2025 macroeconomic outlook

Transcript

Louise Doherty: Hello and welcome to the Thinking Forward podcast with myself, Louise Doherty and Mike Ambery, where we explore the trends and developments impacting the UK pensions market. In this episode, we are delighted to welcome back a really popular guest from last year, Anthony O'Brien from Phoenix Asset Management. Anthony, how are you? Welcome!

Anthony O’Brien: I am very pleased to be back. And yeah. Feeling great. Refreshed fully from the Christmas break and raring to go.

Louise Doherty: Great. Why don't you remind our listeners a bit about yourself and what you do at Phoenix Asset Management?

Anthony O’Brien: Of course. So, my name is Anthony O'Brien. I am the Head of Market Strategies at Phoenix. I joined in April 2021. Our group provides economic forecasts for, you know, for the division which feed into Phoenix's investment strategy. We formulate these forecasts for economic growth, inflation, for central bank policies, and that provides the bedrock for expected asset market returns.

Louise Doherty: Fabulous. So unsurprisingly, we're going to be exploring the 2025 macroeconomic outlook today. But, actually, I thought I'll put our own pension guru to work first. Mike, we've seen a lot of change in our pension industry since we were last together. We've had a budget in October, Mansion House speech in November, December consultations including targeted support, and now a new Pension Minister. So why don't you kick us off for a change and kind of give us your views on what's been happening?

Mike Ambery: Love to Louise. You're right. It's been really busy, since the last time we all spoke. We've had the election, the outcome of the election. New labour government in place. What's that labour government actually done? And what have we looked at around the industry? Had the budget, as you say. Then prior to that, we've had a few changes which impact those in retirement and coming up to retirement. Winter fuel allowance is one of those. Popular and very unpopular in terms of whether that should be permitted or not. And we went onto the budget, a host of economic measures introduced. How's that impacted pensions? Really pensions and employers and so, National Insurance contribution changes, for employers and equally, the impact of inheritance tax being, a couple of main measures there. As we go through, I mentioned Mansion House or Mansion House 2.0. I know it's a hit.

Louise Doherty: Yeah.

Mike Ambery: Well, you know, try and modernize it a little bit. But in terms of that, Chancellor Rachel Reeves really looking back to where the previous Mansion House Compact came through, what can we do to consolidate the industry both in, defined contribution space and local government pension scheme space? Specifically, to drive economies of scale, better outcomes for members and equally considering economic growth. Those economic growth areas being private assets, private markets, helping make sure that those solutions come to life.

Alongside that, a whole host of consultations which, if I, if I was to look at everyone today or hear everyone, there's probably a big sigh because they've probably spent a lot of time around the industry looking at those consultations. What's the good bits out of those? It's great to have the consultation, and to respond back on what will work, what would not work. And, what's the pace of that direction? What am I really looking forward to? Areas in, around retirement.

We've seen a lot of our research through Retirement Voice, look at what retirees do, where to get advice, where to get guidance. Something called targeted support, I think is a really good idea to help individuals, think of themselves as what would somebody like me do? The introduction of that, whether that's in 2026, 2027, I think is a good thing to enable really difficult decisions at the point of retirement to be supported, with and without advice. We'd like to see more around the advisory sector on that as well.

One final thing I'll probably say private markets, private assets again, is the real driver to improve outcomes on DC. How do we wrap our arms around that? Either over the near term whilst looking at volatility, I think is probably a good thing. And I'm sure you're going to come on to, volatility right now.

Louise Doherty: Hmm quite a few surprises, quite a few changes that we've seen.

So probably a similar question to you Anthony. The last time we were all together we were talking about the year of the election. So what have we seen happen. Is it what we expected? Can you give us a bit of a recap of '24 since we were last together?

Anthony O’Brien: Of course. Yeah. So 2024 was definitely heralded as the year of elections. And we saw more than 1.5 billion votes balloted, across 73 different countries. And therefore it was a unique opportunity to gauge the political and the social temperature of more than half the world's population. And the votes were in and, you know, basically, it was a damning verdict of the holders of public office.

