Tariff impact and Fair Value implications

U.S. President Donald Trump unveiled a two-tier tariff framework in April 2025 with a 10% baseline and reciprocal tariffs on 60 countries, based on trade deficits, triggering global economic shock and reactions.

While numerous market updates have followed since initial announcement, most notable was on 12th May 2025 where US and China agreed to revise their tariffs with US dropping their share from 145% to 30% while China dropping the retaliatory tariffs to 10% from 125%.

Despite the reduction, the core uncertainties stemming from the initial policy shifts persist. Although the recent reduction has provided temporary relief, widespread concerns remain among investors about the potential for deeper, long-term structural disruptions.

Market reactions globally

Global asset markets, particularly equities and fixed income, faced sharp turbulence amid rising uncertainties, with volatility reaching pandemic-era levels.

A significant sell-off led to a 13% drop in indices like the S&P 500 in a single day. Currency market volatilities surged by 25%, especially impacting high-tariff and economically weaker nations.

This environment necessitates adjustments in valuation models due to increased volatility parameter uncertainty and less observable market inputs, potentially shifting valuations to Level 2 or 3 in the Fair Value Hierarchy. Additionally, heightened intra-day fluctuations may affect FX rate cut-offs and raise concerns over hedge effectiveness.

However, the May 2025 tariff pause between the U.S. and China has provided temporary relief, stabilizing equity markets and reducing short-term volatility, though underlying uncertainties remain.

Trend in capital markets

Capital markets, particularly credit, responded negatively, with five-year investment-grade and high-yield credit default spreads nearly doubling, signalling heightened default risk expectations.

Central bank interventions led to a drop in USD rates, lowering the Federal Funds Rate to 4.25–4.5%. Asset-backed markets, especially CLOs, saw wider bid-ask spreads, indicating potential future illiquidity.

These shifts intensified one-sided interest rate derivative exposures, increasing counterparty credit risk. Rising market-implied credit risks and spread widening affect CVA and DVA calculations. CLO spread widening reflects uncertainty in underlying assets, posing downgrade or default risks.

Together these changes are likely to impact market breadth and affect observability of fair value hierarchy inputs. The May 2025 agreement to pause tariffs has helped ease some credit market stress, with tightening spreads and a rebound in investor sentiment, though concerns over long-term credit risk and liquidity persist.

Reactions in treasury markets

The financial sector faced severe repercussions, notably in treasury markets. A ‘Flight to Safety’ drove demand for US treasuries, pushing 10-year yields to 5% by April 2025. This surge was also driven by basis trades in the Fund industry.

Tariffs triggered volatility spikes, leading to uneven unwinding of basis trades, collateral calls on treasury bonds, and margin calls on futures, potentially causing a "long squeeze" and constraining market liquidity. Treasury market volatility impacts valuation, as treasuries anchor interest rate curves industry wide. These spikes complicate benchmark construction and heighten valuation uncertainties across the financial landscape, adding further stress to the system.

The recent negotiations between US-China have slightly calmed treasury markets, easing yield pressures and reducing immediate volatility, though structural risks from prior dislocations remain unresolved.

Private sector landscape

The private sector, especially firms reliant on foreign supply chains, faces mounting valuation challenges. Debt investments in highly leveraged companies are at risk, as tariffs strain operations and prompt creditors to reassess recoveries.

Early-stage or distressed companies face even greater scrutiny regarding recoverability and impairment, necessitating detailed evaluations.

Revenue and cost uncertainties complicate future projections, making Discounted Cash Flow models more prone to forecasting errors. Alternative valuation techniques are equally impacted as significant adjustments will be required in comparable selection methodologies and market data on precedent transaction metrics might be skewed raising concerns around its reliability.

Although the new developments offer temporary relief to supply chain–dependent firms, slightly easing operational pressures, but it does little to resolve deeper valuation uncertainties or long-term risks for distressed and highly leveraged companies.

How KPMG can help

KPMG’s Financial Instruments (KFI) team consists of thirty people who provide expert and business-orientated independent valuation services, tailored to the unique requirements of our clients.

KPMG provides expert guidance on fair value determinations, ensuring adherence to industry standards and best practices. With the changing climate, we can help navigate challenges in choosing the most appropriate inputs, model and assumptions.
We assist in classifying securities within the fair value hierarchy, including analysis of unobservable inputs and their significance tests.
We monitor market conditions and financial reporting standards, using proprietary and top tier third-party data for accurate pricing.

The KFI team is readily available and eager to engage with you to identify the right solution for your business. We look forward to hearing from you.