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Allianz Investment Management LLC 2025 Market Outlook

Representatives from Allianz Investment Management LLC provide commentary on market and economic indicators, including Federal Reserve actions, interest rates, credit markets, and economic releases such as inflation, GDP, consumer confidence, housing, retail sales, and job unemployment news. Here is their outlook for 2025.

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Key points:

  • The Fed will have their work cut out for them in 2025 as they try to balance the potential slowing economy against inflation risks on the horizon.
  • Inflation is clearly the wild card in 2025 as risks tilt toward upward inflation pressure with the new Trump administration coming in.
  • Despite the potential for major policy shifts, we expect to see some balance, which ultimately can translate to slower growth on the margin.
  • The trajectory of monetary policy in the U.S. will likely be lower in 2025, but U.S. rates could remain volatile as the Fed remains data dependent.
  • The 10-year Treasury yield is expected to remain above the 4% level this year as U.S. exceptionalism and technical factors keep yields elevated.
  • With two consecutive years of extraordinary returns, the equity market should experience more normalized returns.
  • High valuations, shifting monetary policy, and unknown geopolitical issues are on the list of top risks we are watching in 2025.
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2025 Market Outlook: To cut or not to cut … that is the question for the federal reserve

Following two consecutive years of returns greater than 20% in the equity market, it is hard for investors to envision what more normalized returns will look like. Looking back, 2024 can be characterized as another year where economists were expecting the slowdown that never came. Even with the Fed aggressively holding rates at historically high levels for over a year, the U.S. economy really never missed a beat. This year we are expecting more of the same, perhaps a slower growing economy on the margin, but nonetheless an economic environment with real GDP above 2%. When assessing and formulating this year’s market outlook, the dominant factor of uncertainty will undoubtedly result from the magnitude of policy change brought on by the incoming Trump administration. The magnitude of tariffs, immigration, and fiscal policy initiatives will be a determining factor in the trajectory of the economy and markets alike. Our base case view is that some policies, such as tariff expansion and immigration policy, will detract from GDP, while deregulation and lower taxes will have the potential to boost GDP. On balance, these policy shifts should roughly offset each other, and we should expect an extension of the current economic cycle supported by steady labor conditions, strong consumption, and moderate productivity gains.

That being said, inflation will likely be the wild card of this year’s forecasting game. Despite meaningful progress toward the Fed’s 2% inflation mandate, we are inclined to doubt the sustainability of the current trend of inflation as most of the polices on the docket for 2025 appear to be largely inflationary. In turn, we expect to experience additional volatility in the rate markets as the Fed’s ability to continue cutting interest rates is diminished by the risks of rising inflation. Shifting monetary policy expectations combined with some risks around fiscal unrest in the U.S. point to a steeper interest rate curve, which remains a top risk for 2025.

On the equity front, the bar has been set and it remains unquestionably high. With the price-to-earnings multiple well above 20x as well as historical averages, firms must fire on all cylinders to meet profit expectations or risk letting their foot off the gas. Concentration risk remains a foremost topic as the AI revolution persists and investors question how much gas is left in the tank for the growth engine of the magnificent seven. Either way, all bets are off the table should geopolitical conditions worsen, but that’s not our base case as we look for more normalized returns across equity indices in 2025.

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U.S. GDP Growth

The recent acceleration of growth in the late innings of 2024 has set the tone for 2025 as most economists align with our thinking that we will continue to see more of the same. The consumer and household balance sheets remain in good shape, and until we can see some material cracks in the employment picture for the U.S., it is hard to envision a recession in the coming year. However, the recent GOP sweep in the political landscape has created uncertainty and the potential for major policy changes that has the ability to alter the pace of growth. Some policies, like expanding tariffs and tightening immigration, are expected to have a negative effect on GDP growth. On the other hand, deregulation and lower taxes have the potential to boost GDP. As we transition into the new calendar year, our base case forecast for U.S. GDP is a range of 2.0% to 3.0%.

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Fed funds rate

Playing the Fed parlor game is not much different than riding a perpetual roller coaster, and the reality is that it is not likely to change any time soon with a Fed that has committed to maintaining a data-dependent policy. The only problem is that data is backward-looking, and by the time the Fed is ready to change, the market has been well ahead of them.  Slowing inflation and labor market concerns kicked off the rate cutting cycle with 100 basis points already completed, but given the economic backdrop, this cycle will likely end up being more shallow than previous cycles. We expect the committee members will continue to face challenges in determining the neutral level of the Fed funds rate, and this could prove to be a driver of rate volatility this year. With inflation still above 2%, and the risks tilting toward higher inflation, we expect the Fed to cut rates at a more gradual pace in 2025, and our target for Fed funds is a range of 3.50% and 4.00%, which equates to about three more cuts in 2025.

