Global Economic Outlook: Uncharted Territory

Nomura economists believe average US tariff levels will be around 15% at the end of 2025, substantially higher than at any time since before World War II. This will amount to stagflationary shock on the US, i.e., contributing to weak growth and rising inflation, but for the rest of the world it will be more of a negative demand shock, i.e., weak growth and falling inflation. This is why Nomura expects many central banks to cut rates further in coming months, while the Fed stays on hold. Meanwhile, policy uncertainty in the US has gone well above levels during the pandemic, and this will weigh on business capex and hiring decisions globally.

Many are pondering the question of whether US economic exceptionalism is fading. In a soft scenario, the US moves from exceptional to a normal economy, and the overvalued dollar moves gradually back toward equilibrium. In a hard scenario, investors de-risk from the US by outright selling US dollar assets, and there is a structural decline in the dollar’s status as the global reserve currency. Nomura believes that the soft scenario could be playing out, but has not yet seen strong evidence of the hard scenario.

Tariffs to re-accelerate US inflation

Tariffs are currently the most important factor in the US economy. While damaging to the US economy in the short run, we do not think this will cause a recession this year.

In the face of historically high tariffs, there are only two options for firms in the US – they either absorb the import tax into their profit margins or pass it on to consumers. The latter is typical, and there is no reason to expect anything different this time. That outcome would likely lead to a re-acceleration in US inflation.

With core PCE already above the Fed’s 2% target and economic growth likely weak, we believe the Fed will remain hawkish. Nomura continues to hold the view that the Fed will not deliver a rate cut again until December 2025.

China faces a double whammy

Over the past few weeks, there was a great deal of frontloading of exports. China’s economy performed relatively well in the first quarter, but when the effects of the trade war start to materialize, we expect China's economic growth to significantly slow in the second half of the year, with exports growth contracting towards the end of the year.

China also faces challenges in the property market. New home sales are down 18% YoY, and property prices are still declining, except in first tier cities. China’s government has used up the most effective policies over the past year to boost durable goods sales, but it cannot stimulate demand indefinitely.

There is downward pressure on the economy, which is why China is willing to negotiate with the US. If there is anything positive that comes from the trade war, it could be the determination of China’s government to clean up the country’s non-performing loans, including those extended to the property sector.

Europe may benefit in the longer term

Although it will not be smooth sailing for Europe, Trump could be a powerful catalyst for Europe to become great again.

Germany has approved a notable increase in defense spending, and its infrastructure funding is also going to increase over the next 12 years. At the European level, the €150 billion SAFE (Security Action for Europe) instrument will provide financial levers for member states to ramp up defense. In addition, lower energy prices and increased infrastructure spending in Europe will be a longer-term tailwind to European growth.

Strong Q1 GDP growth numbers are not a true reflection of underlying European growth; the underlying momentum in Europe now looks particularly weak. Headline inflation is expected to fall further in coming months, likely remaining below target in the euro area. As such, our view is that the European Central Bank and Bank of England will cut rates more rapidly than markets expect.

Japan’s economy to pick up after Q3

While Japan’s economy has been driven by services, its elevated inflation has, in contrast, been driven by import-dependent food and energy, not domestic items such as house rents and services. This contrasts with the drivers of inflation in the US and euro area.

We believe Japan’s core CPI inflation which includes all items excluding fresh food, will remain well above 2% through the middle of 2025. Food prices, mainly driven by rice, have been rising since Q3 last year. But, as the government intervenes by releasing stockpiled rice, we believe food inflation will peak in Q3 this year and core CPI inflation will eventually fall below 2% in Q4.

The challenge for the Bank of Japan going forward will be its communication on inflation. While actual inflation is around 3-4%, underlying inflation is much lower, below 2%. We forecast this relation will reverse by around the end of this year, with underlying inflation exceeding actual inflation. This is mainly due to the negative YoY base effect in food prices, and the combined effects of stable US dollar-denominated oil prices and a stronger yen leading to lower energy prices. It will be a challenge for the BOJ to communicate that to the market.

Japan’s economy should bottom out in Q3, and then gradually pick up, partially helped by fiscal policy. We expect the BOJ to hike in January 2026 and stay put thereafter.

A controlled descent for the rest of Asia; India leads the pack

There are multiple cross currents at play, so it is important to focus on the various idiosyncratic stories in the region. We expect a period of below-trend growth and below-target inflation. The region experienced significant export frontloading ahead of the tariffs, so we expect a payback, resulting in much weaker export growth going forward.

Another key factor is rising imports from China. Though this is not a new phenomenon, it has recently accelerated. The net effect is lower growth and further disinflation in the region, calling for more accommodative policies.

A major challenge for Asia is managing US and China simultaneously. This puts ASEAN economies in a tough spot, as their trade and investment linkages with China have strengthened over the last decade. India is ahead of its Asian peers in negotiating a trade deal with the US. Many of the supply chain investments that are moving to India are from the US and its allies, whereas those going into Southeast Asia are primarily from China. When it comes to diversification and the China Plus One strategy, India is likely to be one of the biggest winners from the next round of supply chain reallocation.