Macroeconomic Outlook for December 2024
Eugeniu Kireu, CFA
Jan 24, 2025In December, analysts and market participants focused on the Federal Reserve meeting and labor market and inflation statistics. As expected, the regulator lowered the rate by 25 basis points to a target range of 4.25–4.5%. At the same time, forecasts for future inflation and the Fed rate were revised upward, causing a negative reaction in the debt markets. Additionally, uncertainty regarding changes in the economic policy of the new U.S. presidential administration remains high, and concerns about accelerating inflation are increasingly occupying space in analysts' discourse.
Last month, the index of global high-quality bonds fell by 2.1%, and global high-yield bonds by 0.55%. Emerging market bonds dropped by 1.2%. U.S. high-quality bonds also lost 1.6% in value, while high-yield bonds fell by 0.43%. The developed countries' stock index decreased by 2.6%, particularly the S&P 500 by 2.4%. Conversely, the seven largest companies in the S&P 500 index rose by 6.3%. Emerging market stocks declined by 0.1%, while Chinese stocks (MSCI China index) grew by 2.7%. The expected volatility of the S&P 500 index for the next month increased to 17.4 amid market declines and rising uncertainty.
For the year, major bond indices also showed low returns, with only money market instruments and higher-risk bonds in significant positive territory. Global high-quality bonds became 1.7% cheaper, while the U.S. quality bond index rose by only 1.3%. Global high-yield bonds increased by 9.2%, and American ones by 8.2%. The emerging market bond index rose by 6.6%. Global developed country stocks, excluding the U.S., showed modest results, adding only 5.3%. The emerging market stock index increased by only 8.1%, slightly outpacing the bond market. U.S. stocks, on the other hand, stand apart: the S&P 500 index grew by 25%. At the same time, the exceptional results of the American index hide the fact that this growth was extremely uneven. The large-cap stock index, excluding the 'magnificent seven,' rose by 16.5%, and the equal-weighted S&P 500 index by 13%. Small and mid-cap stocks added even less — 11.5%. The 'magnificent seven' stocks showed another year of stunning growth, adding 67%. Largely, the exceptional nature of the U.S. stock market turns out to be the exceptional nature of the largest tech companies, which dominate this industry and have no serious competitors from other countries.
The latest Fed rate cut in December was accompanied by an increase in long-term bond yields. This market reaction is likely due to two main factors. Firstly, the regulator revised its own inflation forecast for 2025, raising it from 2.1 to 2.5%. Additionally, most members of the Federal Open Market Committee, who decide on the rate level, believe that macroeconomic conditions do not favor a rate cut of more than 50 basis points in the coming year. This is a clear tightening of the regulator's rhetoric compared to the previous quarter when the expected rate cut was 100 basis points. At the same time, the Fed indicates that it does not intend to maintain overly tight monetary policy (despite raising the nominal rate forecast, the expected real short-term rate rose from 1.3 to only 1.4%). This Fed's attempt to walk a fine line between a higher inflation scenario and a recession scenario, while likely extremely important for maintaining the Fed's role and policy independence, presents investors with significant uncertainty. So far, market participants' opinion leans towards higher inflation rather than a recession. This led to an increase in long-term bond yields and a drop in their prices. However, the yield increase is not only due to a reassessment of expected inflation but also due to expectations of higher real rates, i.e., tighter monetary policy. During the reporting period, the yield on ten-year U.S. bonds increased by 31 basis points, of which only 5 basis points are explained by rising inflation expectations, and 26 basis points by the increase in the expected real interest rate.
Corporate bond credit spreads remain at their lowest level since 2000: for U.S. 'BBB' rated bonds, they amounted to 0.97 percentage points, for 'BB' and 'B' rated bonds — 1.7 and 2.6 percentage points, respectively. The reduction in credit spreads of high-yield bonds in 2024 by 30–40 basis points, along with high income from current interest rates, masked the rising default rate on U.S. high-yield securities, which, according to S&P estimates, reached 4.9% (data as of the end of November). More than half of these defaults are related to distressed exchanges, i.e., forced exchange of old bonds for new ones to avoid defaulting on obligations in the present. In the fall, S&P analysts expected the default rate to decrease to 3.25% in 2025, noting that if instead of a 'soft landing' of the economy, we see rising inflation expectations, tariffs, and increased Treasury yields, defaults are more likely to rise to 5.25%. Apparently, the economic situation is currently developing according to the second scenario. Nevertheless, the annual reward for default risk of high-yield bonds is still twice as low as the expected default rate. This offer is not too generous, meaning the risk of rising credit spreads remains high.
