2025 Global Economic Outlook (I) - US and China

Turning back the clock to December 2023, when we forecasted the economic outlook for 2024, our initial view anticipated three to four interest rate cuts by the Federal Reserve throughout 2024. Although most market participants maintained “data-dependent” positions—shifting their forecasts from three to four cuts to as many as seven to eight cuts within a span of several weeks—our conviction regarding the trajectory of wage growth, the resilience of the labor market, and the strength of the U.S. economy as a whole led us to maintain our original perspective. This conviction informed our investment and allocation strategies for the year. In retrospect, our confidence was well placed.

One area that most surprised us was the performance of the Japanese yen. We had anticipated that the Bank of Japan (BOJ) would adopt a more hawkish stance by the end of the summer, given persistently high inflation, thereby guiding the yen towards the 143–145 range by year-end.

The year 2025 will likely be recorded as one of the most eventful years, with several dominant themes:

• Peace and Truce (though possibly offset by conflicts in other regions)
• From Globalization to Regionalization to Nationalization, and back to ‘Bloc-lization’ (i.e., not solely among neighboring countries but also intercontinental alliances)
• Geopolitics taking center stage
• An arms race morphing into a competition for AI supremacy to provide solutions
• A tug-of-war over energy
• A “Whack-a-Mole” scenario of global central bank rate cuts.

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United States

‍Under the Trump administration, the “America First” and “Make America Great Again” themes are expected to remain a constant backdrop. Several policy areas are likely to exert broad influence beyond U.S. borders, most notably trade tariffs, tax cuts, climate policies, immigration measures, deregulation, and the risk of armed conflict. While other issues may still produce residual effects, these key domains will shape both domestic and international economic conditions.

From an economic standpoint, tariffs, tax cuts, and immigration controls are all inherently inflationary and likely to widen the fiscal deficit. Tariffs raise the prices of imported goods, directly increasing consumer price levels. Tax cuts, by reducing government revenue, may complicate the federal government’s ability to service debt and meet interest payments. Meanwhile, stricter immigration controls are poised to limit labor supply, driving up labor costs for businesses and adding further upward pressure on prices.

Tariffs

Trade tariffs are among the most widely recognized policies of the Trump administration. Countries and global organizations are conducting scenario analyses to diversify supply chains and mitigate potential negative impacts. While it is impossible to fully isolate these effects, efforts will focus on minimizing disruptions. The administration’s “carrot and stick” tactic extends beyond tariffs and may encompass other measures (e.g., USD-related sanctions).

Imposing tariffs on imported goods will likely increase the cost of end products, thereby exerting additional inflationary pressure within the United States. The experience of the first Trump administration demonstrates that tariffs are predominantly absorbed into consumer prices. This is evidenced by the observation that prices within Personal Consumption Expenditure (PCE) categories subject to tariffs increased nearly in line with the imposed tariff rates, whereas prices in non-tariffed categories continued to follow their pre-existing trajectory. This approach, sometimes viewed as “hurting oneself 20% while hitting the opponent 100%,” reflects a willingness to absorb some domestic pain to exert greater pressure on trading partners.

While China is the principal target, no nation or region is fully exempt—not even close neighbors such as Canada and Mexico. Goods previously sourced from China and then assembled elsewhere to circumvent tariffs will face stricter rules of origin. The U.S. is set to implement higher standards on products qualifying for entry, making it more difficult for companies to skirt tariff measures.

After the U.S. election results were announced, the U.S. dollar rose against the Canadian dollar, breaking through the critical range of 1.38 – 1.40, a level it had failed to surpass since mid-2022. Trump's 25% tariff threat, posted on his Truth Social app, further accelerated this breakout, with USD/CAD trading above 1.40 for eight weeks. Canada’s exports to the U.S. account for 62% of its total exports, and economics professor Trevor Tombe estimates that a 25% tariff would reduce Canada’s real GDP by about 2.6% annually, potentially pushing the country into recession next year. Any changes in trade policy could disrupt supply chains, impacting many businesses and workers in both countries.

However, president Trump is unlikely to unilaterally implement his full tariff agenda. While Republican electoral victories have bolstered his political capital, the approaching mid-term elections may expose intra-party resistance. If the proposed tariff measures are perceived as too extreme, they are likely to face significant political pushback.

Moreover, the current economic conditions present additional constraints. Unlike Trump's previous term, when the economy was recovering from a trough with strong growth momentum, the current environment is marked by high inflation, a substantial fiscal deficit, and late-cycle dynamics. These factors limit the feasibility and impact of implementing new policies to their full extent.

Deregulation‍

President Trump favors a leaner government, which implies lower taxes and fewer regulations. This is consistent with his academic training and reflected by cabinet nominations. Anticipations of deregulation are visible in financial markets and cryptocurrency valuations.

Tax Cuts

While corporate tax cuts may reduce IRS revenue, they are also viewed as part of a broader “carrot and stick” strategy (e.g., CHIP Act, tariffs) designed to incentivize companies to return operations to the United States. When corporate tax rates were reduced in December 2017, the S&P 500 index rose immediately, with the increase roughly matching the realized earnings growth. The 2017 Tax Cuts and Jobs Act (TCJA) increased the S&P 500's earnings by 11% in 2018. This approach aims to stimulate job creation and ultimately expand the tax base over the longer term.

