Economic Outlook Remains Fairly Positive, but What Will Markets Do?
Recently, it has been unclear how strong or weak the U.S. economy actually is. This is due to the fact that, as a result of the government shutdown, very little economic data has been released. Moreover, the data that did become available was unreliable.
This does not apply to Europe. There, it is evident that economic growth is very sluggish. However, the outlook suggests that growth will gradually pick up over the coming period.
The uncertainty surrounding the U.S. economy is likely to come to an end soon, as the shutdown has ended and regular economic data will once again be published. (Unfortunately, a renewed shutdown in the near future cannot be ruled out, but for now the probability appears to be less than 50%.)
From our perspective, however, it is more important that—regardless of whether strong or weak data are released in the coming period—several significant positive forces are beginning to take hold in the U.S. economy:
- Fiscal policy is shifting from restraint to growth stimulation. Should the Supreme Court declare the import tariffs imposed by Trump illegal, fiscal stimulus could even become substantial.
- The Federal Reserve may cut interest rates slightly further, but regardless of that, the central bank is once again increasing its bond purchases. Moreover, the rate cuts implemented over the past period are only now fully feeding through to the economy.
- U.S. banks have gained greater capacity to extend credit.
- Low oil prices are, on balance, beneficial for economic growth.
- The investment boom related to artificial intelligence is not yet over.
- Equity markets are at record highs, and real estate prices remain very elevated, generating a significant positive wealth effect.
Against this backdrop, we expect relatively strong growth in the U.S. economy in the foreseeable future.
It should be noted, however, that due to Trump’s immigration policies and an ageing population, the labour market is likely to tighten fairly quickly once economic growth accelerates, even if productivity increases as a result of AI. In other words, upward pressure on wages is likely to re-emerge.
This must be combined with the fact that many of the imposed import tariffs have not yet been passed on to consumers. All of this suggests that inflation is likely to rise again within a not-too-distant timeframe.
This brings us to interest rate developments. Markets are currently pricing in three additional interest rate cuts by the Fed this year. We believe, however, that zero or at most one cut is more likely. In addition, we expect yields on 10-year U.S. Treasury bonds to eventually break above the key resistance level of 4.20%. From a technical perspective, this could easily mark the start of a move toward—or even above—5%.
This scenario becomes even more plausible given Trump’s intention to significantly increase defense spending. This indicates that the White House has little appetite for addressing the very large budget deficits and government debt.
If interest rate developments in the United States were indeed to disappoint, this would have major consequences for the dollar as well as for equity and bond markets.
However, there is another, more fundamental development at play. After World War II, the United States established a world order based on rules and laws. To this end, various institutions were created, such as the United Nations, the International Court of Justice, and the WTO.
Within this system, the U.S. was the sole true superpower and was able to act as the “world’s police officer.” This system proved highly beneficial for the United States: it facilitated strong growth in international trade and the emergence of many multinational corporations. As a result, U.S. Treasuries and the dollar became the cornerstone of the international monetary system.
Today, however, this international legal order and these cooperative frameworks are being upended by Washington. The abduction of another country’s president and the use of military coercion against that country are entirely inconsistent with established rules. The same applies to the threat to occupy Greenland. In addition, the U.S. has withdrawn from 66 globally operating organizations that were based on international cooperation and agreements.
The underlying reason is that the United States is no longer the sole superpower and is likely, over time, to be overtaken economically and militarily by China. Many of the advantages the U.S. enjoyed as the only superpower are therefore disappearing. This reality now appears to have fully sunk in in Washington, causing U.S. politics to resemble a state of panic.
Trump has concluded that power, rather than rules, now determines outcomes—a conclusion that Beijing and Moscow reached much earlier, and one that Europe continues to resist. As a result, the U.S. is doing everything it can to expand its sphere of influence as much as possible, with virtually no means being ruled out.
It is clear that this will have enormous consequences for the functioning of economies, multinational corporations, and international trade, and therefore also for financial market valuations. (We will address this in greater detail in next week’s GFM report.)
In any case, the era in which financial markets were viewed exclusively from an economic perspective appears to be over. Geopolitical developments will play an increasingly important role.
