There are a number of key themes investors will need to be mindful of in 2025, including interest rate cuts, debt, emerging markets, US foreign policy and European political risk, says abrdn.
As the new year approaches, Paul Diggle, chief economist at abrdn, says a combination of fiscal loosening and deregulation in the US under a second Donald Trump term will moderately lift growth, with a pick up in demand contributing to stronger inflationary pressures. Large tariff increases on imports, as well as a sharp decline in net migration, will also put upward pressure on prices via a negative supply shock.
“We think the Fed’s preferred measure of core PCE inflation will get stuck at close to 2.5% year over year through 2025 and 2026. This means the Fed will have less room to ease policy. We think it will need to keep interest rates well above neutral to keep inflation expectations anchored. A higher-for-longer profile for US rates will affect central banks across the world,” said Diggle.
Abrdn said debt will also be a key theme, with global government debt having risen above $100 trillion. Trump’s policies could increase the US debt and deficit further and lead to higher term premia on US debt, prompting investors to potentially demand more compensation for the risks of higher inflation and greater uncertainty associated with the Trump presidency.
“In our base case, we see the deficit increasing to above 7% of GDP, and there are scenarios in which it climbs much more. Moreover, we think the term premium may also increase for non-debt related reasons. More negative supply shocks, such as from climate change and geopolitics, will lead to more periods of high inflation and low growth. This may cause sustained positive correlation between bonds and equities, pushing up on the term premium and so US borrowing costs,” said Diggle.
In addition, heightened trade policy uncertainty and a more inflationary backdrop in the US will lead to both emerging market winners and losers in 2025, says abrdn.
“Mexico’s and Vietnam’s large trade surpluses with the US put them at the greatest risk of punitive action from Washington but could emerge as the long-run winners of shifting supply chains, especially if US efforts primarily focus on decoupling from China,” commented Diggle.
Political themes will also play out in 2025. US foreign policy is likely to centre on the ongoing volatility in the Middle East and Iran. While there is an upside scenario in which Iran responds to US pressure by ending its nuclear programme and regional tensions improve significantly, there is also a downside in which direct Israeli-Iranian fighting escalates into a larger regional war.
Meanwhile, political uncertainty is also likely to dominate Europe, with German federal elections likely to occur in the spring and France’s political and fiscal problems also looking more acute following the failure of Michel Barnier to pass a budget containing the fiscal consolidation.
“France’s fiscal position continues to look very challenging, and we think the country should be seen more as a peripheral market than a core one, and French spreads should trade accordingly,” added Diggle.
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