Climate Policy‍

The U.S. stance on climate change has vacillated over the past eight years. The Trump administration will depart from the incumbent’s approach. U.S. oil production will continue to rise. With OPEC+ mired in production disputes, Syria re-entering the oil market (albeit with limited impact), and weakened demand from China and other emerging markets, oil prices will face downward pressure in 2025. A moderated oil price, a major CPI component, could help alleviate inflationary pressures.

Immigration‍

Immigration policy remains a politically charged issue. The Trump administration aims for a comprehensive overhaul, including enhanced border security and potential mass deportations. Such measures would spark ethical, resource, and societal debates. From an economic standpoint, this would be costly. Furthermore, asking Mexico to share financial responsibilities will be on the table. Replacing millions of undocumented workers would drive up labor costs, already elevated since the pandemic.

War and Conflict‍

Geopolitical flashpoints persist globally, ranging from minor border skirmishes (e.g., China/India) to full-scale conflicts (e.g., Russia/Ukraine, Israel/Hamas). President Trump has vowed to halt the latter as soon as he assumes office. We think that a practical outcome may involve constraints, truces, or temporary ceasefires, providing breathing room. Tactics could include threatening EU withdrawal from NATO to pressure other nations, reducing ammunition supplies to Ukraine, or using policy incentives to negotiate with Russia(e.g., easing sanctions or halting NATO’s eastward expansion). The objective is to project power and secure a dominant bargaining position.

Federal Reserve Policy‍

The Federal Reserve’s 25bp rate cut this month matched market expectations. However, the latest dot plot suggests a more hawkish stance, showing a 2025 median target rate at 3.9%—up from 3.4% in September—alongside higher inflation and growth forecasts and a lower unemployment projection. Although Chair Powell offered no clear guidance on the “extent and timing” of future cuts, he expressed strong confidence in the economy. Both the Summary of Economic Projections(SEP) and Powell’s comments indicate greater concern over next year’s inflation than previously anticipated.

Rather than predicting the exact timing of interest rate cuts, we believe we should focus more on the mid- to long-term policy direction, which has higher guiding value for asset allocation. Regardless of political leadership, the Fed faces a challenging environment in 2025. Balancing economic growth, tariffs, inflation, deficits, and possible White House intervention will be akin to a “Mission Impossible.” Yet the Fed must bring interest rates down from current levels. At present rates, the deficit grows by approximately USD 1 trillion every 100 days, and upcoming policies (many of which are deficit-prone) may exacerbate the situation.

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U.S. Equities

The equities market now exceeds USD 60 trillion—more than twice GDP—marking a historic high. Gains have broadened into mid- and small-cap segments due to rotational effects, yet no market rivals the U.S. in attractiveness. After short-term shifts in search of opportunity, capital invariably returns to the United States.

In 2025, we think that large-caps will still drive much of the S&P 500’s earnings growth, but not only from mega-techs. Companies benefiting from policy recalibration—energy machinery, financials, healthcare, and defense—will also contribute.

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China

While Chinese corporations continue to deliver steady earnings performance, international long-term investors remain cautious and reluctant to commit significant funds. Despite central government vows to support the market—effectively setting a "downside floor"—such measures are likely to create only short-term tactical opportunities rather than inspire sustained investment flows. Policy implementation takes time to work through the system, and the market is still waiting to see tangible results before increasing exposure.

Key Challenges and Structural Adjustments

China faces four intertwined challenges:

1. Real Estate Confidence: Real estate sentiment remains weak, with major property indicators—new home starts, land sales revenue, and home sales volumes—still well below their recent peaks. As a result, the property sector is likely to remain a multi-year drag on GDP growth.

2. Local Government Debt: Local government debt significantly constrains China’s fiscal flexibility. By the end of 2023, China’s augmented government debt had reached 131% of GDP.

3. Aging Population: China’s aging population creates demographic headwinds, with fewer workers supporting more retirees. Productivity gains are vital to maintain economic momentum.

4. Weak Consumption: Consumer confidence remains cautious, with high household savings and weak wage growth delaying the recovery in consumption. This sluggish consumption dynamic continues to weigh on efforts to boost domestic demand. Meanwhile, data show that CPI indicators remain persistently soft.

Addressing these issues requires a full policy cycle. China’s planned economy may enable coordinated, if sometimes rigid, responses. For now, we think that policymakers would emphasize supply-side measures over demand-side stimulus, at about a 80/20 ratio.

Our perspective on China's outlook：‍

1. China’s GDP growth in 2025 will likely slow from about 5% to 4.4–4.6%. Stimulus efforts may not spur consumption, and infrastructure investment will increasingly rely on central rather than local funding.

2. The top private firms are expected to lead in job creation and investment, while overcapacity in solar and EV sectors must be addressed.

3. Although real estate and local government debt remain major concerns, productivity gains (e.g., via AI) could alleviate demographic challenges.

4. Exports should remain resilient despite tariffs, aided by diversified markets.

5. Given these factors, the CNY is expected to stay relatively weak in 2025, around 7.5–7.7, with the first quarter particularly volatile.

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Conclusion‍

Both the Chinese and U.S. economies face complex challenges arising from policy shifts and structural adjustments. China must tackle its long-term hurdles through productivity gains and coherent policy coordination, while the U.S. must carefully manage the inflationary effects of its policies alongside fiscal sustainability. Although U.S.-China tensions will likely persist in areas such as high-tech, trade, and intellectual property rights, areas of collaboration will also emerge and be materialized in the coming years.

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