2025: America First falters, Europe-China in sight

In the United States, policy choices are threatening growth and inflation, while Europe and China are betting on a revived fiscal-monetary tandem.

A few months ago as we were approaching 2025, the global economic landscape presented a contrasting picture of performance — China and Europe were posting disappointing results, while the US maintained a solid momentum.

At the time, in China, growth of 5 percent in 2024 remained fragile, the real estate market was still contracting and consumption was struggling to gain traction. In Europe, the quasi-recession that had persisted for a year and a half was partly explained by the weakness of Germany, whose activity had been contracting since the third quarter of 2023.

The US, on the other hand, enjoyed nearly two years of above-potential growth, thanks to robust consumption (especially in services). In the stock markets, the difference was clear. In 2024, US equities climbed 23 percent, compared with only 8 percent for Europe and China (in US dollar terms).

However, we believe that the outlook for 2025 could reshuffle the cards. US "exceptionalism" could run out of steam, while Europe and China could surprise on the upside.

US resilience, long considered an established fact, is facing several challenges. The restrictive monetary policy of the US Federal Reserve — having set benchmark interest rates at above 4 percent for the past two years — is finally seeing its effects spread throughout the economy.

The lag is explained by the absence of excessive private debt and by the savings accumulated during the COVID-19 pandemic, which have made households and businesses less sensitive to rising prices and rates.

But these reserves have now been exhausted. Household residential investment is stagnating due to mortgage rates exceeding 7 percent and a significant inventory of unsold new homes.

Business investment spending is returning to a more moderate pace (around 4 percent compared to more than 6 percent in 2023). Household consumption remains solid but is beginning to slow in services, its most dynamic component.

In this context and with the determinants of services inflation still too strong (wage increases of 4 percent, above the 2.5-3 percent compatible with inflation at its target), the Fed should maintain its restrictive policy in 2025. This is in line with market expectations that only anticipate a limited fall in interest rates.

At the political level, the measures adopted by the new US administration are considered stagflationary, combining inflationary pressures and a potential brake on growth. Two focal points — expansionary fiscal policy and deregulation — could support activity, but the strict migration policy and trade policy risks are slowing it down. Similarly, deregulation alone would not be enough to contain the inflation generated by the other three focal points.

To encourage growth without further fueling inflation, the US administration will have to limit the scope of tariff and migration measures. The first decrees show a firm stance on immigration, but a certain ambiguity on tariffs, suggesting that the US administration could use them as leverage in negotiations with its trading partners.

This cautious approach on trade tariffs is rather reassuring for Europe and China, which are already seeing encouraging signs. In Europe and especially in Germany, recent developments indicate a significant shift toward more expansive fiscal policies, marking a stark departure from the austerity measures anticipated weeks ago.

Germany's centrist parties have reached a landmark agreement to boost defense and public investment, including a constitutional amendment to exempt defense spending from the strict debt brake and a 500 billion euro ($539 billion) special fund for public investment.

At the same time, European inflation is falling toward its target, suggesting several rate cuts by the European Central Bank in 2025.These factors would support the recovery of the manufacturing sector, which has been in recession since January 2023, as well as household consumption, which is benefiting from improved purchasing power and available savings, in the context of lower interest rates and a possible resolution of the Russia-Ukraine conflict.

In China, growth could also surprise on the upside. While the performance in 2024 is largely due to an increase in exports of more than 11 percent, domestic demand is expected to take over. The government seems ready to maintain a policy of sustainable support, both fiscal and monetary.

The numerous measures aimed at stabilizing the real estate sector are producing their first effects. The sector is no longer contracting and should no longer have a negative impact on growth. Household consumption has experienced a strong recovery, surging by over 15 percent on an annualized basis in the fourth quarter of 2024.

To sustain this momentum, the authorities are implementing a proactive fiscal stimulus, aiming for a budget deficit ratio of around 4 percent, the highest in over three decades. A key component of this fiscal package is the allocation of 300 billion yuan ($41.3 billion) to a consumer goods trade-in program, which underscores the government's commitment to enhancing economic activity and addressing existing consumption weaknesses and local government fiscal challenges.

In conclusion, the year 2025 could mark a turning point. The US exceptionalism so visible until now, seems less guaranteed, while the prospects for Europe and China, long underestimated, look more favorable.

The writer is chief economist at Pictet Asset Management.

The views do not necessarily reflect those of China Daily.