2025 outlook: Will tailwinds trump tariffs?
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The global economy is coming off of another year of relatively strong growth in twenty and twenty four LED by the us, but new and important variables are now in the mix with the election of Donald mp and the republican sweep of congress. So can the solid performance continue amid the policy shifts ahead? And what might be the implications for markets? I am alison Nathan, and this is goon sax exchanges.

In this episode, i'm sitting down with yond hott sias, head of golden sex researcher in the firms, chief economist, and dominic Wilson, senior advisor in the global markets research group, to discuss the economic and market outlook for the year ahead. Yan and dome recently published her twenty twenty five macro outlook entitled Taylors probably trump t tariffs on down back to the program.

So first of all.

it's hard to believe a full year has gone by since we'd all SAT down together to discuss the outlook for twenty twenty four. But here we are. And now let me start by saying that when we SAT down a year ago, you were forecasting resilient growth globally, and especially in the U.

S. As well as continue discipline in the major economies that would pay the way for major centuries to start cutting rates. And all of that is generally played out, but meaningful U.

S. Economic policy is just are likely ahead with the election of anal trump and a republican weep. So in your base case, is the trend solid growth set to continue?

Yes, we think so. We expect another year of above trend and above consensus growth and U. S. Outperformance relative to other advanced economies. We're looking for two and a half percent in two thousand and twenty five, down a little bit from what we now think is two point eight percent for two thousand and twenty four. And most of that is driven by strength that was already under way going into the electron.

So I would highlight the strength and real disposable personal income growth, which is really driven by the fact that Price inflation has fAllen a lot more quickly than wage inflation. And so real early wages are all growing at a good, say, one and a half percent pace. Number two, financial conditions have turned from a headwind of growth in two thousand and twenty two, early twenty three, into at least a moderate tail wind to the tune of maybe half a percentage point or soul.

So these were the the trends that were already pushing the economy forward, and we think that's likely to continue. If I look at the growth impact of the major policy changes that we expect in the trump administration unified republican control over the next several months, I think there are two sided. There are some drags and some books.

I would say the drugs are tariff s and slower immigration. I think on tariff s our base case is a reasonably beni one, where the terriers are mostly confined to higher terabits on china and terrace on auto imports from mexico and europe. But we do not build a fall across the board ten or twenty percent tariff into our base case.

That's an important assumption. But under that assumption, the tear of drag is probably reasonably limited. A few tens of a personal point.

Immigration, we think, is going to continue to come down substantially, and we do expect that to run at a slower pace than the historical average of about one million. But we don't have a large decline in the workforce from net negative immigration in our forecast. Of course, some risks around that, but those are the negatives. The positives are, number one, fiscal policies probably going to be somewhat easier extension of the two thousand and seventeen tax cuts plus some more moderate additional tax cuts, both on the consumer and the business and probably regulatory loosening that is going to be more industry specific but probably will contribute to stronger business confidence and probably some boost to capital spending. So when I take IT altogether, i'm still broadly comfortable with what was a pretty optimistic view going into the election.

And if you use those assumptions and apply IT to your inflation outlook because IT seems like there seems to be a lot of concern about inflation given perspective policy. How do you factor that in? And do you think this inflation will continue?

So the underlying trend again going into the election, I think, is that we were on a good path with inflation gradually coming down. And when now at two point seven percent, if you take the core PC index, you actually just over two percent if you take headline P, C, E index and the drivers of lower inflation, in particular, the rebalancing in the labor market, in the slow on wage growth.

I think our underway there are also some lagging components of the inflation indica es, for example, in rent and honors equivalent rent. So the housing components that should continue to help. So x any tariff effects, I would be pretty comfortable with the idea as though that we should get to two percent or they are outs for core inflation by the end of next year.

However, tabs will mechanically add to inflation under all baseline of china plus auto tabs that's worth about four tens of a percentage points. So we've revised up our forecast for where core PC is going to be at the end of next year to two point four percent. And if we were to see and across the born tariff, that would not only hit growth harder, but I would also raise inflation probably to somewhere wrong three percent by the end of next year, if not, but higher.

I want to talk little bit more about that rise case. But first, someone let me talk to you and talk about this relatively benie outlook that yon depicted as our base case and look at friendly backdrop for risc ts. But market of ready to run very strongly valuation are ugly, is quite stretched. So is this good news? Are rePriced?

