(Bloomberg) -- Goldman Sachs Group Inc. is turning more cautious on US credit and equity markets, becoming the latest on Wall Street to sound the alarm as the world's largest economy is battered by President Donald Trump's escalating trade war.
Goldman strategists sharply raised their forecasts for US credit spreads, citing tariff risks and signs that the White House is willing to tolerate short-term economic weakness. The bank also cut its year-end target for the S&P 500 index. At the same time, Goldman's teams raised European earnings estimates and expect the region's credit spreads to show more resilience than the US.
"We are revising our spread forecasts wider to levels that demonstrate a more persistent repricing of risk premium, especially in the USD market," Goldman credit strategists led by Lotfi Karoui wrote in a note. The bank now expects US investment-grade bond spreads to hit about 125 basis points in the third quarter compared with their previous estimate of 84 basis points.
For equities, a team led by David Kostin cut their year-end S&P 500 target to 6,200 points from 6,500, citing a dimmer outlook for economic growth and reflecting this year's slump for the Magnificent Seven group of stocks. The new target implies an 11% gain from Tuesday's close.
US markets have been volatile this year amid concerns that Trump's proposed tariffs will stoke inflation and stall economic growth. But things have escalated rapidly this week. Levies of 25% on steel and aluminum imports came into force Wednesday, triggering an immediate reprisal from the European Union, while a flurry of headlines — including Trump threatening to double metals tariffs on Canada to 50% — have added to investor nervousness.
US investment-grade credit spreads widened to 94 basis points, the highest since September, on Tuesday, according to a Bloomberg index. Still, Goldman's Karoui said that current spread levels are still too tight. "Since the first tariff headlines broke in early February, our message has been simple: add hedges and brace for some rebuild in premia," he wrote in the note published on Tuesday.
As for US high-yield debt, the strategists now expect spreads to reach 440 basis points in the third quarter versus an earlier projection of 295 basis points. Junk-bond spreads are a good indicator of perceptions about the economy, with speculative-grade companies seen as less likely to default if the growth outlook is good, and investors therefore willing to accept a lower premium for the debt.
In the equity market, a 9% drop for the S&P 500 from a peak in February has prompted a chorus of strategists to take a more cautious view. Teams at Citigroup Inc. and HSBC Holdings Plc downgraded their recommendation on US equities this week, while Morgan Stanley's Michael Wilson expects the benchmark to drop as much as 5% to 5,500 in the first half of the year.
Europe's Resilience
While concerns over the US outlook rise, strategists have been getting more bullish on European assets on optimism around higher fiscal spending and an improving economy. The Stoxx Europe 600 Index is on track to outperform the S&P 500 by the most on record this quarter in dollar terms.
Goldman raised its forecast for Stoxx Europe 600 earnings-per-share growth in a separate note on Wednesday. Strategists led by Lilia Peytavin now expect 4% EPS growth for 2025 and 6% for the following two years. "This upgrade reflects a stronger medium-term economic growth outlook in the Euro area and tailwinds from a weaker Euro compared with our 2025 outlook," they wrote.
The dichotomy is bleeding into credit, with investors now demanding a bigger premium to hold junk-rated US debt versus the European equivalent for the first time in two years and investment-grade bonds showing signs of resilience compared with the US.
Goldman's Karoui expects euro-denominated credit markets to hold up better than the US. "In the EUR market, we expect more resilience given a more supportive growth backdrop, but the direction of travel is also wider, mostly in sympathy with the USD market," he wrote.
That relative attraction is also now showing up in the pricing of debt deals. Scientific measurement company LGC Group's €2 billion-equivalent amend and extend deal this week included a 50 basis point discount on the dollar tranche to tempt US investors. The euro tranche priced at par.
Goldman's strategists have been relatively successful in their estimates for US credit spreads in recent years, even when their initial calls weren't in vogue. They correctly predicted in December of 2023 that both US investment-grade and junk bond yield premiums would decline in 2024.
Still, Karoui doesn't expect credit spreads to widen to recession levels. "Rather we view this as a realignment of risk premia to higher macro volatility."
--With assistance from Esteban Duarte, Catherine Bosley, Michael Msika and Claire Ruckin.
(Updates with details throughout.)
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