Rising long-term yields a global phenomenon

US financial market concerns shifting from growth to inflation

Economic activity is picking up in the US but remains lackluster abroad

Policy uncertainty has surged since the US national elections.

Recent turnaround in US economic surprises leading to increases in rate-cut expectations

The outlook has brightened in the US, while it has dimmed for other major economies

Headline US PCE inflation elevated by sticky services prices

US and global equity prices have recently diverged

US leading global upturn in economic surprises

Blue Chip forecasters look for further significant monetary easing apart from Japan

Recent rise in global supply chain pressures could augur a pickup in global inflation pressures

Underperforming German economy generating increased policy uncertainty relative to Europe and the US

Resilient US economy is pushing up longer-term inflation expectations and interest rates

Positive US economic data surprises leading to upward adjustment of interest rate expectations

Recent aggressive policy easing in China has given a massive boost to equity prices

FOMC expects much more easing now than in June

US is clear world leader in business capital spending on artificial intelligence

Blue Chip forecasters expect US to lead aggressive policy rate cuts over coming year—apart from Japan

Ratio of job openings to the number unemployed in the US now below pre-pandemic level

U.S. layoffs not showing as much cooling in labor markets as unemployment rate

While goods prices have moderated, service price inflation remains elevated and sticky

Since Jan 2023, BCEI US outlook has improved, worsened for Japan and the euro area

Persistent negative US economic surprises leading to big rate-cut expectations

Germany is Euro area weakling

Flash PMIs show good start to Q3 in US; loss of momentum in the euro area

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Joseph G. Carson

Has the traditional business cycle become obsolete? Not entirely, but major substantial changes in monetary policies and in the methods for calculating price measurement statistics, have altered the manner in which business cycles end. Business cycles consist of two components: an economic cycle and a financial cycle. Changes in policy and price measurement have shifted the pressures and excesses of the business cycle from the economy to the financial sector. In other words, high P/E ratios have taken the place of high CPI figures.

What Causes the Ups and Downs of a Business Cycles?

Some analysts and academics argue that the traditional business cycle characterized by increasing inflation and interest rates that eventually leads to an end of the cycle no longer exists. This perspective is somewhat supported when comparing business cycles before 1990 with those after.

For instance, since 1990, every business cycle has concluded with relatively low headline and core inflation. In contrast, from 1960 to 1990, business cycles ended with inflation rates of at least 5%, sometimes reaching double digits, with official rates significantly exceeding reported inflation.

However, to assess whether the traditional business cycle is now obsolete, it is crucial to first ascertain if the expansion and recession phases are influenced by government fiscal and monetary policies, developments in financial markets, or an exogenous shock. (Note: The business cycle that ended in 2020 was initiated by an unforeseen event, the pandemic, unlike the recessions of 2000 and 2007. However, in all three instances, both headline and core inflation were relatively low).

Essentially, significant technological advancements and globalization from the mid-1990s and beyond have decreased business cycle volatility, limiting or postponing price pressures that previously would have arisen during a typical business cycle. However, there are other factors at work as well.

During the mid-1990s, the approach to conducting monetary policy shifted from focusing on money and credit growth to targeting real interest rates. Most financial market analysts, myself included, did not initially see this shift in monetary policy as a major transformation. However, it turned into one when the BLS altered its method of measuring consumer prices in 1998.

In the late 1990s, the BLS stopped surveying the owner-occupied housing market to estimate owners' equivalent rent and began using data from the primary rental market, despite the fact that these two housing markets are influenced by different factors and frequently exhibit significantly different supply and demand patterns. At the same time, non-housing financing costs were removed from the CPI, continuing the previous exclusion of housing financing costs in the 1980s.

At that time, participants in the financial market did not consider these changes in price measurement to be significant. However, they were extremely important. During the housing bubble of the early 2000s, while housing prices experienced double-digit increases, the CPI indicated housing cost increases of only 2% to 4%. If the BLS had not implemented the measurement changes in the late 1990s, reported inflation would have been easily double what was reported.

(Note: The BLS excluded housing prices from the CPI in 1983, but continued to survey owner-occupied housing to estimate the implied rent for homeowners, maintaining a direct connection between housing inflation and increases in owners' rent. This connection was severed with the measurement changes in 1998).

The removal of non-mortgage interest costs also had a big impact on reported inflation. A joint research project by economists from Harvard and MIT found that the CPI from 2021 to 2023 would have been twice as high if consumer financing costs for were still included in price measurement.

Still, altering the methods for measuring prices had notable economic and financial impacts. Indeed, the revised CPI measure exhibits significantly less cyclicality, leading the Fed to aim for lower nominal and real interest rates than it would have if the BLS had not made these adjustments. This has led to considerably higher P/E ratios since 2000.

