Richard Eisenbarth, president emeritus of Cini-Little International, Inc., joins Double Take to stew over the increasing role of artificial intelligence and automation in the food-service industry, marinating on how these technologies are transforming kitchen operations and affecting the industry.

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Richard Eisenbarth, President Emeritus of Cini-Little International, Inc., joins Double Take to stew over the increasing role of AI and automation in the food-service industry, marinating on how these technologies are transforming kitchen operations and impacting the industry.

Listen on

Relative value versus directional alpha

The discount rate is one of the most important metrics in the evaluation of financial assets. Current short-term interest rates are a proxy for the discount rate that is used to determine the net present value of all the future cash flows associated with a financial asset.

The change in cash rates and the discount rate, which began in the aftermath of the Covid pandemic when policy rates began to move higher, signalled the transition from a directional market regime to a relative-value market regime. In our view, this has significant consequences for investors. For example, in a directional regime when the market is in an upward or downward trend, buy and hold equity strategies have typically thrived. On the other hand, a relative-value environment may require a more tactical view across an investment universe that also includes a fair amount of dispersion.

We expect 2025 to continue to favour relative-value alpha strategies that seek to generate a return that is uncorrelated with the broader market, while buy-and-hold directional strategies are likely to face challenges and relatively low premiums. Strategies that utilise relative value have shown increased effectiveness due to dispersion across monetary and policy rates, fiscal tightening, growth rates, inflation rates and returns—not only in equities and bonds but also across currencies and commodities.

Key takeaway: Embrace the macro dislocations and uncertainty as opportunities to generate alpha.

US inflation

Due to the large Covid-era stimulus, the US experienced unprecedented inflation, which peaked at 9%. Conveniently, the Federal Open Market Committee (FOMC) redefined its inflation target as Flexible Average Inflation Targeting (FAIT), where an average of 2% could be commensurate with a current level of 2.5% (core personal consumption expenditures inflation). Unfortunately for the FOMC and the new US administration, historically it has been the rule, rather than the exception, that inflation jumps or reaccelerates before it settles at levels closer to 2.5%.

We believe there could be a slight increase in the US consumer price index (CPI) to 2.6% relative to the consensus forecast of 2.4% over the next 12 months. More worryingly, the Cleveland Federal Reserve’s nowcasting model forecasts the December 2024 CPI to be 0.38%, equivalent to 4.5% on an annualised basis.¹ Its year-over-year inflation forecasts are all around 3%.

Forecasted 12-month change in US headline CPI

Key takeaway: Do not ignore risk of inflation running hot before it settles at 2%.

Currencies: US dollar and Japanese yen

The value of the US dollar as represented by the US Dollar Index has rallied 9.5% since October 2024. This has quickly become one of the more crowded trades as both systematic and discretionary strategies latch onto this clear trend. However, a strong, or in this case over-valued, US dollar relative to the Japanese yen and Chinese renminbi does not suit the long-term policy goals of the new US Trump administration. To facilitate ‘friend shoring’ and improved competitiveness for US manufacturers, the dollar needs to move in the other direction.

In the meantime, the US dollar provides a useful and rare negative correlation to bonds and equities. We believe other currencies such as the yen could balance this trend, perhaps making it the anti-fragile currency for 2025

US 10-year Treasury note vs. US Dollar Index

S&P 500 vs. US Dollar Index

Key takeaway: Enjoy the US dollar ride while it lasts; look for other currencies such as the Japanese yen to balance exposure.

US equity earnings

Thus far, US equity earnings in 2024 have not disappointed, with full-year earnings-per-share (EPS) growth expected to be 11.7%, the highest since the post-Covid recovery in 2021. We expect S&P 500® EPS to fall short of expectations yet still provide healthy growth with little chance of a contraction. Over the next 12 months, the S&P 500 EPS consensus forecast is 12.1%, while our proprietary forecast is 6.6%, or approximately one half that of the consensus. Fundamental analysts tend to be an optimistic bunch who start the calendar year with high expectations but then walk back their outlook as each quarter’s earnings become clearer.

Despite positive EPS growth, the value of the S&P 500 has run ahead of the bottom-up earnings since 2023.² This is the same period when EPS grew a meagre 2% in nominal terms against the total return of 26.3% and inflation of 6.5%. In fact, the gap between valuation and earnings has increased due to the boost related to artificial intelligence (AI), a productivity tool which is as yet difficult to quantify.  

S&P 500: Change in forward 12-Month EPS vs. change in price

Key takeaway: US earnings continue to grow but the gap between valuation and earnings has increased.

US bond rollercoaster

One of the most difficult directional views since the pandemic has been US bonds as well as sovereign bonds in general. During the past four calendar years (2021-2024), US Treasuries have delivered very little return (cumulative return of -10%³), and very little diversification, with correlations to equities shifting positive. In 2024, US 10-year Treasury yields ranged from 3.6% to 4.7%, with at least two V-shaped cycles over the year.

