If it's not too late to say it, Happy New Year. Thankfully the Christmas period was relatively quiet, so this week is an opportunity to look forwards rather than review recent events
That said, recent days have given us a hint of some key themes for the year, not least plenty of political noise from incoming President Donald Trump – who had the annexation of Canada and purchase of Greenland by the USA on their 2025 bingo card? We have also seen rising bond yields as investors grapple with the outlook for inflation and growth against a backdrop of very high levels of government debt meaning governments are finding life difficult in balancing taxation and spending decisions.
2025 feels like a year where there is a very wide range of outcomes possible for economics, for politics, and for financial markets. Reading everybody else’s 2025 previews there seems to be an alarming amount of consensus on the year ahead – a decent year for the US economy while Europe and the UK will be weak and in the absence of any significant stimulus China will also underwhelm. The trouble is when everyone agrees generally, something else will happen, and for 2025 it is quite easy to paint both bullish and bearish arguments.
2025 – the bullish scenario
- Market friendly outcomes from President Trump – ‘bark worse than bite’ with noise on tariffs more a tool for negotiations than firm policy.
- Positive political news from Europe – maybe some pragmatism from Germany on government debt.
- Stimulus from China re-accelerates the economy.
- Equity markets continue their momentum with valuations not extreme and earnings growth continues and broadens.
- Some sort of peace prevails in Ukraine.
- Central banks are able to cut interest rates further as inflationary concerns dissipate.
2025 – the bearish scenario
- A trade war driven by Trump tariffs.
- A stagflationary economic environment.
- China failing to get out of the doldrums.
- Persistent political gridlock in Europe.
- Central banks unable to cut interest rates as inflation persists presenting a much more challenging backdrop for financial markets.
There is little chance that the year ahead will be that clear cut – the eventual outcome for the year will likely be somewhere in between these scenarios, with a few surprises along the way. We will now focus on some of the key points and the impact they may have.
Can we predict what Trump 2.0 means?
President Trump is less than two weeks away from his inauguration and ever since November everyone has been speculating over just what Trump 2.0 means. We know from his previous term in office that President Trump can shift the market mood with a single social media post but equally the stock market can influence a President who in his first term saw market performance as a barometer of his success. Another lesson from Trump’s first term in office is markets will at times overreact to Trump’s comments and it does take time to separate noise from actual policy. What is different this time is that Trump in 2016 was unprepared for office but this time will be able to hit the ground running which hopefully means some of the big questions over policy will get answered sooner rather than later. The big questions over tariffs are very hard to answer – we just don’t know if tariffs will be 10% or 100% or where they will be imposed but it is clear that Trump finds tariffs a useful negotiating tool and that they bring other world leaders to the table. Trump loves to negotiate and reach a deal so we can expect as we saw last time round plenty of noise and spectacle but eventually some sort of compromise and agreement.
It’s very easy to paint a positive or negative argument over the potential outcomes from a Trump presidency but what we do know is the clean sweep of Congress by the Republican Party, plus a Republican leaning Supreme Court, means the government does have plenty of scope to implement policy. Policy uncertainty is elevated, but we do know that Trump is minded to cut taxes, spend more and use tariffs as much as a political as an economic weapon.
The Biden Presidential era comes to an end with the U.S. consumer in reasonable health thanks to solid wage growth and falling inflation though the memories of inflation in the past few years certainly cost Kamala Harris and the Democrats heavily in the election. But U.S. households, helped a strong labour market, by COVID payments which took the edge off the inflation shock, the positive impact of house price inflation, and the wealth effect of two consecutive 20% gains in the S&P 500 are in pretty decent shape.
Can Europe catch a break?
We saw some solid returns from European equities last year despite a lack of political direction and leadership, sluggish economic growth, the ongoing energy price overhang from the Ukraine war, growing concerns over government debt levels and persistent weakness in manufacturing. With the Ukraine conflict potentially moving towards an inflection point, can we paint a better picture foe Europe? It appears possible. If nothing else, there is scope to beat very low expectations.
In France we have a new government which appears to have slightly more stable foundations than that of Michel Barnier’s brief tenure, while Germany moves towards an election next month that is likely to see all the main parties campaigning to loosen the debt brake which has constrained German public finances in an extreme fashion since the financial crisis. A little more political stability in France and Germany will be very welcome at a time when Europe is facing challenges from the U.S under Trump, but we have seen in the past that Europe is at its most pragmatic and decisive in terms of policy making when faced with such challenges. We also have support from the European Central Bank in the form of several more interest rate cuts to come and also from the post pandemic recovery fund much of which remains unspent. Europe could also benefit any potential stimulus from China boosting demand. It is also worth noting that many European countries that took significant economic and political pain during the sovereign debt crisis a decade ago, such as Spain, Portugal, Greece and Ireland are now seeing robust growth and are fiscally in far better shape than some of their counterparts.