Economic downturns can stem from asset markets, as shown by the stock market crashes in 2000 and 2007, followed by recessions. The S&P 500 is trading at 22 times the projected earnings for 2025, and even higher compared to free cash flow projections. Other market indicators, such as the price-to-sales ratio, are also exceptionally high.

Therefore, the equity market is susceptible, particularly to an additional increase in market interest rates. Historically, the risk of recession increases when the yield on the 10-year Treasury surpasses the growth in Nominal GDP. According to current figures, there is merely a positive spread of 20 basis points with GDP outpacing the yield on the 10-year Treasury. However, current yields might still be too high given the lofty levels of the equity market.

However, the primary threat to the equity market and the economy lies in the fiscal strategies of the new administration. With the existing budget approaching $2 trillion, it is not financially viable to make the 2017 tax cuts permanent, as they are estimated to cost $4 trillion over the next decade, along with introducing further federal tax cuts. Even if the new Administration succeeds in reducing federal spending, it will not be significant enough to offset both past and new tax cuts, resulting in a budget deficit as large or larger than the current one.

More than three decades ago, President Bill Clinton shifted from his new economic agenda, which featured a middle-class tax cut, to a deficit-reduction strategy in response to the threat of increasing interest rates. At that time, the US was dealing with projected budget deficits ranging from $300 to $400 billion, compared to today's deficits exceeding $2 trillion.

Should the Trump economic team ignore the lessons from 2000, 2007, or even 1993, there is a genuine risk of a significant increase in interest rates. Market interest rates have previously impacted the fiscal strategies of a new president, and they have the potential to do so again, if not, the risk of financial chaos will increase.

Is The Business Cycle Obsolete? Not Completely, But The Way It Ends Has Changed

Sharmila Whelan

A soft landing has been achieved, and the world economy is in the expansion phase of the business cycle.  There will be greater geopolitical and pollical stability. However it is important to understand the headwinds and tailwinds that will shape the global economy in 2025.

**Headwinds**

**Global trade & a strong US dollar:** A strong US dollar is a negative for global trade. Figure 1 which shows movements in the dollar (on a reverse axis) against changes in global exports since 1974 is illustrative. When the US dollar is weak global trade thrives and vice versa. Even today 80% of global trade is settled in US dollars.


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Source: Haver Analytics & Westbourne Research

**Trump’s trade tariff war:** There is no doubt that the US led trade war is set to escalate and there will trade retaliatory measures. A 10% US import tariff on global imports is almost a given. Some countries will be hit harder than others. Overall it will be a drag on global trade while companies incorporate higher market access costs and adjust other production costs and/or accept the profit margin squeeze. Whether the disruption will be short-term or medium term is unclear and depends on how drawn-out America’s negotiations with its trading partners are.

That said Trump sees America’s trade deficit as a leverage tool to be used to negotiate better terms for the country. Permanently raising tariffs to levels that hurt American consumers and companies directly contradicts Trump’s Make America Great Again mantra and are unlikely. So no 60%tariff rates.

**Inflation and monetary policy:** From here on monetary policy decisions will become more complicated. Headline inflation rates remain elevated compared with pre-Covid and is creeping up in the US, UK, Euro-area and in Japan (Figure 2). The exception is Asia.

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The headwind is the pace at which the US Fed, European Central Bank and Bank of England can continue to cut policy interest rates.  The market is now discounting only two 25bps Fed Fund rate cuts this year. The BoE too will be slow to cut. The ECB is the exception and the expectation is that the central bank will continue to ease monetary policy as growth concerns take precedence over price stability.

**Europe:**  Subpar economic performance will persist. Germany is barely growing, while economic activity is slowing in France and Italy. The problem is the reluctance of European households to spend and take on leverage, despite falling interest rates and rising real incomes. This was the reason last year the corporate sector led profit and investment spending upcycles failed to translate into a broader economic recovery. Real retail sales growth remains lacklustre. The credit cycle is in a downswing, and household savings rates are rising as precautionary demand for rainy-day buffers grows. The other major headwind for Europe is Trump. The greatest cost will stem not from higher U.S. tariffs—only 8% of total EU exports in the twelve months to September 2024 went to the U.S.—or even from weaker exports, but rather from rising defence spending and mounting fiscal pressures.

**China:** Turning East, the biggest drag on global growth and financial markets in 2025 will be China. Figure 3 gives a gauge of the health of the economy and the success of the central banks and government’s monetary and fiscal policy stimulus measures. The chart shows that although Asia ex-Japan exports to China are still rising in absolute terms, the rate of growth is decelerating rather than accelerating which is what one would expect to see if the Chinese economy had turned around decisively.

250113SW3.jpg

**US equity market valuations:** The final headwind for international financial markets is the lofty valuation levels of U.S. equity markets, which heightens the risk of both healthy and unhealthy corrections. Figure 4 shows on a price-to-earnings the S&P500 is expensive. The market on other measures, including price to book and price to sales ratios is extremely elevated.