The below chart illustrates our tactical bond signal which is meant to complement the longer-term carry and term premium. It has reflected the bond rollercoaster and importantly its various turning points.  

Monthly bond macro signal attribution by concept: January 2018 – December 2024

Key takeaway: Net long or short bond positions require relative nimbleness in mind as well as exposure.

US economic cycle

Prior to the active stimulus to combat the effects of the Covid lockdowns and large-scale unemployment, the US economic cycle was relatively well behaved for ten years. Given the aggressive policy intervention and very high fiscal stimulus deployed, the US has experienced four phases of the economic cycle in a very short four years.

The below illustrates this journey based on our proprietary leading economic indicators (LEIs) and coincident economic indicators (CEIs). Currently, the US economy is in neither contraction nor recovery, in other words the ‘no landing’ scenario. There is still room for the US economy to expand if the new Trump administration can quickly implement its growth initiatives, such as deregulation and budget cuts. Alternatively, the economy could contract if policies that impede growth, such as tariffs and unfunded tax cuts, prevail. 

US flexcasting indicators

Key takeaway:  As of yet, the “no landing” scenario for the US economy is most likely; consequently, it could expand into a recovery or descend into a contraction. No bets are off.

¹ Source: Federal Reserve Bank of Cleveland https://www.clevelandfed.org/indicators-and-data/inflation-nowcasting, accessed on 14 Jan 2025.

² Source: Factset https://www.factset.com/earningsinsight, as of January 10, 2025. 

³ Source: JPMorgan US Treasury Index.

Rebecca Christie, senior fellow at Bruegel, joins Double Take to discuss European market dynamics, navigating through economist Mario Draghi’s report on the future of European competitiveness.

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The 2024 Newton Charity Investment Survey revealed that, despite concern about inflation having declined, inflation remains a unifying issue across the sector. Its implications are significant for charities, as it affects their level of uncertainty about the future, and their ability to maximise the benefit of grants. While some of the concern is related to short-term spikes and the astronomic figures seen in 2022, our discussions with clients have highlighted that charities recognise the potential for inflation to reach a higher average level than it has in the past.

As well as being an area of concern for charities, inflation forecasting is key to enable them to project grant giving, withdrawal rates and spending needs. In response, we outline our views for the inflation and interest-rate outlook over the next five years to 2030. This long-term perspective is important – we are deliberately not forecasting short-term inflation in the current year which will be driven by short-term growth and monetary pressures. Our focus is to collate market forecasts and our view of the structural forces that will affect broad inflationary pressures and the interest-rate-setting policy response in order to assess where inflation in the UK may settle on average.

The policy-setting environment

Interest rates and inflation are inherently linked, particularly in the UK where, unlike the US, the mandate of the central bank, the Bank of England (BoE), is focused solely on the delivery of an inflation target. In the UK, this is set by the government at 2% as measured by consumer price inflation (CPI), and any outcome that is 1% above or below this amount must be explained to the chancellor of the exchequer. In order to deliver the objective, the BoE relies on setting interest rates, albeit in recent years it has taken direct action in the gilt and corporate bond markets through quantitative easing (buying predetermined amounts of bonds in order to stimulate the economy and increase liquidity) and tightening (shrinking its balance sheet). The chart below shows annual UK CPI back to 1997, when the BoE was given independence from the government. This highlights the volatility in year-on-year changes in UK inflation as measured by CPI, as well as the considerable length of time when inflation either overshot or undershot this target. We have overlaid a five-year moving average rate.

UK consumer price inflation (% change, year on year)

Bank of England inflation forecasts

At its monetary-policy setting meetings, the BoE releases its forecasts for a range of economic variables, including inflation, for the next three years based on its interest-rate setting. The primary output for our purposes is the forecast inflation rate and the fan chart below, which conveys the uncertainty around the future path of inflation.    

Bank of England CPI inflation projection

Given that the BoE sets interest rates according to a model which predicts what will happen to inflation under interest-rate scenarios, it is, in effect, marking its own homework, and inflation typically comes back to its target over the forecast horizon. The fan chart was subject to criticism from Ben Bernanke, a renowned economist, in his review of the BoE’s forecasting and communication.¹

In its report, the Monetary Policy Committee (MPC) also includes the average of market forecasters’ predictions, provided by external researcher Consensus Economics. These are shown for the next three years in the chart below (the latest report is November 2024). 

Bank of England summary of external forecasters

The table below shows the actual inflation data that the markers represent:

For long-run inflation assumptions, most forecasters tend towards the BoE’s target, and setting a five-year average number different to that must be based on a view that inflation will consistently overshoot or undershoot the target. As at 28 January 2025, the Bloomberg consensus for CPI is 2.5% for 2025 and 2.2% for 2026.  

Bond market expectations

The bond market can be a useful source of forward inflation expectations, by considering what is priced into nominal gilt yields relative to inflation-linked gilts, as shown in the chart below and represented by the grey line, with data going back to 2000. This is calculated as the difference between the real yield (the yield accounting for inflation) received from buying an index-linked gilt, and the nominal yield (the yield before accounting for inflation) from buying a five-year conventional gilt.

