As we enter 2025, the performance of financial assets in 2024 has been largely consistent with our view for much of the year. Yet, the end of 2024 offered a new twist, with the U.S. Federal Reserve (Fed) taking a more cautious tone in cutting rates. This has boosted the U.S. dollar (USD) and added pressure to non-USD assets, especially in emerging markets. Meanwhile, a number of political events around the world highlighted the challenges facing ruling political parties in the new year. 2024 ended with higher bond yields and equity consolidations. Yet, we still see value in staying invested in both stocks and bonds in the new year.

The Fed preparing for stubborn inflation

The incoming Republican administration has been busy selecting the new cabinet, shaping expectations on policy direction. President-elect Trump continues to use tariffs as a stick to pressure trade partners, such as Canada, China and Mexico, on issues like border security and drug trafficking. Meanwhile, there is a lot of noise over the Department of Government Efficiency (DOGE) and whether it could help reduce government spending to tackle fiscal deficits.

Overall, the general consensus remains that the new administration could help prolong the current economic cycle with tax cuts and deregulation to boost corporate investment. The impact from tariff threats should be manageable for the U.S. economy. On the flip side, this also means the decline in inflation could take longer.

In its December Federal Open Market Committee (FOMC) meeting, the Fed opted to cut rates by 25 basis points (bps). Recent inflation and growth data are decent, but the fact that policy rates, both in real and nominal terms, continue to be high allows the Fed to ease policy. It is probably conscious of the fact the market was already pricing in a rate cut ahead of the meeting and the central bank does not want to surprise the market. However, the Summary of Economic Projections (SEP) shows that FOMC members now expect a slower decline in inflation, both headline and core, in 2025. Therefore, instead of the 100 bps cut forecasted for 2025 in the September SEP, this has been toned down to just 50 bps. This is in line with the futures and overnight index swap (OIS) market.

Nonetheless, the less dovish tone by the Fed lifted U.S. Treasury yields. The 10-year UST yield jumped 40 bps in December to its highest since May. This forced a consolidation in the equity market, with the S&P 500 down 2.5%, but NASDAQ was able to hold its ground. Small-cap stocks saw more pressure as investors are concerned over high borrowing costs impacting small-cap companies more than large companies.

The U.S. dollar index (DXY) broke above 108 for the first time since 4Q 2022. The Japanese yen (JPY), the Australian dollar and the New Zealand dollar saw particularly large depreciation against the greenback. For the JPY, the Bank of Japan (BoJ) refusing to commit to a rate hike in early 2025 was the culprit.

More political turbulence after a busy year of elections

2024 was a very busy year of elections with over two billion people eligible to vote. The end of 2024 does not imply the end of political uncertainties. While much of investors’ attention has been focused on the U.S. election, there have been plenty of other political events around the world that could influence fiscal and economic policy, and hence investment outcomes.

In Europe, French President Macron faced a significant setback as his Prime Minister Michel Barnier failed to survive a vote of no confidence and failed to gain support from either the far-left or far-right political parties in a budget proposal to reduce the fiscal deficit. While a new prime minister has been appointed, long-term strategic policies to boost the economy may be delayed.

In Germany, Chancellor Olaf Scholz dismissed his finance minister Christian Lindner and coalition partner, effectively collapsing the ruling coalition. Scholz then lost the vote of confidence in the ruling government and called for an early election on February 23, 2025. This could see a reshuffling of power in Germany. The far-right Alternative for Germany (AfD) is gaining popular support even as the center-left and right parties have refused to form a coalition with it.

In South Korea, President Yoon Suk-Yeol was impeached after abruptly declaring martial law on December 3. The acting president, Han Duck-Soo, was also later impeached by the parliament. The Constitutional Court will hear the impeachment case and make a judgment in the months ahead. Meanwhile, in Canada, Prime Minister Justin Trudeau is also facing pressure to step down and call for general elections.

These political turbulences do not only impact domestic economic policies. They are also taking place at a time when U.S. economic and foreign policies could be changing with the new incoming administration. The leadership changes in Europe could introduce uncertainties to the war in Ukraine. Political volatility in U.S. allies in Asia, such as Japan and South Korea, could also impact the U.S.-China relationship in the region.

