Following a bumper 2024, what’s next for the US economy and market?

The US has dominated financial markets this year. The economy has been stronger than expected with GDP growth running at an annualised rate of 3.0% in the second quarter (Q2).

The blue-chip benchmark S&P 500 index has enjoyed a total return of some 22% and US fixed income markets have delivered strong returns because of the apparent success the Federal Reserve (Fed) had in dealing with inflation.¹

Interest rates have begun to move lower and credit markets have reflected the strength of the US corporate sector. A 50:50 allocation to the S&P 500 Growth equity index and the ICE US High Yield bond index would have returned close to 18% year to date.

November’s presidential election will clearly be important as we look to 2025. One potential outcome is likely to see something of a continuation of the economic policies which have helped growth since the recovery from the pandemic.

The Joe Biden-Kamala Harris administration oversaw the implementation of several Acts of Congress that have subsequently boosted investment in the US with a focus on infrastructure and securing the US’s leadership role in technology.

Gross fixed investment spending grew at an annualised rate of 8.3% in Q2 – a sign of corporate confidence.²  The alternative outcome is likely to see some combination of tax cuts and protectionist trade policies that could be disruptive to the macroeconomic outlook in the coming years. 

The fiscal challenge

In terms of November’s upcoming presidential election, one topic that has not been addressed by either Harris or Donald Trump is the long-term fiscal outlook. The Congressional Budget Office’s baseline expectation is the deficit will remain close to 6% of GDP for the next decade and the level of federal debt will reach 122% of GDP in 10 years’ time.³

Some bond investors worry about this - and worry even more that post-election economic policies will cause the debt and deficit numbers to exceed current projections. In short, the fear is that long-term interest rates will be pressured higher as government borrowing rises, and that this will mean fiscal policy is dominant over monetary policy decisions.

Today, concerns about the deficit are reflected in the bond market – not through the yield levels which have come down through 2024 – but in the relative pricing of Treasury bonds and interest rate swaps⁴ . This is evident across the yield curve and most pronounced for long-term maturities. Essentially this is the market saying that investors need more of a premium for holding long-term Treasuries given the fiscal concerns.

Treasuries’ risk premium is still relatively modest. The broader picture suggests concerns amongst investors is limited – after all, financial markets have performed well. Even the dollar, which has weakened a little against the euro and the yen this year, remains above levels that prevailed in the immediate aftermath of the pandemic.

The US is rich enough to deal with its budget deficit if the political will exists and it may take more market concern for that to become evident enough to provide that political focus. It will be a theme during the next president’s term and poses a risk to markets over that period if the fiscal outlook continues to be ignored.

AI and technology remain key drivers

On a more positive note, the US is well placed to continue to dominate the technology space. The frenzy around generative artificial intelligence (AI) peaked in June and technology stocks have underperformed the broader market since then.

However, guidance from technology companies around new products and services suggests earnings growth will remain strong going forward. While AI technologies are becoming more prevalent in consumer products, it is fair to say that we are still in the early stages of this technology revolution. The scope for positive effects on broader productivity performance is clear with applications across a whole swathe of economic sectors, from agriculture to education.

For the coming year, lower interest rates look likely while the economy is continuing to grow. This soft landing should be positive for financial market returns. However, 2024 was a something of ‘a year of surprise’. Growth was better than expected and the Fed was able to pivot on the back of a modest increase in unemployment and lower inflation.

It is not clear that similar positive surprises will be seen in 2025. There are obvious political uncertainties. In the markets, valuations are rich, and for equities, a strong year of earnings growth is embedded in analysts’ forecasts. Some correction in markets is likely, given the political risks and potential for credit problems to begin to emerge, especially if the unemployment rate does move higher.

Yet the US’s performance is still likely to be superior to other developed economies. Ongoing investment in AI and the renewable energy resources needed to power data centres and an expanding electricity grid will remain major themes. But it would be good if a trade war were avoided, and some attention was paid to federal finances.

Lower rates will certainly be a positive for businesses and consumers alike and, as we have observed many times in the past, the ability of consumers and companies to keep spending should never be underestimated.