The danger areas ahead for the global economy in 2025

In the world of finance and economics,  December is not just about office parties and Christmas trees. It also happens to be the 2025 Year Ahead season, as the “bulge bracket” institutions of Wall Street put out their annual forecast tomes as to what they see looming on the horizon for the global economy.

Although the actual predictive ability of such documents is, of course, questionable, they are extremely valuable for gauging the consensus views of what economists and investors are expecting for the year ahead.

On this basis, two points are clear. First, the US has been winning and will continue to win. Since Covid, its economy has been the strongest of all major economies and its stock market has far outperformed all others.

The consensus on this point is striking. Almost no one, it seems, is willing to bet against America at this time. Investors are overweighting the US, and economists suggest they should double down.

Fundamental to this point is the re-election of Donald Trump. Anything that he does to hurt the global economy – like a tariff-led trade war – is only likely to hurt the rest of the world more than it hurts domestically, or so goes the theory.

Second, the global economy is not about to fall over. After the widespread forecasts of recession going into 2022 and 2023, now the oracles of Wall Street are remarkably sanguine. Although they admit that growth, especially in the US, is unlikely to match the breakneck pace of immediately after the Covid monetary and fiscal stimulus, it should normalise to a more sustainable rate.

Globally, although nowhere perhaps looks as compelling as the US, in terms of economic outlook and investment opportunities, the overwhelming sense one gets from the forecast documents is that nowhere else looks all that terrible either.

Europe should continue to grow as the European Central Bank continues to cut rates. Even in the really tough spots such as Germany, economic activity should start to grow again, albeit moderately.

China, too, seems to have bottomed out and with additional government stimulus has hopefully passed its worst.

And finally, for emerging markets such as South Africa, if there is no major slowdown in the rest of the world then things should slowly start picking up. The biggest unknown for these markets is, however, the dollar. If a Trump-fuelled greenback continues getting stronger, that could, as it usually does, hurt emerging markets, particularly those that have borrowed in hard currency.

So far, so good

But such an overwhelmingly complacent consensus from the forecasters can only serve to make one feel uneasy. If there is one thing economic history has proven it is that it is precisely when no one – or very few people – sees any dangers lurking on the horizon that something does indeed leap out. If something is about to trip up financial markets and the economy, what could it be?

First, a question for financial markets is whether there exists a threshold for 10-year US Treasury bond yields that could significantly disrupt equity markets, and if that threshold is likely to be reached in the near term.

Current market pricing reflects expectations of a decline in interest rates. However, with such a strong US economy, bond yields could start climbing on either expectations of higher rates from the Fed or hotter inflation.

Second, where are we in the business cycle? And if we are at the end, does that mean a recession is indeed imminent? Credit spreads are a key indicator of this – the difference between where the US government borrows at and where corporates do.

These, astonishingly, are about as tight as they have ever been. In a normal world, that is consistent with late-cycle complacency, suggesting that spreads’ next move is up and it is time to reduce risk. A further worrying sign is that default rates in the US are starting to tick up, which is another indicator that we have reached the end of this business cycle.

Many on Wall Street are less concerned than one might expect regarding this point. Optimists argue that when it comes to the business cycle, “this time is different”. The pandemic was not a traditional recession, it was an exogenous shock which then precipitated a boom-time fiscal stimulus.

Once again, I am sceptical. Surely the pandemic could not have eliminated business cycles forever? I would say that this business cycle was due for a downturn in 2020, but the pandemic stimulus simply delayed kicked the can down the road.

Third is the great conundrum that is artificial intelligence (AI). At the moment, AI is supposed to change everything – companies that are affiliated to it in any meaningful way are extremely expensive, and priced for global domination. Although there could indeed by meaningful productivity growth from the technology, that does not mean it cannot be a bubble.

Indeed, it is exactly the technologies that do change the world that lead to bubbles because, in the early stages of technological adoption, it is unclear who or what will make money out of it, so people just buy whatever they can, bidding up prices far beyond where they should be.

Finally, what has become more and more apparent throughout this business cycle is the dependence of the global economy on the US consumer. According to the JPMorgan outlook document, consumers contributed a full 78% to US economic growth, which in turn has pulled the rest of the world along.

Clearly, the US consumer is more resilient than many had expected in 2022 and 2023. Why, then, should 2024 be any different?

One factor which is perhaps less appreciated is the “wealth effect” of financial markets on the US consumer, and vice versa. As Goldman Sachs strategist Bobby Molavi made clear in a recent note, US consumers are different. They are the biggest owners of US equities, and US equities are one of the best-performing asset classes on earth.

They are also heavily engaged with alternative asset classes such as gold and bitcoin, both of which have had stellar performances this year. After a quick glance at their share or crypto portfolio, the average US consumer cannot be blamed for spending with such reckless abandon.

But this also means that should there be a correction in share prices, for some exogenous factor, then the consequential negative feedback loop back into the real economy could be brutal.

South Africa needs reforms

For South Africa, early indicators of economic performance under the government of national unity leave much to be desired. The first major economic data release under the new government was much weaker than expected. However, should there be no global slowdown, it is unlikely that there is much chance of a recession. One can expect growth to be steady if pedestrian.

The question remains what the base case economic outlook for South Africa is, without (much) load shedding or any further exogenous shocks. Although many had hoped this would be in excess of 2% or even as high as 3%, it seems the structural damage done to the economy through the Zuma years has lowered it to barely 1%. Without major structural reforms to significantly lower unemployment, attract investment and increase productivity, it is unlikely that economic growth will surprise to the upside.

After the political and economic roller coaster that was the year of elections of 2024, perhaps 2025 will be a moment of comparative calm, with steady if unspectacular global economic expansion and steady appreciation in financial markets. That is pretty much what the whole of Wall Street is expecting. This, however, is precisely why we should have reason for caution. DM

This story first appeared in our weekly DM168 newspaper, available countrywide for R35.