As we move into the first quarter of 2025, the economic landscape is shaping up to be one of divergence, dispersion, and bifurcation. Broad shifts in the labor market, rising inflation expectations, and ongoing government policy changes are creating both challenges and opportunities for businesses and investors alike. Here’s a look at some of the key trends you need to know for navigating the year ahead.
Labor Market Shifts: Optimism Amid Slowdown
Post-pandemic, three sectors—healthcare, government, and leisure & hospitality—have led the charge in employment gains. With optimism growing after the election and consumer confidence on the rise, employment could continue to expand, despite some signs of a labor market slowdown. While the Federal Reserve’s easing since September is linked to the cooling labor market, the December payroll report points to the possibility of a policy shift. If the economic rebound continues to surprise, the Fed might consider reversing course.
Rising Inflation Expectations
Inflation expectations are back on the rise, signaling a shift from the declining trends seen in 2023. Consumers and markets alike are bracing for a potential increase in inflationary pressures. The University of Michigan’s 5-10 year inflation expectations are now on the high end of post-pandemic levels. With the 10-year nominal yield climbing, investors are watching closely to see how this might impact asset valuations, particularly in the riskier equity markets.
Treasury and Deficit Outlook: Challenges Ahead
As the U.S. government faces a growing deficit, Treasury refundings will be under scrutiny. The Treasury’s Quarterly Refunding Announcement (QRA) on February 3rd and 5th will give markets a closer look at the government’s funding strategy. Increased interest outlays and the potential for policy changes under the new administration could shape fiscal and monetary responses in the months to come.
Debt Ceiling, Liquidity, and Bank Regulations
The looming debt ceiling negotiations could once again create liquidity shocks in the market. If Congress fails to raise the ceiling, it may lead to a drawdown from the Treasury General Account (TGA), which could temporarily boost market liquidity, supporting risk assets. However, as the “X-Date” approaches, liquidity gaps could bring sudden corrections in asset values.
On the banking front, changes in capital rules are anticipated, but the timing is uncertain due to ongoing appointments at the Federal Reserve. Bank mergers and acquisitions (M&A) may offer opportunities for portfolio rebalancing as regional banks seek to streamline their operations in response to regulatory pressures.
Asset-Based Finance: Customization is Key
The growth of the asset-based finance (ABF) sector will continue in 2025, with more investors moving from public to private markets. Specialization and customization will be at the forefront, as asset managers with expertise in ABF assets are increasingly in demand. Investors are seeking cash-flowing assets that provide liquidity, which positions ABF as a strong growth area in the coming year.
Geopolitics and Policy Shifts
Geopolitical tensions are on the rise, with the new administration ramping up trade negotiations, border policies, and strategic international positioning. These shifts will influence asset demand, especially U.S. Treasury securities, which remain a barometer of global financial sentiment. The diverging economic conditions between the U.S., Europe, and Asia will create new challenges for investors and businesses navigating global markets.
2025 Outlook: Volatility and Opportunity
As the year progresses, volatility will present both risks and opportunities. Market fundamentals are evolving, with fiscal and monetary policy responses to inflation, labor market trends, and global geopolitics shaping the economic trajectory. The coming year promises to be filled with high event-risk episodes, creating opportunities to reprice risk and adjust investment strategies accordingly.
Key Takeaways:
- Labor Market: Post-pandemic gains continue, but slowing trends may prompt a shift in Federal Reserve policy.
- Inflation Expectations: Rebounding inflationary pressures could impact asset valuations.
- Treasury Refundings: Deficit issues and government funding strategies will be crucial in shaping market conditions.
- Banking: Regulatory changes and M&A activity may provide opportunities for rebalancing portfolios.
- Asset-Based Finance: Growing investor demand for specialized, cash-flowing assets will drive growth in ABF.
- Geopolitics: Geopolitical developments will influence U.S. asset demand and global financial markets.
2025 is shaping up to be a year marked by volatility and shifts in economic and market fundamentals. Staying informed and agile will be key for seizing opportunities and navigating challenges in the year ahead.
Source: https://www.rithmcap.com/insights/eyes-on-the-market-q1-2025/