2025 H1: What investors should expect

Dated: 3rd December 2024

Donald Trump’s return to the presidency, alongside the Republican Party’s sweep of Congress, has set the stage for a potentially transformative year in global trade and economics. With the 20 January inauguration fast approaching, all eyes are on Trump’s next moves as he reshapes US policies on tariffs, corporate taxes and immigration.  

The broad strokes of his agenda are clear, but the finer details remain to be seen. We expect Trump will move quickly to deliver on campaign promises, but tread cautiously to avoid alienating voters or jeopardizing Republican control of Congress ahead of the midterm elections.  

Additional tariffs seem inevitable – our baseline expectation is a 10% universal tariff – but they may also be used as a bargaining chip to win concessions from trading partners.

This strategy, a hallmark of Trump’s first term, is already yielding results. The threat of a 25% tariff on Canada and Mexico has brought Prime Minister Trudeau and President Sheinbaum to the negotiating table.  

As the chart shows, these two nations are among the most vulnerable to US trade policy, with a significant share of their exports destined for the US and a substantial portion of their GDP tied to this trade.

While the willingness of trading partners to negotiate reduces the likelihood of a full-blown trade war, we don’t rule out an escalation. Should Trump adopt a more aggressive stance and other countries retaliate, the resulting disruption would weigh heavily on global economic growth. The broader themes of protectionism and the use of trade policy for non-economic objectives look set to dominate the global stage as we head into 2025.

Expectations for the US economy are too pessimistic in our view, but there is greater uncertainty around forecasts than usual given the return of Donald Trump to the White House. 

Slim Congressional majorities should temper his more extreme legislative proposals. Even so, they will be sufficient to extend his expiring tax cuts and support his deregulatory efforts. And while we expect him to implement protectionist policies, we doubt they will include a universal baseline tariff, nor excessive barriers to Chinese imports. Likewise, we suspect his promise to expel up to 20 million illegal immigrants will go unfulfilled. 

We believe Trump’s pro-growth policies, along with relatively mild supply-side measures, will boost growth to around 2.5% in 2025 with a further acceleration to 2.7% in 2026. Stronger growth necessitates upgrades to our inflation forecasts on top of the impact from higher tariffs, which we assume are applied in a targeted, measured manner. 

Immigration restrictions could be a bigger inflationary factor. Even limited action here could have a material impact given the US economy’s reliance on foreign labour in recent years. We look for CPI inflation to average 2.4% next year before rising to 2.7% in 2026. 

Such a reflationary environment would not only limit the scope for further easing for the Fed, it would also put rate hikes back on the table. We now expect the Fed to cut rates by only another 50 basis points (bps), split between its December and March meetings, and then raise rates by 50 bps in 2026. 

Admittedly, its function might be distorted if its independence were to be undermined by the incoming administration. But our view is that the guardrails are sufficient to ward off any risk of this. A fear of reprisals from the market may have the same deterrent effect.

The UK labour market is facing a chilling reality. Despite a minor recession in 2023, unemployment has remained surprisingly low at around 4%. This stability might seem reassuring, but a closer look reveals cracks beneath the surface. Hiring has plummeted, job transitions have slowed, and new pressures from government policy are adding strain.

Hiring activity, as measured by total hires throughout Q3, has fallen below pre-pandemic levels. This is a sharp reversal from the hiring boom seen in 2021 and 2022. One driver is the significant drop in job-to-job transitions – a key source of labour market churn, accounting for over 40% of hires. These transitions have now plunged to fewer than 600,000 workers, a level that underscores just how weak the labour market has become.

The Autumn Budget introduced by Labour has added to employers’ anxieties. Key policy changes, including a steep increase in the minimum wage and higher employers’ national insurance contributions, will significantly inflate costs starting April 2025. Low-margin sectors like retail and hospitality are expected to feel the hardest pinch. Unsurprisingly, major employers have already warned that these measures could further dampen recruitment.

A leading indicator of hiring momentum is demand for human resources roles, as companies tend to ramp up HR hiring when recruitment plans pick up. As this chart shows, online job postings for HR positions have sharply declined after peaking in 2022.

