Macroeconomic Outlook for January 2025

Eugeniu Chirau

Feb 17, 2025

In January, market participants focused on decisions by leading central banks and economic statistics. The U.S. Federal Reserve left the rate unchanged at 4.25–4.5%, citing reduced confidence that the disinflationary trend is maintained. The European Central Bank and the Bank of England lowered rates to 2.75 and 4.5%, respectively. This divergence in monetary policy reflects differences in inflation dynamics and economic activity in the regions: in Europe, inflation is somewhat closer to the 2% target, and GDP growth statistics were below expectations.

Inflation in the U.S. was 3% for the twelve months ending in January, and according to the index excluding energy and food costs, it was 3.3%. Inflation expectations in the U.S. remain stable: data on inflation-indexed bonds (TIPS) indicate a forecasted inflation level of 3% for the next two years, followed by a decrease to 2.4% over a 10-year horizon. Against this backdrop, real rates remain quite high, especially for long-term bonds, whose yields have risen above 4.5%. It is worth noting that surveys on inflation expectations indicate a higher level, but the same data broken down by respondent groups show a strong divergence of views among supporters of the Democratic and Republican parties, which casts doubt on the predictive power of such data.

The U.S. labor market remains resilient. Unemployment fell to 4%, and the number of new jobs in January increased by 143 thousand — this is below forecasts, but still indicates steady employment growth. Meanwhile, wages increased by 0.5%, which may support high consumer spending.

Economic growth in the U.S. remains confident. In the fourth quarter, the country's GDP grew at an annual rate of 2.3%, mainly due to consumption and government spending components.

The U.S. real estate market is under pressure from high mortgage rates. Average rates remain above 7%, which has led to some decline in the median home price in recent months. However, over 2024, housing prices overall rose by 6%, apparently due to stable real income growth and asset values in the markets in general.

Amid increased demand and the upcoming introduction of trade tariffs, commodity prices on average rose by 4%. This may reflect increased company demand for inventories, driven by the risk of tariffs being introduced. Already in early February, shortly after Trump's inauguration, additional tariffs were announced against China, as well as Canada and Mexico. However, on the same day for the latter two countries, their introduction was postponed, and analysts ironically called it the shortest trade war in history. It is still too early to discount the risk of trade wars, especially between the U.S. and China, as well as the U.S. and the EU. However, it may be more advantageous for Trump to keep the threat of tariffs ready as a kind of wild card and seek concessions or better outcomes in resolving other international issues. In relations with the EU, this is a more likely strategy, although regarding China, the existing containment policy is unlikely to change, and tariffs may become one of its main tools.

The Chinese economy showed GDP growth of 5.3% last year, largely due to significant fiscal and monetary stimuli. Meanwhile, inflation remains extremely low — only 0.5%. The Chinese real estate market continues to face difficulties: housing prices fell by 6–8% over the year, although the decline slowed in December. The reduction in construction volumes is also happening quite rapidly: about 13% for all projects and 22% for new ones. This should help restore balance in the market and consumer confidence, but it is still difficult to predict when this might happen, including because for many, the decline in real estate prices, as well as in the stock market, has led to a significant reduction in the value of their assets.

Overall, global economic trends indicate ongoing uncertainty regarding inflation and economic growth prospects. Economic policy is becoming an increasingly important factor in shaping investment expectations, while the economy remains relatively stable. U.S. financial markets remain expensive, and risk premiums in the stock market still indicate their significant overvaluation. Amid expensive markets and high market capitalization concentration in individual company stocks, stock prices may become significantly more volatile. The recent drop in Nvidia shares amid news of a more efficient computing power model, DeepSeek, was another reminder that asset prices now largely consist of discounted expectations of rapid profit growth applied to already high historical profit levels.

Although this correction itself is not too remarkable in scale or cause, some investors' concerns about market valuations and the sharp reaction to such news are not unfounded. Parallels with other episodes of market growth during technological transformation are evident. During the dot-com bubble, as well as in other episodes of technological boom, the desire to occupy a market niche led to excessive investments and the collapse of plans of weaker companies developing a new product. Many of the investments in AI model training may become unclaimed due to losing to more successful competitors. The problem is also that extrapolating the sharp growth in sales of training equipment and maintaining high business margins may not be justified, especially when other chip developers are striving to enter such a profitable niche. But even more so, the risk is that stock price multipliers usually decrease due to a decline in optimism. As a result, a lower profit is applied to a lower multiplier (reflecting growth prospects), exacerbating the price decline.

At the current level of profits and the Fed rate, the S&P 500 index would need to decrease by 51% for the risk premium to return to the median (since 1914) value of 2.73%. This clearly indicates that the market is very overvalued relative to the historical average, even when taking into account the impact of interest rates. At the same time, to repeat the overvaluation level of 2000, when the premium fell to a record low of -2.54%, the index price under the same assumptions would need to rise by another 72%. Needless to say, in such conditions, no investor with some sense of risk aversion can rely on either the exhaustion of investor optimism or the market continuing to remain at such expensive levels. Of course, rates may decrease, narrowing the range of decline for the premium to return to the average, but it was not too reasonable to lower the rate without a clear cooling of the economy. It is logical to assume that such cooling will negatively affect company profits. Since the end of World War II, the growth rate of S&P 500 company profits has fluctuated around a fairly stable trend of 6% per year. The current profit of the index is about 22% above this trend, and it should not be excluded that a rate decrease will be accompanied by a return of profits to this trajectory or even a fall below it.