Five-year inflation expectations derived from the gilt market²

The ‘breakeven’ inflation rate is a measure of the fixed rate that market participants are willing to pay today in order to receive the actual inflation outcome over the subsequent five years. At the end of 2024 this was 3.6%, but while pricing in an active market is a useful starting point, there are reasons to treat this number with caution, as the breakeven level is typically higher than the outturn of inflation. First, buyers are willing to pay a premium for the certainty of receiving actual realised inflation and hedging their risk. This is particularly the case in the UK, where pension funds and insurers are dominant buyers of these assets to protect against liabilities. Secondly, index-linked gilt coupons and principal are currently linked to retail price inflation (RPI) rather than CPI, and for reasons related to different calculation methods and composition of the inflation baskets for the two indices, RPI tends to be higher than CPI. The situation is further complicated by the fact that RPI will be reformulated in 2030 (just beyond this five-year horizon) to be closer to CPI. At the end of 2024, RPI was exactly 1% higher than CPI, while the long-run average was 0.85% higher, as shown in the chart below. 

Comparison of UK CPI and RPI

While the five-year RPI breakeven rate at the end of 2024 was 3.6%, that would indicate breakeven market expectations for CPI at around 2.8%. Adjusting for market structure considerations would reduce that expectation further. 

Structural considerations

The quantitative easing years which followed the global financial crisis led to rapid asset-price inflation, but not goods-price inflation, which consistently undershot its target. In the early 2000s, the emergence of China as a manufacturing and export centre kept inflationary pressures at bay, boosting corporate profit margins and consumers’ real incomes. Since the Covid-19 pandemic, there has been a regime shift and there are reasons to believe that inflation will now be structurally higher than during the prior two decades. 

Some trends remain disinflationary, particularly technological disruption and the integration of artificial intelligence. The adoption rate of this technology in areas previously reserved for humans could have a dramatic impact on labour supply and wage inflation.³ However, other long-term trends have reversed. 

Deglobalisation has been replaced with protectionism and reshoring, going against the traditional mantra of comparative advantage in favour of domestic employment. Asia’s role as the global manufacturing centre is changing, and while it remains dominant, local growth and inflation has reduced the cost advantage enjoyed by Western companies. In recent years, there has been a growing focus on investment in decarbonisation initiatives, electrification and reindustrialisation. In the long term, as costs of energy production from renewable sources fall, there is potential for technological disruption. In the short term, however, the impact could be inflationary, with lower investment in fossil fuels while the world remains reliant on them, and a shortage of key minerals such as copper for electrification.⁴ The peace dividend and low levels of geopolitical risk enjoyed for a long time has changed dramatically in the last few years, and with defence spending on the up and commodity prices more volatile, the inflationary aspects of geopolitical uncertainty are likely to be seen in the data. 

We expect inflation data to be more volatile and to settle at a rate above the Bank of England’s target over the five-year forecast period

As a result, we expect inflation data to be more volatile and to settle at a rate above the BoE’s target over the five-year forecast period. Where the average rate settles will depend partly on the reaction function of central banks and their willingness to sacrifice short-term employment and growth for lower levels of inflation. The BoE’s credibility and belief in the mantra of inflation targeting will be on the line.

In the short term, measures announced in October’s Budget are likely to push up inflation. According to the British Retail Consortium, 67% of leading retailers stated that they would raise prices as a result of the increase in employer National Insurance contributions and other costs.⁵ Household inflation expectations have also nudged up, which may feed through to higher wage demands.

Bank of England short and long-term inflation expectations

Interest-rate implications

Interest rates are the BoE’s primary tool to control the price of money and, so the theory goes, the level of inflation through economic activity. We expect policy setting to face very different challenges over the next few years compared to the last 20 years, with the government debt-to-GDP ratio at 100%, stubborn twin deficits (fiscal and trade), a structurally slower economy relative to history, and substantial expected gilt supply. The net result is that investors are demanding higher yields on UK bonds and cash than might otherwise be the case, such that forward interest-rate expectations are currently elevated.

To assess where interest rates are likely to settle is to consider the neutral interest rate – the level at which monetary policy is neither stimulating nor restricting economic growth. This is a hotly debated topic, but we would estimate that the neutral rate in the UK is approximately 3% on a nominal basis. The evolution of demographic trends, productivity growth and the savings and investment balance has brought the neutral interest-rate level down over time, in a similar manner to the reduction in the structural growth rate of the economy. 

Current interest rates and gilt yields are therefore in restrictive territory and would be expected to slow activity, particularly in the context of a highly indebted economy such as the UK. Reducing nominal and real interest rates back towards neutral will require a restoration of fiscal credibility, and presents the BoE with the challenge of keeping interest rates high for long enough to calm inflation, but not so long as to drive the economy from low growth to negative growth.

