Key Takeaways

• Even before taking office, a second Trump administration is already moving the macro-financial needle and raising downside risks for the global economy. The degree of ultimate policy implementation is a key unknown.
• Our preliminary policy read on the new U.S. administration is that positive growth effects will be minimal, inflation pressures will rise, and the Fed is likely to stop cutting rates earlier. This will lead to tighter financial conditions, a stronger dollar, and a more complicated macroeconomic picture elsewhere.
• Owing to a "wait and see" approach, our GDP growth forecasts have not moved much since the previous publication, other than incorporating changes related to base effects.
• Risks include the full implementation of the proposed U.S. agenda on taxes, trade, and immigration; the end of resilient consumer spending and labor demand; and bond market stress. AI is an upside.

The global macroeconomic outlook is hostage to the policy implementation of the new U.S. administration. The recent macro pattern featuring an outperforming U.S. economy continues. But potentially large changes in fiscal, trade, and immigration policy from the U.S. are significant unknowns at this juncture. Specifically, it is unclear to what extent campaign promises will translate into policy, and when.

Given the size of the U.S. economy, policy action on any of these fronts can move the global needle, affecting some economies more than others. For now, S&P Global Ratings has taken a probabilistic approach and is assuming partial implementation of U.S. campaign promises. Of course, to the extent that U.S. policy actions spill over to the rest of the world, other countries may respond in kind. We plan to update our forecasts, narratives, and risks as the picture becomes clearer.

Recent Macro Pattern Continues While Markets Are Moving

The recent pattern of real performance in the three largest economies is carrying on. The U.S. continues to outshine its peer group. GDP rose by 2.8% year on year in the third quarter (Q3), down fractionally from the second quarter (Q2), since services spending and labor demand remain strong.

The eurozone economy continues its modest rebound from a borderline recession centered on Germany. GDP growth reached 1.6% quarter on quarter in Q3, also accompanied by strong services spending and labor demand. In China, growth is running below the official 5% target for the year, reflecting the ongoing effects of the property sector overhang. The policy response remains measured and consumer confidence and spending are still weak.

Inflation continues to trend toward central bank targets in the major economies, but with emerging divergence. Progress in lowering inflation has stalled in the U.S., with the most recent readings for sequential inflation moving sideways. Services inflation in particular remains persistent. A similar story prevails in Australia and to a less extent in the U.K. Canada has seen the sharpest drop in inflation, which now stands below the central bank's target. Elsewhere, the eurozone has seen an uptick in core inflation, which is currently tracking on target.

Chart 1

Central banks continue to reduce their policy rates, mostly gradually. The Bank of Canada was first out of the gate and leads the pack with an accumulated 125 basis points (bps) of cuts since the middle of 2024. The European Central Bank (ECB) and the U.S. Federal Reserve (Fed) have both cut rates by 75 bps to date, while the Bank of England has cut by 50 bps. The Reserve Bank of Australia is the outlier, with no cuts to date. As expected, central banks are lowering policy rates at a much slower pace than they raised them in 2022 and early 2023, with only two 50 bps cuts in this group so far.

Chart 2

Markets have significantly increased expectations that the Fed will stop cutting rates versus only a few months ago. This is most clear in forward pricing for the October 2025 meeting of the Federal Open Market Committee. Seen through this lens, market expectations for the Fed funds rate have moved higher by about 100 bps in the past two months to 3.9% from 2.9%. The movement reflects concerns over potential inflation pressures from tariffs, tax cuts, and restrictions on labor supply (as a consequence of immigration policy changes) that would require a forceful response from the Fed. Importantly, market views of policy rates for other major central banks have not shown this pattern. For example, the gap between the expected Fed funds rate and ECB deposit rate for October 2025 has more than doubled to over 200 bps in the past two months.

Chart 3

Roughly in parallel with Fed funds rate expectations, U.S. 10-year yields have moved higher in recent months. From a trough of about 3.8% in September, yields have climbed to almost 4.5% in late November. In addition to higher inflation pressures, higher yields at the long end also reflect expectations about the supply of Treasuries. Supply is likely to be higher, given an estimated increase in the size of fiscal deficits under the Trump administration. Again, other major economies have not seen similar movements in their longer-term government yields. The yield on 10-year German bunds has been flat over the same period.