The UK faces a tough road ahead as rising labour costs and subdued economic growth weigh on hiring activity. Addressing the challenges of a stagnating labour market will be essential to reviving momentum and restoring confidence. Without timely intervention, the current freeze in hiring could harden further, leaving both employers and job seekers out in the cold in 2025.

Long-dated gilt yields have climbed back to ranges last seen before the global financial crisis, levels that first emerged after the Bank of England (BoE) gained operational independence in 1997, which allowed it to set interest rates independently and stabilize inflation expectations. 

As the first chart below shows, these yields historically hovered within a 4% to 6% range. The reversion to these levels signals a normalization in bond markets, sparking renewed buying interest from domestic investors seeking reliable returns. 

Valuations matter 

Notably, long dated gilt yields have now risen sharply above equity yields, as shown in the second chart. This development shifts the valuation balance, favouring gilts in the bond-equity yield gap – a long-standing metric guiding asset allocation decisions. This should encourage further buying from investors looking to hold a diversified portfolio. 

With inflation receding and monetary policy expected to ease gradually, short-dated bonds stand to gain from lower rates, offering tactical opportunities for investors seeking near-term stability.  

Meanwhile, the steep yield curve, illustrated in the third chart, underscores the benefits of holding long-dated bonds, as their higher yields provide a cushion against potential rate adjustments. 

However, not all segments of the curve offer the same appeal. The intermediate maturities, heavily targeted by new issuance, present rich valuations and may lack the risk-reward appeal found elsewhere. Investors should weigh these dynamics carefully, balancing exposure across the curve to optimize returns while managing risk.

As investors look ahead to 2025, many of our recent discussions with clients have focused on how the incoming Trump administration’s policies might shape the US and global economic landscape. Will the agenda lean towards traditional Republican causes such as deregulation and cutting taxes, or pivot to more unorthodox measures, such as raising tariffs, stricter immigration policies, and attempts to gain influence over the Fed’s monetary policy.  

While many are drawing lessons from Trump’s first term to predict what lies ahead, there are important differences between then and now. Eight years ago, the US economy arguably required some kind of inflationary jolt. Today, the context is different. The economy has far less slack, as shown in the first chart, where both the unemployment gap and output gap are estimated to have closed. 

The lingering effects of the 2021-22 inflation shock, ongoing large federal government deficits, higher levels of government debt, and a narrower gap between inflation-linked Treasury yields and potential GDP growth – highlighted in the second chart – further complicate the policy environment. All this suggests that policies that worsen the trade-off between growth and inflation or persistently widen the deficit will have a larger effect on the future trajectory of government debt. Financial markets may be less forgiving of policies that push in those directions.

We at Absolute Strategy Research believe these constraints could serve as a moderating force. Bouts of market volatility might act as a periodic reminder of these challenges, and steer policy toward those that support growth. Ultimately, this leaves us optimistic about the broader outlook for the US and global economies. 

As 2024 unfolded, the narrative of US exceptionalism held firm, buoyed by a resilient labor market, strong consumer spending and high productivity growth. These factors drove upward revisions to US productivity and GDP growth forecasts, reinforcing higher yields and fueling the dollar’s stellar performance. 

Looking ahead, it’s hard to bet against these gains extending into 2025 – unless the US economy stumbles, or its peers improve. The productivity gap between the US and key global economies – as seen in the first chart below – highlights this divergence. While US productivity has climbed steadily to a 76% gain since 1990, the combined average of the UK, Germany and Japan remains subdued at 36%. This disparity highlights the structural advantages underpinning US economic resilience.

We expect consumer spending will remain a key driver for US economic growth, supported by falling inflation, lower interest rates, and wealth effects from a rising stock market. The dollar’s cyclical strength got an extra boost with Donald Trump’s return to the Presidency, reviving the so-called “Trump trade.”

Expectations of fiscal expansion have driven US yields higher, widening the 2-year swap rate differential with the Eurozone. As the chart below shows, these dynamics are reflected in the parallel declines of the EUR/USD exchange rate and the swap rate differential since September 2024. 

Meanwhile, the euro, already down nearly 7% in just two months, faces additional headwinds.  Speculative net short positions in the currency could grow further, especially given rising risk premiums tied to political uncertainty in France and Germany. This leaves little standing in the way of EUR/USD slipping toward parity by 2025.

