Of course, it’s the end of the year, I’m caught up in the whirlwind of “2025” predictions about the economy and politics, and while I’m not a big fan of short-term forecasts, I think it might provide some themes. that will condition the markets. and savings until 2025.

I leave it here.

The financial markets, governed by US stocks (more than 65% of the world’s market capitalisation), are in a dizzying situation in 2025.

Retail investor surveys have never been so optimistic, stock market concentration is at levels last seen in 1929 (the top ten stocks account for 40% of the market) and valuations are stratospheric (a simple measure, the price to earnings ratio, has only been higher in 2020 and 2001). In that respect, many investors might pose the question ‘when is the crash?’. My sense is that absent a damaging trade and supply chain war between the US and China in Q1, we will likely see a very meaningful rotation from US equities to cheaper markets in parts of Asia, but more so Europe (the election of Friedrich Merz as German Chancellor in late February might be the catalyst for this).

The Plaza Problem

Another explanation is the strength of the dollar, which makes foreign assets less expensive for American investors. After the election of Donald Trump, several key currencies weakened significantly: the yen, the Brazilian real, the Indian rupee, the renminbi and the euro. While new Treasury Secretary Scott Bessent will see the benefits of a strong dollar, the weakness of “foreign” currencies is anathema to the worldview of Donald Trump, who dreams of a Plaza deal (a “Mar deal -a-Lago”) that could restore the competitiveness of the dollar.

The problem with this view, as we head into 2025, is that the weakness of Asian currencies and the euro, relative to the dollar, is driven largely by diverging economic performance. In that context, a Trump administration that runs the economy ‘hot’ risks postponing a grand currency accord. It also risks a resurgence in inflation (and bond yields), which I suspect will be a story for next summer.

China – Japan or Greece?

The one factor that could temper inflation is China, a very large political economy that we know increasingly less about. My bet is that commentators will spend much of 2025 debating whether China is ‘Japan’ or ‘Greece’, in the sense of how the deleveraging of its economy materialises. China will become the risk factor for 2025 – economically, geopolitically and commercially in the way it will respond to the onset of tariffs from Washington.

Despite recent competitive monetary stimulus, China’s economy is plagued by deflation, in terms of property prices, activity and declining business activity. At the root of this phenomenon is a call to the problem.

This year’s policy meeting has done little to fix the economy’s structural cracks, and the concern is that domestic “reform” (i. e. political repression) is undermining the willingness of more entrepreneurs to invest, and also that Xi is transforming China into a more closed state. one that curbs the will of those inside, adopts a uniquely self-centered technique to keep insiders outside, and relies on several fundamental advances in technological industrialization for the extension of the “Chinese Dream. ”

The contradiction here, and specifically between the three strands to emerge from the plenum, is that in its policy making and economy China needs innovation but is creating a socio-political system that smothers it.

In this respect, the third plenum and the recent liquidity boost missed a trick in not outlining a Keynesian style stimulus for the economy (or even longer-run structural one). The property market is slowing, entrepreneurs are very cautious and the risks associated with local government debt are rising. While China has so far managed to duck a major recession, the government may have become too complacent about the deleveraging process, and the possibility that this accelerates downwards, dramatically so as was the case for Greece, or tortuously as was the case for Japan.

Bond markets – suffering the hangover from elections

As China slows, the key variable to watch is long-term Chinese bond yields, which have declined in recent months as investors take a bearish view of the economy. Elsewhere, bond markets will most likely see plenty of action, driven by the fiscal fallout from elections around the world.

There are still general elections in Japan and the prospect of elections in Germany next February (23). In the United States, the United Kingdom and France, elections saw bond yields rise against a backdrop of near-record debt and very gigantic deficits.

This is where the budget hangover begins. Governments in all regions will be held back by bond markets and under pressure to cut spending and, in some cases, raise taxes. This tension alone can potentially tilt economic policy more toward supply-side replacements, and also replace the kind of issues that politicians address, such as immigration and identity politics.

Fiscal rectitude would likely only reign supreme after a few tantrums in the bond market. Specifically, two countries deserve to be watched: France and the United States. First, the French budget procedure has been very long and, given that France will have to partially reduce its deficit over the next three years, it is unlikely that the French political class, let alone its public, will be in a position to implement more austerity. . deep. In this way, rising French bond yields will be inevitable in the markets and may also periodically push them higher.

The other market to watch out for is the U. S. bond market, which may also be the tightening factor for stocks and other more dangerous assets in 2025. Since the Federal Reserve cut interest rates by 50 core issues in September, bond yields have risen and remain stubbornly high. With the U. S. economy developing strongly and other economies stabilizing, the threat is that inflation will rise (although falling oil costs and deflation from China would possibly offset this), leading to higher costs. bond yields, or that the Trump administration’s preference for managing the “hot” economy is causing yields to rise. In this sense, the bond market can also be Trump’s sworn enemy. The market’s reaction to this week’s Federal Reserve meeting is a sign of things to come.

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