Scenario Analysis: Tariffs and a Strong US dollar
Key findings
- With tariffs taking center stage, multi-asset-class investors may face a variety of stresses on their portfolios. We model a what-if scenario with an inflationary spike, a drag on growth and strength in the U.S. dollar.
- History shows that USD strength has had varied implications for asset classes, depending on the underlying economic backdrop.
- Under our scenario, both U.S. equities and bonds take a hit, while global stocks face two distinct pressures in USD terms — economic headwinds and home-currency depreciation.
Despite President Trump's preference for a weak U.S. dollar,[1] diverging monetary policy and strong growth in the U.S. could lead to USD strength. Global uncertainty, fueled by tariffs and other geopolitical tensions, could also drive investors toward safer assets such as Treasury bonds, which could further strengthen the dollar. We highlight a scenario, using the MSCI Macro-Finance Model, to help multi-asset-class investors assess the potential impact of tariffs and a stronger U.S. dollar on their portfolios. In this scenario, the value of a diversified portfolio of global equities and U.S. bonds could decline by almost 15%.
Historical periods of US-dollar strength
Historically, dollar rallies have been driven by a diverse set of factors such as:
- Higher U.S. interest rates relative to other economies
- Stronger domestic growth compared to global peers
- Safe-haven inflows during times of crisis
- The dollar's role as a global reserve currency
Not all dollar rallies were the same
The table highlights major surges in the U.S.-dollar Index, focusing on the largest six-month gains across diverse economic environments. We used the Nominal Advanced Foreign Economies U.S. Dollar Index from 2006 onward and the Nominal Major Currencies U.S. Dollar Index (Goods Only) prior to 2006. Source: Federal Reserve Board, retrieved from FRED, Federal Reserve Bank of St. Louis, MSCI
A scenario for tariffs and dollar strength
In our scenario, we assume tariffs and retaliatory measures lead to a short-term inflation spike of about 1 percentage point above the baseline, but that this shock dissipates relatively quickly. In contrast, economic growth faces a more persistent slowdown, with long-term growth settling around 20 basis points below the baseline.[2] We also assume a sustained 8% appreciation of the U.S. dollar relative to foreign currencies, returning the dollar index to levels last seen in 2002. This surge reflects several factors: higher interest rates due to inflationary pressures, a U.S. economy that may prove more resilient in a trade war and elevated economic and geopolitical uncertainty favoring safe-haven U.S. assets. As the exhibit below illustrates, these economic shocks go along with a higher interest-rate path.[3]
Trajectories for macroeconomic variables under the scenario
Economic growth, inflation and nominal short-rate paths under the scenario (full line) and under the baseline scenario (dashed line). Source: MSCI Macro-Finance Analyzer
The shift in macroeconomic expectations from the baseline to the alternative scenario leads to an asset repricing. The table below summarizes the resulting shocks to various U.S. asset classes: Equities sell off as real rates rise, Treasury bonds decline as nominal rates increase and oil prices move higher. We also include additional shocks for global ex-U.S. equities — which underperform U.S. equities due to a greater impact from tariffs — and for European interest rates, which we assume will ease slightly amid larger headwinds in European economies.
Scenario assumptions
Risk Factor | Scenario Assumptions |
|---|---|
Risk Factor U.S. equity | Scenario Assumptions -17% |
Risk Factor Europe equity | Scenario Assumptions -22% |
Risk Factor Emerging-market equity | Scenario Assumptions -22% |
Risk Factor One-year U.S. Treasury yield | Scenario Assumptions 115 bps |
Risk Factor 10-year U.S. Treasury yield | Scenario Assumptions 70 bps |
Risk Factor One-year U.S. breakeven inflation yield | Scenario Assumptions 100 bps |
Risk Factor 10-year U.S. breakeven inflation yield | Scenario Assumptions 15 bps |
Risk Factor 10-year EUR sovereign yield | Scenario Assumptions -20 bps |
Risk Factor Oil prices | Scenario Assumptions 5% |
Risk Factor EUR/USD | Scenario Assumptions -7% |
Assumptions about risk-factor shocks are informed by the MSCI Macro-Finance Model, analysis of historical data and judgment. Equity shocks are expressed in local currency. Breakeven inflation (BEI) is measured in basis points (bps). A negative shock for EUR/USD implies a strengthening of the U.S. dollar relative to the euro.
To evaluate the impact of this scenario on multi-asset-class portfolios, we used MSCI's predictive stress-testing framework and applied it to a hypothetical global diversified portfolio consisting of global equities and U.S. bonds and real estate.[4] Under the scenario, the portfolio's value drops 13%, as both bonds and equities trade down simultaneously. International assets sell off more steeply due to larger headwinds combined with weakening home currencies. The exhibit below provides more detailed results.
Portfolio impact under our scenario
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The first two months of the year have underscored the uncertainty investors face. In this blog post, we explored a scenario that assumes USD strength, a short-term inflation spike and a longer-term growth drag. Under these conditions, both equities and bonds sell off, with international equities taking the larger hit.
The authors thank Will Baker for his contribution to this blog post.
1 “Trump's Tariffs and the Dollar,” Wall Street Journal, Feb. 3, 2025.2 See here for a discussion of the potential impact of tariffs on economic growth and inflation: Warwick J. McKibbin and Marcus Noland, “US tariffs on Canada and Mexico would hurt all three economies; retaliation would worsen the damage,” Peterson Institute for International Economics, Feb. 4, 2025.3 This is not a forecast but a hypothetical scenario. We used the MSCI Macro-Finance Model to translate macroeconomic assumptions to U.S. market impact. You can find the scenario here.4 Treasury inflation-protected securities (TIPS) are represented by the iBoxx TIPS Inflation-Linked Index provided by S&P Dow Jones Indices. Treasurys, equities and corporate bonds are represented by MSCI indexes. Private equity is represented by model portfolios. U.S. real estate is represented by the MSCI/PREA U.S. AFOE Quarterly Property Fund Index. The composite portfolio is 50% global equities (35% public and 15% private),10% Treasurys, 10% TIPS, 10% U.S. investment-grade bonds, 10% U.S. high-yield bonds and 10% U.S. real estate. The results are generated by using model correlations to propagate shocks to the portfolios, using MSCI's BarraOne®. MSCI clients can download the correlated BarraOne stress test and RiskMetrics® RiskManager® stress test.
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