Emmanuel Petit, General Partner, Head of Fixed Income
While 2024 ends on a rather positive note for fixed-income markets, 2025 suggests that dynamics will be out of sync between different zones.
What to Remember from 2024 ?
The pivot by central banks, marked by the start of a rate-cutting cycle, was the key event for fixed-income markets in 2024. This adjustment occurred in a context where inflation, although declining, remains far from the 2% target. Despite their differences, the monetary policies of the Fed and the ECB converged in the same direction. Anticipation of these moves by investors allowed markets to respond positively throughout the year. However, uncertainty increased during the final quarter.
Notably, Donald Trump’s election introduced divergence in expectations on either side of the Atlantic. This resulted in rising long-term rates in the United States, driven by promises of economic stimulus, while short-term rates in Europe declined amid fears of weakened growth. Despite these differing causes, the effects were similar, with moderate steepening of yield curves in both regions.
Overall, central banks managed to maintain a relative balance in 2024. However, very distinct economic dynamics on either side of the Atlantic appear to be shaping up for 2025. The year ends with significant political instability in Europe. While the election results in the United States are clear, the potential impact of measures from the Trump administration could exacerbate these divergences.
What Is Your Central Scenario for 2025 ?
We expect a divergence in economic and monetary policy trajectories between the Atlantic regions in 2025. Central banks appear to stay the course, with yield curves continuing to steepen and increased risks on long-term rates. Based on market expectations of four rate cuts, Europe’s trend aligns with the U.S. dynamic. The ECB’s terminal rate could exceed 2%, though it may need to adopt a more aggressive pace, with growth remaining its primary concern amid persistent political uncertainties and the protectionist tendencies of the new U.S. president.
In the U.S., further rate cuts by the Fed seem unlikely given inflationary risks tied to the incoming administration’s program. The central bank has managed to approach its inflation target without triggering a recession, achieving the near-ideal “Immaculate Disinflation1” scenario. The neutral rate likely now stands higher than previously anticipated. Labor market developments and the impact of Trump’s promised measures will need close monitoring. It’s not inconceivable that the Fed may raise rates again in 2025.
The year should continue 2024’s trend of gradual yield curve steepening. Agility will be key as opportunities may arise from events and decisions with contradictory effects across regions. Credit market performance will hinge on the alignment of monetary policies with the macroeconomic environment in each zone. In this context, the Fed’s flexibility contrasts with the ECB’s apparent rigidity. However, given current fundamentals, the asset class retains a certain appeal. We remain attentive to cyclicality in our positions and overall credit quality. While valuations in some segments may seem high, we consider them justified given the fundamentals as long as the macroeconomic environment does not deteriorate.
Tailwinds and Headwinds ?
Political dynamics remain the primary concern among headwinds. Early elections in Germany and a fragile governmental context in France weigh on the sluggish growth of the Eurozone’s two main engines. Trump’s proposed measures—tax cuts, anti-immigration policies, and tariff increases—threaten to deepen Europe’s struggles while bolstering the U.S. economy. These measures also carry inflationary risks that should not be overlooked.
The Fed may find itself torn between inflation and employment concerns. The labor market is beginning to send mixed signals, and Trump’s intent to reduce immigration could exacerbate tensions and boost wage inflation. A return of inflation could force the Fed to raise rates, destabilizing credit markets.
Nevertheless, some factors remain supportive. The economic environment continues to favor the asset class. Although absolute returns are lower than in past years, they are relatively more attractive than those of monetary assets. This should sustain inflows. Furthermore, amid today’s uncertainties, the asset class has shown remarkable resilience. Central banks’ ability to make necessary adjustments and approach their inflation targets has ensured relative market stability. It is hoped they will continue along this path.
For more information, visit the website:
www.am.eu.rothschildandco.com
