You would be forgiven if, as a starting point, you expected these three areas to be in alignment. After all, they are deeply interconnected, which suggests self-reinforcing dynamics. But 2024 brought some unusual dispersion in this relationship that actually widened, rather than narrowed, over the course of the year.
Begin with geopolitics. In 2024, Russia secured a greater advantage in the Ukraine war than the consensus forecasts of a year ago anticipated. Similarly, the human suffering and physical destruction resulting from the Israel-Hamas war in Gaza exceeded most observers’ already-grim expectations, and spread to other countries, such as Lebanon. The apparent impunity of the strong, together with the absence of effective means of preventing dire humanitarian crises, has deepened the sense for many that the global order is fundamentally imbalanced, and lacks any enforceable guardrails.
As for domestic politics, upheaval has been the order of the day in many countries. Governments have collapsed in both France and Germany – Europe’s largest economies – leaving the European Union without political leadership. And following Donald Trump’s victory in last month’s presidential election, the United States is preparing for a political transition that is likely to bring a significant increase in the political influence of a new “counter-elite.”
Meanwhile, an “axis of convenience” – comprising China, Iran, North Korea, and Russia – is seeking to challenge the Western-dominated international order. Other recent developments – from the now-impeached South Korean president’s abrupt declaration of martial law (which was quickly reversed) to the collapse of Bashar al-Assad’s regime in Syria – have reinforced the impression that we are living at a time of exceptional geopolitical and political volatility.
The last year also brought some worrisome macroeconomic developments. Europe’s malaise has deepened, as countries grapple with low growth and large budget deficits. And China has failed to respond credibly to the clear and present danger of “Japanification,” with unfavorable demographics, a debt overhang, and a prolonged property-market downturn undermining growth, economic efficiency, and consumer confidence.
And yet, stock markets have remained relatively stable and delivered high returns, including almost 60 record-high closes for the S&P index. The US economy’s exceptional performance is a major reason why. Far from weakening, as most economists expected, the US pulled even further ahead. Given the amount of foreign capital the US is attracting, and the scale of its investment in the future drivers of productivity, competitiveness, and growth, it is likely to continue outperforming other major economies in 2025.
One consequence of this success is that the US Federal Reserve did not deliver the soothing 1.75-2-percentage-point interest-rate cuts that markets were pricing in a year ago. This trend, too, is set to continue: at December’s policy meeting, the Fed signaled fewer cuts in 2025, and a higher terminal (long-run) rate.
But political and geopolitical upheaval – and the limited prospects for significant improvements – does pose a risk to the endurance of US economic exceptionalism. Even if the US continues outperforming its peers, as expected, the range of possible outcomes, in terms of both growth and inflation, has widened. In fact, global economic and policy outcomes as a whole are now subject to a larger possibility set, both because the downside risks have grown and because upside innovations – such as in artificial intelligence, life sciences, food security, health care, and defense – could transform sectors and accelerate productivity gains.
Absent a major policy reset, my baseline scenario for the US includes a somewhat lower immediate growth rate, even as the economy outperforms its peers, and sticky inflation. This will present the Fed with a choice: accept above-target inflation or attempt to bring it down and risk tipping the economy into recession.
Globally, economic fragmentation will continue, pushing some countries to diversify their reserves further away from the US dollar and explore alternatives to Western payment systems. Yields on US ten-year government bonds – a global benchmark – will edge higher, trading mostly in the 4.75-5% range. As for financial markets, they might find it more challenging to maintain their status as the “good house” in a challenging geo-economic neighborhood.
This is how things appear now. But, beyond recognizing the wider dispersion of possible economic outcomes in 2025, it will be crucial regularly to test whichever baseline one embraces against actual developments.
