Global Market Perspectives, 1Q 2025 Market insights, global market insights, global market perspective, economic forecast, US financial outlook

Theme 1

A complex global picture is emerging, with significant divergence in growth and policy actions.

Theme 2

The U.S. economy remains resilient, but with pockets of weakness requiring careful watch.

Theme 3

The Federal Reserve to adopt a slower, more cautious approach to policy.

Key themes

Hover over each tile to read more about this quarter's key themes.

While the U.S. continues to thrive, China and Europe are struggling. Proposed U.S. import tariffs threaten to intensify these diverging fortunes, reinforcing the U.S. exceptionalism theme. Policymakers will need to respond accordingly.

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Strong household and corporate balance sheets have created a very resilient economy, Yet, low income households and small businesses are struggling and require further interest rate relief to prevent their weakness from spreading.

Recent U.S. economic strength has combined with a rising threat of tariffs to increase upside inflation risks. The Fed will cut rates just a few times in 2025, hitting a floor of 3.75%. Interest rate relief will be shallow and restricted.

Theme 4

Equity market gains may be challenged by elevated bond yields and expensive valuations.

Theme 5

Fixed income credit spreads to remain range bound, with a bias upwards.

Theme 6

Flows into cash continue, but in this constructive environment investors should be in risk assets.

A strong economic backdrop will support continued solid earnings growth. Yet, expensive valuations imply elevated vulnerability to any earnings disappointment, while the recent rise in bond yields may exert pressure on gains.

The shallow Fed cutting cycle means that Treasury yields are unlikely to trend much lower. Credit spreads are near historic tights, but solid fundamentals and elevated starting yields imply credit could generate strong returns in 2025.

Although there are broad valuation concerns and policy uncertainty, the many pockets of value, as well as inflation concerns and reinvestment risk, mean that investors should be optimizing this constructive macro environment.

A complex global economic picture is emerging

Key takeaway

Diverging economic fortunes implies global policy desynchronization in 2025.

The brief global growth scare in mid-2024 activated synchronized central bank policy loosening. Yet, while U.S. strength was swiftly reasserted, Europe is expected to weaken further. China’s outlook was boosted slightly by high hopes for fiscal stimulus. However, this has been offset by the threat of a sharp rise in U.S. tariffs on China’s exports. Indeed, the likely onset of U.S. tariffs confronting numerous trade partners suggests that the divergence in global economic prospects is likely to persist through 2025. In addition, growth-supportive fiscal policies and deregulation only reinforce U.S. exceptionalism. The pace of global central bank rate cuts is also likely to diverge in early 2025. Not only does U.S. economic resilience imply a reduced need for policy stimulus, but with tariffs and restrictive immigration policies threatening a pick-up in price pressures in 2025, the Federal Reserve will be increasingly cautious about its policy path. By contrast, weak growth, or recession, in other developed economies means their central banks will need to cut rates meaningfully more than the Fed.

Slowdown concerns remain amid pockets of weakness

Key takeaway

Low income households and small business are struggling under high borrowing costs and elevated prices. Policymakers are rightfully concerned about these pockets of weakness.

Despite continued strong performance by the broad economy, concerns persist with lingering pockets of weakness on both the household and corporate side. Amongst households, while overall retail spending remains resilient, this strength has been largely driven by middle and high-income households. By contrast, having likely depleted their excess savings, low-income households have pulled back on spending since mid-2021 and, given the softening labor market, have become increasingly cautious. Small businesses have also diverged from larger firms. They have been negatively impacted by their greater sensitivity to the rise in interest rates—an estimated 64% of their total liabilities are in floating rate debt versus only 18% for larger firms. The senior loan officer survey suggests that, despite easing over recent quarters, credit availability for smaller firms remains tighter than pre-pandemic. Surveys suggest that Fed cuts have already supported an improvement in small business confidence and earnings, while the lowering of credit card interest rates have supported indebted households. However, further relief is required if these two important pockets of the U.S. economy are to recover sufficiently and a bifurcated economy is to be avoided.

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Federal Reserve: cautious in the face of uncertainty

Key takeaway

The Fed is set to slow its easing path, cutting rates just a few times in 2025, and hitting a likely floor of 3.75%. Interest rate relief will be shallow and restricted.

