2024 in review: What could go wrong (or right) in 2025?

• Geopolitical risks to continue and potentially rise; volatility risk will be ongoing.
• Election outcomes across key European and global economies will impact domestic and cross regional policies.
• Will the continuing AI and tech stock focus be enough to support equity markets?
• Will European markets continue to be hindered by structural issues?
• Inflation risks from fiscal policy and demographic change and consequent policy limitations.
• The risk of frothy markets remains.

The US economy remained resilient through 2024 although inflation remains stubbornly above the Fed’s 2% target. Europe, or at least the EU’s core, fell deeper into despair during 2024 as the German growth engine broke down and rising French debt and the inability to agree a budget led to multiple governments' collapses while the periphery, particularly Spain, continued to be a lifeboat of the sinking eurozone. The UK’s growth has slowed since the election in July as consumers, investors and businesses reacted badly to the new Labour government’s budget. 

US equity markets continued to soar throughout 2024 led by the super 7 mega cap stocks with AI stocks leading the way for the S&P 500 to reach new highs in 2024. Bond markets wavered, torn between concerns about if and when the Fed would begin its interest rate cutting cycle, rising US debt levels, and acting as a safe haven as geopolitical risks grew. US growth remained resilient throughout most of 2024, while Europe and the UK saw growth slowing on lower productivity, stickier wage inflation, rising tax burdens and increasing debt concerns. Although equity markets fell from record highs at the end of July after investors rotated away from large tech stocks in early August and early September, and markets were further jostled by a surprise rise in Japanese interest rates, which caused a sudden unwinding of the yen carry trade, tech stocks recovered as the Fed initiated its rate cutting cycle with an outsized 50 bps cut in September as inflation continued to fall and labour markets eased. 

Bond yields surged through to the end of October with Treasury yields pushed to 15-year highs as uncertainty about US debt sustainability, rising geopolitical risks in the Middle East along with increasing tensions between the US and China, NATO and Russia, and concerns about the 2024 election cycle in the US and Europe started to hit markets. This had a consequent impact on currencies in 2024. The US dollar continued to climb following Trump’s re-election, and with rising expectations of growing rate differentials as the ECB continues its rate cutting cycle as the euro economy continues to weaken, the euro has fallen. The British pound was, prior to the July election, one of the best performing currencies this year. It has since fallen on growing concerns around economic weakness, rising debt, and falling investor confidence.

Oil markets in 2024 have been supported by concerns over OPEC+ cuts, the widening of tensions in the Middle East, and the ongoing Ukraine-Russia war, with benchmark Brent averaging about $80 per barrel this year. But these were counterbalanced by doubts about the Chinese economy and its demand as well as a strong dollar and rising non-OPEC+ output which outweighed OPEC+ cuts. However, global oil consumption growth is slowing, reflecting a steady decline in the oil intensity of the global economy. Furthermore, OPEC+ retains significant spare capacity – exceeding 7% of current global production – following recent output cuts. This spare capacity is roughly twice the 2017-2019 average, when Brent crude oil prices averaged $63 per barrel.

Gold surged in 2024, reaching record highs in October. Gold has been supported by safe haven demand as rising geopolitical tensions, along with interest rate cuts, increasing government debt, and economic uncertainty, has pushed retail investors and central banks to purchase more. 

What to think about in 2025

There are a number of new and continuing risks to investors in 2025. Although inflation is expected to continue to slow in Europe, there is greater uncertainty about the UK and the US. The consensus expectation that there has been a soft landing for the US economy, that inflation returns to target with growth remaining stable and employment moderating, allowing the Fed and other globally important central banks to continue cutting interest rates back to neutral risk levels is slowly being shattered. As noted by Goldman Sachs, both ahead of and since the election, markets have upgraded US growth, pushing US equities and the USD higher, and building in a larger divergence between US and European rate markets. The prospect of rising debt levels due to tax cuts (in the US) and demographic changes, e.g., aging populations and, particularly for the UK and Europe, rising social welfare costs, along with the development of tariff wars (with the consequent impact on currencies) which highlight structural inefficiencies, including poor productivity rates and other input inefficiencies, may result in a reversal, putting strains on central banks and limiting their abilities to cut rates at the speed investors are currently expecting. In short, the significant monetary policy easing to push global growth back to potential rates in 2025, fostering an attractive environment for risk assets, expected by Invesco, may not happen. We increasingly seem to be in an extended business cycle, which implies a potential for a no-landing scenario emerging, reactivating inflationary pressures in the US. Add in rising geopolitical tensions due to the expected increase in trade frictions if President-elect Donald Trump does impose at least some degree of his suggested tariffs, along with the growing divergence in monetary policy and tightness of financial conditions that rising US inflation and tariffs would cause, and we may see cracks in expected fiscal and monetary policies to appear. At best, a continued cautious approach to monetary easing may therefore be expected. 

