Economy will remain supportive of markets in 2025

Chief Economist Eugenio J. Alemán discusses current economic conditions.

Happy New Year, 2025!

As we start a new year it will be important to look at what lies ahead, at least from an economic perspective. And the most important issue is that the economy’s fundamentals remain solid with very few misalignments that could derail it, at least for now.

Inflation: while still slow in coming down, it is close to the target. At some point during the year, Federal Reserve (Fed) officials will have to decide if the interest rate path they have chosen for the rest of the year will be enough to bring it down to the 2.0% target. Just in case, they have extended the runway for achieving the target, to 2027 rather than 2026. Hopefully, markets will be patient with the Fed.

Economic growth: Economic growth projections remain strong, which is one of the reasons why inflation is expected to remain above target. Furthermore, positive vibes regarding the incoming Trump administration could push economic growth even higher, depending on whether the new administration is serious about the fiscal deficit or not.

Housing market: The U.S. housing market will continue to suffer from high mortgage rates. However, the sector’s prospects seem to have improved somewhat as many, but especially those in the existing home sales market, have started to realize that waiting for lower rates doesn’t seem to be the correct strategy. Still, the low supply of homes could continue to put upward pressure on home prices and make them even less affordable.

Manufacturing sector: The sector will continue to struggle under the pressure of high interest rates. However, new investments in the construction of manufacturing plants brought about by the incentives provided by the CHIPS and IRA acts are going to start making their inroads and brighten the prospects of the manufacturing sector, even if interest rates remain high.

Service sector: The U.S. service economy is alive and well and has continued to move the economy forward. Although there are signs that the less well-off are struggling under high prices and high interest rates, they will continue to engage in the economy as long as jobs are plentiful and there is full employment. On the flipside, those who are better off have continued to push forward helped by higher interest payments on savings, stock market returns, equity in their homes, and a strong labor market.

Tariffs: Many argue that Trump’s tariffs 2.0 are going to be very similar to the Trump tariffs 1.0 and thus have little to no effect on inflation. For that, we will have to wait and see what the actual plan is. The new tariffs have been sold as broad-based across all imported products and countries across the global economy. If that is what is finally decided, analysts will have to go back to the drawing table and update their expectations about inflation and Fed policy. For now, our inflation and Fed forecast does not include the potential for broad-based tariffs because of the uncertainty surrounding the implementation.

When we hear clients and advisors worrying about the U.S. dollar, the U.S. deficit, the U.S. debt, etc., many times we remember the saying: “In the land of the blind, the one-eyed man is king.” In some sense, the U.S. economy used to be considered the ‘one-eyed’ man in a world full of troubled economies. Of course, this explanation seems to be highly self-centered, and many could argue that the U.S. economy can no longer be considered in this light. Many argue that China is now the biggest threat to U.S. hegemonic claims. Thus, in order to set the record straight, let’s discuss the case of China, which is challenging U.S. supremacy in the global economy and also what we consider to be the biggest threat to sustained economic growth.

Tariffs are a threat to the Chinese (Communist Party) way of Life

Back in 2005 one of us was attending a conference in Frankfurt, Germany. One of the speakers at the conference was the Chief Economist of one of the largest global chemical companies in the world. After his presentation, the obvious conclusion to every person paying attention (not many were actually paying attention!) to his arguments on China was that China was going to be the ‘production hub’ of the global economy and the rest of the economies of the world were going to be mere observers/spectators or, what China may call today, ‘consumption hubs.’ Twenty years after that presentation, the global economy is faced with this dilemma: Will it allow that 2005 view of the global economy or would it challenge it?

As we said above, the U.S. is not alone in claiming to be the best economy in the world as China continues to compete for the title, with good arguments to support its claim. But if we believe that the U.S. economy is past its prime while China is the new kid on the block, we have to be careful in analyzing each country’s strengths/weaknesses. Yes, China is a force in itself, as it has continued to promote itself as the ‘production hub’ of the global economy. However, China is not the ‘consumption hub’ of the world and it relies on the rest of the world to continue buying its goods. This is a big misalignment for the Chinese and global economy, one that is going to be threatened by protective policies, i.e., tariffs, being considered across the global economy, but more specifically within the developed countries.

The largest ‘consumption hubs’ for Chinese production are the U.S. and European economies, which are where the highest-income consumers reside. True, the rest of the countries in the world could help China as they absorb some of its production, but less developed countries cannot keep absorbing all of the goods being produced by the Chinese production hub unless goods prices continue to come down, which is a defeatist strategy if pursued over time. Thus, if this strategy continues to be implemented, it has the potential to push the Chinese economy into goods-deflation cycles.

China has become such a large producer of so many types of goods that the inability to continue to sell these goods across the global economy could generate severe issues for its economy. Furthermore, global overproduction of goods could trigger something similar to what happened during the Great Depression, although the dimensions of such an event are probably only going to be limited to China rather than to the rest of the global economy as was the case then.

One of the lessons the U.S. (and the world) learned during the Great Depression was that Say’s Law, which argued that every supply created its own demand, was flawed, especially if income is unequally distributed and/or if households hoarded cash.

That is, if individuals do not have the incomes necessary to purchase what is being produced (i.e., highly unequal distribution of income) or if they hoard cash rather than spend it (which is what Chinese households are doing), then this creates a situation of overproduction that contributes to deflationary pressures.

This is one of the reasons why so many economists outside of China have been recommending the country develop its internal consumption market, as the current strategy is bound to fail in the long term. However, developing domestic consumption markets means improving incomes across all income levels as well as improving income distribution, which is more easily said than done and is inconsistent with production strategies that flood the global economy with ever-cheaper goods.

Thus, it is true that China is a production powerhouse and will continue to challenge other production hubs across the global economy. However, its dependence on the rest of the global economy to absorb its excess production is its Achilles heel.¹

1: Achilles heel: a weakness or vulnerability that can lead to failure, despite overall strength.

Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those of Raymond James and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Past performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.

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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.

Employment cost Index: The Employment Cost Index (ECI) measures the change in the hourly labor cost to employers over time. The ECI uses a fixed “basket” of labor to produce a pure cost change, free from the effects of workers moving between occupations and industries and includes both the cost of wages and salaries and the cost of benefits.

US Dollar Index: The US Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the

U.S. dollar gains "strength" when compared to other currencies.

Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.

Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households.

Producer Price Index: A producer price index(PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.

Conference Board Coincident Economic Index: The Composite Index of Coincident Indicators is an index published by the Conference Board that provides a broad-based measurement of current economic conditions, helping economists, investors, and public policymakers to determine which phase of the business cycle the economy is currently experiencing.

Conference Board Lagging Economic Index: The Composite Index of Lagging Indicators is an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.

New Export Index: The PMI New export orders index allows us to track international demand for a country's goods and services on a timely, monthly, basis.

Gold is subject to the special risks associated with investing in precious metals, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated.

The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.

Source: FactSet, data as of 12/6/2024