Market Outlook 2025

Authored by: Polina Elkina , Jake Bentley-Evans and Patrick O'Neill

Key Takeaways

• The Federal Reserve is expected to cut interest rates in the longer term, with a projected range of 3 to 3.5% by the end of 2025
• Inflation continues to adjust back to the 2% inflation-target level and unemployment is projected to maintain a steady increase in the future despite rising job creation rates, with projections pinned down at 4.0% entering 2025
• Trump’s recent election win is poised to bring back protectionist policies on U.S-China trades, potentially affecting several supply chains
• Treasury yields signal reduced recession risk, corporate bonds gain from GDP growth, and rate swaps fall with lower Fed rates
• Commodities such as gold are at an all-time high, while oil demand hinges on global factors like OPEC
• TMT continues to drive growth due to AI; the Energy, Industrials, and Materials Sectors benefit from GDP and infrastructure demand, and the Consumer sector stays resilient amid stabilizing inflation
• EM equities outperformed developed markets in Q2, strengthened by China's $1 trillion stimulus package and APAC equities remain undervalued compared to the U.S. and Europe

Economic Trends:

Interest Rates

In September, the Federal Reserve announced its first cut of interest rates since March 2020, cutting rates by half a percentage point, from a target range of 5.25-5.50% to 4.75-5.00%, seeking to maintain inflation and unemployment at a maximum level of 2% in the longer term.

While a cut in the future was not unexpected, the decision came as somewhat of a surprise with most analysts predicting a 0.25 percentage points cut. This suggests a shift in priority from the Fed, from focusing on restricting inflation levels throughout COVID, to now balancing both sides of its dual mandate, hoping to achieve a soft landing and prevent growth from slowing further.

Naturally, there was extensive speculation after this cut, with the primary question being: “did the Fed cut rates because it triumphed in its fight against inflation or because the economy is in peril?” While this must be prefaced as speculation, a 0.5% p.p decrease in the rates indicates the Federal Reserve is optimistic about the future of the economy, suggesting fear of recession was not the driving factor behind the decision. Additionally, its decision to cut rates was by no means unconventional compared to other central banks; with the UK, New Zealand, Canada, the EU, and many emerging markets having already lowered interest rates. Critics of the Federal Reserve’s cuts argued fiscal policy might have been a more optimal route to decreasing unemployment and stimulating growth, without risking destabilising inflation. However, data suggests wage growth was exceeding CPI inflation, indicating that recession remained unlikely, even if inflation increased slightly because of rates cuts (Figure 1).

Following the cuts in September, it became clear that the Fed was intending to begin slowly paving a way back to ‘neutral’ interest rates, like pre-pandemic monetary policy: “The minutes did not suggest support for another large rate cut, hinting instead that US central bankers were inclined to gradually lower rates to a “neutral” setting that no longer crimps growth.” As anticipated, the Fed announced further cuts on November 7th, reducing target levels from 4.75% to 5%, to 4.5% to 4.75%.

As to whether can expect further cuts this year, either option appears feasible, however, speculation from the Financial Times suggests another quarter percentage point cut may incur: “... most of the Federal Open Market Committee (FOMC) members estimated the policy rate would fall by another half-percentage point this year followed by a series of cuts in 2025 to leave rates at 3.25-3.5 per cent.” Regardless, the Fed’s decision to cut rates by 0.75 percent demonstrates that their intention is to gradually reduce rates over the long run. Additionally, we can analyse the projections released after their September meeting, when they announced the first stage of rates cuts. These projections suggest that rates will be lowered to a range of 3% to 3.5% by the end of 2025. For reference, the releases these projections at every other meeting, so expect to find updated data after their next meeting on December 18th.

Inflation

Since the Federal Reserve cut interest rates, inflation has reacted with a slight increase; from 2.4% in September, to 2.6% in October. However, the overall trend of inflation since 2023 has been a steady decrease towards the Fed’s target level of 2%. The question remains whether this is sustainable now that the Federal Reserve has begun its process of lowering interest rates to the neutral level, or whether inflation was only stabilising due to historically high rates.

Unemployment

Unemployment has been on a steady increase since the start of January 2023, where it was at historic lows of 3.4%. As of October 2024, US unemployment is at 4.1%, which is still relatively low.

