The start of President Donald Trump’s second term has already been volatile for financial markets.

The prospect of sweeping US deregulation and fresh tax cuts have spurred equity markets to record highs in 2025. But the new US government’s crackdowns on immigration and sudden tariff threats against Canada’s, Mexico’s and China’s exports endanger the favourable economic outlook.

Investors should therefore prepare for a more turbulent 2025 that will offer opportunities as well as risks.

In the US, financial markets should find support from an expected soft landing ofr the economy, deregulation, and tax cuts. However, tighter immigration and new trade wars may stoke inflation, forcing the Federal Reserve (Fed) to keep interest rates above 4%. This would push US Treasury yields higher and strengthen the US Dollar.

In Europe, the risks of US tariffs and weak growth are likely to drive the European Central Bank (ECB) to keep cutting rates. We expect interest rates to fall to 1.50%, pushing the Euro below parity against the US Dollar.

In Asia, US tariffs may curb the region’s exports and thus, for example, lower China’s growth from a solid 5.0% last year towards 4.0% this year. In response, Asian governments are likely to loosen fiscal policy to support domestic growth.

Looking ahead, we do not expect stagflation despite the threat of fresh trade wars. But investors should consider gold as a hedge against the risk that new tariffs would cause inflation to rise and growth to falter.

US – Strong growth but risk of tariff wars

The US economy has started the year strongly, underscoring the favourable outlook for equity markets before President Trump’s surprise threat on 1st February to impose new additional tariffs on all exports from Canada, Mexico and China. First, January’s US manufacturing ISM survey signalled activity in the sector is expanding for the first time in over two years.

Second, the latest Federal Reserve Senior Loan Officer Survey (SLOOS) showed only a net 6% of banks were tightening standards for loans in 4Q2024. Thus, conditions for bank lending are still loose, keeping US corporate bond spreads low.

Third, high-frequency trackers of US GDP estimate that growth may be as high as 3-4%. The New York Fed’s Weekly Economic Index implies GDP is expanding near 3.0% while the Atlanta Fed’s forecast is 3.8% - far higher than the 2.3% GDP growth recorded on average each year by the US since 2000.

We thus see strong US growth supporting US equities. But while the Trump administration has delayed imposing 25% tariffs on Canada and Mexico by one month until 4 March, additional 10% tariffs on all Chinese exports has already come into force on 4 February.

We see four key implications if trade wars start this year.

First, tariffs will hurt the US economy. We forecast US growth to slow to 2.2% in 2025 from 2.8% in 2024. But if Washington engages in broad trade wars, the US will suffer a much sharper slowdown as trading partners retaliate against US exports.

Second, steeper US tariffs will raise US import prices. US core inflation is still near 3.0%. We forecast one more 25 basis points Fed rate cut. But if tariffs keep inflation well above the central bank’s 2% target, then the Fed will be forced to leave interest rates high at 4.25-4.50%.

Third, increased US tariffs underscore our view that 10-Year US Treasury yields will rise to 5.00% as a second Trump term boosts inflation.

Fourth, higher tariffs will help the US Dollar to rally by cutting US demand for imports.

Thus, trade wars are the key risk to the outlook, likely driving interest rates to stay higher for longer in 2025.

China – US tariffs the key risk this year

China’s economy recorded a firmer end to 2024. In 4Q2024, China’s GDP beat forecasts, as sudden stimulus measures announced last year to support the economy, and the frontloading of exports to beat US tariffs this year, spurred activity.

For 2024, GDP growth was 5.0%, hitting China’s target for the year. 4Q2024 GDP expanded strongly by 1.6% quarter-on-quarter as growth accelerated from a 4.6% year-on-year pace in 3Q2024 to 5.4% in 4Q2024.

Since last September, officials have unveiled wide-ranging measures to revive economic growth This included interest rate cuts, funds for stock market investments, loosening of banks’ liquidity requirements, measures to support property purchases and a promise for more fiscal spending. The 4Q2024 GDP report shows China’s stimulus measures have begun to buoy activity. But weak links remain with property investment still contracting by 10.6% YoY in December.

Moreover, 2025 has begun with the US surprisingly imposing additional 10% tariffs on all Chinese exports. We think the initial impact should be manageable. The new 10% tariffs may shave US$100 billion or around 0.5% off China’s GDP, reducing the growth rate from 5.0% in 2024 to 4.5% this year. But if US tariffs rise to 20-30% then China’s growth may fall more sharply towards 4.0% or less in 2025. US-China talks will thus be key for limiting downside risks to China’s outlook for this year.

Europe – More rate cuts likely to support weak growth

The economic outlook continues to be challenging in the Eurozone. 4Q2024 GDP showed no growth. Thus, for the whole of 2024 the economy only expanded by 0.7% compared to US growth of 2.8% and Chinese growth of 5.0%.

For this year, we forecast growth to remain weak at 0.7% again in 2025. Consumers are benefiting from low unemployment, but companies remain cautious as the French government struggles to pass a new budget through parliament and Germany holds national elections. In addition, more competitive Chinese exports in key sectors like electric vehicles and the risk of steeper US tariffs are threatening European manufacturers.

The ECB thus continues to cut interest rates to support growth, reducing its deposit rate again by 25 basis points to 2.75% in January. We expect the ECB to keep easing at every meeting until its deposit rate reaches 1.50% this year, pushing the Euro through parity to 0.98 against the US Dollar during 2025.

Japan – Further interest rate rises likely in 2025

Last month, the Bank of Japan (BoJ) raised its overnight call rate by 25 basis points from 0.25% to 0.50%, as prices and activity in Japan are evolving in line with the central bank’s outlook, thus keeping inflation on track to settle at the BOJ’s 2% target.

The move was widely expected by investors with the latest consumer price index (CPI) data for January showing core inflation in Japan staying above the BOJ’s 2% goal at 2.4%.

The BOJ thus continues to slowly normalise interest rates after the shock of the pandemic helped inflation rebound and end Japan’s three “lost decades”.

The central bank has lifted its call rate three times since March 2024 from -0.10% to 0.50% now. We expect two more 25 basis points hikes in July and December - bringing the call rate to a neutral level of 1.00% which may help the Japanese yen from weakening further.