In addition to the macroeconomic uncertainties there are a number of potential risks for 2025 that should be considered, including:

The rise of geopolitical uncertainty: Although there will be fewer elections in 2025, the consequences of the 2024 elections will begin to bear fruit in 2025: President-elect Trump will be sworn into office; the European Parliament will be forced to focus more on security and defence as member states will be asked to reconsider increasing their defence allocations. As noted by BMI, NATO markets and many Asian economies will come under pressure to raise defence spending to continue receiving US military support during a Trump presidency. This will either entail higher budget deficits or the politically unpopular option of cutting non-defence spending. The EU itself may see cracks appear among its membership in relation to its response to Trump’s policy initiatives. If Trump chooses to base tariff rates on trade imbalances, then EU countries will be affected differently, potentially causing a rift within the EU. In addition, the elections in Germany, France, Ireland, Czechia, and Poland may result in leadership changes as anti-incumbent sentiment comes to the forefront due to growing economic uncertainties and, for France, Germany, and Ireland in particular, growing societal discord resulting from lack of integration by recent immigrant groups. There is also the issue of the ongoing war in Ukraine and the wider changes taking place in the Middle East. Turkey is, it appears, looking to take on a wider role across the region after the ousting of Bashar al-Assad in Syria. It is likely to challenge Iran for regional influence, potentially destabilising an already volatile region as it seeks to shift the power nexus between Russia, China and the US.

The impact of demographic changes: Much has been made of Europe, the UK and even the US facing a demographic transition due to aging populations and the absorptive capacity for immigration. Aging populations create labour shortages, slowing economic growth and tax revenues. They also put pressure on fiscal policy, as they require more public spending and affect public debt sustainability. However, there is another issue that is emerging related to demographic change in the US, UK and Europe: immigration. There are now widespread measures to limit migration which, as noted by BlackRock, may exacerbate the challenges of an aging workforce, keeping wage growth elevated and reignite wage pressures and inflation. However, there are hopes that investment in AI may increase productivity growth and fuel GDP growth without stoking inflation but this is more of a medium term expectation. As noted by JP Morgan Asset Management, although the massive increase in immigration in recent years clearly upset the electorate, it also played a major role in the US's ability to maintain a strong rate of growth and bring down inflation. For Europe and the UK, high levels of immigration are leading to more frequent civil disturbances, resulting in some countries having taken anti-immigration steps, including Germany reimposing border checks and Poland suspending the right to asylum for some migrants.

Trade wars: We have previously discussed rising geo-fragmentation with global companies being forced to reconsider their supply chains as geopolitical considerations have come increasingly to the fore. Countries are changing domestic priorities (often tied to industrial policies) and rethinking their participation in economic blocs for sensitive and strategically important sectors. Potential tariffs pose risks to economies reliant on US demand, leading to inflationary pressures. Retaliatory measures by countries may be designed to avoid escalating tensions, but there could also be the response that results in further protectionist measures from the US. One of these measures could be for countries to “allow” their currencies to weaken further against the dollar, thereby nullifying the tariff impact. They could also, especially in the case of China, engage in supply chain warfare, cutting off or limiting supplies of critical inputs for US industries. This, in turn, could worsen trade wars, ultimately hitting global growth.

Energy: Although there have been mixed forecasts about oil and LNG markets in 2025, the problem of energy insecurity in Europe remains as long as the conflict in Ukraine continues. Even though, at the time of writing, Israel appears to be close to negotiating a cease-fire with Hamas, the collapse of Syria and the still opaque role that Turkey is taking on across the wider region, in particular potentially challenging Iran for regional influence, maintains the threat of a widening conflict. In addition, supply disruptions in the energy sector, particularly in materials needed for renewable energy products such as solar panels, batteries, and wind turbines, along with changes in US and other state actors policies in relation to infrastructure investments and decarbonisation efforts could precipitate a renewed synchronised upswing in commodity prices, posing a significant threat to global inflation and economic activity. And, although Equity markets have been rising on the expected productive efficiencies AI innovation will bring, there is also the issue of increased load demand from AI itself, including data centers which could lead to a significant surge in load demand. This could also impact energy prices. 

