Anticipated Consequences of 2025: Fiscal Aftermath Due to Electoral Expenditures
Anticipated Consequences of 2025: Fiscal Aftermath Due to Electoral Expenditures
As the year 2025 approaches, I can't ignore the overwhelming chatter about economic and political forecasts. While I'm not necessarily keen on short-term predictions, I've decided to touch upon a few trends that will likely influence markets and economies in the upcoming years.
To start with, financial markets, predominantly US equities (accounting for over 65% of the world market cap), are entering 2025 in an extraordinary position.
Retail investor surveys are brimming with optimism, the market concentration is at levels last seen in 1929 (with the top ten stocks accounting for 40% of the market), and valuations are sky-high (the price-to-earnings ratio being higher only in 2020 and 2001). This could naturally lead some investors to wonder, "When is the crash?" My take is that, barring a devastating trade and supply chain war between the US and China in Q1, we might see an important shift from US equities towards cheaper markets in parts of Asia, particularly Europe (the election of Friedrich Merz as German Chancellor in late February may push for this).
The Plaza Problem
Further, the strength of the dollar, making foreign assets more economical for US investors, is a reason for this. Following Donald Trump's election, a range of key currencies have weakened noticeably – yen, Brazil's real, the Indian rupee, renminbi, and the euro. While the new Treasury Secretary Scott Bessent recognizes the advantages of a strong dollar, the weakness of these foreign currencies is repugnant to Trump's vision, who dreams of another Plaza Accord (a "Mar-a-Lago Accord") that might rebalance the dollar's competitiveness.
However, as we move into 2025, the weakness of Asian currencies and the euro, relative to the dollar, stems primarily from diverging economic performances. A Trump administration that attempts to run the economy "hot" may unwittingly postpone this currency accord and risk a resurgence in inflation (and bond yields), potentially setting the stage for 2025's summer story.
China – Japan or Greece?
The looming factor that could moderate inflation is China, an enigmatic political economy we're learning less and less about. My wager is that commentators will spend a significant part of 2025 debating whether China is "Japan" or "Greece," in the context of how its economy's deleveraging unfolds. China, a massive political economy, will become an uncertainty for 2025 – economically, geopolitically, and commercially in the way it responds to Washington's tariffs.
Despite recent aggressive financial stimulus, the Chinese economy struggles with deflation – in house prices, activity, and a decline in entrepreneurial activity. Underlying this, there is a generalized demand problem.
This year's plenum on economic policy has not significantly repaired the economy's structural flaws and concerns linger that internal "reform" (i.e., a political crackdown) exacerbates the reluctance of entrepreneurs to invest, and equally, that Xi is shaping China as a more autocratic state that stifles internal growth and adopts a self-centered approach towards external interests, relying heavily on significant advancements in technological industrialization to sustain the "China Dream."
The incongruity here, and specifically between the emerging policies from the plenum, is that in creating a policy environment and economy, China requires innovation but fosters a socio-political framework that smothers it.
In this respect, the third plenum and the recent liquidity boost missed a crucial opportunity to propose a Keynesian stimulus for the economy (or perhaps a longer-term structural one). The property market is waning, entrepreneurs are highly cautious, and the risks associated with local government debt are rising. While China thus far has dodged a major recession, the government may have become excessively complacent about the deleveraging process, and the possibility that this accelerates downwards, either dramatically as with Greece, or gradually as with Japan.
Bond markets – hanging over from elections
As China slows, the critical variable to observe will be the Chinese long bond yield, which has been falling in recent months as investors cast a pessimistic eye on the economy. Elsewhere, there is likely to be a good deal of activity across bond markets, stirred by the fiscal repercussions of elections worldwide.
We still have a general election in Japan and the prospect of an election in Germany in late February (23rd). In the case of the US, UK, and France, elections have spawned higher bond yields in the face of record indebtedness and vast deficits.
In that respect, the fiscal hangover starts. Governments across various regions will soon find themselves constrained by bond markets and required to curb spending and, in certain cases, even to raise taxes. This pressure could ultimately prompt economic strategy shifts towards supply-side modifications and alter the issues that politicians focus on, such as immigration and identity politics.
Fiscal rectitude may only come after a few bond-market tantrums. Two countries particularly worthy of monitoring are France and the US. First, France's budgetary process has been excessively lengthy, and with France expected to reduce its deficit by half over the next three years, France's political class – not to mention the public – may not be prepared for deeper austerity. Higher French bond yields will therefore remain a constant in markets, occasionally spiking high.
Another market to keep an eye on is the U.S. bond market, which could potentially curb equity and other riskier assets by 2025. After the Fed reduced interest rates by half a percentage point in September, bond yields have on the rise and show no signs of dropping. The robust growth of the U.S. economy, along with other economies stabilizing, creates a risk where inflation increases (with lowered oil prices and deflation from China acting as counterweights), pushing bond yields higher. Or, the Trump administration's goal to overheat the economy might spike yields. In this perspective, the bond market might turn into Trump's adversary. The market's response to this week's Fed meeting hints at what could be ahead.
In the context of economic forecasts for 2025, Fed Chair Jerome Powell will likely face pressure to manage inflation, as a stronger US economy and the weakened values of key foreign currencies, such as the euro and renminbi, could contribute to a resurgence. Meanwhile, the performance of Chinese bond markets will be closely watched, as the deleveraging of China's economy could significantly impact global bond markets and potentially spark market tantrums in countries like France and the US, where governments may need to implement fiscal rectitude due to rising bond yields.