… We explore what we believe are the top five macroeconomic trends to watch for in 2025.

1. The rate-cutting cycle is getting cut short

We expect the US Federal Reserve (Fed) to cut to a higher terminal rate following the Republican sweep in the US election.

Specifically, we now see the rate-cutting cycle stalling at a Fed funds rate of 3.0–3.75% in the second half of 2025, 75 bps higher than our pre-election expectations.

This is, in part, driven by stronger short-term growth. While the exact contours of the policy agenda under a second Donald Trump term remain opaque, we expect a combination of fiscal loosening and deregulation to modestly lift growth, albeit with most of the boost coming in 2026 when any extra tax cuts would take effect. This pickup in demand will contribute to stronger inflationary pressures.

Other aspects of Trump’s agenda will also put upward pressure on prices via a negative supply shock. These include large tariff increases on imports from China and targeted increases on some other trade partners or product groups, as well as a sharp decline in net migration, which has been an important driver of the easing of the labor market in recent years.

As a result of these shifts in aggregate demand and supply, we think the Fed’s preferred measure of core PCE inflation will get stuck at close to 2.5% year over year through 2025 and 2026 (Chart 1).

This means the Fed will have less room to ease policy. We believe they will need to keep interest rates well above neutral to keep inflation expectations anchored. Trump’s policy changes could also put some modest upward pressure on equilibrium interest rates themselves via larger fiscal deficits or stronger private investment. A higher-for-longer profile for rates will affect central banks across the world in different ways (Chart 2).

In general, the direction of travel for emerging markets (EMs) remains for lower rates, but the pace and extent of their cutting cycles might be more restrained. By contrast, the spillover effects from Trump’s trade policy agenda will add to Eurozone growth concerns, encouraging a slightly deeper easing cycle.

2. Debt is a worry again

Global government debt has risen above $100 trillion, nearly 100% of global GDP (Chart 3). US government debt is well over 100% of GDP, and the deficit is 6.7%. This is extremely large, given that the economy is essentially at full employment.

Trump’s policies could increase the US debt and deficit even further depending on what he does. We expect to see the deficit increase to above 7% of GDP.

Fiscal sustainability doesn’t turn on any particular level of debt or deficit. Instead, it depends on the relationship between the real growth rate of the economy (g) and the real interest rate paid on debt (r). If r exceeds g, the debt stock increases without bound unless fiscal policy runs a primary surplus. Because the US dollar is the global reserve currency, r is lower in the US than it might be in other countries that have tried to run similar economic policies. US government securities are in high demand as a place to store value, meaning US asset prices are higher and interest rates lower than otherwise.

The dollar’s status as a reserve currency is the result of very deep and liquid US capital markets and powerful network effects. However, it also relies on perceptions of US rule of law and institutional stability. So, it is possible that if Trump pursues policies perceived as weakening US institutional credibility, especially around the Fed, this could threaten the dollar’s standing as a reserve currency.

Given the lack of alternatives to the US dollar and the appointment of broadly institutional policymakers to key economic positions in the incoming administration, this extreme outcome seems unlikely. However, Trump’s fiscal policy may still lead to higher-term premia on US debt (Chart 4). Increased Treasury supply may require the price to fall to clear the market. Investors may demand more compensation for the risks of higher inflation and greater uncertainty associated with the Trump presidency.

Moreover, we think the term premium may also increase for non-debt-related reasons. More negative supply shocks, such as climate change and geopolitics, will lead to more periods of high inflation and low growth. This may cause a sustained positive correlation between bonds and equities, pushing up the term premium and US borrowing costs.

3. There can be EM winners as well as losers from changing patterns of globalization

Many EMs will find it difficult to navigate heightened trade policy uncertainty and a more inflationary backdrop in the US. But there can be winners as well as losers in 2025 and beyond.

Aside from China, Mexico’s and Vietnam’s large trade surpluses with the US put them at the most significant risk of punitive action from Washington. They, among other EMs in APAC, depend the most on exporting to the US while utilizing substantial inputs from China.

While these vulnerabilities are reasons to expect bouts of market pressure, many of the same EMs will likely emerge as the long-run winners of shifting supply chains, mainly if US efforts primarily focus on decoupling from China. For example, in our modeling work, Mexico ranks as the most vulnerable to US trade measures and the biggest potential reshoring winner.

