Paul Stimers, partner at Holland & Knight and founder of the Quantum Industry Coalition, joins Double Take to jump into the quantum advantage, cybersecurity implications and the future of this groundbreaking technology.

The podcast is intended for investment professionals ONLY and should not be construed as investment advice or a recommendation. Any stock examples discussed are given in the context of the theme being explored and the views expressed are those of the presenters at the time of recording.

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US President Donald Trump’s trade tariffs are widely expected to have an inflationary effect on the US domestic economy. However, rather than being outright inflationary, we think tariffs are more of a bargaining tool for Trump to achieve certain fiscal objectives. This has led to an increase in policy uncertainty, which could lead to slower economic activity. 

Since his inauguration, Trump has imposed tariffs of 25% on imports from Canada and Mexico,[1] and 20% on imports from China.[2] He has also threatened tariffs on the European Union and committed to so-called reciprocal tariffs on a range of other countries.[3] The fear is that tariffs could ramp up the cost of goods for US importers who could pass these on to retailers and, in turn, to end consumers.

Nevertheless, while we believe there are certainly inflationary forces at play in the global economy, such as secular drivers like deglobalisation and decarbonisation, our views on tariffs as a contributing factor are more sanguine. We do not think tariffs will be as inflationary as the market fears.

We do not think tariffs will be as inflationary as the market fears.

External revenue

As part of this deal making, we would highlight Trump’s rhetoric on creating an “external revenue service.” [4] The intention of this is to collect tariffs, duties and revenue from foreign sources to relieve the tax burden on internal sources, i.e. domestic companies.

Trump believes there should be an external revenue service. When it comes to renegotiating tax policy in 2025, we could see tariffs as part of that package – the idea being to generate more revenue from external partners, maybe through broader tariffs, at the same time as cutting taxes internally.

It is indeterminate whether this is inflationary or not, so we are not convinced that tariffs overall will be inflationary. However, we do believe that interest rates around current levels probably make sense for the economy and the yield curve may be a little steeper. Importantly, it has led to policy uncertainty which could potentially lead to an economic downturn in the short term.

Banks

As well as imposing tariffs, Trump is seeking to roll back regulation across a wide range of industries. This has been evidenced by a flurry of executive orders since his inauguration, tackling areas including government spending, defence, immigration and climate.[5]

Banking is another sector that we believe could come under Trump’s deregulatory lens. Prior to Trump’s inauguration, the Federal Reserve announced a cut to a proposed increase to capital requirements under the Basel III regulation.[6] But we think there is a possibility that the Trump administration could water this down further.[7] 

During the 2008 global financial crisis, more regulation was required and the banks needed more capital. They have spent over a decade building capital levels and the banks in the US, especially the large banks, are now in very good shape.

If capital requirements are indeed left untouched, we believe financial stocks could help stimulate the economy through increased lending activity. They could also return more capital to shareholders in the form of dividends.

If capital requirements are indeed left untouched, we believe financial stocks could help stimulate the economy through increased lending activity.

Energy

Energy is another sector potentially in line for a cutback in regulation. Trump’s ‘drill, baby, drill’ pledge could increase the domestic supply of oil and natural gas but that could be offset by a tougher diplomatic stance on Iran and Venezuela, restricting supply. [8][9] When you net these two forces, the oil price and natural-gas price appear to be favourable at their current levels.

We are positive on natural-gas players because of the huge electricity demand needed in the US to support the manufacturing renaissance that Trump is seeking to enable through lower taxes on domestic companies. We see this trend continuing.

We would also caution investors about getting too excited about a coming surge in US energy supply. Trump telling the energy companies to ramp up production is like ‘pushing on a string’. Many of these companies have become much more disciplined over the last decade and have increasingly focused on returning capital to shareholders through dividends and buybacks as opposed to increasing production. We believe this is positive for dividend investors.

[1] FT. Donald Trump confirms he will impose 25% tariffs on Mexico and Canada on Tuesday. 3 March 2025.

[2] FT. US to raise tariffs on China and push ahead with Canada and Mexico levies. 28 February 2025.

[3] FT. Donald Trump threatens to impose 25% tariffs on EU goods. 26 February 2025

[4] Guardian. Trump says he will create ‘external revenue service’ to collect tariff income. 14 January 2025.

[5] BBC. What has Trump done since taking power. 29 January 2025.

[6] FT. Federal Reserve halves proposed capital requirement rise for largest US banks. 10 September 2024.

[7] The Banker. Further Basel delays expected as UK and EU wait on Trump. 20 January 2025.

[8] BBC. Trump vows to leave Paris climate agreement and ‘drill, baby, drill’. 21 January 2025.

[9] The National. Trump-led US may tighten oil markets with stricter sanctions on Iran and Venezuela. 6 November 2024.

Donald Trump’s trade tariffs are widely expected to have an inflationary effect on the domestic economy. However, rather than being outright inflationary, we think tariffs are more of a bargaining tool for Trump to achieve certain fiscal objectives. This has led to an increase in policy uncertainty, which could lead to slower economic activity. 

