Positive economic trends will drive markets in 2025 in spite of politics
Geopolitics intrudes into the outlook for markets and economies in a way that we haven’t seen for a very long time. However, while fast-shifting politics are likely to be the biggest influence on any given day, in terms of 2025 overall, we think that the positive currents for the major economies and risk assets will predominate.
Our positive forecast does make a couple of significant assumptions.
- The radical and disruptive agenda of the Trump presidency will be constrained by the reactions of the equity and bond markets from inflicting direct and serious damage to the US economy.
- The negative impact of tariffs will be partially offset by domestic stimulus measures in the countries affected e.g. China.
Economic growth, falling inflation and lower interest rates should drive favourable returns from risk assets. The outlook for the US economy and equity market appears strongest, though Europe appears set to outperform over-pessimistic expectations. The UK will be a laggard, as inflation moves the wrong way and interest rate cuts are stalled, though even here modest economic growth is likely to be sustained.
Core inflation stalls
Source: macrobond, as of 25 February 2025
US economy appears set fair despite headwinds and squalls from the Trump political agenda
Declining US inflation delivers real earnings growth for the US consumer. With wage inflation following the downward trend of consumer inflation, the Federal Reserve has room to cut interest rate cuts. Lower interest rates are supporting an improvement in credit availability for businesses. These factors combine to produce a supportive backdrop for continued US economic growth in 2025.
The tariffs and other disruptive policies of the new Trump administration do come with an economic cost. We can see a sharp negative impact on the latest Purchasing Managers’ Index (PMI) of activity, although that is probably overstated by the increased partizan divide observed in US economic surveys in recent years.
The stock market reaction to the imposition of tariffs on Mexico and Canada prompted a month’s delay to implementation. Since then, market reactions to new announcements have been more muted. This is a dynamic equilibrium, but political sensitivities over the stock market and economic sensitivities to Treasury yields, especially given the extent of the Federal debt, are likely to act as a constraint on policies that have a direct, negative impact on the economy.
US wage growth slowing
Souce: Columbia Threadneedle Investments and Bloomberg as at 25 February 2025. The Atlanta Federal reserve Wage Tracker is 4 month moving average and averages 0.6% above the ECI.
Europe set to outperform over-pessimistic expectations
We can see an ongoing recovery in consumer spending in Europe, as confidence has recovered from the lows of the Russian gas crisis. Consumer confidence is still below average levels and the current rise in natural gas prices is unhelpful. However, Europe gas futures show a clear downward trend over the next five years as new supply comes online and renewables lift domestic energy production.
Wage inflation is gradually declining as lower headline inflation slowly filters through into indexed pay rises, while a sluggish economy caps wage rises despite unemployment at record lows. This will allow the European Central Bank to continue its dovish policy of interest rate cuts, supporting activity and consumer spending.
Europe faces a series of national and regional political crises, some structural and some from the policies of the new Trump administration on tariffs and Russia. However, these crises are currently triggering positive responses rather than the usual muddle and indecision. New US policies have been met with a coordinated European diplomatic response to-date. The recent election in Germany seems set to deliver a stable government, an outcome that could not have been relied on beforehand.
Consumers in Europe are beginning to spend again
Eurozone retail sales volume, seasonally adjusted
Souce: Columbia Threadneedle Investments, Bloomberg and Macrobondas of 25 February 2025.
UK has a very tricky six months in prospect, struggling with low growth and high inflation.
Some of the UK’s problems are externally driven. For example, three-quarters of the increase in gilt yields can be linked to shifts in the yields of US Treasuries. However, the current government has not helped itself with policies that have acted to push up gilt yields, inflation and will likely postpone interest cuts until inflation at least stops rising.
The current rise in energy prices is likely to suppress UK consumer spending and sentiment, postponing any domestic recovery. However, continued US growth and an economic recovery in Europe are both positive, external factors that should support modest growth in the UK economy.
The Bank of England pre-emptively cut interest rates based on their own, unreliable, forecasts of falling wage inflation. The Bank of England would be better advised to hold off further rate cuts, despite the weak economy. Retaining confidence in the central bank and anchoring longer-term inflation expectations will be increasingly important as we expect inflation to peak at 3.7% this year.
Futures prices for delivery in January 2026, USD MMBtu
Souce: Columbia Threadneedle Investments, Bloomberg and Macrobondas of 25 February 2025.
Low inflation and falling interest rates make equities attractive, but there’s a lot priced in.
Low inflation and falling interest rates make risk assets attractive, especially in the US. There’s a lot priced into existing equity valuations, again, especially in the US. However expensive valuations have not historically stopped further appreciation, rather they have increased losses when recession hits. Our assessment that the US economy is set fair means that the outlook for equities remain positive.
Gold continues to shine. It has broken its previous inverse relationship with interest rates, rising even as real yields have increased. This reflects a flight to safe havens in the face of geopolitical uncertainty. It also reflects the reassessment of what constitutes a safe haven, as Western governments have extended banking sanctions and frozen Russian foreign currency reserves, as well as bank accounts of a significant number of individuals.
Gold surges on geopolitical scares despite rising rates
Souce: Columbia Threadneedle Investments, Bloomberg as 25 February 2025
