As investors return from their summer break, attention inevitably turns to the outlook for the year ahead. Often, a good place to start is with the consensus outlook. This year, the consensus forecast envisages a soft landing in the US, a modest decline in UST 10Y bond yields and further upside for US equity markets. But many forecasters also talk about the likelihood of “fatter tails” to the modal forecast, implying higher probabilities of more extreme outcomes for macro-economic variables. Moreover, the global economy may be less synchronised in 2025 relative to recent years, thanks in large part to the dominance of the US exceptionalism narrative.

From a global perspective, the Trump administration is likely to be the most different aspect to the economic and markets backdrop in 2025 relative to 2024. A vote for Trump was not a vote for policy continuity, and as the year progresses, we will gain more clarity on the administration’s implementation of policies on tariffs, immigration, deregulation and fiscal policy.

While it is difficult without detail to make clear quantitative assessments around proposed policies, it is a little easier to make predictions on their qualitative impacts. Increases in tariffs and a decline in net migration are broadly inflationary; the former because it is likely to see a one-off rise in the prices of imported goods and the latter because it will tighten the labour market, all else equal.

On the other hand, a strong deregulatory agenda and stock market (if sustained) are growth positive, probably by enough to offset the negative growth impact of lower immigration.

While President Trump’s policy agenda may look and feel quite different, we would encourage investors to view it through the lens of regime change. The narrative of regime change centres on the notion that the free trade and globalisation dynamics that defined economies and financial markets for the three decades prior to 2016 are no longer. Rather, national interest and economic security are the defining policy objectives in the new regime. Tariffs, lower immigration and “America First” policies are all consistent with the broad contours of this new regime.

Markets have thus far viewed the coming shift in US economic policy as a positive for both the economy and financial markets, prompting investors to focus on the narrative of US exceptionalism. Heading into 2025, the key issue for investors will be how long this narrative sustains. In recent months, it has driven capital flows into the US, spurring strength in the US dollar, out-performance of US equity markets and a repricing of US rate expectations. For now, with a pro-US growth administration elected to govern for the next 4 years, Europe beset with political uncertainty in its largest economies and question marks over the proactivity of Chinese authorities, most investors probably feel like they have no choice but to run with the prevailing narrative.

But with expectations elevated and much in the way of good news already priced into markets, it makes sense to approach the coming year with a little caution, in our view. Stronger nominal GDP growth tends to correlate positively with earnings growth and so it is not surprising to see markets re-rate on perceptions of better economic conditions. But to do this from already expensive valuations suggests somewhat of a one-eyed view about the future.

Outside of the US, the broad direction of travel at the end of 2024 was to downgrade European and Chinese GDP forecasts, with economists viewing these regions as most vulnerable to increased tariffs. Unsurprisingly, economists are now expecting a deeper easing cycle from the European Central Bank (ECB). Beyond a potentially quite different and less synchronised economic outlook for the year ahead, we also note that geo-political risk remains high, especially relative to financial market volatility.

Against this backdrop, we continue to advocate for diversified portfolios. The risk of higher inflation (tariffs, fiscal easing, lower immigration) argues for some exposures to gold, infrastructure and/or inflation-linked bonds. In the other direction, the risk of weaker growth (global trade war) argues for some allocation to government bonds, preferably ex-US. We also think some exposure to the EM ex-China, Commodity, AUD or Resources complex makes sense, given the relative cheapness of these assets and attractive risk/reward attributes in the event tariff policy is more benign than expected.

Locally, 2025 is expected to deliver stronger growth in Australia than was achieved in 2024. Consensus forecasts also envisage a more balanced economy, with a shift from government led growth in favour of better private sector consumption and investment outcomes. Inflation is expected to continue to decline. Risks to the outlook locally are the outcome of the next Federal Election (change of government or minority government) and interest rates (steady policy for longer than expected).

In any year, there are always multiple risks to the outlook, but we think there are three worth highlighting. First, upside surprises to inflation. A sustained rise in inflation would challenge the consensus expectation for a continuation of the disinflation narrative and disrupt the benign macro-economic environment that has underpinned the rally in growth assets. Second, a global trade war: the risks of a broader trade war look under priced, in our view. Elevated US equity valuations may amplify the reaction to any economic weakness that results from a trade war. And finally, fiscal risks – 2024 was notable for the number of countries that embraced fiscal easing (Japan, Brazil, UK, Australia) and it is possible with the Republican clean sweep that US fiscal policy may be eased at some point, too. While markets are happy to turn a blind eye to fiscal issues for the time being, sustained fiscal easing raises the risks around higher terminal rates in the US and higher term premia at the longer end of the curve.

The information contained in this article is believed to be reliable as at January 2025 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article.

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