My economic wishlist for 2025

US implements higher tariffs on trading partners, but there is no major global trade “war”

The 2018 US trade war with China lead to a 1 percentage point increase in the average US tariff rate from ~1.5% prior to 2018 to 2.7% and has remained at just under 3% as the Biden administration kept most of the Trump tariffs as well as expanding some. Trump’s proposed tariff increases (if fully implemented) would take the average US tariff rate to ~17% - its highest level since the 1930s (see the chart below).

Inflation doesn’t reaccelerate

However, this fast pace of disinflation (for headline CPI) hasrun its course, with headline inflation below 3% on annual basis but is still running above 2% (the level of inflation targeted by most major central banks). The other issue is that core inflation remains higher than central banks would like, at over 3%, although outcomes are mixed across countries (see the chart below).

Despite the unemployment rate remaining relatively benign across numerous major economies including the US and Australia, wages growth is still slowing. This is positive for services prices, which are often correlated to wages growth. 

Other large weighed items like housing-related inflation is also likely to soften based on new asking rents in the US and Australia.

Bond yields settle back down

Though, strong US jobs data for December has seen financial markets now pricing in just one rate cut this year. Yields have also risen on expectations of higher inflation from Trump 2.0 tariffs when the new administration starts. The lift in bond yields has probably gone too far, given our view that core inflation has further room to decline and because the risk to growth is to the downside. Higher bond yields threaten the outlook for equities from a valuation point of view. The risk premium (calculated by subtracting the 10-year bond yield from the earnings yield) is negative in the US and sub 1% for Australia (see the next chart). We expect that US 10-year yields will decline back towards 4% later this year.

Global growth broadens out

The US has been an exceptional outperformer in the last two years, in respect to economic growth and sharemarket returns. The global economy looks to have expanded by 3.2% in 2024 and we expect growth of around 3% this year, which is around its long-run average. US GDP growth looks to have ended 2024 up by 2.6%. This is much stronger compared to its peers including Australia (1.0%), Eurozone (1.3%), Japan (0.4%) and the UK (1.6%). GDP growth is higher in China (at around 5% last year) but this is because emerging market GDP growth always tends to run above advanced economies.

Better growth outcomes across the rest of the world outside of the US could result from a pick up in the Eurozone (which has been skirting around a recession in the last two years) and in China which are both important trade partners for many large south-east Asian economies like India, Indonesia, Thailand, Korea and Vietnam.

A broadening out of economic growth across other major advanced economies would help to put downward pressure on the US dollar, which is positive for emerging markets because emerging market debt is priced in US dollars. A lower USD also encourages investment outside of the US.

A simmering in global geopolitical risks

The chart below highlights the events that caused the largest spikes in the index.

While it's clear that geopolitical threats and risks remain, the impact to the Australian economy and global markets is more nuanced. Some events can cause initial large falls in sharemarkets, but a year after the event markets have tended to be higher, which shows that sharemarkets eventually recover from the initial shock.

But in the short-term, less geopolitical risks would be welcome for markets, as it will reduce volatility and uncertainty.