Our estimate

The average levels of inflation and interest rates over the next five years are closely linked subjects. It is likely that cash rates will remain above inflation, creating a positive real return in line with the pre-global-financial-crisis years and without the financial repression of the 2008-2023 period. Provided that the BoE sticks to its inflation-targeting regime, it is likely to hold rates higher for longer to bring inflation down and combat the forces of ‘sticky’ inflation. The path to lower inflation, and whether a recession can be avoided, will rely on the BoE’s policymaking skills. Given the global and local structural factors noted above, we would place a higher probability of inflation reaching an above-target average level than an at-target or below-target level, particularly in the shorter term.

In terms of our forecast point estimate, we believe a 2.5% inflation rate to be reasonable within a 2-3% range for the five-year average. There is a high probability of inflation printing outside of this range within any 12-month period. We would expect the accompanying average BoE base rate to be between 3.5% and 4%, implying real yields of 1-1.5%. Clearly, a recession would change these forecasts, as would a sustained risk premium in the bond market. Forward market pricing of short-term rates is currently in the low to mid-4% range, but this reflects current angst around fiscal policy and could easily drop with a credible fiscal plan or an economic slowdown.

Glossary

Visit our knowledge centre for a glossary of common investment terms and to learn more about key investment concepts.

1. Forecasting for monetary policy making and communication at the Bank of England: a review, Bank of England, 12 April 2024 (https://www.bankofengland.co.uk/independent-evaluation-office/forecasting-for-monetary-policy-making-and-communication-at-the-bank-of-england-a-review/forecasting-for-monetary-policy-making-and-communication-at-the-bank-of-england-a-review)

2. Note that the severe negative rate relates to the global financial crisis of 2008 when market pricing ceased to work effectively.

3. See, for example, Klarna’s announcement that it cut its spending on external marketing suppliers by 25%; even creative industries may see the impacts of generative artificial intelligence: Klarna touts ‘brutally efficient’ AI-enhanced marketing, WARC, 20 May 2024  (https://www.warc.com/content/feed/klarna-touts-brutally-efficient-ai-enhanced-marketing/en-GB/9541)

4. For more on this subject we recommend a very readable speech by the European Central Bank: A new age of energy inflation: climateflation, fossilflation and greenflation, 17 March 2022 (https://www.ecb.europa.eu/press/key/date/2022/html/ecb.sp220317_2~dbb3582f0a.en.html)

5. National Insurance increase will force retailers to raise prices, British Retail Consortium, 15 January 2025 (https://brc.org.uk/news-and-events/news/corporate-affairs/2025/ungated/national-insurance-increase-will-force-retailers-to-raise-prices/)

Relative Value versus Directional Alpha

The discount rate is one of the most important metrics in the evaluation of financial assets. Current short-term interest rates are a proxy for the discount rate that is used to determine the net present value of all the future cash flows associated with a financial asset.

The change in cash rates and the discount rate, which began in the aftermath of the Covid pandemic when policy rates began to move higher, signaled the transition from a directional market regime to a relative-value market regime. In our view, this has significant consequences for investors. For example, in a directional regime when the market is in an upward or downward trend, buy and hold equity strategies have typically thrived. On the other hand, a relative-value environment may require a more tactical view across an investment universe that also includes a fair amount of dispersion.

We expect 2025 to continue to favor relative-value alpha strategies that seek to generate a return that is uncorrelated with the broader market, while buy-and-hold directional strategies are likely to face challenges and relatively low premiums. Strategies that utilize relative value have shown increased effectiveness due to dispersion across monetary and policy rates, fiscal tightening, growth rates, inflation rates and returns—not only in equities and bonds but also across currencies and commodities.

Key takeaway: Embrace the macro dislocations and uncertainty as opportunities to generate alpha.

US Inflation

Due to the large Covid-era stimulus, the US experienced unprecedented inflation, which peaked at 9%. Conveniently, the Federal Open Market Committee (FOMC) redefined its inflation target as Flexible Average Inflation Targeting (FAIT), where an average of 2% could be commensurate with a current level of 2.5% (core personal consumption expenditures inflation). Unfortunately for the FOMC and the new US administration, historically it has been the rule, rather than the exception, that inflation jumps or reaccelerates before it settles at levels closer to 2.5%.

We believe there could be a slight increase in the US consumer price index (CPI) to 2.6% relative to the consensus forecast of 2.4% over the next 12 months. More worryingly, the Cleveland Federal Reserve’s nowcasting model forecasts the December 2024 CPI to be 0.38%, equivalent to 4.5% on an annualized basis.¹ Its year-over-year inflation forecasts are all around 3%.

Forecasted 12-month Change in US Headline CPI

Key takeaway: Do not ignore risk of inflation running hot before it settles at 2%.

Currencies: US Dollar and Japanese Yen

The value of the US dollar as represented by the US Dollar Index has rallied 9.5% since October 2024. This has quickly become one of the more crowded trades as both systematic and discretionary strategies latch onto this clear trend. However, a strong, or in this case over-valued, US dollar relative to the Japanese yen and Chinese renminbi does not suit the long-term policy goals of the new US Trump administration. To facilitate ‘friend shoring’ and improved competitiveness for US manufacturers, the dollar needs to move in the other direction.   