So, the first stand out point was very much that it was the first time ever that we have seen the incumbents of all of the 12 Western developed, countries which held national elections in 2024, where the incumbents lost vote share. So, whilst many swung to the right, including obviously the US, some swung to the left, you know, very much in the UK and South Korea, but some swung both ways at the same time and we saw that in France.

So basically the picture has been painted of a very angry electorate who have been stung by inflation, who are fed up with economic stagnation, often seeing immigration as the culprit. And there is this feeling which has been linked to incoming inequality, where anger has been directed to not just politicians, but big business, to capitalist society, to the system in general. Hence the desire for some change and extreme political solutions.

So rising prices and the cost of living was definitely the top concern amongst the vast majority of countries. So whilst recessions are unpopular, their impact tends to be unevenly distributed whilst inflation tends to sting everybody at the same time.

So there was also no interest in austerity. You know, the political parties which promise to cut taxes, to raise spending, have done very well. And that's despite public debt already at very high levels.

So I guess the second standout point, I would say, was that whilst geopolitics and politics in general have dominated the headlines, they actually haven't had much of an impact on global economic growth. So as a result, global growth pretty much outperformed any of the most optimistic forecasts in 2024. But it did mask, you know, seriously differences between regions where we had stellar performance from the US, which outweighed the weak performances that we saw from the euro area, China and Japan.

And I guess my final standout point was asset price performance. The S&P 500, posted a total return of about 25% in 2024, and that's the second consecutive year that we've seen returns of above 20%. Given that 2023, recorded its return of 26%. Now, the last time that we saw the S&P 500 record consecutive years of above 20%, returns was back in 1998 and 1999. And at the same time, we saw credit markets have ended the year with IG credit spreads at the tightest levels that we've seen since 1998 there.

So even though we've seen an awful lot of uncertainty being priced into the market and quite a lot of interest rate cut expectations being taken out, you know, markets have done incredibly well.

Louise Doherty: It's perhaps not what we predicted.

Anthony O’Brien: Definitely not what I predicted.

Louise Doherty: I think I asked you the crystal ball question, so we'll have to look back and see what you did predict - not to put any pressure on - because my next question is going to be, what should we be thinking about now, actually going into '25.

What are the big kind of questions you're thinking of?

Anthony O’Brien: Well, to quote the musical Hamilton, "Winning was easy, governing is harder". And in no other country have we seen that more, you know, play out than in the UK. So, after months of unpopular decisions and rhetoric, 2025 has to be the year where voters see the sign that the Labour Party really does have a plan, and also that voters think that that plan is going to work.
But how does the government achieve this? Implementing reforms, pro-growth strategy when it has so little money? And therefore we've seen from the last budget it quite literally, well, fiscally speaking. Bet the farm on the NHS. So greater borrowing is definitely not the answer.

And we've seen that from the reaction in gilt markets so far this year. You know, debt loads across Western economies are in very poor shape. Fiscal deficits have ballooned, you know, as governments responded to once in a lifetime crises such as global financial crisis, the pandemic and also the energy price shock that we saw from the Russia-Ukraine war, and even that and, you know, the IMF were predicting that, global debt should, reach 100 trillion this year, which is 93% of global debt to GDP, and that's forecast to rise to 100% of debt to GDP by the end of 2030. Now, if we remember back in 2010, we were told by Professors Reinhart and Rogoff that 90% was the cap for debt sustainability, but that turned out to be wrong. Indeed, six of the G7 have breached that threshold, and some considerably so, without causing a prolonged fiscal episode. In truth, investors, you know, don't really know where that limit is. There is no one size fits all, but there are tipping points and non-linearities. The 25 percentage point rise in Greek debt to GDP from 75% to 100% didn't really matter, but the same rise to 150% was critical. And once markets decide that the risk is non-viable, creditization does occur.

So we have seen a rapid rise in yields across the globe since the end of November. And while some of this was due to inflation expectations and downward revisions to interest rate cuts expectations, you know, worries - there have definitely been worries about fiscal sustainability and increased government bond supply.

And we've seen this as a rise in what we call term premia. Now term premia is the yields, the additional yield that long bond investors require above, the expected path of short term rates. And that has risen. And we've seen that cause this rise in interest rates so far this year.