Can China convert headwinds into tailwinds?
China continues to face significant headwinds with the root of all problems seemingly the property market where there remain 79 million vacant or unsold properties. Consumer confidence is very low and the savings rate is extremely high and well above pre pandemic levels. China also faces long term headwinds with the population in decline and the working age population now falling. There have been repeated hints from President Xi that the government is moving towards greater economic stimulus and such comments back in September sent Chinese equities up by over 30% in just seven days. But that surge in markets has faded with the fear we are going to see more incremental stimulus rather than a policy ‘bazooka’.
Much like elsewhere President Trump has a role to play here in that significant tariffs on China may well increase the potential for China to undertake significantly more stimulus with the Chinese authorities not wishing to be seen to ‘lose’ a trade war.
Can the UK find its economic mojo?
In the UK the mood music has changed quite significantly in recent months with a poor start for Keir Starmer and the new government having a tough first six months in office. The Labour government came to power acknowledging the fiscal challenges ahead but also targeting economic growth of 2 ½ percent a year driven by increased public sector spending as well as supply side reforms not least in the planning sector. However economic growth has stalled, business confidence is weak and consumer confidence remains fragile as consumers recover from a period of significant inflation the likes of which has not been seen for 30 years. The fiscal legacy from the previous government was always likely to constrain the new government’s ability to swiftly change the economic narrative but the budget in October, with notable increases in taxation on businesses has had a negative impact on both investment and hiring intentions. The budget also failed to convince the OBR to alter their growth expectations which means the Chancellor now has very little bandwidth to loosen fiscal policy from here.
While the government has promised no repeat of the October budget in terms of further tax hikes we are likely to see UK inflation remain sticky as businesses pass on the consequences of the National Insurance and minimum wage increases to consumers and this in turn means that the positive potential impact of interest rate cuts will be restrained because the Bank of England is likely to have limited scope to cut rates much further against the backdrop of inflation staying above target.
Where do central banks go from here?
The inflation shock of 2021-2023 is now moving out of the data with inflation coming down close to 2% across the US, UK and eurozone. However, recent numbers have been climbing once again as the base effects of the energy price falls come out of the data and persistent wage growth and services inflation keeps inflation above central bank targets.
It is also worth remembering CPI is a year-on-year measure. When considered at the index level the data highlights how prices are structurally higher. According to Bloomberg data, the Consumer Price Index in UK five years ago was at a level of 106; at the end of November, it was 135. Looking at inflation this way highlights why consumers have struggled in many places to cope with such an adjustment over a short space of time. All the same, central banks target year on year inflation and given the positive gap between interest rates and inflation (even though it is not at target) we expect to see further rate cuts over the course of this year. However, it won’t be long before central banks shift to more of a ‘wait and see’ stance.
In the US growth remains strong and there is significant policy uncertainty ahead under the new Trump administration, much of which could be stimulative and/or inflationary. Currently the Federal Reserve is expected to cut twice over the course of the year, but that view may change, and when it does, markets may not like it. In the UK the sticky levels of inflation may constrain the Bank of England in cutting rates further but another 50 basis points of rate cuts by the end of the year seems plausible. Given lower inflation pressures and a weaker economic backdrop the eurozone is more likely to see a greater number of rate cuts over the year. Â
A positive backdrop, but plenty of uncertainty.
To summarise, there’s a wide range of outcomes in 2025 – this is an uncertain environment but with interest rates coming down further, companies in decent shape and valuations outside of a few stocks not looking extreme there is scope for further upside in markets. The are however, plenty of potential curveballs with the most uncertainty around politics.
We are on a gradual path where the world is becoming more bifurcated between the US and China, with globalisation trends reversing and the supply chain trends of the pre pandemic era being rapidly rethought. Countries need to think about how they respond to tariffs and whether they negotiate, retaliate or try to mitigate via domestic stimulus.
As always, our views can and will change and these outlook commentaries tend to have a very short shelf life – maybe even more so this year with President Trump about to enter the White House. Where we’re positioned right now is still slightly positive in that we remain overweight equities and underweight cash. We are neutral on bonds with a preference for high yield bonds followed by investment grade bonds over government debt. Regionally we don’t have significant preferences for now outside of an overweight to US equities where despite strong returns, we see fewer headwinds than elsewhere for the moment.
Source: Columbia Threadneedle Investments as at 9 January 2025
