International | 1:01 PM
By Tim Murray, T. Rowe Price Capital Markets Strategist Multi-Asset Division
Risks have shifted from recession to inflation
As we entered 2024, concerns lingered about the potential economic impact of rate hikes made in 2022 and 2023 by the U.S. Federal Reserve and other key central banks.
However, as the year progressed, global growth expectations for both 2024 and 2025 moved higher, with forecasted growth for the U.S. experiencing the sharpest uptick.
But inflation concerns reignited in the latter part of 2024. This was partially due to concerns about the potential impact of U.S. President-elect Donald Trump’s campaign promises of higher tariffs and tighter immigration controls.
There also was evidence in late 2024 that inflation rates had stopped falling, with the three-month moving average for the U.S. consumer price index showing a clear upward trend since last July. Notably, services inflation remained somewhat sticky while goods inflation began to show hints of rebounding.
The implication for investors is that they should consider whether their portfolios are properly hedged against inflation risks. They may want to consider adding exposure to asset classes such as natural resources equities that historically have responded well to higher inflation.
“U.S. exceptionalism” has become more extreme
One long-running trend that strengthened dramatically in 2024 was “U.S. exceptionalism”the idea that the U.S. enjoys unique structural advantages over other global markets. Not only did the U.S. economy experience one of the sharpest upticks in expected growth, but U.S. earnings expectations grew at an even faster rate.
U.S. outperformance in 2024 was driven by several fundamental factors, including U.S. dollar appreciation, a surge in capital spending in artificial intelligence infrastructure, and the incoming Trump administration’s promises to relax regulatory burdens and seek lower corporate tax rates.
But the trend now appears somewhat extreme, in our view. From December 31, 2010, to December 17, 2024, the average one-year outperformance of the Russell 3000 Index relative to the MSCI All Country World Index ex U.S. was +6.18%. But, over the year ended December 17, 2024, that difference ballooned to +13.89%.
The bottom line is that stock markets have priced in a great deal of “U.S. exceptionalism.” A partial reversal could be on the horizon if elevated U.S. earnings expectations are not met in 2025.
The Fed’s rate-cutting cycle will be modest
At the end of 2023, the Fed “pivoted,” as Chairman Jerome Powell indicated that rate cuts were likely to begin sometime in 2024. This led many investors to increase their allocations to longer-duration U.S. Treasury bonds.
However, the U.S. economy proved much more resilient than expected in 2024. Progress on curbing inflation also appears to have stalled.
So, expectations for Fed rate cuts have turned considerably more modest. As of December 19, 2024, futures markets were pricing in an end point of 3.97% for the key federal funds ratejust -1.4 percentage points below the most recent rate peak.
This shift had numerous implications for asset class performance. Cash once again proved to be king in 2024, as very short duration bonds not only were sheltered from rising rates, but maintained healthy yield levels through the year.
If inflation remains stubborn, that might again be the case in 2025.
Views expressed are not by association FNArena’s.
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