The U.S. dollar rebounded before and after the election. This was in line with interest rate market moves and continued expected outperformance of the U.S. economy. According to the benchmark DXY index, the U.S. dollar has risen 7% since late September and is near levels last seen in the early 2000s. In bilateral terms against other major currencies, the moves since late September have been broadly consistent. Higher bond yields and a stronger currency both point to tighter financial conditions in the U.S., which have historically been a strong determinant of a slower expansion of output.

Our Broadly Unchanged Forecasts Have Widening Confidence Bands

Our new baseline growth forecasts are broadly in line with our previous quarterly Credit Conditions Committee (CCC) forecast (see table 1). U.S. GDP growth will slow gradually to 2% or below starting next year, consistent with a soft landing, before rising back to potential. The eurozone will continue its gradual recovery in 2025 to reach its potential growth rate. China's growth will slow toward 4% as the U.S. tariffs weaken exports and investment.

Elsewhere, the picture is mixed. In the advanced economies, Japan will rebound next year and settle at about 1% growth, with the U.K. following a similar pattern toward its trend growth of 1.5%. In the major emerging markets, India retains the global growth baton, where the rate of expansion should stay just below 7% over the next few years. Elsewhere in emerging markets, Brazil and Mexico should eventually converge to about 2% growth (with Mexico having a weaker 2025), while South Africa should pick up to about 1.5% growth in the next few years.

Table 1

Our detailed regional forecasts are as follows:

United States: Uncertainty Looms As Trump Takes Office

We forecast the economy will expand 2.0% in the next two years--incorporating a partial implementation of proposed Trump policies--following 2.7% GDP growth in 2024. We expect the Fed to reduce its policy rate more gradually than considered in our September forecast update and reach an assumed neutral rate of 3.1% by fourth-quarter 2026--from fourth-quarter 2025 previously. Uncertainty around our forecasts is high given unknowns about the extent President-elect Trump's campaign promises will materialize. Trump's policy proposals, at face value, could result in higher inflation in the near term and lower growth in the medium to long term. And the probability of a disruption to the Fed's easing bias over the next two years has risen.

For our full report on the U.S. economy, see "Steady Growth, Significant Policy Uncertainty," published Nov. 26, 2024, on RatingsDirect.

Europe: Interest Rate Cuts To Accelerate

We project eurozone GDP growth of 0.8% in 2024 and 1.2% in 2025, with Germany lagging its peers and Spain continuing to outperform. Changes to our previous forecast largely reflect revisions of past data. Due to a more pronounced drop in energy prices, we expect inflation will be marginally lower in 2025 than we anticipated. A long period of very stable macroeconomic forecasts might come to an end because new leaders in the U.S., EU, and Germany may take decisions early next year on tariffs, defense, and general spending that could reshape the economic outlook.

We anticipate the ECB will cut interest rates more quickly than we previously expected due to persistently weak confidence and better visibility on the disinflation trajectory. That said, we do not expect the cuts will exceed our previous forecast. We now project that the main policy rate will reach 2.5% before summer {May?) 2025, compared with our previous expectation of September 2025.

For our full report on the eurozone economy, see "Next Year Will Be A Game Changer," published Nov. 26, 2024.

Asia-Pacific: Slower Global Demand Hits Growth

While China's stimulus measures should support growth, we expect its economy to be hit by U.S. trade tariffs on its exports. In all, we now project 4.1% GDP growth in 2025 and 3.8% in 2026; that's 0.2 percentage points (ppts) and 0.7 ppt lower than our forecast in September. Asia-Pacific's growth will be impeded by slower global demand and U.S. trade policy. But lower interest rates and inflation should ease their drag on spending power.

In emerging markets, robust domestic demand growth is also buoying GDP growth. Swings in capital flows driven by shifts in expectations about U.S. interest rates and trade policies require central banks to be vigilant and cautious. In turn, we expect Asia-Pacific central banks to take their time bringing policy rates down.

For our full report on the Asia-Pacific economies, see "U.S. Trade Shift Blurs The Horizon," published Nov. 25, 2024.

Emerging Markets: Trade Protectionism Adds To Risks

A likely increase in protectionist trade policies among major economies will hurt GDP growth in most emerging markets in the next couple of years. However, the magnitude of the effect will depend on the details, which will become clearer in the coming months. For now, we assume only a modest increase in tit-for-tat tariffs between the U.S. and China in 2025 and no new tariffs for the rest of the world, which would produce a relatively modest net impact on GDP in most major emerging markets outside China.