Mike Ambery: Thanks, Anthony. Just looking at certainty or uncertainty. I’m rather uncertain why we haven't mentioned President Trump up to now. So I think we'll go there and we'll go there for the first topic area of how do we feel the micro economic predictions will play out in terms of trade and growth?

Anthony O’Brien: Well, this is a very difficult one because, you know, there are many questions about what President Trump will do now that he is actually in office. You know, his economic policies whilst campaigning were rather vague, ill-defined. And there's always been a major dichotomy between what he says and what he ends up doing.

So one of the largest uncertainties, and certainly the one that investors are most interested in, is trade policy. Now, when campaigning, President Trump pledged 6% tariffs on Chinese imports and a universal tariff of between 10 and 20%. And that could see US tariffs’ rates rise to levels not seen since the Great Depression.
So, it's always unclear whether Trump will follow through on his full slate of, of tariff increases or whether he just uses it as a threat, as a bargaining tool. But the impact is likely to be more harmful for Europe. Indeed, trade and tariff policy uncertainty have been mentioned far more times in European companies earning calls than by US businesses. Free trade is a cornerstone of the EU and trade barriers exacerbate key challenges it faces. The EU runs a good surplus with the US of $200 billion, which is a key source of friction with the new administration.

But the outcome of tariff increases is not simple to calculate and depends very much on many unknown factors. However, the threat of tariffs and the uncertainty generated could have a greater impact than the tariffs themselves. Indeed, we've seen this drag already in key business surveys even before President Trump entered the white House.

On the positive side, the UK could be less of a target. We may be a small open economy and especially exposed, but we're in the relatively rare position of having a trade deficit with the US, according to US calculations. And hence perhaps we could negotiate a better deal.

Mike Ambery: Fantastic, Anthony, that's really great.
Could we maybe look at what that means to the economic outlook as well?

Anthony O’Brien: Of course. Despite the risk of a tariff war, we expect the world economy to grow by about 3% this year, which is close to the 3.2% pace that we saw in 2024. But the growth divergence, which we saw is now becoming the norm. So we expect the UK to settle around 0.8% growth in GDP in 2024. But we forecast that to expand to 1.3% in 2025. However, as a response to the budget, we now think that growth will be dominated by government spending, with the private sector remaining rather muted in light of increased uncertainty, low consumer and business confidence, and less favourable policy. So we've kept all Bank of England forecasts the same.

We believe that the gradual approach to monetary easing will continue this year, with quarterly cuts through to May 2026, reaching a terminal rate of around 3.25% for bank rate. In the US, the combination of current economic momentum and potential policy changes support the solid pace of growth, but at the same time above target inflation and therefore limited interest rate cuts.
Consumer spending should remain the core pillar of growth for 2025. But business investment is very strong too, especially in IT. And hence we think that growth, GDP growth, could be 2.5% in 25, despite the negative impacts from higher tariffs and lower labour supply.

Finally, we see another challenging year for the euro area. The potential for large increases in tariffs will likely reduce business investment and hiring, and moderate household spending. As such, we have revised down our 2025 GDP forecast 0.8%. Germany should continue to underperform, with Spain outperforming, with Italy and France falling somewhere in the middle.

Mike Ambery: Anthony, that's enough to absorb. But let's go a little further if we can. How do you think this will impact inflation and long term objectives?

Anthony O’Brien: We've also seen stickier inflation data in Europe and the US this year, suggesting that the last mile for inflation convergence to target is certainly proving more problematic than was envisaged only a few months ago. Taking the UK, for example, CPI inflation printed at 1.7% in September but has since risen to 2.5%.

Now looking forward, with the addition of VAT on school fees, higher water and energy bills, that's likely to push inflation up towards 3%. And that's before we discover how employers will react to the double whammy of national living wage hike and employers' NICs increase.

How much of those extra costs are actually passed on to prices, we can only in later on this year. But for the UK, we think that inflation was likely to fall back towards target, but only in 2026. 

Louise Doherty: So, let's take a change of direction. Thinking about innovation and AI, what are the considerations as this becomes more like business as usual for us?

Anthony O’Brien: 2025 could be the crunch time for AI. Will the bubble burst or will the technology start to deliver? So more than $1 trillion has been spent on AI. Companies now have to show that there is real consumer value.So in healthcare that value seems clear. We've seen it in AI being used in diagnosis tools. Defense, we've seen AI as integral to the use in drones. But elsewhere most companies are still not sure what the technology can or cannot do, or how best to use it.