Since his inauguration, Trump has imposed tariffs of 25% on imports from Canada and Mexico,[1]  and 20% on imports from China.[2] He has also threatened tariffs on the European Union and committed to so-called reciprocal tariffs on a range of other countries.[3] The fear is that tariffs could ramp up the cost of goods for US importers who could pass these on to retailers and, in turn, to end consumers.

Nevertheless, while we believe there are certainly inflationary forces at play in the global economy, such as secular drivers like deglobalization and decarbonization, our views on tariffs as a contributing factor are more sanguine. We do not think tariffs will be as inflationary as the market fears.

We do not think tariffs will be as inflationary as the market fears.

External Revenue

As part of this deal making, we would highlight Trump’s rhetoric on creating an “external revenue service.” [4] The intention of this is to collect tariffs, duties and revenue from foreign sources to relieve the tax burden on internal sources, i.e. domestic companies.

Trump believes there should be an external revenue service. When it comes to renegotiating tax policy in 2025, we could see tariffs as part of that package – the idea being to generate more revenue from external partners, maybe through broader tariffs, at the same time as cutting taxes internally.

It is indeterminate whether this is inflationary or not, so we are not convinced that tariffs overall will be inflationary. However, we do believe that interest rates around current levels probably make sense for the economy and the yield curve may be a little steeper. Importantly, it has led to policy uncertainty which could potentially lead to an economic downturn in the short term.

Banks

As well as imposing tariffs, Trump is seeking to roll back regulation across a wide range of industries. This has been evidenced by a flurry of executive orders since his inauguration, tackling areas including government spending, defense, immigration and climate.[5]

Banking is another sector that we believe could come under Trump’s deregulatory lens. Prior to Trump’s inauguration, the Federal Reserve announced a cut to a proposed increase to capital requirements under the Basel III regulation.[6] But we think there is a possibility that the Trump administration could water this down further.[7] 

During the 2008 global financial crisis, more regulation was required and the banks needed more capital. They have spent over a decade building capital levels and the banks in the US, especially the large banks, are now in very good shape.

If capital requirements are indeed left untouched, we believe financial stocks could help stimulate the economy through increased lending activity. They could also return more capital to shareholders in the form of dividends.

If capital requirements are indeed left untouched, we believe financial stocks could help stimulate the economy through increased lending activity.

Energy

Energy is another sector potentially in line for a cutback in regulation. Trump’s “drill, baby, drill” pledge could increase the domestic supply of oil and natural gas but that could be offset by a tougher diplomatic stance on Iran and Venezuela, restricting supply. [8][9] When you net these two forces, the oil price and natural-gas price appear to be favorable at their current levels.

We are positive on natural-gas players because of the huge electricity demand needed in the US to support the manufacturing renaissance that Trump is seeking to enable through lower taxes on domestic companies. We see this trend continuing.

We would also caution investors about getting too excited about a coming surge in US energy supply. Trump telling the energy companies to ramp up production is like ‘pushing on a string.’ Many of these companies have become much more disciplined over the last decade and have increasingly focused on returning capital to shareholders through dividends and buybacks as opposed to increasing production. We believe this is positive for dividend investors.

[1] FT. Donald Trump confirms he will impose 25% tariffs on Mexico and Canada on Tuesday. March 3, 2025.

[2] FT. US to raise tariffs on China and push ahead with Canada and Mexico levies. February 28, 2025.

[3] FT. Donald Trump threatens to impose 25% tariffs on EU goods. February 26, 2025

[4] Guardian. Trump says he will create ‘external revenue service’ to collect tariff income. January 14, 2025.

[5] BBC. What has Trump done since taking power. January 29, 2025.

[6] FT. Federal Reserve halves proposed capital requirement rise for largest US banks. September 10, 2024.

[7] The Banker. Further Basel delays expected as UK and EU wait on Trump. January 20, 2025.

[8] BBC. Trump vows to leave Paris climate agreement and ‘drill, baby, drill’. January 21, 2025.

[9] The National. Trump-led US may tighten oil markets with stricter sanctions on Iran and Venezuela. November 6, 2024.

Paul Stimers, partner at Holland & Knight and founder of the Quantum Industry Coalition, joins Double Take to jump into the quantum advantage, cybersecurity implications and the future of this groundbreaking technology.

The podcast is intended for investment professionals ONLY and should not be construed as investment advice or a recommendation. Any stock examples discussed are given in the context of the theme being explored and the views expressed are those of the presenters at the time of recording.

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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.

The podcast is intended for investment professionals ONLY and should not be construed as investment advice or a recommendation. Any stock examples discussed are given in the context of the theme being explored and the views expressed are those of the presenters at the time of recording.

Listen on

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.

The podcast is intended for investment professionals ONLY and should not be construed as investment advice or a recommendation. Any stock examples discussed are given in the context of the theme being explored and the views expressed are those of the presenters at the time of recording.

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.

The podcast is intended for investment professionals ONLY and should not be construed as investment advice or a recommendation. Any stock examples discussed are given in the context of the theme being explored and the views expressed are those of the presenters at the time of recording.

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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.