. We are more negative on energy, consumer staples, and telecoms.
Position for more potential broadening — With fiscal spending ramping up in response to Trump’s US-centric agenda, we expect the broadening theme in earnings growth outside the US to continue, especially in developed markets. We think insurers should at least consider neutral exposure to developed markets ex US.
Expect rangebound yields — The duration narrative is likely to flip flop between growth and inflation, causing yields to fall and rise within a range. We expect this to keep the Fed on hold and the US 10-year to be rangebound.
Consider opportunities to add spread exposure — Given a “no recession” base case, we considered wider high-yield income levels during the equity market correction to be an opportunity to add risk. From current levels, we think spreads could potentially still widen around 100 bps before breaking even with Treasuries, though we don’t expect spreads to reach that level.
1 Bank of America Securities, 31 March 2025.
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