Yeah look, I think that's exactly the right place to focus, he said. On an kind of outside basis, the backdrop the yeah just presented is a pretty friendly one. You've got robust U S.

growth. You ve got basically falling U S. Inflation over that period.

You've got rate cuts continuing without recession. You've got kind of CoOperate friendly policies coming most likely. And there's also pretty strong flavor of U S, L.

Performance within. But even outside the U. S, I would say our kind of baseline forecasts, sort of stablish growth, more rate cuts, falling inflation.

I think the big chAllenge, as you mentioned, is we're very clearly above are the forecasts in terms of our U S. Growth outlook. But the market has already moved in that direction.

If you look over the last couple of months, we've seen equity is up, we've seen yields up. We've seen signal parts of the equity market perform. We ve seen the dollar stronger, and we've seen this of U.

S. Our performance come through. And I would say some of that predates the election. Some of that is that we worried about recession risks in the late summer, seems like a while ago now, but that, that risks faded. But taking out that risk was the sort of first leg of but we've clearly pushed further in that direction since the election.

And so when we look at the judgment in the gap between what we're saying and what's Price, I think our judgment is still that at the margin, our growth view is more positive than this mix of growth in flame, more positive than the market is yet pricing and that the U. S. Outperformance theme is, is still not fully reflected.

So our central case, that kind of baseline situation, we still think you've got some upside to equities, you ve got some upside to the dollar. You ve got about performance of non U. S.

Bonds and european born fields, falling road of the U. S. But I would say that judgment is much more finally baLanced than before. I think we're gonna be much more conscious of win the market kind of questions that and the distribution of risks, yang hinted that, that's gonna a much more important part of the investment picture than before.

And with that context in mind, and I wanted to ask a little bit about the fed outlook, we're obviously coming up on the december fomc. You expect another twenty five basis point cut. But as I said earlier, there is a lot of concern about the inflation trajectory. Bony els, as you to say, dom have jumped pretty dramatically. So are you concerned at all that inflation could prove sticker and that could put a wedge into the fed's policy trajectory from here?

That's definitely possible. And of course, monetary policies are very pragmatic business. So you're going to have to respond to new information on on inflation and on the economy.

One point I would just make, all that I think very important, is often misunderstood, is that strong spy itself is not really a reason for the fed not to move. Their Mandate is focused on labor market conditions, not on GDP grow. Those two are obviously related.

But if you look at two thousand and twenty four, we've had growth significantly above their own expectations, market expectations, even our expectations. But nevertheless, the labor market has rebaLanced and labor market utilization has declined on that. We're probably still in a process where labor market rebalancing still continuing.

And there are some risk, I think, that will see further declaration in the labor market and ultimately, a situation where they really won't find the appropriate to have the funds rate at levels that are, by their estimates, very clearly and restrictive territory. And I think that's one reason why they will want to continue cutting rates. At the december meeting, we do expect to twenty five basis point cut.

That's not obviously a certainty that still data to be released that could change, but that is our expectation. And then we have ongoing cuts in early two thousand and and twenty five cuts in january and march and then a slow down to once a quarter in q two and q three, which take us down to the three and a quarter to three and a half percent range by the end of the third quarter. And there are risks around those.

If we've saw more labor market deceleration, I think they might continue to go a little bit more, more quickly. But it's certainly possible that inflation will prove to be a little bit sticker. Certainly, on the surface, it's going to look like more inflation, although you could also make the argument that an increase in the inflation induces that really just driven by tariffs is a one of Price increase like a value out attacks hike that monetary policymakers should not necessarily pod a lot of weight on. So it's going to really depend on the numbers and on where they think that an appropriate monetary policy is based on inflation and the labor market. And I feel good about the idea that we'll get a reasonable amount of additional rate cuts given that the funds rate at the moment still pretty hired for a half to four and three quarters.

And dum is please striking to me that even as policy rates have come down and we continue to expect them to come down and the market in general also expect them to continue to come down, and we have seen the degree pricing in Bonnie's recently. So do you think bony les have gone too far at this point? I mean, at four or forty four fifty and the ten year.

yeah we definitely have a group people who worried a lot about a big spiking in in bond deals and a further Spike in bond deals coming out of the election. We've just been less worried about that than I think a lot of investors have. As you are described, we have a fiscal impulse.

