Headwinds and Tailwinds in 2025

A soft landing has been achieved, and the world economy is in the expansion phase of the business cycle. There will be greater geopolitical and pollical stability. However it is important to understand the headwinds and tailwinds that will shape the global economy in 2025.

Headwinds

Global trade & a strong US dollar: A strong US dollar is a negative for global trade. Figure 1 which shows movements in the dollar (on a reverse axis) against changes in global exports since 1974 is illustrative. When the US dollar is weak global trade thrives and vice versa. Even today 80% of global trade is settled in US dollars.

Trump’s trade tariff war: There is no doubt that the US led trade war is set to escalate and there will trade retaliatory measures. A 10% US import tariff on global imports is almost a given. Some countries will be hit harder than others. Overall it will be a drag on global trade while companies incorporate higher market access costs and adjust other production costs and/or accept the profit margin squeeze. Whether the disruption will be short-term or medium term is unclear and depends on how drawn-out America’s negotiations with its trading partners are.

That said Trump sees America’s trade deficit as a leverage tool to be used to negotiate better terms for the country. Permanently raising tariffs to levels that hurt American consumers and companies directly contradicts Trump’s Make America Great Again mantra and are unlikely. So no 60%tariff rates.

Inflation and monetary policy: From here on monetary policy decisions will become more complicated. Headline inflation rates remain elevated compared with pre-Covid and is creeping up in the US, UK, Euro-area and in Japan (Figure 2). The exception is Asia.

The headwind is the pace at which the US Fed, European Central Bank and Bank of England can continue to cut policy interest rates. The market is now discounting only two 25bps Fed Fund rate cuts this year. The BoE too will be slow to cut. The ECB is the exception and the expectation is that the central bank will continue to ease monetary policy as growth concerns take precedence over price stability.

Europe: Subpar economic performance will persist. Germany is barely growing, while economic activity is slowing in France and Italy. The problem is the reluctance of European households to spend and take on leverage, despite falling interest rates and rising real incomes. This was the reason last year the corporate sector led profit and investment spending upcycles failed to translate into a broader economic recovery. Real retail sales growth remains lacklustre. The credit cycle is in a downswing, and household savings rates are rising as precautionary demand for rainy-day buffers grows. The other major headwind for Europe is Trump. The greatest cost will stem not from higher U.S. tariffs—only 8% of total EU exports in the twelve months to September 2024 went to the U.S.—or even from weaker exports, but rather from rising defence spending and mounting fiscal pressures.

China: Turning East, the biggest drag on global growth and financial markets in 2025 will be China. Figure 3 gives a gauge of the health of the economy and the success of the central banks and government’s monetary and fiscal policy stimulus measures. The chart shows that although Asia ex-Japan exports to China are still rising in absolute terms, the rate of growth is decelerating rather than accelerating which is what one would expect to see if the Chinese economy had turned around decisively.

US equity market valuations: The final headwind for international financial markets is the lofty valuation levels of U.S. equity markets, which heightens the risk of both healthy and unhealthy corrections. Figure 4 shows on a price-to-earnings the S&P500 is expensive. The market on other measures, including price to book and price to sales ratios is extremely elevated.

Now with all the gloom out of the way, let’s turn to the tailwinds.

Tailwinds

US economy: Within the developed world, the US will once again be the best performing economy in 2025, and the rest of the world stands to benefit from a strongly growing American economy. The US corporate profit cycle is in full upswing. US private sector balance sheet fundamentals are strong. Both corporate and household debt measured as percentages of GDP and disposable income, respectively have trended down since 2020.

Pro-business deregulation will be the cornerstone of Trump’s second-term domestic policies. This should give a significant multi-year boost to the US economy, and corporate earnings. The U.S. corporate tax rate is set to drop from 21% to 20%, with a likely further reduction to 15% for domestic producers. Financial services, traditional energy sectors and pharmaceuticals are positioned to benefit the most, though companies across industries can expect reduced regulatory and compliance burdens.

Meanwhile employment growth is stable at around 1.4% YoY is more or less in line with the pre-pandemic average, and the unemployment rate well below. Hourly earnings are rising by 4% YoY while retail sales have been strengthening, growing by 3.8% YoY in November (Figure 5).

Global crude prices: Stable to declining oil prices is another positive tailwind for global economy, The International Energy Agency (IEA) forecasts that global oil demand will increase from 840,000 barrels per day (b/d) in 2024 to 1.1 million b/d in 2025, bringing total consumption to 103.9 million b/d. On the supply side there is considerable uncertainty around when OPEC + will begin to unwind production cuts. Cuts, at the earliest are expected to be phased out from end March 2025 and to last through September 2026. However, despite stronger demand and slower cuts the IEA does not anticipate severe supply-demand balances that would push up crude prices. Their current market estimates still indicate a 950k b/d supply overhang in 2025.

Government finances: In 2022 five sovereigns defaulted on debt and another six the following year. In 2024 Argentina went through a major debt restructuring as did Sri Lanka. However, with interest rates falling the risk of debt defaults is declining. The health of Asian public finances stands out in particular (Figure 6). In most Asian countries there is scope to loosen fiscal policy to support growth, if need be.

We are also less pessimistic than consensus and the IMF about US public finances and expect significant fiscal spending consolidation in the second term of the Trump administration. The end of support to Ukraine, Israel and the Inflation Reduction Act will also take pressure off government finances.

Global election cycle: The final tailwind is the global election cycle. Currently attention is focused on Germany’s elections on February 27, political uncertainty persists in France, where the government remains in limbo, and in Canada, following the resignation of long-serving Prime Minister Justin Trudeau. However, 2025 will see far fewer elections globally, suggesting reduced political upheaval and greater domestic stability. So far, at least 12 national elections are confirmed, with only a few expected to be pivotal- Germany, Australia, Canada, and potentially Egypt.