2025 Markets Outlook #1
Understanding Goldman Sachs' 2025 Markets Outlook
Baseline forecast of solid US growth, low inflation and non-recessionary rate cuts with pro-business policies. US remain outperform with non-US seeing stable growth. Friendlier risk asset backdrop alongside US outperformance. Markets have priced in upgraded US growth post-elections, pushing equities and USD higher. Larger divergence between US and Europe rate markets. However, risk of disappointment rises. Broad mandate gives Trump more possibilities. Less worry on sustained fiscal risk premia in bond markets, though fiscal policies could raise terminal rate. Risk focused on tariffs; risk of broader trade war seems underpriced. Potential USD upside, but pressure on non-US equities. Stretched US valuations amplify reaction to any economic weakness and dampen long-term expected returns. Positive tailwinds if tariffs are narrowly targeted, oil prices fall more sharply on glut, or inflation prove overdone. Backdrop justifies upside exposure to US equities while diversifying with options to limit major tail risk.
Tariffs pose direct threat to central economic forecast of solid growth and lower inflation. Tariffs against China increase 20pps could be implemented early on. Impact likely more tapered compared to 2018-2019 and China's reduced trade exposure to US. US have shifted imports from China to other countries since- Mexico, Korea and India. Tariff on Europe would see more disruptive global trade arrangements, with larger impact on US inflation (est. 1pp on core PCE), driving higher front-end rates, flatter curve and lower equities. Broad Dollar upside would negatively impact rest of the world. Ultimately, disruptive macro and market impacts would spill back on US. 40% chance of across-the-board tariff scenario.
Republican sweep raise expansionary fiscal policies expectations. Expect a watered-down version of additional tax cuts to accommodate Trump's campaign promises - focused on individuals and domestic manufacturers, 10% of the GDP. Defense spending also expected to rise. With lower immigration and high tariffs, even a modest fiscal loosening risk putting upward pressure on inflation and Fed to stop cutting cycle prematurely. Potential for higher terminal rates is a broader global phenomenon. In Japan, fiscal policies likely loosened after disappointing election outcome for ruling LDP. Could see a wage-price spiral with BoJ hiking rates to a higher terminal rate than consensus. New UK government proposed substantial front-loaded fiscal expansion. The additional spending will keep BoE on a gradual easing path with higher terminal rate possible.
Reinforced economic outlook where US growth stronger than DM peers. Tariffs coupled with modest tax cuts, federal spending and lighter regulation - boost domestic business and weigh on foreign activity levels should continue to tilt capital flows towards the US and support the Dollar on a broad basis. However, number of conflicting dynamics mean that there is a wide distribution of risk around these views. While a 'currency pact' that weakens the Dollar is unlikely to be sustainable without a shift in macro factors, it is possible that a strong fiscal policy response abroad could mitigate or even dominate the effect of tariff threats. China's ongoing fiscal stimulus has helped offset some potential impact and Germany's evolving fiscal debates have bears watching. In most cases, Dollar has reset higher in response to election results and has been highly valued in recognition of strong US economic performance. Scope for sharper Dollar strength that sends EUR towards parity is only likely if the tariff agenda broadens and deepens beyond the base case, or if bolder fiscal ambitions and steeper rate curves don't weigh on US equities.
Expect 20pps additional tariffs on Chinese goods imposed in 1H 2025. Fresh hit to exports and investor sentiment on top of an already tough cyclical picture for the Chinese economy - however, with a smaller impact than 2018-19. Tariffs on China are widely expected, constituting a smaller surprise. China's export exposure with US has declined since. Not likely to change the broader policy efforts to foster a rotation of Chinese growth towards domestic demand in 2025. Extent that China responds with a mix of retaliatory measures, currency depreciation, and fiscal and monetary policy will likely be greater relative to 2018-19. Bigger challenges and prospects of China's macro picture are domestic. While renewed trade disruptions may impede any rebound in the international capital flow to China, reality is that international investors have already shed large proportion on perceived underwhelming stimulus delivery. While NPC meeting offered limited detail beyond measures on local government debt, expectations that fiscal deficit target to be raised to 3.6% of GDP in 2025 from 3% in 2024. While overall urgency seems lackluster, it is possible that policymakers are waiting to see the new measures under the Trump administration to respond.
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Downgraded GDP forecast over higher trade uncertainty and ongoing Chinese competition in key industries. Policy space to respond to these headwinds is limited given fiscal concerns in core economies like France. Further constrained by pressure to increase spending on Ukraine and the broader security of Europe. ECB to respond with deeper rate cut path. Sustained outperformance of European rates versus US. Better market opportunities lie in outright longs in Bunds or renewed compression of rate spreads between core Europe and Central and Eastern Europe, where lower growth and rate outlook should spill over eventually. UK's relative outperformance benefits the pro-cyclical Pound.
Negative outlook for EM. Open economies are vulnerable to global trade war, delaying prospects for portfolio capital flows. EM complex will need to rely on own macro and asset market fundamentals. Favour EM with lower external risk and smaller internal imbalance. Given subdued valuations and pro-cyclical backdrop, EM equities likely to outperform fixed income, with greater room for policy support in China and lower in India. EM equities will struggle relative to US equities - especially in vol-adjusted returns. EM hard currency fixed income more defensive than local currency assets in strong Dollar environment, tight hard currency spreads mean that local currency assets have more scope to outperform if tails are avoided.
Oil prices range-bound with Brent to remain in $70-85/bbl range. Including roll return, energy and broader commodity indices should offer modest positive returns. Trump administration raises risk to Iranian supply, where disruption risk already elevated by Iran-Isreal conflict. Upside tail risk adds to value of longs. Medium-term risk skew to downside. Clear shift towards a broad-based tariff agenda could hurt global demand. Oil prices might become tailwind for disinflation trends.
Declining inflation across economies allowed central banks to focus on growth risk and lower policy rates from restrictive levels. The period of negative correlation between equities and yields have given way to a more mixed picture. US equities and Treasury yields have near-zero correlation. Across-the-board tariffs would raise US core inflation to near 3%.
US equities valuations continue to climb, with expectations that pro-business policies will boost after-tax earnings. Credit spreads are at 6th percentile in the last 15Y even with segments of the market that were pricing more elevated risk premium now compressed. High all-in yields are also supporting demand for credit even with compressed spreads.
Prospects of a broader trade war seems underpriced and upward pressure on US yields remains possible in early 2025. Diversification particularly non-US bonds should protection against growth risk. US inflation risks are quite well-priced at the front-end of the curve, expectations are more moderate further along the curve. TIPS may offer a good portfolio hedge. Long USD positions should also provide protection against US rate upside and broadening tariff risks, reinforcing the case for US investors to keep hedging their overseas exposures.