However, the question remains as to whether this trend of rising unemployment is set to continue, or plateau (Figure 4). While the Fed has cut rates, there are several other factors, like job creation rates and labour force participation. In 2024, has been an average of 200,000 jobs created per month, suggesting unemployment levels are manageable for the US economy. Furthermore, labour force participation has been on a steady increase post-COVID. However, it is unlikely this results in a return to pre-pandemic levels, partly due to long-COVID and persistent health concerns, which have ruled out a small but noticeable portion of the labour force.

A continuing rise in unemployment may be attributed to high persistent inflation. Unemployment is set to further increase this year, as a delayed reaction to historically high interest rates, only now being cut. According to the FOMC: “the median projection for unemployment this year is 4.4%, up from 4.0% in June”.?

U.S.-China Trade Relations

Once the U.S.'s largest trade partner, China has been surpassed by other Asian economies, the EU, and Mexico, with Canada now matching its share. With the Trump administration's trade war, U.S.-China decoupling began in 2018. Other Asian economies have gained the most, growing their share of U.S. imports by 4 percentage points since 2018.

The U.S. has reduced direct trade with China but remains indirectly reliant on Chinese goods, via the interlinkage of economies, suggesting U.S.-China trade declines may be overstated in trade data. Countries like Vietnam for example, now taking a larger share of U.S. imports, increasingly depend on Chinese imports for manufacturing and assembly.?

In addition, U.S. imports of Chinese electronics have dropped nearly 15% since 2017, driven by trade restrictions and allied measures targeting semiconductor exports to China. Between 2021 and 2023, U.S. semiconductor exports to China fell by 50%, with similar declines from the EU and Taiwan. For instance, integrated circuit shipments to China decreased by 18% from Taiwan and 37% from the EU, while global semiconductor sales contracted by 11% in 2023.

The trend is further evident in Foreign direct investment (FDI) flows (Figure 6). In 2023, China attracted just $33 billion in FDI compared to $415 billion in the U.S.—a stark contrast to a decade ago when both countries drew similar levels of investment. According to Rhodium Group, EU investments in China have steadily declined over the past decade, reflecting concerns over Chinese policies, geopolitical risks, and efforts to diversify supply chains. This substantial drop in foreign investment underscores the growing economic divide between major economies and China.

Surveys show a declining interest in increasing investments in China. U.S. and German firms planning to expand have dropped from nearly 70% to 50% in recent years, while UK firms saw a sharper decline from 60% in 2019 to 35% in 2023 (Figure 6). Ongoing concerns about China's economic policies, regulatory environment, and broader geopolitical tensions are likely contributing to this hesitation.

However, it is important to note that the process of relocation is timely. Few companies plan to completely exit, notably only 4% of UK firms, 0.2% of German, and 0.7% of Japanese businesses. More are contemplating moving some operations, with about 20% of U.S. companies reporting intentions to relocate in 2023, a lower percentage which could be attributed to a slightly improved investment climate in China. As shown in Figure 7 there is a trend of declining interest from foreign firms in China, and this trend is expected to continue.

Trump's previous presidency was marked by significant tensions with China, and his recent victory could lead to a revival of these policies, which might further accelerate decoupling in trade and investment.

The reintroduction of U.S. trade tariffs on sectors like electronics and agriculture could lead to higher consumer prices and increased production costs. Tariffs on imported components, especially in industries reliant on global supply chains like electronics and semiconductors, could raise end-product prices, reducing competitiveness and slowing technological advancements, particularly in sectors like green energy.

In addition, the anticipated push for "reshoring" or bringing manufacturing back to the U.S. might be intensified. The U.S. government has advocated for diversifying away from Chinese and other foreign supply chains, aiming to reduce dependency and strengthen domestic resilience. This reshoring trend could support U.S. jobs in the short term but may also raise operational costs for businesses that previously relied on cheaper overseas manufacturing, potentially leading to higher consumer prices in sectors where raw materials and intermediate goods are crucial.?

FICC:

Fixed Income

Currently, US Treasury yields exhibit a flat curve, with both the 1-month and 20-year yields at 4.70%. It is important to note that the data analysed below was accessed on November 17, 2024, and is subject to change. There are minimal fluctuations among bonds of varying maturities, with the lowest-yielding bonds (26-week) at 4.26%, creating a narrow spread of just 0.44% from the highest-yielding bonds. Yields are transitioning back to a positive curve after being inverted since July 2022. One month ago, 1-month US Treasury bonds yielded 4.93%, while 5-year bonds offered 3.86%, reflecting a -1.07% spread. A year ago, the spread was slightly wider, with 1-month bonds yielding 5.52% and 5-year bonds at 4.52%, resulting in a -1.10% spread. This shift suggests a gradual improvement in investor sentiment toward the economy.