Diversification remains key

Overall, the macroeconomic backdrop of the global economy continues to be favorable. Despite the Fed’s reluctance to cut rates more aggressively, we still see the threshold for a policy reversal to hiking rates to be very high. Hence, we are likely to enjoy a U.S. economic backdrop of steady growth and borrowing costs. However, the policy outcome from the new U.S. government and the political turbulence around the world means the range of possible outcomes for investors has widened, both to the upside and the downside. This calls for a more diversified approach to investing in equities, fixed income and alternative assets.

Global economy:

• In the December FOMC meeting, the Fed reduced its policy rate by 25 bps. However, investors were more focused on the updated economic projections. The FOMC members revised their 2025 inflation forecasts upward, driven by more resilient growth and potential policy changes from the incoming Trump administration. Consequently, they also reduced the projected rate cuts for 2025 from a total of 100 bps in the September forecast to just 50 bps.
  (GTMA P. 28, 29, 30)
• The European Central Bank also cut its rate by 25 bps, with President Christine Lagarde suggesting that the eurozone could see inflation returning to its 2% target by 2025. Meanwhile, the BoJ kept its policy rates unchanged in its December meeting, citing the need for more wage growth data before committing to rate hikes in the near term.
  (GTMA P. 18, 19, 20)
• December was a turbulent month politically worldwide. French Prime Minister Michel Barnier faced a vote of no confidence in parliament as he sought to implement fiscal consolidation. Germany announced a general election for February 23, following the collapse of the ruling coalition. In South Korea, President Yoon Suk-Yeol was impeached after declaring martial law on December 3. More political changes could occur in 2025 in developed economies after a busy 2024 election year.

Equities:

• Rising bond yields, as the Fed scaled back its rate cut projection for 2025, weighed on equities. The MSCI World and S&P 500 indices fell by 1.6% and 1.4%, respectively, in December, while the NASDAQ gained 2.4%. Some of the post-election excitement has subsided, and investors are now awaiting potential policy announcements following the January 20 inauguration. The small-cap Russell 2000 dropped 8% as investors worried about the interest costs for small-cap companies if interest rates remain higher for longer. In contrast, the MSCI Europe declined only 0.4%, while the MSCI Japan rose 5.1% due to a weaker JPY.
  (GTMA P. 33, 34)
• In Asia, the MSCI Asia ex-Japan rose marginally by 0.6%, despite weak performance in the U.S. and a strong USD. China and Taiwan were strong performers, while ASEAN, India and South Korea saw declines. The South Korean market was affected by domestic political turmoil and concerns about business and consumer confidence. Taiwan continued to benefit from strong demand for artificial intelligence-related semiconductors.
  (GTMA P. 33, 41)

Fixed income:

• U.S. Treasury yields rose across the board as the Fed adopted a less dovish stance with a more moderate forecast for rate cuts in 2025. The 10-year yield increased by 40 bps to 4.6%, while the 2-year yield rose by 9 bps, resulting in a steeper yield curve.
  (GTMA P. 55, 60)
• Corporate credit spreads remained largely stable in December, as steady economic momentum helped keep defaults relatively low. However, a Moody’s report highlighted a rise in defaults in the leveraged loan market to its highest level since the pandemic.
  (GTMA P. 56, 58, 59)

Other financial assets:

• Gold briefly surpassed USD 2700/oz, but higher rates led to a consolidation around USD 2600-2650. The general expectation is that demand from emerging market central banks for reserve diversification and Asian consumers could support gold prices. Brent crude edged up marginally from USD 72 per barrel to USD 76 per barrel. Geopolitical events with direct impacts on oil supply were largely muted, and investors are watching how the incoming Republican administration might change oil and gas regulation and drilling policy, potentially increasing supply capacity.
  (GTMA P. 76, 77, 78)
• The USD index rose 2.9% to 108.5, given the U.S. interest rate outlook and ongoing economic outperformance. The JPY lost 4.8% over the month due to the BoJ’s cautious approach to higher rates. In Asia, the Korean won (-4.6%) also suffered alongside the JPY, compounded by domestic political issues. Despite tariff threats, the Chinese yuan remained relatively stable, depreciating only by 0.34% in December. The People’s Bank of China will need to balance the potential negative impact of tariffs with preventing currency depreciation that could lead to capital outflow.
  (GTMA P. 13, 15, 74, 75)

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