In the meantime, the dollar provides a useful and rare negative correlation to bonds and equities. We believe other currencies such as the yen could balance this trend, perhaps making it the anti-fragile currency for 2025.

US 10-year Treasury note vs. US Dollar Index

S&P 500 vs. US Dollar Index

Key takeaway: Enjoy the US dollar ride while it lasts; look for other currencies such as the Japanese yen to balance exposure.

US Equity Earnings

Thus far, US equity earnings in 2024 have not disappointed, with full-year earnings-per-share (EPS) growth expected to be 11.7%, the highest since the post-Covid recovery in 2021. We expect S&P 500® EPS to fall short of expectations yet still provide healthy growth with little chance of a contraction. Over the next 12 months, the S&P 500 EPS consensus forecast is 12.1%, while our proprietary forecast is 6.6%, or approximately one half that of the consensus. Fundamental analysts tend to be an optimistic bunch who start the calendar year with high expectations but then walk back their outlook as each quarter’s earnings become clearer.

Despite positive EPS growth, the value of the S&P 500 has run ahead of the bottom-up earnings since 2023.² This is the same period when EPS grew a meager 2% in nominal terms against the total return of 26.3% and inflation of 6.5%. In fact, the gap between valuation and earnings has increased due to the boost related to artificial intelligence (AI), a productivity tool which is as yet difficult to quantify.  

S&P 500: Change in Forward 12-Month EPS vs. Change in Price

Key takeaway: US earnings continue to grow but the gap between valuation and earnings has increased.

US Bond Rollercoaster

One of the most difficult directional views since the pandemic has been US bonds as well as sovereign bonds in general. During the past four calendar years (2021-2024), US Treasuries have delivered very little return (cumulative return of -10%³), and very little diversification, with correlations to equities shifting positive. In 2024, US 10-year Treasury yields ranged from 3.6% to 4.7%, with at least two V-shaped cycles over the year.

The below chart illustrates our tactical bond signal which is meant to complement the longer-term carry and term premium. It has reflected the bond rollercoaster and importantly its various turning points.  

Monthly Bond Macro Signal Attribution by Concept January 2018 – December 2024

Key takeaway: Net long or short bond positions require relative nimbleness in mind as well as exposure.

US Economic Cycle

Prior to the active stimulus to combat the effects of the Covid lockdowns and large-scale unemployment, the US economic cycle was relatively well behaved for ten years. Given the aggressive policy intervention and very high fiscal stimulus deployed, the US has experienced four phases of the economic cycle in a very short four years.

The below illustrates this journey based on our proprietary leading economic indicators (LEIs) and coincident economic indicators (CEIs). Currently, the US economy is in neither contraction nor recovery, in other words the “no landing” scenario. There is still room for the US economy to expand if the new Trump administration can quickly implement its growth initiatives, such as deregulation and budget cuts. Alternatively, the economy could contract if policies that impede growth, such as tariffs and unfunded tax cuts, prevail. 

US Flexcasting Indicators

Key takeaway:  As of yet, the “no landing” scenario for the US economy is most likely; consequently, it could expand into a recovery or descend into a contraction. No bets are off.

¹ Source: Federal Reserve Bank of Cleveland https://www.clevelandfed.org/indicators-and-data/inflation-nowcasting, accessed on 14 Jan 2025.

² Source: Factset https://www.factset.com/earningsinsight, as of January 10, 2025. 

³ Source: JPMorgan US Treasury Index.

Rebecca Christie, senior fellow at Bruegel, joins Double Take to discuss European market dynamics, navigating through economist Mario Draghi’s report on the future of European competitiveness.

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Christopher Gardner, professor at Stanford University, and Richard Mattes, professor at Purdue University, join Double Take to set the table on ultra-processed foods (UPFs), digging into health implications, regulatory challenges and the role of UPFs in the American diet.

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Christopher Gardner, professor at Stanford University, and Richard Mattes, professor at Purdue University, join Double Take to set the table on ultra-processed foods (UPFs), digging into health implications, regulatory challenges, and the role of UPFs in the Western diet.

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Economic and market background

In late December, NASA’s Parker Solar Probe made history by surviving the closest solar encounter ever attempted by a spacecraft. Travelling at 430,000 miles per hour, the fastest-ever human-made object endured temperatures of up to 982°C (1,800°F) and intense radiation as it entered the sun’s outer atmosphere in a quest to gain a better understanding of our star.¹

During the final quarter of 2024, financial markets also broke some records, with the Nasdaq and S&P 500 US equity indices reaching all-time closing highs on 6 December,² marking the peak of a rally that followed Donald Trump’s victory in the US presidential election. Nonetheless, market participants felt the heat at times too, notably in mid-December when attention turned to an increasingly hawkish Federal Reserve (Fed). Meanwhile, bond markets saw a sharp sell-off over the quarter, with yields rising as concerns grew over inflationary pressures and as the US economy demonstrated continued resilience.