We don't have a very large fiscal impulse coming down the pipe. We have a fed forecasts that is now clearly below the market and on the kind of baseline case. And so those are things that should thank you.

And if you look at what with forecasting for the ten year old over the course of then we're seeing right here, I would say I don't have a huge fight to pick with the level of bonuses. I think part of what happened and part of this sort of surge that we've seen is coming off levels that we thought were too low. The market did worry in August and september recession risks that you on in the team was pretty clear were not in the often. And so I think of a decent part of that move has come really coming out of that position, like said, maybe a little high to our central case, but I would say yet at a level that we think looks particularly odd.

So we are now here again. As I said, flooding was four point five on the ten year that is hi. I mean, at what level does that become problematic for the equity bulcke that you presented?

yeah. And we get this question a lot, and I would say there are kind of two answers. There's a sort of local answer in a bigger picture answer. The local answer is usually the market cares a lot about pace of movement. So if there was expectation actually coming out of the election that we would see whether republican sweep a sharper and faster move higher in bond deals.

And I think in some ways, the fact that we haven't seen that has probably one of the things that has helped the equity market to move higher, so that could reappear. But at the moment, we're not really pushing quickly higher over these sort of recent periods and sort of steady out. The bigger thing for us is generally like what is driving the yield increase.

And now they said a large part, that first leg of increase in yields that we've seen since september has been about relaxing about growth. If this is coming from a market is getting more optimistic about growth, more optimistic about the kind of policy outlook and your driving equities and born you tie together in general, that's a more digestible and manageable situation. I think what will be more damaging for the equity market is if the worries shift either back towards inflation or towards the city of fiscal risk.

So if we start to see the market worry about the eel path because he thinks the inflation profiles is getting sticker or worries that there's a sort of fiscal problem that, that needs to be taken into account more that's a further leg of eels, but that will be more damaging, I think, and more difficult equities to shake off. We generally described more than I view in the central case of how a large worry. But to the extent that there's a risk kind of working there in the bomb market, I think you need that driver revealed to shift to something that is more clearly negative. And I think if it's just the kind of groth environment driving, will probably be able to manage .

well in the other risk in our base case is valuation already being quite stretched across risky assets. So should that be here I look.

And again, that's something that David in the team of highlighted. Valuations are high, the high and equities, the credit spreads are tight. And so that's part of the story again, of having taken credit for a lot of the good news.

I think there's a horizon issue with waiting valuations. If you look over kind of ten year periods, these are long horizons. This tells you that your perspective returns on risky assets are going to be low, the Normal. That's what David.

The team found that a pretty reasonable conclusion from the starting point that we have your ability to tell you where we're going over the next twelve months may be even the next couple of years as much, much lower from valuation alone. We saw this year. You came in with pretty high starting valuations, but if the second back drop is strong enough, then that's usually what dominates.

I would say what we've tend to fine is that you pay that Price for equity valuations disproportionate ates when the cycle turns down. So our expectation is that's not what we're going to see in twenty twenty five. That's true.

You can kind of probably manage the situation where valuations are high. IT means that you're vulnerable to being wrong on that. If we're wrong about assumption, if something happens, that puts the economy into a more difficult than we think.

On a central case, you could find that you see a disproportion reaction to that. We saw maybe hints of that in August in the market panic about recession risks. So that tail is was thinking about with protecting against. But in the central case, I think, you know our view is that this is a longer term problem, but but not necessarily an obstacle for the next twelve, eighteen months given the kind of social backdrop we're talking about.

And you on lets then dig into that risk case, which primarily, in our view, revolves around policy developments more extreme than what we are currently assuming. So what could that look like? And what are the implications or might be the implications for grow?

Yeah, I say that's the key known unknown what is going to happen to tariff policy here? They're obviously also unknown, unknown. And overall, when we look at the risk of a recession, since we always provide an estimate of that looking forward, twelve months or fifteen percent, that's not a big number that below the consensus as IT has been throughout the last couple of years.

And it's only about online with the long term average. Since there has been a recession about once every seven years in the period. We think that the probability of a higher tariff key on unknown a ten percent that alone, maybe even twenty percent across the board tariff, we think that probability is pretty high.

But it's not quite the baseline. Ines or alec phillips or chief political economist is of the view that you know it's maybe a around forty percent. It's certainly very possible that the trumpet administration ultimately imposes and across the board tariff, but more likely that there will be negotiations and in the end, there is not such a tariff.

