Key Trends and Challenges for 2025

By Raj Singh
Portfolio Manager, Multi-Asset

With the U.S. Presidential elections largely settled, investors are shifting focus back to macroeconomic and policy landscapes. The U.S. economy shows resilience, supported by strong consumer spending and healthy corporate balance sheets. The corporate sector remains robust, with ample cash reserves, providing a buffer against potential revenue declines. Prospects for deregulation under the new administration are boosting business sentiment.

However, concerns about a U.S. economic slowdown linger. While interest rate cuts could alleviate some weaknesses, the labor market's resilience is slowing inflation's return to the Federal Reserve's 2% target. Tariffs and restrictive immigration policies could exacerbate price pressures in 2025, complicating the justification for aggressive monetary easing barring a sharp slowdown in labor markets. The U.S. Fed reduced interest rate at its Dec 2024 meeting but flagged a slower reduction pace for 2025, while it continues to reassess level of neutral policy rate This evolution from a pivot to a cautious stance may means that interest rate relief will be limited for struggling sectors, intensifying the economic divide in the U.S.

China's economic prospects look uncertain. Donald Trump’s threats of increased tariffs underscore the need for proactive policy support. While hopes for a substantial fiscal stimulus have dimmed, some fiscal expansion may help cushion economic downturns. The disparity between U.S. strength and European economic weakness may widen in 2025 if Trump’s tariff threats materialize. Stagnant growth in Europe could lead to further disinflation, compelling the European Central Bank to cut rates more aggressively than the Fed. This global policy divergence may contribute to a modest slowdown in global growth and strengthen the U.S. dollar, potentially disadvantaging emerging markets. However, pockets of technological strength in Asia and India’s economic resilience could mitigate some negative trends.

Despite these challenges, positive signs are emerging. Strong economic conditions, rising corporate earnings, and favorable credit conditions create a supportive environment for global equities. In 2025, the U.S., China, and the EU are signaling stimulative policy actions that, barring inflation or geopolitical disruptions, should foster market growth. Optimism is bolstered by the possibility of U.S. policy catalyzing economic growth, as the new administration and Congress push for deregulation and tax reductions.

Such measures could enhance domestic capital formation, durable goods consumption, and M&A activity. While implementation details remain unclear, the overall trend leans toward pro-growth initiatives. This could create opportunities in economically sensitive industries, particularly in sectors like materials, capital goods, consumer cyclicals, and financials, while large cap U.S. technology companies may continue to benefit from strong earnings.

Innovation, especially in computing and life sciences, adds to the optimistic outlook. Advancements in AI are still in early stages but promise to boost productivity and economic growth. In healthcare, new treatments for weight loss could address significant health issues, potentially lowering societal healthcare costs. Globally, while it may seem the U.S. has driven equity market performance, countries like India and Japan have also shown strong growth. Nonetheless, volatility is expected to persist, with market sensitivity highlighted by the August 2024 global sell-off triggered by the Bank of Japan’s rate hike. Such rapid shifts can create concentration risks, but for long-term investors, this volatility may present opportunities.

In fixed income, yields have moved up significantly as markets reduced expectation of U.S. interest rate cuts in 2025 on potential inflation pressures from tariffs and tax cuts. However, the longer-term path for interest rates may trend lower, making extending duration advantageous. This strategy can help mitigate reinvestment risk and position portfolios for falling front-end yields while also providing cushion in portfolios if U.S. economic growth fails to meet elevated market expectations.

Credit spreads are likely to remain stable with a slight widening bias, supported by stable corporate fundamentals and attractive yields. The recent U.S. election outcome has positively impacted credit markets, fostering a pro-growth environment. Overall, fixed income remains a prudent choice, providing reliable income and opportunities for enhanced returns and investors would benefit from harnessing diversification in an evolving landscape.

This content was published on Hong Kong Economic Journal y on7 January 2025. (Chinese only)