Investment outlook
The economy and markets
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Section 2: The economy and markets
Key points to know
The U.S. steady slowdown continues
Entering 2025, headline U.S. economic growth had already slowed to 2.5% from 2024’s blockbuster pace of 3.2%. We expect the U.S. economy will gradually decelerate to a cruising speed closer to 2.0% over the coming quarters (and may be on track to have a negative first quarter reading). Recent data have mostly corroborated that view. Job growth has remained healthy even as the unemployment rate has stalled above 4.0%. Consumer spending is slowing but remains strong at around 3% year-over-year. After flatlining earlier in the cycle, housing sector activity has improved over recent months. Altogether, the data indicate continued expansion, albeit at a slower pace than in recent years.
The rest of the world is closing the gap
If 2024 was the year of U.S. economic outperformance, 2025 is shaping up to present a narrower gap (Figure 1). In Europe, fiscal policy has turned sharply more supportive after recent progress to reform Germany’s debt brake. The European Central Bank is easing its policy rate, with two rate cuts completed and at least one more likely. This combination of fiscal and monetary easing, along with signs of a rebound in consumption driven by improving real incomes, should support overall growth. In China, policymakers are targeting 5% growth in 2025, similar to last year’s pace. We think that is achievable, as fiscal policy is also set to become more supportive. At the same time, the languishing property sector shows signs of bottoming after several years of contraction.
Policy uncertainty is rising
U.S. political and policy changes are happening across immigration, anti-trust, financial regulation, taxes, spending and tariffs, with varying economic implications. The scope of tariff targets and amounts seems to be an ever-moving target, and creates clear inflation risks. Immigration changes should reduce net immigration to pre-Covid levels of around one million per year. The Tax Cuts and Jobs Act will likely be renewed, possibly with small additional tax cuts including reform of the SALT deduction, a subsidy for domestic manufacturing and/or cuts to personal income taxes for tips or overtime. The effect of these combined measures on real growth may roughly balance out, but we estimate new tariffs will add around 0.3% to core inflation, with risks of as much as 1.0% more if tariffs are more extreme than we expect.
Inflation and interest rates look to remain stubbornly sticky as U.S. economic growth decelerates slightly.
Treasury yields should remain range bound
We continue to expect the 10-year Treasury to trade in a 4.25% to 4.75% range this year. That view assumes two Federal Reserve interest rate cuts in 2025, reducing the policy rate to 3.75% to 4.00%. Several elements in our framework argue for lower yields: slower growth, moderating inflation and Fed rate cuts. However, we think these dynamics will be offset by factors that are currently boosting yields: uncertainty and upside risks to inflation, fiscal loosening and the term premium. Bond returns across markets this year are more likely to be driven by relative value, security selection and income, rather than major shifts in risk-free rates.
All market and economic data from Bloomberg, FactSet and Morningstar.
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