To further support this contention, the 2/10 split (the spread between 2-year and 10-year bond yields) provides valuable insight into future economic sentiment and the likelihood of a recession. One year ago, 2-year bond yields stood at 4.90%, while 10-year bond yields were at 4.53%, resulting in a spread of -0.37%, which strongly signalled the probability of a recession. Currently, 2-year yields are 4.31%, and 10-year yields are 4.43%, with a positive spread of 0.12%. This shift suggests a decreasing recession risk and growing investor optimism about the economy's future.

The Bond market is likely set to improve as Treasury yields transition to a flat curve, highlighting reduced recession fears. Corporate bonds will benefit from stabilising inflation GDP growth. Long-duration Treasury bonds can be expected to appreciate, while the credit risk of corporate bonds reduces. Overall, fixed-income bonds are an attractive investment.

Rates Swaps are expected to decrease in response to the Federal Reserve’s plan to lower the target level of interest rates to 3.5%. This will benefit firms with liabilities, as they will be able to reduce their borrowing costs. Subsequently, we should expect to see a surge in swap activity as firms adjust for long-term cost savings, particularly those with high debt levels.

Currencies

BRICS currencies face increased risks from U.S. protectionist policies. The U.S. Dollar surged 0.6% following President-elect Trump’s announcement of potential 100% tariffs targeting BRICS nations, aiming to thwart their shared currency ambitions. Analysts view a BRICS currency as unlikely due to economic divergence among member nations and the dollar's entrenched role in global trade. Trump’s fiscal stimulus and trade policies are expected to bolster USD strength, with reduced intervention to weaken the currency.

The GBP/USD (Cable) faces near-term pressure, with ING forecasting a drop to 1.24 due to U.S. monetary tightening and protectionist policies. However, BoA projects a recovery to 1.38 by the end of 2025, supported by improving UK fundamentals and Fed rate stabilization. Seasonal USD weakness in December may drive short-term fluctuations. For the EUR/USD, Rabobank predicts parity by mid-2025, constrained by Eurozone political instability and inflation uncertainty. Emerging market currencies, particularly those reliant on USD-denominated debt, are expected to experience increased volatility, further cementing the dollar’s dominance in global trade.

Commodities

As a defensive investment, gold continues to attract cautious investors during periods of economic uncertainty, particularly as the Federal Reserve's goal of achieving a soft landing remains unmet. Although stabilizing inflation has diminished gold's role as a hedge, it retains its appeal as a safe asset amid ongoing economic transitions. Gold reached an all-time high of $2,788.54 per troy ounce this October.?

GDP growth supports Oil demand while stabilising inflation ensures price predictability. Oil prices are much more contingent upon global factors, such as OPEC decisions and global demand, as opposed to monetary policy and national macroeconomic shifts.

Equities:

TMT

Technology and Media are set to grow as a result of improving economic conditions. Telecommunications demand tends to remain more stable, in contrast. Historically, during times of lower interest rates, discounted cash flow models have resulted in technology outperforming other sectors. Flattening yields reduce uncertainty, encouraging investment in innovation, and further boosting technology. Reduced financing costs will support the expansion of TMT companies.?The rapid growth of data centers, driven by advancements in AI, cloud computing, and big data, is significantly increasing global energy demand.

Energy and Utilities

Data centers and server farms, critical for AI development, require substantial, reliable energy to maintain operations. Nuclear energy is emerging as a key solution to decarbonize these facilities, providing a stable baseload that addresses the intermittency of renewables like wind and solar. Innovations such as Small Modular Reactors (SMRs) offer flexibility and scalability, enhancing nuclear energy's integration into digital infrastructure. This growing demand highlights the need for energy solutions that combine nuclear reliability with the environmental advantages of renewables.

Renewables such as solar and wind energy are also integral to sustainability. Solar power offers environmental and cost benefits by reducing carbon footprints and enhancing energy independence, as demonstrated by companies like Google and Apple. Advancements in photovoltaic technology and energy storage promise increased solar adoption, though challenges like high upfront costs and land requirements persist. Similarly, wind energy has the potential to support data center operations by reducing emissions and enhancing reputational benefits, though it faces intermittency and high infrastructure costs.