Policy divergence: This will be reflected in the growing split between central bank policies, with the US and the Bank of England being slower to cut rates than their European counterparts and the Bank of Japan raising rates. Questions around debt sustainability and appropriate debt levels will plague not just the US though, but include other developed markets, with Europe increasingly coming under the spotlight. Fiscal divergence may also develop, pushing the neutral rate higher. 

So what does this all mean for investors?

It is clear that, as Merrill Lynch noted, as globalisation recedes and isolationism resurges, driven by nationalist sentiment both within the US and globally, investment strategies must adapt to this new reality.

If disinflation remains on track, it should support more dovish monetary policies, with the ECB most likely to continue to cut rates. However, inflation risks loom and the Fed and other central banks may need to adapt quickly. And, as noted by Schroders, fiscal plans in Europe, UK, and China will play a big part in shaping the overall economic cycle and the strategies of central banks. The bond market itself will be changing in 2025. In alignment with Fed Chair Jerome Powell, who said on 18 December “that given the policy rate is down a full percentage point from its peak and therefore significantly less restrictive, the Fed can therefore be more cautious as it considers further adjustments to the policy rate,” it does appear that the Fed is unlikely to pursue aggressive rate cuts in 2025, with only two more pencilled in according to latest dot plot projections. Therefore, as suggested by BlackRock, given persistent budget deficits, sticky inflation, and heightened volatility, long-term Treasury yields are likely to climb as investors demand higher compensation for risk. So, with yields not dropping as quickly many investors may have anticipated a month ago, traders are currently holding the shorter to middle of the curve, anywhere from two-year to five-year notes. However, if inflation does fall, holding cash is going to look less attractive. Lower inflation would imply a steepening of the yield curve and therefore, the best bet in that scenario would be to extend duration according to Morningstar research. Another option for investors would be to consider inflation linked bonds. Much will depend on how large a spending stimulus may result from expected deficit spending under a Trump administration combined with slower immigration that limits productive capacity. In Europe, the ECB is expected to continue to lower rates in 2025, with the deposit rate finishing the year around 1.75%, down from 3% after the December meeting. The uncertainty around US trade tariffs could weigh on confidence and subsequently lower real GDP growth next year, underpinning expectations of a lower euro.

As noted by Goldman Sachs, equity valuations have increased and leave little room for further valuation expansion. The combination of higher valuations and rising earnings that we saw in 2024 has been unusual. Index returns will therefore need to be driven largely by earnings growth. Although the huge interest in AI will remain as digitalisation is one of the key themes many businesses are focusing on, it may benefit investors to broaden their exposure, as the shift in mega-cap technology companies from relatively capital-light to capital-intensive business models may lead to a decline in prospective returns on invested capital.

Gold is expected to remain strong throughout 2025. As noted by UBS, lower interest rates, persistent geopolitical risks, and US government debt concerns should continue to support gold in 2025. However, there may be some downside risk from weaker-than-expected global industrial activity and falling demand from retail purchasers.

When it comes to oil, according to World Bank projections, the global oil supply is anticipated to surpass demand by an average of 1.2 mb/d next year. This level of oversupply has only been exceeded during the COVID-19 pandemic and the 1998 oil price collapse. While demand growth in China and India will account for almost half of the projected increase in 2025, consumption in advanced economies is poised for a slight decline. 

As we head into 2025, the geopolitical risks we saw in 2024 will not fade as we see the implementation of new leaders' policies which may add to volatility, not decrease it. There is also a high risk of government leadership changes in Germany, France, Japan, and Canada with other countries, such as Mexico, Argentina, and Turkey, also expected to generate considerable political noise. Markets will continue to focus on AI innovation and hope that expected deregulation in the US will continue to be supportive to markets there, with structural constraints likely to keep European markets growing more slowly. Market participants should also consider the potential impact of government change on climate policy approaches (and investment), inflation risks from demographic change and consequent policy limitations. The risk of frothy markets remains.

While every effort has been made to verify the accuracy of this information, EXT Ltd. (hereafter known as “EXANTE”) cannot accept any responsibility or liability for reliance by any person on this publication or any of the information, opinions, or conclusions contained in this publication. The findings and views expressed in this publication do not necessarily reflect the views of EXANTE. Any action taken upon the information contained in this publication is strictly at your own risk. EXANTE will not be liable for any loss or damage in connection with this publication.