But not all paths point to a stronger dollar. A cyclical recovery in the Eurozone, buoyed by surprise fiscal stimulus from Chinese or European policymakers, could shift the narrative. Similarly, fears of substantial tariff-related economic disruptions – baked into the current market outlook – may prove overblown. Finally, there’s the contrarian angle: the consensus firmly backs continued dollar strength, but markets often have other ideas. 

As we approach 2025, one thing is certain: volatility, which has been notably subdued, is primed for a resurgence. Whether it’s the push toward parity or a surprising reversal, we’re keeping a close eye on all signals – including the “Tariff man” and his next move.

The UK is emerging as a rare bright spot in Western Europe as we head into 2025, with growth outpacing much of the region. We can thank the recent Autumn Budget for much of the anticipated 1.4% growth in the coming year. It combines significant tax hikes – set to raise the equivalent of 1.5% of GDP in additional revenue – with even larger increases in spending. 

Government departments, particularly the health service, are set to benefit most from this spending spree. A considerable portion will flow into wages, which should boost consumer demand. The fiscal multiplier is likely to be relatively high, underpinning growth. Still, we are less optimistic than the government’s independent forecaster, the Office for Budget Responsibility (OBR), which forecasts 2% growth for 2025. 

Looming challenges include Donald Trump’s recent victory in the US presidential election, which brings the spectre of protectionism back to the forefront. While the UK is less exposed than export-driven economies like Germany, the US remains Britain’s largest trading partner. Around 70% of UK exports to America are services and thus largely immune to the threat of tariffs. But uncertainty in trade policy could still weigh on business confidence and planning.

The labour market presents another layer of complexity. Payrolled employee data reveals a cooling jobs market when government-heavy sectors are excluded. While public sector hiring has driven an impressive recovery, employment in other sectors has dipped, with vacancies below pre-pandemic levels. Recent tax hikes, such as the National Insurance (social security) increase that raises employer contributions by 20% for an average-income worker, are likely to dampen hiring further. 

If UK growth does fall short of the OBR’s forecasts, there’s a strong likelihood that more tax increases could follow in the autumn. For now, the outlook reflects a mix of resilience and risk, with recovery resting heavily on public sector strength and fiscal policy.

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The UK retail industry heads into 2025 with cautious optimism, buoyed by resilient consumer demand but shadowed by significant business challenges. Retailers are operating in a landscape shaped by competing forces: steady sales growth and looming tax increases. 

Inflationary pressures, which rose to 2.3% in October 2024, are expected to persist following announcements in the Autumn Budget. While these pressures weigh on household budgets and real incomes, retail sales volumes are still higher than they were a year ago, thanks to strategic discounting and consumer spending on essentials. However, discretionary spending remains at risk, constrained by rising savings rates and broader economic uncertainties. 

Economic growth is forecast to reach 1.5% in 2025, yet the broader picture remains challenging. Businesses face persistent cost pressures, including higher employer taxes, wages and energy costs, and supply chain disruptions. Many retailers are expected to lean on innovative pricing and value-focused strategies to strengthen consumer sentiment.

Structural shifts are also evident in the jobs market. Retail vacancies remain 38,000 below pre-pandemic levels. Rising labour costs, paired with proliferating automation – such as self-checkouts now extending beyond supermarkets to fashion retail – are likely to accelerate the decade-long decline in retail jobs. Businesses will need to balance operational efficiency with competitive compensation to attract talent. 

Encouragingly, interest rates are likely to ease further in 2025, offering some respite for credit-reliant businesses and mortgage-burdened households. While insolvencies in retail trade remain high, their recent decline suggests a tentative sign of stabilisation in the industry. 

For the year ahead, adaptability will be key. Retailers embracing digital transformation, refining customer engagement, and leveraging data-driven insights will find opportunities to thrive in a cost-sensitive market. Despite the headwinds, 2025 holds promise for those ready to innovate and stay ahead in a cost-sensitive market.

After a turbulent few years, optimism is making a comeback in Global real estate markets. The cyclical pressures weighing on property values and investment activity are beginning to unwind, paving the way for a recovery in real estate capital markets. While still nascent, this recovery should gather momentum in the year ahead. 