The U.S. stock market remains expensive, as evidenced by the negative risk premium. In a situation where profit, which is a source for potential cash distributions to investors, yields less (in terms of its relation to stock price) than U.S. Treasury bonds, the main hope for stock investors to earn money is a faster profit growth rate in the future. The phenomenal dynamics of the 'magnificent seven' stocks became the main reflection of these expectations, but the real economic benefits of AI development (besides massive capital investments in creating and training models) are yet to be seen.
One of the current challenges for AI development is the limitation of data on which models can be trained, and many models have already nearly exhausted this resource. This likely means that the easiest, most extensive path of AI model development will soon end, and further development will require a new technological leap (for example, the development of AI agents).
In 2000, the risk premium in the stock market dropped to -2.5% (almost 1 percentage point below the lows of the current cycle). Investor optimism has never been so strong in the entire modern history of the U.S. stock market. This resulted in huge losses when the dot-com bubble burst. We cannot say that investors' optimism about the impact of internet development on the economy and companies was unjustified. However, as we know, not all the companies expected to benefit from technology development did so, not as quickly and not in the way everyone thought. And despite all the technological development (thanks to competition), the rate of company profit growth remained on the same average growth trajectory of 6% that formed after World War II.
The current optimism about AI largely resembles the dot-com bubble, but there are also huge differences in both market structure and the economy. The correction of Nifty Fifty stocks (an informal name for blue-chip stocks on the American stock market) in the 60s is mentioned much less frequently, although the situation with the concentration of a large share of market capitalization in a small number of stocks and investors' belief that there is no price too high for the largest and most reliable U.S. companies' stocks very much resembles the current situation.
No market cycle is an exact repetition of previous ones, and it cannot be ruled out that the consequences of such low risk premiums and high market concentration will be less dramatic. Strong U.S. economic growth, full employment with stable inflation, and long-term mortgages taken at low rates may give investors enough flexibility to expect benefits from the AI revolution without needing to sell off positions in their investment portfolios. At the same time, changes in the economic situation may force many to reconsider their views on the future and start addressing more pressing issues by realizing profits in investments.
High rates should gradually affect the economy and lead to a slowdown in its growth rates, as well as a reduction in consumer spending financed by debt. The average credit card rate in the U.S. remains above 20%, the average rate on a 30-year mortgage has risen again above 7%, and AI development is unlikely to help households pay such high interest rates.
So far, the U.S. economy continues to be one of the most stable and fastest-growing, significantly outpacing other developed countries. U.S. GDP growth in the fourth quarter is expected to be around 2.7% annually. The unemployment rate in December fell to 4.1%, and the labor market added about 256,000 jobs — much more than expected. The number of new unemployment benefit claims remains consistently low, the number of job openings has increased, and wages continue to grow at nearly 4% annually.
Consumer prices rose by 0.4% in December and by 2.9% for 2024. Real GDP growth of about 3% annually with inflation around 3% means that the current budget deficit, amounting to about 6.4% of GDP, is not large enough to pose any significant risks to the U.S. debt burden in the coming years.
The possible introduction of import tariffs adds significant uncertainty regarding both future inflation and future economic growth. We do not yet know what these tariffs will be or what the responses of the U.S.'s trading partners will be, which will play a key role in determining the balance between potential price increases on goods and a reduction in trade between countries overall.
Fiscal policy will also play a huge role. Reducing the budget deficit, which was actively discussed during the Republican election campaign, could become an additional factor in strengthening investor confidence in the stability of future inflation and the reasonableness of the government's fiscal policy. At the same time, if government spending cuts are implemented, it will likely lead to a slowdown in GDP growth rates. For Treasury bonds, this will be a clearly positive factor, whereas in risky assets, a reduction in consumption and company profits may outweigh the positive effect of a rate cut.
Despite the significant rise in long-term interest rates, the overall situation in the economy and markets has not undergone significant changes in recent months. Markets continue to balance between optimism about economic growth and technological prospects and concerns about high rates, inflation, and fiscal policy. Meanwhile, the best expectations of analysts and investors seem to have already been realized, and over time there are fewer reasons for additional optimism. The current year may prove challenging for markets even in the absence of significant changes in economic and market trends, and in the event of their occurrence, become a turning point. Nevertheless, uncertainty regarding many factors, primarily political ones, remains high, and history shows that even the most carefully crafted forecasts do not withstand the test of complex, opaque interconnections and the uncertainty of the real world.