We believe that US tariff threats against Mexico and talks of ripping up the US-Mexico-Canada free trade agreement are a means of pressuring Mexico to stem migration and raise border security with the US.

As such, we do not anticipate a breakdown of the US-Mexico trading relationship. Mexico’s deep integration with US manufacturing underpins our view that it will ultimately be spared from major trade restrictions, as was the case during Trump’s first presidency. Indeed, the more the US decouples from China, the more it will need other countries, and Mexico is well-placed to capture this change.

Away from trade, a slower pace of Fed easing will complicate monetary policy decisions for the more Fed-sensitive EMs (e.g., Mexico, Indonesia) and potentially add to foreign exchange pressures in those markets where fiscal policy and debt concerns are highest (e.g., Brazil).

4. Any ceasefire in Ukraine or the Middle East will be unstable

US foreign policy will try to create the conditions for ceasefires in Ukraine and the Middle East.

Ukraine

The incoming Trump team appears divided over whether an increase or a decrease in Ukrainian aid in the short term is the best way to achieve a ceasefire. Given Russian momentum on the battlefield and Ukrainian opposition to formalizing territorial losses, there is also a significant possibility that talks will not begin or fall apart rapidly.

Nevertheless, we now anticipate a ceasefire agreement, even if it is fragile. We envisage this involving Russia retaining occupied territory, Ukraine receiving limited security guarantees, which fall well short of a path to NATO membership, and a pathway to modestly ease Russian sanctions.

Europe will be under pressure to increase its share of aid for Ukraine, which will put upward pressure on defense budgets during fiscal consolidation across the bloc.

Middle East

We also expect ongoing volatility in the Middle East, even as Israel reduces the scope of combat operations in Gaza and Lebanon. For a start, any ceasefire will be extremely fragile and easily broken. More fundamentally, we expect the focus of Israeli and US security policy to focus on Iran increasingly.

The incoming Trump administration will likely be in support of Israel’s efforts to restore deterrence. We project intermittent military exchanges between Israel, Iranian-backed militia groups, and Iran itself. We also expect US policy towards Iran to return to a similar position to the one it was in under Trump’s first term (“maximum pressure”), with greater use and enforcement of sanctions (including on oil exports) and a constraint on the Iranian nuclear program.

5. Europe is the next locus of political risk

Following the collapse of the traffic-light coalition, German federal elections are likely to occur in the spring.

Germany

A key electoral issue is the future of the debt brake, which limits deficit spending to 0.35% of GDP. The rule has been criticized as Germany grapples with a significant public investment shortfall, economic stagnation, and increased defense and climate spending pressure.

Left-wing parties favor relaxing these rules, including current Chancellor Olaf Scholz’s SDP and the Greens. And Friedrich Merz, who would become chancellor if the CDU/CSU coalition wins, has expressed openness to reform.

We believe Germany’s next government will reform the debt brake in some capacity, but the contours of any changes are much less certain.

Much depends on the eventual government’s seat count. A two-thirds majority of the Bundestag must pass constitutional amendments to the debt brake. Some polls suggest a grand coalition of the CDU, SPD, and Greens might be able to achieve this. This could see the limit on deficit spending increased or a permanent exemption to the debt brake for infrastructure spending made. Without a supermajority, the government could still legislate to temporarily trigger the escape clause. However, Scholz’s attempts to use this method previously ran into legal frustration.

Either way, any reform of the debt brake is likely to translate to only modest fiscal expansion for several reasons:

France

Meanwhile, France’s political and fiscal problems are more acute. Michel Barnier’s minority government's failure to pass a budget containing the fiscal consolidation required by the European Commission’s Excessive Deficit Procedure has left France in a deep political hole.

Fresh parliamentary elections are only possible one year after the previous election. Emmanuel Macron’s presidency will need to hobble along until the summer before a new parliamentary vote can be called. It is unclear how a government can be formed in the meantime that will retain parliamentary confidence. So, France’s precarious fiscal position continues to look very challenging. We believe the country should be seen more as a peripheral market than a core one, and French spreads should trade accordingly.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed, and actual events or results may differ materially.

AA-101224-186960-1