Markets have sharply reduced their rate cut expectations since the first Fed rate cut in September, reflecting both an improvement in the growth outlook and a potentially more inflationary backdrop due to the incoming administration’s proposed tariff and immigration policies. Popular thinking has been that the Fed would cut policy rates to neutral. However, since the neutral rate cannot be directly observed, there are a wide dispersion of market estimates around its value, ranging from a low of 2.8% to a high of 4.6%. The upshot is that faced with elevated uncertainty around the neutral rate and the inflationary impact of tariffs, the Federal Reserve now needs to tread cautiously and is set to slow the pace of easing to every other meeting. The Fed sees just two rate cuts in 2025. However, evidence of cooling labor demand, coupled with concerns around low-income households and small businesses, suggests that the Fed may cut policy rates three times in 2025, leaving rates at a floor of 3.75%. Yet, it is not difficult to imagine a scenario whereby new tariffs prompt the Fed to enter a prolonged pause period early in the year.

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U.S. equities: Climbing the valuation wall

Key takeaway

Extended valuations and elevated bond yields present U.S. equities with a challenging environment but, provided earnings growth is strong, U.S equities can deliver solid gains.

The S&P 500 hit a record high 57 times in 2024. It is not unusual for the equity market to achieve new all-time highs during bull markets, and new highs do not necessarily mean the market is due for a pullback. Yet, with valuation measures now showing that U.S. equities have never been as expensive, earnings must deliver against lofty expectations. Earnings prospects for 2025 are fairly positive. Not only is the U.S. economic outlook constructive, but U.S. policy may spur additional economic growth as the new administration signals a push for deregulation and lower corporate and individual taxes. However, a key challenge to the bull market is the rise in bond yields. If this persists, yields will exert pressure on equities, limiting potential gains. It may not take much of an increase in rate expectations to whipsaw the stock market. There also remains vulnerability around the outperformance of the Magnificent 7. While the secular trend upward of the Mag 7 should persist over the long run, their expensive valuations, coupled with elevated bond yields, imply that investors should pay increased attention to stocks trading at more attractive valuations.

Learn more about the factors impacting markets and portfolios in the quarter ahead by downloading the full PDF.

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Despite tight spreads, credit may generate strong returns

Key takeaway

Credit spreads are near historic tights. But solid fundamentals and elevated starting yields imply credit could generate strong returns in 2025.

Fixed income returns were quite volatile in 2024 as investor speculation about the size and pace of central bank cuts drove interest rate volatility. However, overall, the total yield generated from fixed income today remains attractive relative to history, and credit continues to offer additional carry to U.S. Treasurys. As a result, yield buyers should continue to be attracted to credit. Credit spreads remain near historic lows. While this presents a slightly challenging valuation backdrop, the broad outlook remains positive. The economy is cooling slightly but remains in good health, and corporate balance sheets across both investment grade and high yield companies are also healthy. As such, while there may be only a modest widening bias, spreads are likely to remain broadly rangebound in 2025. The combination of supportive fundamentals and elevated starting yield should enable credit to generate strong returns for investors in 2025. Ultimately, fixed income assets continue to provide a reliable source of income and yield, offer mitigation against widespread market volatility, and present opportunities to enhance returns within investment portfolios.

Risk asset outlook: Resisting the temptation of cash

Key takeaway

The strong economic outlook and pockets of value in the market, as well as inflation concerns and reinvestment risk, mean that investors should resist the temptation of cash.

Flows into money market funds have continued to increase. Valuation concerns and U.S. policy uncertainty have led investors to feel more comfortable in cash. Yet, these concerns are likely overdone. While it is true that the change in government has raised policy uncertainty, the incoming administration’s policy stance is for broad deregulation and lower corporate and individual taxes. It is not yet clear how these policies will be enacted, but they are unlikely to be damaging to U.S. economic growth – reinforcing the constructive macro environment, which provides a strong backdrop for risk assets. In addition, while the S&P 500 index is expensive, there are many segments of the market which are attractively valued and therefore less vulnerable to pullbacks. A key concern for 2025 is the potential for a renewed increase in inflation—this makes it even more important for investors to consider real returns and to target risk assets that can deliver a higher return than cash. Finally, with Fed policy rates still biased lower, investors face reinvestment risk and should lock in higher yields now, suggesting some urgency for investors to put their cash to work.

global market perspectives

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Diverging fortunes

4Q 2024

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As global growth has weakened, policymakers have started to respond. The U.S. Federal Reserve is committed to avoiding recession, while China’s recent policy measures also raise the odds of a global soft landing.