The path to net-zero emissions by mid-century relies on a diversified energy portfolio, with nuclear energy playing a pivotal role alongside renewables like wind and solar. Nuclear power complements these sources by providing a stable baseload supply, addressing their intermittency. SMRs, with their adaptability and cost efficiency, further enhance decentralized energy production and integration into existing systems. While nuclear energy has disadvantages, it generally offers the best return on investment compared to solar and wind, making it a more practical choice for large-scale data centre power needs (Figure 10). Balancing these energy options is critical for sustainable growth in the data center industry, with nuclear energy providing the stability required for high energy demands and renewables offering environmentally friendly solutions for a greener future.

U.S. companies can expect to see a rise in demand as a result of stable inflation and GDP growth, although this analysis is weighted more towards energy than utilities since utilities is a defensive sector. Treasury Yield forecasts also support a modest rise in demand for energy. Utilities will benefit from the Fed’s rate cuts since debt servicing costs will be reduced.?

Industrials

Improving GDP growth forecasts (2%) support increased demand for infrastructure and manufacturing. As a cyclical sector, flattening Treasury Yields suggest there will be an increase in investment, since investor confidence has increased. Furthermore, lower borrowing costs will encourage debt-financed projects, while stable inflation will support profitability. Overall, industrials are expected to benefit from increased economic activity and lower financing costs; particularly in infrastructure, transportation, and manufacturing.?

Basic Materials

Should expect a rise in demand, as a consequence of increased industrial activity and infrastructure investment following GDP growth, particularly for metals such as copper and aluminium. This will support industrial commodity suppliers such as mining companies. Stable inflation will increase confidence from producers, since input costs will be deemed less volatile: boosting investment in production.

Healthcare

Stabilising inflation will reduce input cost pressures. Additionally, biotech and pharmaceutical firms will benefit from reduced financing costs for research and development, as a result of the Fed’s decision to lower interest rates. Overall demand for healthcare services will remain resilient, as a defensive sector.

Financials

On the one hand, net interest margins will decrease as a result of flattening Treasury yields. On the other hand, banks will still benefit from steady loan demand, and reduced interest rates will result in increased borrowing from both households and businesses. Rising equity markets will benefit asset managers and insurers.?

Consumer and Retail

Inflation stabilisation will maintain affordability in the Consumer sector. Discretionary sectors will improve from consumer spending as a result of GDP growth and steady unemployment levels. Consumer staples will remain stable, as a defensive sector. Retail, travel and luxury goods will benefit the most from improving economic conditions as the sectors with the highest volatility in demand.?

APAC and Emerging Markets:

South-East Asia

While China remains a vital market within APAC, the growing importance of other economies is increasingly evident. In 2020, China accounted for over 40% of APAC benchmarks, but this share dropped to 24% by 2024. Taiwan’s semiconductor industry has thrived on rising global chip demand, while countries like Vietnam and Indonesia have emerged as prominent suppliers and manufacturers in the tech sector. The prospect of increased U.S. trade tariffs on China has made these nations more attractive to foreign investors as alternatives to China.

Indonesia, in particular, is positioning itself as a key player in the Electric Vehicle (EV) supply chain. This year marked the opening of Southeast Asia’s first EV battery plant, a $1 billion joint investment by Hyundai Motor Group, LG Energy, and Indonesia Battery Corporation. The plant, integrated with Hyundai’s EV initiatives, is set to expand with an additional $2 billion investment, aligning with Indonesia’s strategy to become one of the top three EV battery producers by 2027.

This development signals the emergence of a broader Indo-Pacific EV supply chain. North-East Asian nations, including China, Korea, and Japan, already lead in automobile manufacturing. Indonesia, holding 22% of the world’s nickel reserves, supplies a crucial component for EV batteries. Although the region lacks lithium, Australia, another APAC key player, provides about half of the world’s supply, creating a concentration of all critical components of the EV supply chain within APAC.

Equities and Private Equity

Despite a 2.8% year-over-year (YOY) decline in financial sector M&A activity across APAC in Q3, improving economic conditions have led analysts to predict a rise in M&A volumes in 2025. This would align the financial sector with the broader upward trend observed in APAC M&A activity across other industries. Notably, mainland China bucked the regional trend, showing a YOY increase in financial sector M&A deals in Q3, partially driven by a stimulus package announced by the Chinese government in September. Five of the ten largest financial M&A deals in Q3 involved Chinese targets, underscoring the country's pivotal role in regional markets.

