2025 Q1 Market Outlook: Diverging fortunes

In 2025, the likely onset of U.S. tariffs may lead to the divergence in global economic prospects. Growth-supportive fiscal policies and deregulation only reinforce U.S. exceptionalism. Meanwhile, the Fed faces risk of stalled progress towards inflation target. The Fed will be more cautious about its policy path, while weak growth in other developed economies means their central banks may need to cut rates more significantly.

Q: what is the Fedˇ¦s current stance on rate cuts?

Since the first Fed rate cut last year, market expect the Fed would cut policy rates to neutral. However, there are a wide dispersion of market estimates around its value. With elevated uncertainty around the neutral rate and the inflationary impact of tariffs, the Federal Reserve now is set to slow the pace of easing. The Fed sees just two rate cuts in 2025. However, cooling labor demand, coupled with concerns around low-income households and small businesses, suggests that the Fed may cut policy rates three times. However, new tariffs may prompt the Fed to enter a prolonged pause period.

Q: What challenges are developed markets facing in the global economy?

Outside the U.S., developed market central banks have made progress with disinflation, but this has come at the cost of weakening economic growth. China has continued to underdeliver on inflation due to the economic pressure triggered by the property downturn and weak consumer demand. Policymakers have had to turn to both monetary and fiscal stimulus. The global economy may need to navigate the potential increase in U.S. import tariffs. Taking current tariffs proposals, the estimated negative impact to each economy ranges from just 0.4% to as much as 9%. Of course, the scale and scope of tariffs is highly uncertain.

Q: What is the impact if diverging monetary policies of central banks?

Based on the economic concerns in Europe, The European Central Bank (ECB) needs to move with greater urgency than the Fed, likely cutting rates at each meeting through 2025 and taking policy rates below neutral. Persistent inflation concerns due to fiscal policy mean that the Bank of England (BOE) may remain cautious for a little longerˇXbut it too is likely to accelerate its pace of easing in 2025.
Based on the economic concerns in Europe, The European Central Bank (ECB) needs to move with greater urgency than the Fed, likely cutting rates at each meeting through 2025 and taking policy rates below neutral. Persistent inflation concerns due to fiscal policy mean that the Bank of England (BOE) may remain cautious for a little longerˇXbut it too is likely to accelerate its pace of easing in 2025.

Q: What opportunities exist consider the divergent global picture?

U.S. equities are currently at expensive valuation, although earnings prospects are positive, rising in bond yields may limit market gains. Investors should focus on to stocks with more attractive valuations. The macro environment suggests that strong earnings growth is likely across a variety of economically sensitive companies, sectors, and cap sizes, which are meaningfully less stretched than the Mag 7. Small-cap valuations are more attractive than large-cap valuations. Despite recent gains, outperformance may be constrained by the shallow rate cut.

While U.S. outperformance is likely to persist in 2025, expensive valuations should prompt investors to consider some global diversification. Japan offers less stretched valuations with positive growth prospects due to corporate reforms. The UK presents relatively cheap valuations but faces structural issues, creating potential for upside surprises. Indiaˇ¦s market, through expensive, could thrive due to robust economic growth and lower susceptibility to U.S. tariffs while we think Taiwan equities may continue to benefit from strong AI related demand. In China, investors may consider high dividend equities which may benefit from policy makerˇ¦s capital market reforms and lower interest rate.

Longer-end bond yields are likely to remain relatively range-bound in 2025. By contrast, with the market Fed funds rate expectations more hawkish than our own, it may exert more downward pressure on short-term yields.

Overall, the total yield remains attractive, and credit continues to offer additional carry to U.S. Treasurys. Credit spreads remain near historic lows. While this presents a slightly challenging valuation backdrop, the broad outlook remains positive. The economy is cooling slightly but remains in good health, and corporate balance sheets across both investment grade and high yield companies are also healthy. While there may be only a modest widening bias, spreads are likely to remain broadly rangebound. 

Fixed income continues to provide a steady source of income and yield. Within Asia Fixed Income, investors should be selective on issuers and focus on high quality balance sheets to navigate complex dynamic of trade, geopolitical tensions and reconfiguration of supply-chains.