After a bumpy October which saw a tense run-up to the US election and continued instability in the Middle East, US stocks soared in November as investors embraced the decisive election outcome and anticipated the incoming administration’s policy agenda of business-friendly tax cuts and deregulation. In the weeks following Trump’s win, some of the top performers included economically sensitive businesses and names that would benefit from a relaxation of the regulatory environment, such as banks and small-cap companies.

Outside the US, European and emerging markets struggled amid fears that proposed US tariffs could ignite a trade war and dampen growth elsewhere. Japanese equities fared relatively well over the quarter though, as they continued to rebound from their dramatic summer sell-off.

The Fed lowered interest rates at its December meeting, as widely expected, but its Chair Jerome Powell repeatedly emphasised caution, indicating that future reductions in borrowing costs would depend on further progress in reducing stubbornly high inflation.³ Although he expressed confidence that price pressures would continue to ease, he noted that policymakers were starting to consider how Donald Trump’s proposals relating to tariffs, tax cuts and tougher immigration policy might affect the outlook.

The Fed’s policymakers now project they will make only two 0.25% rate reductions during 2025 – a combined half a percentage point less than they had forecast when meeting in September. US stocks plunged sharply in the immediate aftermath of the Fed’s December announcement, and the traditional ‘Santa rally’ failed to materialise during the final trading days of the year.

Europe’s continued economic weakness was exacerbated by political turmoil over the quarter as the governments of two of its largest economies – Germany and France – collapsed, while Italy, which had experienced a relatively strong rebound following the Covid pandemic, showed new signs of stagnation.⁴ Meanwhile, escalating tensions between Russia and the West, following the use by Ukraine of US and UK-supplied missiles to hit targets inside Russia, dominated headlines.

While equities may have ended the year with a whimper, stock markets experienced a strong year overall, with North America once again the standout performer. 2024 was also notable for the strength of the US dollar, amid robust US growth, while gold logged its best year since 2010 and hit an all-time high on 30 October.⁵

Equity markets

Total returns (£), rebased to 100 at 31.12.23

Note: all indices are FTSE series.
Source: FactSet, January 2025.

Total returns (%) to 31 December 2024

Source: FactSet, 1 January 2025. All equity market returns are sterling total returns.

Regional overview

On 29 December it was announced that former US President Jimmy Carter, who later won the Nobel Peace Prize for humanitarian work, had died at the age of 100.⁶ While US consumer price inflation, which rose by 2.7% year on year in November,⁷ is far below the double-digit levels experienced during much of Carter’s 1977-1981 presidency, Fed Chair Jerome Powell has expressed disappointment at how inflation has moved “sideways” in recent months, hindering progress towards the central bank’s 2.0% target.

November’s consumer price inflation data did indicate that the increase in services inflation was slowing, with rents rising at the slowest pace in over three years. Furthermore, there were tentative signs that the labour market could be cooling, with unemployment rising to 4.2% in November from 4.1% in the previous two months. However, proposed trade tariffs from the incoming Trump administration have the potential to counter these disinflationary trends.

According to the US Bureau of Economic Analysis, the economy has remained robust and supported by consumer spending, with gross domestic product (GDP) increasing by 2.8% on an annualised basis in the third quarter, after expanding by 3.0% from April to June.⁸

US consumer price inflation (CPI)

% change, year on year

Source: FactSet, January 2025.

Enrico Letta, former Italian prime minister and author of a report commissioned by the European Union (EU) on the future of the single market, has warned that the political crises in Germany and France should not be allowed to slow the implementation of much-needed economic reforms. A second report by former European Central Bank (ECB) President Mario Draghi presents detailed plans on how to improve European competitiveness. Although there is considerable uncertainty as to how the EU will implement these recommendations, it is widely acknowledged that substantial investment is necessary. This will be crucial as European productivity continues to lag the US, and Europe must also address potential increased US tariffs and growing trade tensions with China.

With inflation fears having largely subsided in December, the ECB cut interest rates for the fourth time in 2024 as the economy remained weak. Germany, the eurozone’s largest economy, is now expected to grow by only 0.2% in 2025.⁹

The UK’s economy also appeared lethargic towards the end of the year, unexpectedly shrinking for two consecutive months for the first time since the 2020 Covid pandemic, according to the Office for National Statistics.¹⁰ The declines were a setback for Chancellor of the Exchequer Rachel Reeves, whose first Budget on 30 October avoided increases to the main direct personal taxes but imposed higher costs on businesses.

As part of that autumn Budget, the UK government reformed its fiscal rules in pursuit of faster economic growth through increased public investment and spending, but business groups have warned that employers may face challenges with higher social security contributions. Forecasts from the Office for Budget Responsibility (OBR) point to moderately higher borrowing requirements than previously expected each year, and inflation a little above target until 2028, potentially curtailing the ability of the Bank of England (BoE) to cut interest rates. The BoE kept its rate unchanged at 4.75% in December, although three of the nine Monetary Policy Committee members voted for a cut.¹¹ It was less willing to reduce rates in 2024 than its US and European counterparts.