Though headline transactional data has yet to reflect a rebound, other indicators show more promise. Sentiment has improved significantly from last year’s lows, broadly following the path of interest rates. As shown in the chart, the Sentix Real Estate Sentiment Index has risen as interest rates have fallen, reflecting how improving financial conditions are bolstering investor confidence. 

Elsewhere, pricing appears close to bottoming out, with prime properties starting to face competitive pressure as investors seek to time their re-entry into the market. 

Investors tend to follow the trends set by occupiers in real estate. But this cycle has been anything but typical. Occupational markets have generally mirrored the resilience of the global economy, while liquidity in capital markets has fallen back to levels last seen during the global financial crisis. 

In 2025, we expect fundamentals to anchor the market once again. Falling interest rates and a stable economic outlook should create a more favourable investment environment. But as interest rates settle at a higher base, risk premiums will likely remain squeezed, making rental growth a critical factor for returns in the next property cycle.

On January 20, Donald Trump will begin his second term as President of the United States. However, the economic landscape he inherits this time will be vastly different from the one he faced in 2016. While uncertainties persist about the policies his administration will implement, one thing is clear: the US economy is far more fragile now than it was eight years ago.

Let’s start with the labor market. In 2016, it was improving, with falling unemployment and solid job creation in the private sector. Today, the picture is markedly differently. Unemployment has been rising steadily for the past 18 months, and private sector job creation – excluding the resilient health and education services sector – has dwindled to an average of just 32,000 jobs per month over the last six months. Compare that with the 150,000 monthly average in the same period in 2016.

Secondly, the industrial sector, which was experiencing a cyclical recovery in 2016/20, now shows signs of stagnation. Back then, corporate tax cuts implemented at the start of Trump's first term helped accelerate an already positive trend in industrial activity. But by 2025, the fiscal impetus is expected to be much more modest, likely insufficient to revitalize the sector amid sluggish industrial production and declining capacity utilization.

And finally, in late 2016, core Consumer Price Index (CPI) inflation stood at just 1.4% year-over-year, with economic debates often centered on fears of deflation. At the time, the reflationary effects of Trump's policies were welcomed. Today, the situation has flipped. After a period of high inflation, consumers are now acutely sensitive to price rises. Any renewed pressure on inflation could have a major impact on household consumption, adding another layer of vulnerability to the economy.

Compared to 2016, the US economy in 2025 resembles a china shop – with Donald Trump playing the role of the bull. The strength of recent growth belies deeper structural challenges, requiring a degree of caution ahead. Yet, market valuations appear to reflect an overly optimistic scenario.

The BoJ raised its policy rate to 0.25% in July. Since the policy rate is highly accommodating, as suggested by various policy rules, the BoJ will likely continue adjusting its degree of easing towards a neutral rate of interest.

Japanese companies have changed their price and wage-setting behavior by passing on cost increases to their sales prices since 2023 and by raising wages significantly in 2024 amid severe labor shortages. Wage increases have also begun to be reflected in sales prices. Since the labor share hasn’t increased this year, there is room for further wage hikes, especially in large companies, and base-wage rises from spring wage negotiations in FY2025 will likely match or be slightly above this year's result. This would be passed on to prices, so even if rising import prices fade, the CPI is expected to remain at around 2%. 

The BoJ is expected to raise the policy rate to 0.5% in January 2025 if it becomes more confident that the wave of wage increase in FY2025 will spread to SMEs, and if it's reasonable to believe that a negative economic shock from US President Trump’s tariff policy is unlikely to disrupt the economic recovery, as Japan can partially replace Chinese exports to the US.

More importantly, however, will be the extent to which the BoJ raises interest rates. The level of the neutral rate of interest and natural rate of interest behind it, are crucial here. The BoJ has published natural rate estimates based on various models as a starting point for discussions on where the natural rate stands, which vary between -1.0 and +0.5% as of 2023. Japan’s potential growth rate, which defines the major trends of the natural rate, is recovering after having sunk due to the pandemic. Furthermore, in terms of the savings/investment balance, the continued expansion of fiscal expenditure since the pandemic will act as a factor absorbing savings, while the increased issuance of government bonds and reduced purchases of government bonds by the BoJ will reduce the scarcity premium of government bonds as safe assets, which will also raise the natural rate. Thus, it is appropriate to see the natural rate at around 0% as of now, slightly above the average of the estimation results, with range of error. Adding the long-term trend of the inflation rate, the neutral rate is estimated between 1.5 and 2.0%. Market participants would then be useful in adjusting the terminal rate that the BoJ will reach, while adjusting the view of the neutral rate based on the response of the economy whenever the BoJ raises the policy rate. We expect the BoJ to raise the policy rate to 1% during FY2025, beyond which the BoJ policymakers will continue to explore the terminal rate by discussing the level of the neutral rate.

