March 2025
The new U.S. Administration’s platform represents a departure from the previous Administration’s agenda. Financial markets thrive on stability, whilst the new Administration’s governance style has introduced heightened uncertainty. As the financial sector continues to navigate this changing landscape, enhancing stress testing capabilities is critical to be able to simulate a wider range of scenarios, for example sudden regulatory overhauls, abrupt policy changes or political upheaval.
The need for expanded stress testing
The new U.S. Administration has a markedly different style from the Biden Administration’s approach to economic and foreign policy. Tariffs, tax cuts and de-regulation, together with the current global geopolitical environment and a major shift in U.S. policy towards Europe, have combined to increase uncertainty across financial markets, regulatory landscapes and global relations. This uncertainty has helped to underscore the importance of strengthening stress testing frameworks, to ensure firms are prepared for the unique challenges that could arise.
Political uncertainty and market volatility
One of the most significant impacts of the current U.S. Administration’s tenure on financial markets has been the nature of its policies. The Administration's approach to trade, fiscal policy, regulatory reform, and international relations has often been marked by rapid shifts in direction. For instance, the imposition of tariffs has led to market disruptions - such as losses and volatility across equity, FX and commodity markets – for which many financial institutions were not fully prepared. Firms should therefore seek to incorporate potential geopolitical tensions and trade policy shifts into their stress testing models.
Geopolitical risks and changing trade relations
Beyond the domestic policies of the current U.S. Administration, the broader geopolitical ramifications should not be overlooked. Its stance towards international allies, withdrawal from multilateral agreements like the Paris Climate Accord, and approach to military alliances such as NATO have impacted geopolitical risk. Such factors have combined to create a more volatile operating environment, and trigger currency fluctuations, regulatory changes and trade disruptions.
The critical role of stress testing in financial stability
Stress testing is a vital risk management tool that can be used to evaluate how firms might withstand adverse economic conditions. Traditional models focus on economic recessions, interest rate fluctuations, and housing market downturns. However, political uncertainty can be just as destabilising, requiring enhanced stress testing methodologies. Current stress testing approaches might not be designed to accommodate such fluctuating uncertainty to draw out the financial impacts on firms.
Enhancing stress testing capabilities
Stress testing is a useful tool that enables businesses to manage areas with elevated risk and volatility proactively. Firms should continue to innovate and adapt their stress testing capabilities to accommodate finance, business, and risk expectations. This requires incorporating more granular and agile models that can simulate the effects of political uncertainty, sudden policy shifts, and extreme geopolitical events, including:
- Trade policy shifts: modelling abrupt changes in tariffs and their effects on global supply chains both 1st and 2nd order.
- Social and political factors: using sentiment analysis, social media trends, and political risk assessments.
- Geopolitical instability simulations: evaluating the effects of military tensions, trade wars and regulatory changes on market stability.
The illustrative scenarios below should be expected to have varying impacts in different parts of the world, with some economies demonstrating resilience while others potentially struggle to cope with the shocks. The scenarios highlight the interconnectedness of the global economy and the potential for cascading effects from political instability and economic uncertainty.
Key scenarios and their possible impacts on financial markets
| Scenario | Potential impacts |
| Escalating trade wars | Decline in global trade, supply chain disruptions, increased consumer prices. This scenario results in inflationary pressures, rising consumer prices, and declining GDP growth. |
| Geopolitical instability | Rising global tensions lead to market disruptions, flight to safety with capital outflows from emerging economies, and increased demand for safe-haven assets like gold. This scenario could lead to a decline in social cohesion, impacting economic activity and investor confidence. |
| Economic policy uncertainty | Unpredictable fiscal and monetary policies create volatility in markets, leading to reduced business investments, fluctuating interest rates, and increased risk premiums. Investor confidence may wane, leading to lower stock prices and constrained credit markets. |
| Financial market disruptions | A sudden financial shock—such as a major market crash or bank failure—causes large-scale selloffs, credit contractions, and liquidity crises. Investors react by shifting capital to lower-risk assets, further exacerbating volatility. |
The above scenarios highlight an urgent need for more agile stress testing capabilities that can be adapted to emerging events. This in turn can help drive firms’ ability to create timely risk intelligence to manage their businesses and risk profiles at volatile times. Failure to do so could lead to increased unexpected financial losses and bring increased regulatory scrutiny.
As a priority, firms should ask themselves the following:
- Do our existing stress scenarios adequately capture ongoing geopolitical events and trade risks?
- Does the scenario expansion and parameterisation accurately assess the correlations and impacts of financial and non-financial events on the business and risk profile? Are the 2nd and 3rd order impacts understood?
- Have the sector-specific risks and sensitivities been understood to focus efforts on high-risk areas and we have considered correlations within and across portfolios?
- is the speed of the stress testing process sufficient to support timely business and risk decisions in a rapidly evolving environment?
Watch out for more specific analysis in our next article. In the meantime, contact Andrew Fulton, Steven Hall or Kaie Uukkivi for more insights and consultation.
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