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Inflation

The progress the Fed has made on bringing down inflation from the peak has not gone unnoticed, but getting back down to the 2% target has proven to be more difficult than originally thought. The primary driving force that pushed inflation lower throughout 2024 was the deflationary pressure from the goods sector of the economy. Looking forward, goods deflation has likely run out of gas, and if anything, the prospects of higher tariffs could be a substantial influence on the inflation backdrop in 2025. Service prices have the potential to decelerate with shelter cost growing at a slower pace, but sweeping changes to immigration policy could alter the labor market and change the trajectory of wages. Accordingly, we continue to expect core inflation will remain within a range of 2.0% to 3.0% throughout the year. 

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10-year Treasury

Rewinding back to the middle of last year, I don’t think anyone would have anticipated long-term yields rising in the wake of a rate cutting campaign by the Fed. The inverted yield curve between Fed policy rates and the 10-year has completely collapsed as the Fed has lowered rates by 100 basis points while the 10-year yield has risen by the same amount. Resilient growth and U.S. exceptionalism relative to other DM countries has helped lift rates, and we expect this phenomenon to continue throughout 2025. Throughout 2024, expectations for the terminal policy rate have been a major factor in rate volatility, and we anticipate that this will continue this year. Our reasoning for expecting 10-year rates to remain above the 4% level includes a shallower rate cutting trajectory with a higher terminal rate compared to previous cycles, solid growth prospects in the U.S. driven by consumption, and the growing presence of term premium in the yield structure due to fiscal concerns and technical factors. Overall, we expect the 10-year yield at the end of 2025 between 4.0% and 4.5%.

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U.S. Equities

When people say “history repeats itself,” they don’t mean it literally, but when reflecting on last year’s performance of the S&P 500®, there are some similarities. Following a 24.23% return in 2023, the S&P 500® notched a 23.31% return in 2024, solidifying two back-to-back remarkable years for the equity market. It was another year where most economists underestimated the strength of the consumer, and once again the economic slowdown that everyone is bracing for has yet to come. Economically speaking, this year will likely bring more of the same, but the reality is, the bar is high for equity returns, and the likely path for gains across the broad U.S. equity indices should be more normalized. While we would agree that valuations look stretched, to coincide with our views on a continued growth trajectory, modest fiscal expansion, and a marginal loosening of monetary conditions, we envision a more normalized return closer to 10% for the S&P 500® Index in 2025. That being said, the path to a normal performance of the index this calendar year will likely not be a linear one. With uncertainty surrounding policy shifts of the incoming administration, higher interest rates, or tariff angst, we expect many ups and downs along the way. As a firm with a strong history of risk management, we can certainly appreciate the uneasy feeling surrounding a market layered with stretched valuations against a backdrop of shifting fiscal policies among a host of unknown geopolitical risks, but our base case for equity returns in 2025 is plus 5% to plus 15% with the foot remaining on the gas for the U.S. economy this year.   

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List of definitions

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The views, opinions, and estimates expressed above reflect the views of Allianz Investment Management LLC (AIM LLC) as of January 2025. This document is provided for informational purposes by AIM LLC, a registered investment adviser that is a wholly owned subsidiary of Allianz Life Insurance Company of North America. These views may change as interest rates, market conditions, tax rulings, and other investment factors are subject to rapid change which may materially impact analysis that is included in this document. This report does not constitute a solicitation or an offer to buy or to sell any security, product, or service. It is not intended and should not be used to provide financial advice as it does not address or account for an individual's circumstances. Consult with your advisor and tax professional before taking any action based upon the information contained in this document. Past performance does not guarantee future results and no forecast should be considered a guarantee. Any investment and economic outlook information contained in this document has been compiled by AIM LLC from various sources, including affiliated entities. AIM LLC takes reasonable steps to provide up-to-date, accurate, and reliable information, and believes the information to be so when provided, but no representation or warranty, express or implied, is made by AIM LLC as to its accuracy, completeness, or correctness.


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