While it is important for the BoJ to carefully assess the outcome of any rate hike, there is also risk of distortions to the economy if the process of reaching the neutral rate is too slow. This could involve higher-than-expected inflation which might be reinforced if the yen depreciates rapidly, or exuberant asset prices as evidenced partially by rising Tokyo condominium prices.

In the first half of 2025, we expect to gain greater insight into the policy proposals the Trump administration plans to implement. Until then, forecasting the impact on the economy and inflation will remain challenging. However, examining underlying economic trends can provide perspective in early 2025 and their potential impact on monetary policy and global financial markets.

The labor market is cooling, with the labor supply-demand imbalance of the post-pandemic era easing. Aggregate labor demand, measured by the sum of filled and unfilled jobs, has remained flat over the past three years, allowing labor supply to catch up. Although demand still exceeds supply by 761,000, levels are returning to those seen in 2019. This normalization should help alleviate wage pressures, bringing wage growth closer to the Federal Reserve’s 2% inflation target.

Core inflation, as measured by the Consumer Price Index (CPI), excluding food and energy, is currently at 3.3% year-over-year, higher than many forecasts. This inflation is largely driven by persistent shelter inflation. However, there are signs that shelter inflation could normalize to pre-pandemic growth rates. Alternative measures of rent inflation, which tend to lead the official CPI owners’ equivalent rent data, have decelerated to or below pre-pandemic levels. Given that shelter inflation constitutes over 40% of the core CPI basket, its deceleration could help bring overall inflation rates back toward the Fed’s 2% target in the coming quarters.

A benign inflation environment could allow the Fed to continue its rate-cutting cycle, steepening the U.S. Treasury yield curve. With over $7 trillion in money markets earning front-end yields, a steeper yield curve could attract these assets further out into higher-yielding credit. 

The dollar appreciated again during 2024 against the main developed and emerging currencies. Thus, the dollar rose by 5% against the euro, by 7% against the Japanese yen and remained stable against British sterling. Against the emerging countries, the dollar appreciated significantly against Latin American currencies (20% against the MXN and 25% against the BRL) but also against the yuan (2%). In addition, the currency market also recorded strong volatility, with changes in the Fed's monetary policy expectations and the election of Trump.

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Since the 2010s, the dollar has appreciated significantly in nominal and real terms and ended the year at its highest level since 1994. While the currency market is likely to show high volatility in line with the volatility of rates and the many uncertainties, we estimate that the dollar should remain at high levels in 2025.

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One of the main market movements following the US elections was the sharp appreciation of the dollar. While this appreciation reflects expectations of a widening interest rate gap between the United States and the rest of the world, it also reflects fears of greater trade tensions and therefore, an increase in risk aversion. This increase is concentrated on economies dependent on exports or that have bilateral trade surpluses with the United States. This can translate into less capital inflows and/or outflows, weakening their currencies. Furthermore, in the event of a more pronounced slowdown, the central banks of these countries could lower interest rates further, thereby strengthening the dollar. Thus, given that customs policy is expected to be an important focus of the new US government, the dollar should remain at high levels.

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One of the factors explaining the widespread appreciation of the dollar is the good performance of the US economy relative to other developed economies, with a growing productivity gap. Indeed, while productivity gains in Europe averaged 0.7% during the 2010s and 0% in Japan, these gains amounted to 1.2% in the United States. This differential has increased further after the Covid crisis. The main reasons for this productivity differential are the favourable energy price differential in the United States, more dynamic non-residential investment and specialization in high value-added sectors such as new technologies. These structural elements should keep the dollar high.

Current account balances of major economies
In billions of dollars, 4 rolling quarters