However, downside risks to our forecast are high, and potential tightening in financial conditions because of trade-related uncertainty adds another hazard.

For our full report on the emerging market economies, see "Trade Uncertainty Threatens Growth," published Nov. 26, 2024.

Risks Shift To Near-Team U.S. Policies

The main risk to our baseline is the exact policy implementation of the incoming U.S. administration on tariffs, taxes, and immigration. In our current forecast round, we have assumed only partial implementation of campaign promises. Once the new administration takes office, actual policy implementation will become clearer.

Let's look at a scenario in which the U.S. imposes a 60% tariff on all imports from China plus new tariffs on other trading partners, cuts personal and corporate taxes, and deports millions of illegal immigrants. If that happens, we anticipate lower U.S. output, higher inflation pressures, and increased volatility and rates along the yield curve. These effects will spill over to other economies--very asymmetrically--in terms of activity, trade, and key financial variables.

The durability of the nexus of strong services spending and labor demand also constitutes another downside risk. While in our baseline scenario we assume continued resilience, services spending could begin to crack, given still-high interest rates and rising uncertainty about U.S. policy. Should services spending slow and labor demand begin to fall, we would likely enter into a sharp slowdown/recession scenario.

Another downside risk is the end of quiescence in the U.S. bond market. While 10-year yields rose before and after the election, the market has so far remained orderly. Stress in the bond market cannot be ruled out, given that deficits under the Trump administration are projected by the U.S. government as being higher than under a Harris administration, plus the uncertainties discussed above. A failed auction or a spike in yields could lead to higher volatility and spreads, closed access for parts of the market, and tighter financial conditions.

On the upside, recent productivity gains in the U.S. could broaden and deepen. These gains have come from investments and new technologies around the energy transition, as well as AI, and have boosted potential growth by 40 bps-50 bps. While energy transition gains might be limited elsewhere, given the specific characteristics (subsidies) of the U.S. Inflation Reduction Act, AI capabilities are more widespread and only at a very early stage. This could boost productivity across a range of economies.

Global Macro 2025: Fasten Your Seatbelts

The global economy will start 2025 in a relatively good position. Macro resilience has been a key theme over the past few years. Higher interest rates in response to an unexpectedly sharp rise in post-pandemic inflation have not caused the sharp slowdown feared by most forecasters. Services spending has remained strong and labor demand robust. Losses in output and employment have been modest. Asset prices have risen and volatility has been low. Central banks are now cutting interest rates and a normally elusive soft landing appears within reach and remains our baseline scenario.

Central to this positive global macro story has been the U.S. The world's largest economy has continued to outperform and steady the global macro picture. That could be about to change. The new administration looks to "juice up" an economy that is already running at or above potential, raising the specter of higher inflation pressure, higher U.S. rates along the curve, and a stronger dollar. This tightens U.S. financial conditions and will spill over to a swathe of other economies, mainly emerging markets.

More critically, U.S. trade policy could turn much more disruptive if implemented along the lines promised in the campaign. As we have shown in "How Would China Fare Under 60% U.S. Tariffs?," published Nov. 17, 2024, maximum U.S. tariffs on Chinese imports could significantly damage that economy. And, like before, China is almost sure to retaliate.

Tariffs on other trading partners are likely to cause commensurate damage to their economies, with the risk of retaliation as well. On balance, we think tariffs will be growth destroying and further contribute to ongoing economic (and political) fragmentation. Moreover, none of this will help narrow the U.S. trade and current account deficit, which reflects a lack of U.S. savings relative to investment.

How much of the proposed policy agenda was campaign bluster versus actual intent remains to be seen. But one thing is clear: volatility will be a feature, not a bug. Buckle up.

Related Research

• Economic Outlook Emerging Markets Q1 2025: Trade Uncertainty Threatens Growth, Nov. 26, 2024
• Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty, Nov. 26, 2024
• Economic Outlook Eurozone Q1 2025: Next Year Will Be A Game Changer, Nov. 26, 2024
• Economic Outlook Asia-Pacific Q1 2025: U.S. Trade Shift Blurs The Horizon, Nov. 25, 2024
• How Would China Fare Under 60% U.S. Tariffs?, Nov. 17, 2024