Investment Outlook

Lower short-end interest rates, slightly lower long-end rates and decent economic growth should continue to support investor risk appetite. However, valuations are already fair if not somewhat richly valued.

• We think the Federal Reserve (Fed) will undertake four 25-basis-point cuts—one at every other 2025 meeting.
• The US labor market is likely to soften at the margin.
• With personal consumption expenditures being two-thirds of US gross domestic product, record household net worth should fuel demand.
• We see the Bank of England’s (BoE) Monetary Policy Committee in a position similar to that of the Fed.
• Euro area inflation should come down faster than that of the US because demand is much less robust.
• Conditions are different in Japan, where inflation is around 2.0% and small rate hikes are possible.

Credit investors have the potential to outperform US Treasurys given higher yield levels and the possibility of tighter spreads.

• Based on bottom-up fundamental analysis, our credit research team suggests 93% of Bloomberg US Aggregate Index industries are in the expansion phase of the credit cycle.
• Of the industries under our credit analysts' coverage, 36% had positive credit outlooks, a significant rise from 13% in June of 2024.
• Our analysts' upgraded outlooks are predominantly based on better expectations for margins and free cash flows.
• Our risk premium framework estimates credit losses within investment grade and high yield credit to be below historical averages in expansion/late cycle regimes. That could be a key reason why spreads are so tight.
• Yield spreads for high yield credits rated BB and B appear historically very tight, while CCC credits only recently started to look rich.
• Our favored US markets, ranked by expected total return, are leveraged loans, investment grade and high yield. Within global credit, the emerging market space has higher return potential than euro or sterling markets.

Disinflationary trends should remain in place near term; therefore we see downside for government bond yields. 

• Under the new US administration, we think existing and possibly increased tariffs, tax cut extensions and adjustments to current policies appear likely.
• Lack of clarity on potential US fiscal policy makes it nearly impossible to accurately model economic outcomes. However, we created a range of scenarios that suggest inflation may run a bit hotter than expected pre-election.
• Policy changes are not likely to interrupt the economic expansion.
• The US yield curve is likely to steepen as the Fed trims the short-rate and longer-term yields do not decline as much. By the end of 2025, the federal funds rate could reach approximately 3.5% and the 10-year bond yield about 4.0%. 

US dollar valuation is rich relative to emerging and developed market currencies. If the tide turns, we could see foreign currencies improve quickly.

• With limited divergence in central banks’ policies, short-term interest rate differentials are less likely to influence US dollar performance.
• Factors like relative economic growth, trade policy, risk appetite and expected performance of US assets could buoy the US dollar in the very near term.
• Globally, relative US economic performance may attract overseas demand for dollars.
• Oftentimes, the dollar is perceived as a global safe-haven asset and there is no shortage of geopolitical risk.
• Risks associated with US government deficits are rising, and we do not see major changes to the path forward.
• We remain cautious on China, but view upside economic surprises as possible, which would benefit the country and its emerging market neighbors.
• Latin America and South Africa are attractive regions to add foreign exchange exposure.

The macro landscape could be more challenging for equity markets, particularly after such strong 2024 performance.

• Bottom-up consensus earnings expectations suggest the MSCI Europe Index could rebound from flat growth to a mid-single-digit pace in 2025. The S&P 500 Index and MSCI Emerging Markets Index are expected to grow earnings by more than 10%.
• We are conservatively positive about corporate earnings growth relative to consensus.
• US equity outperformance has been significant over recent years. But the S&P 500’s price-to-earnings (PE) multiple has also expanded, helping to drive total return.
• Annual total returns are more likely to be in line with the rate of earnings growth that the S&P 500 Index delivers.
• In the global indices, trailing PE multiples are slightly beneath their five-year averages.

There is a tremendous amount of market optimism regarding the new US administration, however the implications of potential trade policies have yet to play out.

• Global credit and US equity valuations are historically expensive. Most markets are priced for solid economic and corporate earnings growth.
• Many consumer and business sentiment measures surged after the US election. It is possible that sentiment has become too frothy.
• Inflation has been trending lower globally; economies need that to continue.
• Most government bond yields could turn higher if inflation returns in a meaningful way.
• The US has been a beacon of economic strength over the past three quarters, but we expect some slowing is on the horizon. The extent of the slowing and how it impacts the labor market will guide risk appetite.
• Escalating military conflict is never positive for investor sentiment, so we are monitoring developments closely.