Outlook 2025: Plan for growth, prepare for volatility

2024 has been another year of strong returns for investors, with the classic 60/40 portfolio1 returning 18.2% year to date (YTD),2 after delivering a 13.3% return in 2023. Like last year, returns have been overwhelmingly driven by equities which returned 29.7% YTD, while bonds returned just 0.9% (Figure 1).

Developments in inflation have been key to this better return environment, with headline inflation rates across the developed world (DW) now either very close to 2% or heading there rapidly. This has allowed central banks to begin the process of normalising monetary policy settings, supporting returns for both debt and equity. At the same time, gross domestic product (GDP) growth has held up remarkably well, with the US economy set to deliver another year of above-trend growth, and the Euro area and UK economies seeing a solid pickup in domestic demand and GDP growth after a difficult 2023.

Looking ahead to 2025, we expect global GDP growth to remain healthy. Indeed, the DW consumer is in excellent shape, with real incomes rising rapidly, interest rates falling and labour markets robust. If newly elected President Trump puts in place the tariffs he promised during the campaign (10-20% on imports across the board and 60% on imports from China), this is likely to dent the current momentum somewhat, but the bulk of the impact isn’t likely to be felt until 2026.

Inflation is a more nuanced story. Much of the decline in DW inflation has come through goods inflation, which has been heavily influenced by temporary factors. In 2025 it may not act as the disinflationary force it was in 2024, and US fiscal policy could prove, yet again, to be supportive of above-trend demand growth. At the same time, the tariffs (if implemented in full) would add around 1-2 percentage points to inflation for a year, depending upon the extent of the pass-through to the consumer.3 If President Trump’s proposed deportations were executed at scale, this could also add to inflationary pressure by tightening the labour market. Such an endeavour would be logistically challenging, however. At the time of this writing it is unclear if there will be a programme and, if so, how large it will be. All told though, both headline and core inflation could be more buoyant, and therefore more challenging for policymakers, than markets and investors are currently assuming.

In past Outlooks we have emphasised the structural changes in the global economy that we believe have taken place in recent years. Understanding those changes, which are deeply founded in deglobalisation, shifts in political economy preferences, and geopolitical developments, remains crucial, in our view, to successful investing over the next decade or more. Many of these factors that we have discussed at length in our previous annual Outlooks will again be in play next year, but shortterm ‘return to normal’ dynamics are also likely to play an important role and will be crucial determinants of returns in 2025.

Despite starting conditions similar to the inflation of the 1970s – the onset of regional conflict, a sharp rise in commodity prices, a tight US labour market, and large amounts of fiscal stimulus – the recent period of inflation has not morphed into a sustained inflation problem. Key to that outcome is that policymakers have learned the key lesson of that prior period, which is that monetary policy must firmly and forcefully address the inflation challenge when it arises and not allow inflation expectations and an ‘inflation psyche’ to become entrenched.

But the war against inflation may not be over. With globalisation reversing, populations aging, and productivity outcomes currently lacklustre there is, in our view, far more underlying inflationary pressure in the global economy than has been the case for decades. Indeed virtually all of the fall we have seen in inflation across the DW has come from weakening goods inflation, while services inflation has remained remarkably stable (Figure 2). This has occurred despite significant amounts of monetary policy tightening and, in some instances (most notably in the Euro area and UK), weak domestic demand.

The falling prices of commodities (which are goods) are certainly part of this story. But it is more than that – in the US, for example, the prices of other goods, such as appliances, furniture, and electronics, have also been declining, as Figure 3 demonstrates.

Falling import prices have been a big contributor to this weakness in goods inflation. While the disinflation in import prices has been broad-based by origin of imports, China and Canada have been big contributors to the outright deflation that has occurred (Figure 4).

Falling export prices from China are in part related to the weakness of China’s domestic economy. With the property market weak and domestic demand sluggish, there has been plenty of focus from policymakers on supporting the export sector. The subsidies and other support for that sector have led to China imparting a sizeable disinflationary shock to the global economy.4 This has helped to turn rapid goods-price inflation into goods-price deflation.

But rather than being a structural, and therefore durable, feature of the underlying economic landscape (as it was in the early 2000s), we view this as a temporary phenomenon related to the state of China’s domestic economy and the current focus of policymakers. In fact, as we have discussed in previous Outlooks, we believe the supply-side dynamic of the global economy has changed and that deglobalisation and weaker demographics mean more underlying inflationary pressure in the global economy. This should mean a return to greater bargaining power on behalf of DW workers, but it will also likely mean that China no longer exports deflation through its manufacturing sector and that goods prices globally are not the disinflationary force that they were in the decades following the fall of the Berlin Wall.

Indeed, US import prices already seem to have turned higher. Around one-third of US consumer goods are imported, but they account for a larger share of the volatility in consumer goods prices and history would suggest that the current trend of rising import prices, but falling goods prices at the consumer level, is unlikely to continue for very long (Figure 5).

On top of that lies the potential tariffs. Assuming a 15% tariff (the midpoint of the 10-20% promised range) on all non-China imports and 60% on imports from China would give a weighted average tariff of slightly more than 20%, taking it back to levels not seen since at least the 1930s (Figure 6). The degree of pass-through to consumer prices is unclear, but by our estimation the tariffs could add 1-2 percentage points to consumer prices.

This is a one-off price level shift and does not represent a sustained lift in the rate of inflation. As such, the US Federal Reserve (Fed) is unlikely to tighten monetary policy as a result but will be on guard for second-round effects. In the context of the goods price dynamics just described, this is likely to mean that the Fed will ease more slowly and the path to normalisation will be longer.

Continue reading our comprehensive macroeconomic report and implications for investors.