Challenges: Trump's trade plans don’t bode well for growth
While we do not expect a recession in 2025, uncertainty looms. One thing we do know for sure: the US national debt continues to climb.
On the eve of a new year, it’s important to weigh not just opportunities but also the risks. When will these risks materialise? How realistic are they? And what does novelist Ernest Hemingway have to do with America’s rising debt?
Growth risks from Trump’s policies
Donald Trump wants to implement much tougher immigration and trade policies. In our base case scenario, we anticipate a gradual increase in US import tariffs starting in the second quarter of 2025. This could lead to a slowdown in economic growth later that year.
A recession is unlikely in 2025 or 2026, but we expect growth in the eurozone to remain below trend levels. And with higher import tariffs causing lower growth, the European Central Bank (ECB) will be forced to significantly cut its policy rate, likely to 1%.
In the US, the situation is different. Tariffs combined with a tight labour market will likely lead to higher inflation. In the short term, we expect the Fed to continue with rate cuts. However, due to higher US inflation, the Fed has less leeway than the ECB. We expect the Fed to lower its policy rate to 3.5%. This relatively high rate level will ultimately have a dampening effect on US growth. Additionally, the difference in monetary policy between the ECB and the Fed will lead to a significantly stronger dollar.
A lot is unknown about the policies that Trump will actually implement. Should he take a tougher stance than we account for in our base case, growth could come under further pressure.
Hemingway and the national debt: a cautionary tale
During Trump’s second term, the US national debt will increase further. In this context, let’s make a brief detour into American literature. In Ernest Hemingway’s novel ‘The Sun Also Rises,’ a character describes how he went bankrupt: “Gradually, then suddenly.” It’s an apt description of a simmering problem that accelerates. The US national debt is such a simmering problem.
For now, financial markets seem unconcerned. Investors view the dollar as a stable currency and US government bonds as relatively safe investments. However, at some point, markets might begin to doubt whether the US government can repay its debts – and if that does happen, yields on US government bonds could rise sharply.
To pay those higher interest rates, the US would have to take on even more debt. The risk of such a debt spiral is that it ends with a shock: a debt crisis. Indeed – gradually, then suddenly. While we don’t expect this to happen in the short term, in the long term the growing US national debt poses a risk. Raising taxes could address this issue, but there is currently no political will to do so.
Are US stocks expensive?
US equity valuations present another challenge. Based on valuation metrics like the price/earnings ratio, US stocks are more expensive than their European counterparts. From a historical perspective, US stocks are expensive too.
However, when we zoom in at the sector level, we see that valuations are especially high in the IT sector. At the same time, valuations of the US and European IT sectors are quite close to each other (see the bar chart below). The higher overall valuation of the US equity market mainly stems from the IT sector comprising a much larger portion of the equity market in the US than in Europe. At the regional index level (US versus Europe), valuations are therefore more divergent than in the underlying sectors. In addition to this nuance on high US valuations, we see enough reason to remain positive about US equities and the IT sector. You can read more about this in the article Opportunities.
Do high valuations pose a risk? In terms of return expectations, yes. High valuations suggest that much of the positive economic and corporate news has already been priced in. That is one reason why we expect single-digit equity returns in 2025 rather than double-digit gains.
Geopolitical unrest
Geopolitical developments remain a risk. In recent years, oil prices occasionally spiked in response to escalations in the Middle East conflict. This risk remains real in 2025, with further escalating tensions potentially fuelling higher oil prices, which could in turn lead to rising inflation.
Stay diversified and disciplined
Some risks are more urgent than others. The US national debt poses more of a long-term risk, while Trump’s plans could already impact financial markets in the coming quarters. There is enough reason to enter the new year on a moderately positive note and to remain ‘risk-on’ in your investment portfolio to some extent. Diversify your positions, invest with discipline, and stay alert to risks.