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Theme 2

The U.S. economy: Slowdown does not imply recession

Labor market cooling has triggered recession concerns, but the continued strength of consumer and corporate balance sheets implies that job layoffs, and therefore recession, can be avoided. A moderation to trend growth is likely.

Theme 3

Central banks are determined to secure soft landings

The Fed is set to lower rates towards 3% and may frontload rate cuts if there are further signs of labor market weakness. The Fed’s commitment to a soft landing will be mirrored by other central banks keen to avoid overly strong currencies.

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Hear why Seema Shah, Chief Global Strategist, believes that despite global economic and geopolitical risks, coordinated central bank easing offers a prime risk-on investing opportunity.

1Q 2025 Global market perspectives

Seema Shah Chief Global Strategist

Principal Global Insights Team

Brian Skocypec, CIMA Director, Global Insights & Content Strategy

Benjamin Brandsgard Insights Strategist

2Q 2024

1Q 2025

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Synchronized easing cycles to limit dollar downside

Key takeaway

As global central banks confront slowing growth and strengthening currencies, they will likely accelerate their pace of easing to match the Fed’s.

A synchronized global monetary easing cycle is underway. Such concerted efforts raise the odds of a global soft landing. The initial stages of the ECB easing cycle were less intense than the Fed's, cutting rates at every other meeting. With the Euro area economic backdrop so stagnant and euro strength further challenging the struggling manufacturing sector, the ECB is unlikely to maintain its gradual pace. It will likely shift to back-to-back rate cuts during 4Q 2024, falling in line with the Fed's policy path. For the Bank of England, currency pressures and fiscal tightening will likely contribute to an acceleration of its rate-cutting pace in 2025. With the People's Bank of China firmly in easing mode, the Bank of Japan remains the only outlier of the major central banks. Yet, the vicious unwind of the yen carry trade during early August as the BoJ announced a sharper-than-expected tightening of monetary policy has likely served as a warning signal. Going forward, the BoJ will likely adopt a gradual and cautious approach to hiking, limiting yen appreciation. With most central banks likely to match the Fed's pace of easing in 2025 and the BoJ tightening at a modest pace, the scope for further dollar weakness is limited.

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U.S. equity: Dependent on Fed soft landing success

Key takeaway

Fed success in piloting a soft landing should drive further positive gains in earnings and, therefore, U.S. equities.

Strong policy easing moves have helped U.S. markets recover and even hit new highs after having been whipsawed in early August when concerns about the U.S. economy spiked. History suggests that the Fed’s success in piloting a soft versus hard landing will play a key role in dictating the forward path for U.S. equities. For example, in 1985 and 1995, rate cuts supported strong equity gains as recessions were avoided, while in 2001 and 2007, even aggressive easing could not prevent steep market declines amid economic downturns. Today, the absence of glaring household or corporate balance sheet vulnerabilities means Fed rate cuts should be enough to prevent recession, supporting a positive backdrop for corporate earnings and, therefore, equities. Although positive returns may be constrained by a more subdued performance from Magnificent Seven technology stocks, the broadening risk appetite and earnings growth across a variety of other companies, sectors, and cap sizes are meaningfully less stretched and provide reassurance about the diversity and resilience of the U.S. markets.

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Realization of a soft landing could provide a lift to yields

Key takeaway

While history suggests Fed cuts should push yields lower, the improvement in economic outlook suggests some mild upward drift in long-end yields, resulting in a steeper yield curve.