While the Bank of Japan’s (BoJ) governor Kazuo Ueda has resolved to continue raising interest rates from their current very low levels, the central bank opted to keep its short-term policy rate on hold at 0.25% at its December meeting.¹² The timings of future rate hikes are likely to be linked to gaining further certainty over US President-elect Donald Trump’s economic policies, including the threat of higher tariffs, as well forthcoming wage negotiations. BoJ policymakers hope that workers’ regular pay, which has been increasing annually by 2.5-3%, will continue rising and support consumption. There are indications that companies plan to keep raising pay owing to growing labour shortages.

Japan’s GDP grew at an annual rate of 1.2% in Q3 2024, surpassing economists’ expectations, despite weak consumption.¹³ The yen has stayed close to historical lows in recent months owing to Japanese interest rates trailing behind those of other major economies, with currency weakness contributing to increased import prices.

On 29 January China will enter the lunar year of the ‘wood snake’, which typically signifies transformation and growth. The country expects its economy to have expanded by around 5% in 2024, in line with its official target,¹⁴ but there has been some venom from a prolonged property market downturn, increasing local government debt and subdued consumer confidence.

Although an official target is unlikely to be announced until an annual parliamentary meeting in March, President Xi Jinping believes China will see a similar growth trajectory in 2025.¹⁵ This is despite the threat of high tariffs from the incoming US administration, which could damage exports, a key driver of the economy. In this context, stimulus measures are likely to focus on boosting consumption and expanding domestic demand. China has pledged to increase the budget deficit by issuing additional debt, and ease monetary policy.¹⁶ However, Beijing may delay implementing further direct fiscal stimulus measures until after the new US administration’s initial actions.

Investment implications

At the start of 2024, there was broad concern that a recession or a reacceleration of inflation would upset the global economy and equity markets. Instead, we have seen a continuation of the disinflationary growth that began in late 2022. Risk assets have spent the last 12 months climbing the proverbial wall of worry, and 2024 turned into a banner year for those invested in broad equities, with the MSCI AC World Index up 18% in US-dollar terms.¹⁷

Significant attention has been given to the narrow scope of the equity-market rally, specifically the notion that its progress was reliant on a limited number of individual securities. While this observation may have held true in the early part of 2023, last year witnessed a broadening of market participation. Although a relatively small number of stocks contributed disproportionately to the total market return, numerous equities have provided substantial returns throughout the year.

It is not only equity markets that have been on the front foot. Corporate credit spreads (the yield premium over government bonds) relentlessly narrowed over the course of the year, suggesting investors have grown increasingly sanguine about the risk of recession.

Contrary to the widespread pessimism at the beginning of 2024, investor optimism has increased alongside the rise in equity markets. Sentiment and positioning are now at the upper end of historical ranges by many measures. While this does not preclude further advances in risk assets, it presents a more challenging starting point compared to early 2024. The potential for disappointment is higher when expectations are generally positive.

Trump’s return

The general optimism regarding the US economy and equities is partially informed by the outcome of the US election. It is widely believed that Donald Trump’s first term as president from 2017-2021 had notable economic and market impacts, particularly owing to the Tax Cuts and Jobs Act. The expectation is that Trump’s second term will also be favourable to businesses, especially when compared to the previous administration. There is anticipation that regulations may be reduced in key economic sectors, with policies likely to encourage growth. Additionally, there have been significant nominations to positions such as Treasury Secretary and chair of the Council of Economic Advisers.

Nevertheless, various other factors contributed to the economic outcomes during Trump’s first term. The Fed had shifted to a more accommodative stance in early 2016, while the ECB and BoJ increased large-scale asset purchases. Consequently, global credit conditions were easing; China managed to complete the bailout of its financial system and implement a substantial stimulus programme, and bank lending was accelerating in the US and Europe as commercial banks had completed the process of repairing their balance sheets. By early 2017, the global economy was experiencing its first period of synchronised growth since the 2008 financial crisis. While the Tax Cuts and Jobs Act served to increase US corporate earnings, the foundations for the economic upswing in 2017 were established prior to Trump’s administration.

Today, the global economy has limited momentum. China continues to grapple with the burden of a deflating housing market, and Beijing has not yet implemented policy measures sufficient to reflate its domestic economy. Europe has significant structural issues, worsened by losing access to cheap Russian energy and with reduced demand for German exports from China. In the US, while the economy is stronger, it is in a mature phase of its cycle. This is not to suggest that a recession is imminent, but a reacceleration of the global economy as seen in 2017 appears unlikely in 2025.

The Fed’s divergent path

The divergent fortunes of the world’s economies are evident through the lens of central banking. Collectively, monetary authorities have been easing policy since 2023. However, they are on the cusp of charting different paths. While many central banks remain inclined to administer further reductions in their respective policy rates, the Fed has recently indicated that there may be fewer interest-rate cuts in 2025 than had previously been expected.