250113SW4.jpg

Source: National Sources and Haver Analytics

Now with all the gloom out of the way, let’s turn to the tailwinds.

**Tailwinds**

**US economy:** Within the developed world, the US will once again be the best performing economy in 2025, and the rest of the world stands to benefit from a strongly growing American economy. The US corporate profit cycle is in full upswing. US private sector balance sheet fundamentals are strong. Both corporate and household debt measured as percentages of GDP and disposable income, respectively have trended down since 2020.

Pro-business deregulation will be the cornerstone of Trump’s second-term domestic policies.  This should give a significant multi-year boost to the US economy, and corporate earnings. The U.S. corporate tax rate is set to drop from 21% to 20%, with a likely further reduction to 15% for domestic producers. Financial services, traditional energy sectors and pharmaceuticals are positioned to benefit the most, though companies across industries can expect reduced regulatory and compliance burdens.

Meanwhile employment growth is stable at around 1.4% YoY is more or less in line with the pre-pandemic average, and the unemployment rate well below. Hourly earnings are rising by 4% YoY while retail sales have been strengthening, growing by 3.8% YoY in November (Figure 5).

250113SW5.jpg

**Global crude prices:** Stable to declining oil prices is another positive tailwind for global economy, The International Energy Agency (IEA) forecasts that global oil demand will increase from 840,000 barrels per day (b/d) in 2024 to 1.1 million b/d in 2025, bringing total consumption to 103.9 million b/d. On the supply side there is  considerable uncertainty around when OPEC + will begin to unwind production cuts. Cuts, at the earliest are expected to be phased out from end March 2025 and to last through September 2026. However, despite stronger demand and slower cuts the IEA does not anticipate severe supply-demand balances that would push up crude prices. Their current market estimates still indicate a 950k b/d supply overhang in 2025.

**Government finances:** In 2022 five sovereigns defaulted on debt and another six the following year. In 2024 Argentina went through a major debt restructuring as did Sri Lanka. However, with interest rates falling the risk of debt defaults is declining. The health of Asian public finances stands out in particular (Figure 6). In most Asian countries there is scope to loosen fiscal policy to support growth, if need be.

We are also less pessimistic than consensus and the IMF about US public finances and expect significant fiscal spending consolidation in the second term of the Trump administration. The end of support to Ukraine, Israel and the Inflation Reduction Act will  also take pressure off government finances.

250113SW6.jpg

**Global election cycle:**  The final tailwind is the global election cycle. Currently attention is focused on Germany’s elections on February 27, political uncertainty persists in France, where the government remains in limbo, and in Canada, following the resignation of long-serving Prime Minister Justin Trudeau. However, 2025 will see far fewer elections globally, suggesting reduced political upheaval and greater domestic stability. So far, at least 12 national elections are confirmed, with only a few expected to be pivotal- Germany, Australia, Canada, and potentially Egypt.

Headwinds and Tailwinds in 2025

Mickey D. Levy

Household net worth, the value of all financial and nonfinancial assets net of all debt held by households and nonprofit organizations, reached an all-time high of $168.8 trillion in 2024Q3 (Chart 1). While GDP and its components that describe the flows of national expenditures and income receive the most attention from economic commentators and financial markets, the quarterly household net worth data collected and published by the Federal Reserve Board and Haver Analytics are nevertheless important.  They are both a reflection of economic performance and a significant contributor to it.

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Consistent with its typically accentuated cyclical pattern, in the last two years household net worth has risen $25.5 trillion, or 18.8%, while nominal GDP has risen 11.8%.  The value of assets has risen 16.4% while liabilities have risen 6.1% (Chart 2).  Household net worth is now 7.8 times higher than disposable personal income, up from a low of 5.6 times following the Great Financial Crisis in 2010 (Chart 3). Of the total assets, $128.7 trillion is financial wealth that includes stocks and bond holdings, private equity and pensions, while nonfinancial assets, primarily real estate, are $61.3 trillion.  Household holdings of real estate net of outstanding mortgages is $35 trillion (Chart 4).

The two-year surge in wealth followed the 23.7% decline in the first three quarters of 2022 when the value of stocks and bonds and private equities fell as the Fed raised interest rates and bond yields soared.  The subsequent rebound in wealth as the Fed has eased rates a bit and bond yields remain several percentage points above inflationary expectations has been striking.

**The distribution of wealth.** Not surprisingly, data provided by the Fed’s quarterly report on household net worth and the U.S. Census Bureau indicate that the distribution of household net worth is very unevenly distributed, but the large majority of cohorts of households have benefited and a relatively large number of households have accumulated a lot of wealth. The Fed’s Household Net Worth data show that of the 133 million households in the U.S., the top 1% (1.33 million) hold 30.8% of total household net worth and the 90th-99th percentile of households (12 million households) hold 36% of the total wealth, the 50th-90th percentile (53.2 million households) holds 30.3% of the wealth and the lower half of households hold 2.4% of wealth.

