Headline inflation in the US has fallen from 3.4% to 2.4%, and in the eurozone it has fallen from 2.9% to the European Central Bank’s (ECB) target of 2.0%. This progress has enabled seven of the ten main central banks in developed markets to begin cutting interest rates, with the ECB initiating its first cut three months before the Federal Reserve (Fed) in June. The two governing councils are now beginning to normalise monetary policy. Is the mission accomplished for 2025?

Cruising altitude

Throughout 2024, we have maintained a soft landing scenario for the US economy, despite a surge in inflation in the first quarter of the year and fears of recession in the summer.

We have maintained our position and believe that this situation is likely to continue into 2025. We expect the US economy to grow by 2%, slightly above potential, while inflation should average around 2.2%. In fact, the soft landing narrative is somewhat obsolete: the US economy never really landed and continues to fly at cruising altitude. The key question for 2025 will be whether the new Trump administration will be reflationary or stagflationary.

Towards public policy uncertainties

In 2024, 40% of the world’s population voted. The elections in India and the European Union (EU) brought their share of surprises, while the result of the US presidential elections was clear and uncontested, but opened the door to many questions. We are moving from an era of political uncertainty in 2024 to an era of public policy uncertainty in 2025.

The new Trump administration is widely seen as pro-growth, pro-business and pro-deregulation, likely to extend tax cuts and reduce corporate taxes. With the US economy already on a positive trajectory, these reflationary policies could push the economy into overheating. In this so-called “no-landing” scenario, the Fed could be forced to end its rate-cutting cycle prematurely, posing a risk to equities and their high valuations. It will therefore be a delicate balance to maintain.

Clash of the titans

Another uncertainty lies in US tariff policy. It is unclear whether the Trump administration will pursue the proposed 10%-20% global tariff and the 60% tariff on China. More modest tariffs, similar to those seen in 2018-2019, are more likely as Donald Trump seeks to bring “iconic deals” back to the White House. While the market may be concerned about announcements and executive orders, we believe Trump will avoid creating another inflationary spike, focusing instead on securing trade deals.

Trump was elected because rising prices under the Biden administration proved toxic at the polls, and he will aim to avoid repeating that mistake. The other battle could be with the Fed. We expect the Fed to cut rates to 3.5% in 2025; although there is a risk it will do less if it perceives inflation threats from tariffs. However, if the tariffs remain a one-off effect and inflation expectations remain anchored, the Fed could ignore the short-term effects and continue its policy adjustments. Jerome Powell has clearly stated, “We don’t guess, we don’t speculate and we don’t assume,” in reference to future economic policies under Donald Trump.

Ultimately, we believe that the bond market will be the arbiter of acceptable fiscal policies. While the S&P 500 will be the barometer of Donald Trump’s economic success, the borrowing rate on 10-year treasuries will judge his financial viability. With US debt potentially reaching 160% of gross domestic product (GDP) by 2035 in the worst-case scenario, the Senate will be keen to avoid an uncontrolled interest burden.

Whatever the cost

What about Europe, caught between the two giants of the United States and China? We expect the eurozone economy to grow below potential at 0.8% in 2025, with downside risks. The ECB is well aware of the weaknesses in our economy and is ready to act. We expect further cuts to reach 2% in 2025, but note that it is conceivable that the central bank could cut rates further to counter any further tariff-induced weakness and its economic impact.

A second Trump administration could in fact be a decisive and transformative moment for Europe, particularly with regard to its own defence. As the French president said after Donald Trump’s victory: “Do we want to read the history written by others?”

In other words, Europe must write its own history by protecting its own interests. The sudden break-up of the German coalition has reopened the debate on the “golden rule” on federal debt. With Germany’s deficit at 63% of GDP, there is considerable scope for Germany to stimulate investment, both for its own good and by joining the joint debt effort for European defence.

This could become the “whatever it takes” moment to protect Europe, although it is likely to take time and not be a short-term catalyst to change investor perception of Europe.

This white paper is taken from “.”

Alexandre Drabowicz is chief investment officer at Indosuez Wealth Management.