The third quarter of 2024 saw an acceleration in expectations of global central bank policy easing amid growth concerns. As a result, sovereign yields declined through the quarter, with 10-year U.S. Treasury yields ending around 60bps lower than where they began. With the Fed’s cutting cycle finally underway, history suggests there may be some additional downward pressure on U.S. Treasury yields. Yet, with significant Fed easing already priced into forward rates, the front end of the yield curve may already be close to its floor. A steepening of the yield curve is likely as the long-end should drift modestly higher as preemptive Fed easing engineers a soft landing. U.S. election-related volatility, plus market focus on fiscal sustainability as 2025 tax cut extension negotiations come into view, also likely limits the downside for bond yields. Overall, fixed income has continued to deliver positive performance in 2024, as macro conditions remain largely solid. The total yield generated from fixed income today remains attractive relative to history, and credit continues to offer additional carry to U.S. Treasurys.

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Cash is not optimal in a rate cutting environment

Key takeaway

Rate cuts are reducing the attractiveness of cash. With global stimulus lifting prospects for risk assets across the globe, investors should be optimizing this constructive environment.

With the Fed’s monetary easing cycle now underway and rate cuts potentially front-loaded, the attractiveness of cash has declined. Some $6.4 trillion is currently sitting in money market funds, potentially representing an important tailwind for risk assets. Putting a number on the potential flow into risk assets is difficult. In recent years, some of the increases in money market funds have simply been a conversion of demand deposits such as checking accounts and savings, which investors will likely maintain in liquid, safe assets. Yet, with risk assets facing a fairly positive outlook, there will inevitably be some flows into equities and credit. Equities not only offer exposure to important secular themes, such as artificial intelligence and technology, but in a rate-cutting, soft landing environment, there is strong potential for positive returns. Similarly, high yield credits should also benefit from a rotation out of MMFs as investors look to higher yielding assets. In addition, core fixed income can offer important income stability and a hedge against downside economic risk. The final quarter of 2024 will likely be beset by U.S. election volatility. Investors will need to keep cool heads, focus on the fundamentals, and resist the temptation to revert to cash.

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Theme 4

Equity markets confront valuation challenges, but Fed cuts should support continued gains.

Historically, a Fed cutting cycle without recession has resulted in a strong equity market performance. While stretched valuations suggest gains may be more limited this time, a broadening of gains beyond just tech presents opportunities.

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Theme 5

Fixed income typically shines in a late cycle slowdown.

Fixed income spreads are tight, but elevated yields continue to draw investor interest. Fed cuts, combined with strong growth, should reduce default risk, extending the credit cycle.

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Theme 6

With potential gains across asset classes, staying in cash is the leading risk.

With the Fed’s rate cutting cycle now underway, the attractiveness of cash is rapidly diminishing. With stimulus lifting prospects for risk assets globally, investors should be optimizing this constructive environment.

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Seema's Key Takeaways

Seema's Key Takeaways, 1Q 2025

Hear why Seema Shah, Chief Global Strategist, believes a shift toward easier financial conditions positions investors for potential outperformance during the remainder of 2024.

4Q 2024 Global market perspectives

Seema's Takeaways

Christian Floro, CFA, CMT Market Strategist

Jordan Rosner Sr. Insights Strategist

Christian Floro, CFA, CMT Market Strategist

Jordan Rosner Sr. Insights Strategist

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The stock market and earnings

S&P 500 Index price and trailing earnings-per-share, 1990-present

S&P 500 Index (LHS)

S&P 500 EPS (RHS)

6,000 5,000 4,000 3,000 2,000 1,000 0

$250 $200 $150 $100 $50 $0

1995 2000 2005 2010 2015 2020 2025

Tech bubble peak: 1,527 EPS $53

Housing bubble peak: 1,565 EPS $93

December 31, 2024: 5,882 EPS $237

Source: Clearnomics, Standard & Poor’s, Bloomberg, Principal Asset Management. Data as of December 31, 2024.

The stock market and earnings

S&P 500 Index price and trailing earnings-per-share, 1990-present

S&P 500 Index (LHS)

S&P 500 EPS (RHS)

5,000 4,000 3,000 2,000 1,000 0

$200 $150 $100 $50 $0

1995 2000 2005 2010 2015 2020

Tech bubble peak: 1,527 EPS $53

Housing bubble peak: 1,565 EPS $93

March 29, 2024: 5,254 EPS $223

Source: Clearnomics, Standard & Poor’s, Bloomberg, Principal Asset Management. Data as of March 31, 2024.