The global economy continues to demonstrate resilience despite significant changes in U.S. trade and investment policies and the resulting uncertainties. While the impact of increased tariffs and changes in trade flows begins to show in price and production data, consumer spending, labor markets and business performance remain mostly strong, providing an important shock absorber. As a result, the baseline scenario for major economies remains one of moderate growth and contained inflation, even in a context of greater political uncertainty. This is what emerges from the analysis by Magdalena Polan, head of EM macroeconomic research at PGIM.
The balance of risks has changed
It is more likely – the report finds – that the US economy will react more sharply to the tariff shock, the expansionary fiscal policy and the Fed’s further monetary easing, all complicated by the partial shutdown of the federal government. The trajectory remains uncertain: the economy may initially overheat, with stronger real growth and rising inflation. However, if tariffs weigh more heavily than expected and labor supply constraints limit production capacity, a deeper slowdown could follow, ultimately tempering inflationary pressures. “The risk of a similar increase in inflation in the Eurozone appears lower, strengthening confidence in our central scenario where – underlines Polan – ‘we can get by’. Instead, we see divergent inflation risks: downward in the Eurozone (and Japan) and upward in the United States and the United Kingdom in the short term”. In such a scenario, China faces a comparable change in risks. Growth is slowing towards the end of the year, while inflation remains subdued despite policy support. For both the Eurozone and China, PGIM continues to see “limited risks of a full-blown recession or sharp slowdown, and even slimmer chances of a productivity-led boost over the next 12 months.”
The Fed’s response: the market compass
While the baseline scenario remains a “get by” scenario, the main risk lies in an overheating of the US economy fueled by a more accommodative Fed, coupled with more expansionary fiscal policy. PGIM’s baseline scenario assumes that the Fed reduces the reference rate to 3.25%, remaining “at the highest end of the neutrality range”, in line with President Powell’s indications. “Caution is needed,” warns Polan, “especially with regards to inflation. The effects of tariffs could prove to be persistent, as pre-tariff inventories are depleted and the costs of higher production factors, such as steel, impact supply chains.” The shrinking workforce adds further pressure, while strong demand from higher-income consumers allows companies to pass on costs without eroding margins. Fiscal expansion will strengthen demand, and revenue from tariffs will mitigate short-term fiscal risks. A likely easing in trade tensions between the US and China would further support sentiment. As a result, markets are currently pricing in moderate easing and rising inflation in the short term, followed by stable inflation in the medium term. However, if the Fed downplays tariff-induced inflation beyond the initial effects and prioritizes downside risks, particularly in labor markets, it could cut rates more aggressively than expected. This would provide further stimulus, giving markets and the global economy a brief “burst of energy.” However, medium-term inflation concerns could push long-term yields higher. “While we do not believe this is an immediate risk in the fourth quarter,” Polan continues, “the Fed’s reaction will dominate market narratives.”
Currency dynamics: dollar weakness persists
We believe that divergence in monetary policies, combined with growth convergence across major economies, will lead to sustained weakening of the dollar. That said, much of this adjustment has already occurred and the future direction will depend on US policy choices. A weaker dollar continues to support emerging market currencies and could ease currency-related tensions in U.S.-China trade negotiations. Stronger emerging market currencies and subdued commodity prices will limit upward price pressures, allowing emerging market central banks to cut rates further (though the picture remains mixed). A weaker dollar is also positive for the external financing options of many lower-rated emerging markets.
Euro area: positive prospects
The euro area enters the end of 2025 with mixed, but overall positive, prospects. The early resolution of trade negotiations between the United States and the European Union and favorable waivers for automobiles, pharmaceuticals and semiconductors provided a short-term boost. However, the increase in US duties (15% versus the expected 10%) will offset the impact of the German fiscal stimulus, which is more substantial and concentrated in the initial phase. Meanwhile, exports are normalizing after a pre-tariff increase, cooling activity. “We maintain our quarterly growth forecast and – underlines Polan – we see the chances of an upward surprise reduced”. Growth models are also changing. Economies previously affected by the crisis, such as Italy and Spain, continue to outperform, supporting overall activity, thanks to EU funds and greater flexibility in their use, which also benefits the CEE region (outside the euro area). On the risk front, France’s sovereign spreads are widening, reaching their highest levels since the beginning of the year compared to bunds following the resignation of former prime minister Lecornu, while peripheral ratings are converging towards those of central countries. These outperforming countries are less exposed to energy or geopolitical shocks, adding resilience to euro area growth even as core economies come under pressure. Inflation remains subdued and we believe the ECB has essentially concluded its easing cycle, with a single cut expected in 2026 as insurance against downside risks. This position should reinforce the dollar weakness thesis discussed above. Risks, however, remain tilted to the downside if tariffs and uncertainty weigh more heavily on activity while inflation remains low.
