Macro market analysis playlist

January 2025 highlights

Stormy weather: Just one year after markets were overly pessimistic on the growth outlook entering 2024, conditions have flipped, and the consensus is now overly sanguine on the growth outlook and overly pessimistic on the inflation backdrop. While growth remains healthy, a confluence of factors is likely to weigh on growth in the quarters ahead, pressuring real growth down from elevated above trend levels to more moderate levels of activity.

Where is my mind? Investors aren’t alone in this offsides outlook – the Fed is equally complacent on growth and excessively pessimistic on inflation. The Fed’s assessment of the balance of risks has abruptly shifted back to a focus on upside inflation risks over downside employment risks. Whether that’s a function of somewhat firmer inflation prints in recent months or looming tariff risks, the Fed’s newfound hawkish stance looks offsides with respect to the likely tenor of the incoming data flow. A dovish pivot looms, and the bar has been lowered.

Blown away: We’ve entered overshoot territory once again. Markets are now pricing in just one cut for all of 2025, outhawking even the Fed. Cooler growth and softer inflation prints are likely to pull the narrative pendulum back toward Goldilocks, but overshoots of this magnitude rarely reverse slowly or simply back to equilibrium. They have a habit of overshooting in the opposite direction. Should we see that softer data flow while the Fed maintains its hawkish stance, be on the lookout for a potential growth startle or scare.

Hey: While softer growth is our expectation, starting points matter. Slower does not equate to slow. Rather, a downshift closer to trend growth is the likely scenario. With real growth expected to settle around 2.25%–2.5% and inflation continuing to cool toward target, nominal growth is likely to fall between 4% and 5% – an environment where earnings tend to grow high single digits. While markets are likely to contend with policy uncertainty as we move through the year, high single-digit earnings growth and a modest dividend yield provide a solid foundation for low double-digit returns in 2025 even without any further multiple expansion. Not too shabby. 

Debaser: Tariff risks may be on everyone’s minds, from markets to the Fed. And while the broadly held view is that tariffs are inflationary, the empirical data suggests otherwise. Tariffs represent a price-level shift rather than an inflationary process. The 2018 tariffs show this clearly, as inflation rates for tariff-impacted goods predictably spiked before resolving back to their pre-tariff trend as the price shifts rolled out of the 12-month window. All the while other goods remained in deflation. Arguably the greater risk is a negative demand shock, as nominal incomes continue to ease as tariffs are implemented. The policy implications are neither clear nor obvious.