If that does happen, we think I would hit growth pretty hard. We're getting a negative growth impulse of somewhere round one percent tage point. And obviously, when that peaks depends on when exactly be implemented.

Alex, things IT probably would take a little bit longer than the china Harris, which could happen very soon after inauguration, but IT might take another, say six months, so before a universal tariff would actually occur. But then the growth impact around the personal sh point, and we think the inflation impact is probably also around a percentage point as that happens. So it's a more difficult environment from the perspective of certainly the growth inflation trade off more unfriendly for sure from a monetarily policy perspective.

It's a little bit complicated because these things go in opposite directions. And I think IT is worth noting that, again, this is a Price level effect, the impact on inflation of even a pretty sizable tariff shock. IT last for twelve months.

But then barring ongoing equation, IT should drop out of the numbers. So I think IT would make sense in that sort of environment for monetary policy to also focus on the downside risks to the grow side. And this is what we saw in early two thousand and nineteen when the fed was faced with a trade policy shock and decided to to cut three times.

Now that was a different situation. Inflation was much lower. The funds RAID was also much lower. So it's not necessarily what would happen that this would precipitate additional easing, but it's certainly could. And I wouldn't want to go into this kind of episode with the with the sort of strong ideological view on which way terms should affect monetary policy is really going to depend on a lot of factors. But IT increase the uncertain year on the interest rate path as well .

for short and done. If we get an announcement that we're going na have a ten or twenty percent across the board tariff, what do U. S. Assets do?

Yeah I mean, the clearer and larger impact is on unknown U. S. asset. I would say for the U S.

The thing we think is clearer as the impact on the dollar, we've estimated dollar outcomes under different assumptions and think that if you get a full shift to that across the board tire, if you should see meaningfully further dollar appreciation than we've seen the markets moved in that direction. But we think has Price something much more like a narrow ly focused agenda at this point. I think the impact reflecting a little bit what yan said about monetary policy.

I think the impact on other U S, S, I markets is less clear. I think the full test case and the the threat of retaliation to that could I think way on us equities, you clear of overseas, but good way on U. S.

equities. And I think in the end probably push U. S. Eels lower like I did in two thousand and nine. But the distribution environs of these outcomes is definitely gonna up. And I think it's just easier to be confident about effects than the others.

Young, let's talk a bit about X, U, S, europe and china already experiencing economic chAllenges and now are facing the threat of some policy ships ahead that could be unfriendly. Let's start with europe. What's our mainline view and what are the risks around that?

We're below consents on on europe. We're not forecasting a recession, but we definitely have below consensus and actually below trend growth in the euro area. Looking for zero point eight percent, fifty thousand and twenty five.

The consensus is at one point two percent B, C, B S at one point three or pretty clearly below. We did make a downgrade to our european growth forecast on the heels of the U. S.

Election outcome basically because we found in our research over the last year that european companies are more sensitive to trade policy uncertainty than U. S. companies. So even though we don't have a universal baseline tariff in our forecast and the only thing that really directly affects europe is the potential auto tariff, we nevertheless felt that the increase in uncertainty and the potentially looming baseline tariff is already enough to take something like a half percent of point out of european and growth on A Q four to q four basis or a few tens, at least on an annual average basis.

As I said, this is slightly below trend for the euro area, which is also why we expect the sofa very strong european and labor market to slow. And we do see this small increase in the unemployment rate in the europe area from an inflation perspective. We don't think that the tariff s and the likely retaliation against the fs.

Is really going to move the needle, we think will continue to see declines in inflation back to two percent for core inflation by the end of next year. And that means from a monetary policy perspective, it's much less complicated in europe than in the U. S.

Is a negative growth shock, but not really an inflation shock. And so I think the U. C, B. Is going to continue easing, and we actually added twenty five faces points of easing to our forecast. We're not one seventy five by late two thousand and twenty five.

And what about china?

In china, we also made a small downgrade to our growth for where at four point five percent, that's actually in line with the consensus. And IT is not a huge downgrade, will only shave two tents from our preelection forecast because we are assuming that while the increase in tariff s could subtract as much as seven tenth from growth, we expect more than half of that to be offset by additional policy easing along some of the same lines that we have already seen over the last couple of months. Easy on monetary policy, probably some additional rate cuts, increase in lending by banks that are effectively stay directed and easier fiscal policy. So we we do think that the headwinds for china, not just from trade policy, but also from the property downturn and the demographics, those headwinds are likely to be pretty serious. But policy is now also making more than effort to offset some of those headwinds.