Across all sectors, APAC M&A activity totaled $165.81 billion in Q3, a 37.7% YOY increase and surpassing Europe’s aggregate value of $130.89 billion for the same period. Anticipated interest rate cuts by the Federal Reserve in 2025 are expected to lower financing costs, likely boosting global M&A activity further. Western private equity firms have shown increasing interest in APAC’s tech sector, fueled by the recent AI boom and its associated supply chain demands. In September, Blackstone announced a $16.4 billion acquisition of AirTrunk, a leading APAC data center platform, highlighting the sector’s strong appeal. The MSCI APAC IT index reflects this trend, with gross yearly returns of 42% as of October 31.

Emerging markets (EM) equities outperformed developed markets in Q2, gaining 8.7% compared to 6.4%. Chinese equities have garnered particular attention due to the government’s $1 trillion, 5-year stimulus package aimed at bolstering the economy. This stimulus is expected to have positive spillover effects on other Asian EMs, supported by the ongoing "friend-shoring" trend. Currently, EM and APAC equities trade at a discount to European and American counterparts, although average stock valuations, excluding Taiwan and India, remain consistent with historical norms.

Semiconductor Supply Chains

The semiconductor industry is poised for significant growth, with its market value rising from $611.35 billion in 2023 to a projected $1 trillion by 2030. Semiconductors are essential to various industries, underscored by NVIDIA’s recent supply chain issues with its primary supplier, Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC). Taiwan, which produces 92% of the world’s most advanced semiconductors, has faced challenges acquiring equipment needed for AI and high-performance computing chips, highlighting the global impact of supply chain disruptions.

Although Taiwan dominates semiconductor manufacturing, it relies on countries like Japan, the U.S., and South Korea for critical production equipment. The supply chain is complex, concentrated in the Indo-Pacific, and characterized by nations specializing in specific aspects, such as Taiwan’s manufacturing expertise and the U.S.’s leadership in intellectual property and software. This distributed model creates diverse opportunities for investors across sectors and regions, driven by the growing global reliance on information technology.

Geopolitical tensions, particularly concerning Taiwan’s sovereignty, have raised concerns. However, the industry's global interconnectedness and vital role in the economy are likely to mitigate long-term geopolitical impacts, ensuring its continued growth and importance in the years ahead.

Investment Outlook

For equity investors, innovation-driven sectors such as technology and renewable energy are expected to maintain strong growth, reflecting the increasing emphasis on sustainability and innovation. Investors should be cautious of traditional financial firms which may face challenges from fintech disruption and evolving regulations in areas like cryptocurrency and payment systems.

China's decoupling from the U.S. highlights potential opportunities across key industries. Leaders like CATL, BYD, and Gotion High-Tech drive innovation in batteries in China. Renewable energy integration by firms such as Sungrow and CATL supports solar, wind, and vehicle-to-grid (V2G) technologies. In alternative energy, solar power offers strong growth potential, led by LONGi and Trina Solar, while wind energy shows promise despite higher upfront costs. Nuclear energy, with advancements like Small Modular Reactors (SMRs), provides reliability and low-carbon benefits but faces financial and regulatory challenges, making it more suitable for long-term strategies. Together, these sectors position China as a leader in EVs and renewable energy technologies.

Investors bullish on these sectors might consider ETFs such as the iShares Global Clean Energy ETF (ICLN) for renewable energy, the Global X Autonomous & Electric Vehicles ETF (DRIV) for EV technologies, and the VanEck Rare Earth/Strategic Metals ETF (REMX) for materials supporting these industries. Investors can consider data center REITs like Digital Realty Trust (DLR), Equinix (EQIX), and DigitalBridge Group (DBRG) to capitalize on the growing demand for digital infrastructure driven by cloud computing, AI, and data storage needs.

In the fixed-income space, US Treasury bonds are likely to deliver moderate returns in 2025, making a neutral position optimal. Corporate bonds in high-risk sectors should be approached conservatively, as an economic slowdown could increase the likelihood of defaults. A strong dollar impacts exporters and USD-indebted economies while presenting hedging opportunities for investors. The dollar is expected to remain robust through 2025, supported by fiscal stimulus and resilient U.S. economic performance. For commodity-focused portfolios, overweighting industrial metals may be advantageous, driven by demand from infrastructure development and green energy projects. Key industries such as construction, technology, and transportation are expected to sustain strong demand for these materials. Conversely, oil could be underweighted due to ongoing downwards pressure, price volatility and a diminishing market share as renewable energy adoption continues to rise.

Disclaimer!

Please be advised that EUTIC does not provide formal investment advice and is not a licensed financial adviser. The content we produce is intended solely for educational purposes, aimed at individuals interested in markets and economic trends. Any information provided should not be construed as financial advice or a recommendation for any particular investment strategy.

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