The U.S. Census Bureau’s Survey of Income and Program Participation (SIPP) Report provides wealth data on households in specific percentiles of all households for 2022.  The median household had $176,500 in net wealth, the 75th percentile household had $614,700 and the 90th percentile household had $1,603,000 in net wealth. Based on the recent 2-year rise in household net worth and 133 million households, that means approximately 13.3 million households have net wealth above $1.9 million, and roughly 20 million households have net worth above $1 million.  Presumably, for many households, a sizable portion of their net wealth is the value of their home, but the data show sizable increases in financial assets as well.


250103ML3.jpg

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**Economic impacts.** The rise in household net worth has had a material impact on the economy, boosting consumption, business investment and domestic demand. While the primary factor driving consumption is real (inflation-adjusted) disposable personal income that is determined by employment and wages, the sharp persistent rise in wealth has contributed to the resilience of the consumer.  This wealth-induced rise in the propensity to spend is reflected in the relatively low rate of personal saving in 2023-2024 which is several percentage points below the post-GFC period when the sharp decline in household led households to spend less and increase saving to replenish their depleted balance sheets (Chart 5).

Besides the wealth effect on consumption, the rise in wealth flows into the economy and affects economic performance in numerous ways.  The appreciation of real estate and financial assets has provided privately owned businesses the impetus and financial ability to expand, increase their capital expenditures and hiring.  This impact on small businesses is important, as 77% of all employment is in privately-owned firms, and 45% of all employment is in firms with less than 250 workers.  The opposite was true following the GFC when the sharp collapse in real estate undercut small business financing.


250103ML5.jpg

Charitable giving, which totaled $550 billion in 2023, flows directly into the economy, providing financial support for the operations and activities of non-profit organizations.  Gifting of household wealth is sizable.  Consider that 31.6% of all household net worth is held by people 70 years old and older, and 42% is held by people aged 55-69. Parents gift large sums to their children for down payments for home purchases, to pay for grandchildren education and a wide array of other activities.  Many make infra-family loans to family members.  Currently, assets in IRA and Keough accounts total $14.5 trillion, and required minimum distributions (RMDs) after-tax are direct additions to measured disposable income.

**Economic policy implications.**  Material declines in household net worth can have the opposite effect of dampening economic activity. Economic policymakers, in the U.S. and overseas, have occasionally ignored the sources and impacts of sizable changes in household net worth, contributing to misguided policies.  The sharp decline in U.S. household net worth during the GFC—its peak-to-trough fall of 16.4% reflected steep declines in the S&P500 and the Case Shiller Home Price Index—constrained the recovery of consumption and the economy, despite the Fed’s sustained zero interest rates and massive quantitative easing along with the fiscal stimulus of the Economic Recovery and Reinvestment Act of 2009.  The failure of aggressive monetary and fiscal stimulus to lift aggregate demand resulted in a soft recovery and low inflation.  This had a lasting impression on policymakers.  Fueled by its belief that policy responses to the GFC were too timid, fiscal policymakers shifted toward hyper-stimulus in response to the pandemic, while the Fed incorrectly presumed that inflation would stay low like it did following the GFC, which contributed to its poor forecast and decision to maintain excessively easy monetary far too long, a costly mistake that still has lingering effects.

Decades earlier, Japan’s asset price bubble in the late 1980s that resulted from the Bank of Japan’s excessively easy monetary policies burst, and the resulting 75% collapse in real estate values and the Nikkei generated a massive loss in wealth and capital.  The Japanese government failed to acknowledge the problem, providing insufficient fiscal stimulus to offset the hit to wealth and delayed recapitalizing the severely damaged commercial banks until 1997.  As a result, the negative wealth effect resulted in insufficient aggregate domestic demand, bouts of mild deflation and a “lost decade”.

China’s recent collapse of its government-generated excesses in real estate have generated dramatic losses in wealth, widespread bankruptcies of major land developers and undercut local government finances that relied heavily on revenues from land sales.  Real estate had been the dominate portion of total household net worth in China—its share was more than double the U.S.’s 33% share—and its negative impacts on consumption and domestic demand have been quite severe.  The Chinese government has acknowledged and tried to the problem, but its government debt has soared, which has constrained the amount of stimulus it has provided.  To date the housing market continues to have excess supply, and cautious consumers tilt toward saving rather than spending.

The experiences of the U.S., Japan and China highlight the importance of sizable shifts in household net worth and suggest policy makers need to gain a better understanding of the sources and economic consequences of sizable shifts in wealth.

Household Net Worth and Economic Performance

Viewpoints: 2025

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