And tell me, you leader to this, but for all the reasons you on just laid out, you are more cautious on assets outside of the U. S.

Yeah, I think that's particularly because of that risk. ase. I mean, that's true in the central case, but it's obviously clear in that risk case.

I think there's a bit of a acting what Young just mentioned about the risks for european, for china. I think there's been a lot of focus on the prospect of china tariffs. That part of our baseline is part of a lot of people's baseline ines and expectations that, that's coming up pretty high.

We saw in two thousand and nineteen that the actual announcement of tariff s still moved markets, particularly for the chinese currency. So you could still get reaction to that. But I would say overall, markets feel Better for that as the outcome in china related areas.

And so it's a little bit, as we discussed before, that the risks really on this across the board kind of tariff outcomes that that's the risk that would lead to, I think, more significant, further repricing and in line with what Young just laid out, I think that's particularly true for the incremental impact on europe and some of the non china economies in the emerging market space mentioned. The dollar, which is of see both the U S, N on on U S S. set.

So further depreciation in other currencies against the dollar likely in that case. But I would say also meaningful downside potentially in non us security, particularly those sort of non china equities that perhaps reflected less of that risk already. And we also think that bond yields in line with the notion that the ecb and others would would probably cut rates more quickly as as he undescribed to respond to these growth risks that bonfield in europe could then fall more sharp, please. It's another reason for thinking that bonds and european bonds may be Better diversified in important holiday s than treasuries, that they have some ability to rally further in, in one of those major risk cases.

When I put this all together, IT seems like investors right now should be feeling generally pretty good investors in U. S. assets. And we think that that's going to continue, but it's tRicky because the downside risks feel very meaningful. So how do you think investors should be positioning relative to this outlook?

Yeah, I think if that's exactly the right way to do describe the chAllenge, which is basic view, is you want at some level to be maintaining the theme of exposure to the U. S. Growth resilience that we still expect, enter the further upside that we think probably still exists in equal ickle U S.

Equities as that happens. And then you've got two risks to contend with. One is, is the market our point where it's reflecting that already. And the other is this tail risks that we focused on terrorist.

But some of the other risks that we touched on, and I would say in some ways as a continuation of twenty twenty four, we have had a similar of view that you're trying to keep your exposure to the U. S. Growth theme while also being sensible about the terrorists.

Ks, that might appear and protect yourself against IT. But the key risks are a little bit different. I would say we're still in the mode where again, because the markets taking credit for this, you're gonna feel Better fading worries, probably not the terrible worry.

That's the one we would probably say we ve outlined as a serious worry. This to be something if the market worries about other aspects of the growth and inflation view, in general advice gonna to push back against that easier to find opportunity when the market is worrying about things in the market, not worrying about things. But in terms of the broader set up, I would say there are two things you can do to help yourself with that exposure.

One is diversification across assets. We think they're even with some of this inflation and risk and fiscal risk that bonds, particularly non us bonds, as I mentioned, a few hedged the effects. Part of IT offer good protection against the equity portfolios for some of these risks.

And I think even U. S. Treasuries and tips, we expect modest positive total returns and they could help if growth disappoints.

We talked on the equity side about broadening out the U. S. Equity exposure towards a more equal location and mitigating some of that concentration risk that has appeared.

And I do think keeping this long dollar exposure against long equity positions fits the broad direction of travel we have in our base case, but also hedges you again some of these territorial cases, U S. Rate upside cases that could be more difficult for equity. The other thing I would say is we think there's strong arguments still also for looking at options protection to also help you protect against those microbes.

You've seen the Price of optionality in, in the major markets come down after the election, which is something that we expected to happen. And so it's easier to use options, both equities and in terms of expressing some of those long dollar views may be also in commodities, gold and oil, which, which we haven't touched on, but as protection against some of those key risks. And so we think for investors you are able to do that who have Mandates to do that, that using options either to express the views that you want to or to protect them is is also gonna. I think that's worth a higher level of focus than usual dyan.

Thanks so much for joining us.

Thank this episode .

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