Fed Chair Jerome Powell outlined in his 18 December press conference that the Federal Open Market Committee was unhappy with the progress that has been made on inflation, which has remained above target in recent months despite a series of rate cuts. By the end of the press conference, the market was once again pricing in ‘higher-for-longer’ interest rates.

In the wake of the Fed meeting, the US dollar broke out from the range it had been in since early 2023 when the Fed’s dovish pivot brought the dollar bull market to an end. The renewed strength of the dollar contributes to tighter global credit conditions, which is a concerning development for the already weakening global economy.

Interest rates (%)

Source: FactSet, January 2025.

Bond vigilantes

In late 2018, Trump famously warned Powell to “feel the market” after Powell noted that the Federal Reserve was “a long way from neutral” amid declining US equities and widening credit spreads. On that occasion, Trump ultimately proved correct as Powell ended up performing a dovish pivot in the final days of 2018. However, this time the Fed chair may indeed be pre-emptively feeling the market.

Since the central bank began cutting interest rates, the US yield curve has steepened as longer-dated yields have moved sharply higher. Bond yields started to rise before the election result, moving up from the lows of September when markets were concerned about growth, but they have continued to climb since the election, and the relentless supply of government bonds, both in the US and globally, is likely to remain a significant macroeconomic trend in the coming years. The bond market is finding it challenging to determine an interest rate that adequately compensates investors amid sustained fiscal expansion and persistent inflation above target levels. In this context, monetary and fiscal policy are likely to remain at odds in the foreseeable future.

US 10-year Treasury yield (%)

Source: FactSet, January 2025.

Not all plain sailing

Equity-market volatility remained relatively low during 2024, a characteristic often observed during periods of disinflationary growth and accommodative monetary policy. However, with the Fed’s shift towards a more hawkish stance, it is likely that markets will no longer receive the same level of support. This change in US policy is expected to tighten global credit conditions at a time when the global economy is far from robust. As evidenced by the events of 2018, external economic and market weaknesses can eventually affect the US. Despite investors’ generally optimistic outlook for 2025, it is unlikely that sailing will prove to be as smooth as it was in 2024.

Conclusion

Investors enter 2025 against a backdrop that appears relatively constructive, at least in the short term. The US economy has remained resilient, and the incoming US administration has a policy agenda focused on growth and deregulation. This environment is likely to present significant investment opportunities, particularly in areas that benefit from technological advancements and policy support.

Nevertheless, several challenges lie ahead. Notably, the Fed’s more cautious stance on interest-rate cuts indicates a tighter monetary-policy environment, which could affect global credit conditions. Meanwhile, the large and growing fiscal impulse, as well as the prospect of trade tariffs, could allow inflation to reassert itself.

Outside the US, the global economy has limited momentum, as China and Europe grapple with their respective structural issues. Meanwhile, geopolitical tensions pose significant risks, as the conflicts in Ukraine and the Middle East, and possible changes to US/China trade relations, have the potential to cause disruption globally.

In this context, we consider it crucial to maintain flexibility and conduct thorough evaluations of the attributes of individual securities in order to unlock investment opportunities.

We must adjust to changing times and still hold to unchanging principles.

Jimmy Carter, US president 1977-1981

¹ NASA’s Parker Solar Probe Makes History With Closest Pass to Sun, NASA Science, 27 December 2024
² S&P 500, Nasdaq hit record closing highs; Lululemon gains, data supports rate cut view, Reuters, 7 December 2024
³ Fed lowers rates but sees fewer cuts next year due to stubbornly high inflation, Reuters, 19 December 2024
⁴ Italy’s growth bubble bursts to reveal fragile outlook, Reuters, 17 December 2024
⁵ Source: FactSet, 31 December 2024
⁶ Former US president Jimmy Carter dies aged 100, Financial Times, 29 December 2024
⁷ US consumer prices post largest rise in seven months; rents finally slowing, Reuters, 11 December 2024
⁸ US third-quarter economic growth unrevised at 2.8%, Reuters, 27 November 2024
⁹ Germany faces lethargic growth, potential hit from Trump, Bundesbank says, Reuters, 13 December 2024
¹⁰ UK economy suffers first back-to-back declines since 2020, Reuters, 13 December 2024
¹¹ Bank of England keeps rates steady, policy split widens, Reuters, 19 December 2024
¹² Bank of Japan keeps rates unchanged with few clues on next move, Reuters, 19 December 2024
¹³ Japan revises Q3 GDP higher, keeps alive BOJ rate-hike expectations, Reuters, 9 December 2024
¹⁴ China’s GDP growth expected around 5% this year, senior official says, Reuters, 14 December 2024
¹⁵ Xi says China’s economy on course to expand by 5% despite Trump concerns, The Guardian, 31 December 2024
¹⁶ China pledges more debt, rate cuts to counter Trump’s tariff threats, Reuters, 12 December 2024
¹⁷ Source: FactSet, 31 December 2024