Only 5% of US businesses say they are using AI in their products or services, and this takes time. Investment needs to be made, processes rethought and workers retrained. But a recent survey showed one third of employees in the US say they are using AI for work at least once a week.

So perhaps much of the use of AI is in secret, as workers use it to streamline tasks such as preparing for podcasts. Employees may worry that if they admit to using AI to get things done more quickly, bosses will give them more work to do, or take it as a signal that fewer workers are needed.

Hence, AI adoption is perhaps as much a managerial challenge as a technology one.

Louise Doherty: So what I think you're trying to say is that Mike and I shouldn't ever admit to management that we might use AI to prepare for podcasts. Absolutely not.

I do have to admit, though, so I don't use it for the podcast, but I was asked by my brother for some top tips on how to interview candidates because he's never done it before. So I went onto a search engine, looked up top tips for interviewing and AI on the search engine gave me ten top tips. I shared them with my brother, and he has now interviewed and has hired a candidate.
So we're going to see if the quality of the candidate comes through or not from the top tips from me/slash AI.

Mike Ambery: So that feels to me AI could be the future and that's where all the money's going to.

Louise Doherty: So you want me to ask a future question?

Mike Ambery: If you could please.

Louise Doherty: It's crystal ball time.

Mike Ambery: That's the way.

Louise Doherty: And actually, this time I really need to look back to see what you said. So crystal ball, what are your predictions for 2025 now we're settled into kind of the first quarter?

Anthony O’Brien: Well, the definite first one is that the electoral trends which we saw in 2024 are set to continue in 2025.

So the latest opinion polls show that the incumbent governments of Australia, Canada, Germany and Norway are on course to lose power. Now, most of these countries, it is the popular right which are making the biggest gains. So in Norway we've got the right wing populist Progress Party currently leading in the polls, where it came fourth in 2021, and the German ADF are currently in second place.

So the acute inflation crisis may have passed, but prices are still high, economic growth is still stagnating, and the generational wealth gap is widening. Hence, 2024 is likely not to be an anomaly.

The second, Trump is back, things are going to get volatile. The new US administration are creating uncertainties that we didn't even know existed, and now they have to be considered and managed. Take President Trump's statement that he does not rule out using tariffs or military force to take control of the Panama Canal or of Greenland. Light-hearted banter, maybe, but the German chancellor took it seriously enough to warn that Greenland is covered by the EU mutual defense clause. Although it's unlikely that Trump would order an invasion of Greenland, we now have politicians discussing a NATO country invading another NATO country, hence the end of NATO.

Finally, volatile markets. We've already seen a lot of volatility in the bond market, but relative calm elsewhere. Risk markets have already moved a long way in a risk positive direction, both ahead and since the election. US valuations look historically high. Credit spreads, as we've said before, start 2025 at incredibly tight levels.

Price for perfection in a very uncertain environment. With inflation stubbornness limiting monetary easing capabilities, perhaps risk markets have to build in a higher uncertainty discount this year.

Louise Doherty: So it sounds like we should continue to expect volatility, both politically and economically.

Anthony O’Brien: I think that would be a very wise idea.

Louise Doherty: There we go. We have got one prediction that we were all comfortable with.

All: Yeah.

Louise Doherty: And you're not getting off the hook Mike, what about you? Predictions. So that's mine, volatility. 

Mike Ambery: Okay. Well I'd go first off the only predictable thing is unpredictability. That linking in from maybe some of the pension reforms and pension policy. What should we expect from some of what Anthony shared with us?

I'd say, as an investor, a consumer, my contributions. Don't know whether my contributions are going to increase through pension adequacy review and when, as yet.

And the next question is, how is my money invested and how can I make opportunity out of that economic growth, that spend? Some of that really does revert back to private markets. So looking into private markets over the near term and that, outcome based performance is something that we should be looking at.

Secondly, the unpredictability. We see that in, people retiring. We've seen more people look for certainty from different forms of annuity products. So looking in terms of that emotive certainty as well as financial certainty I think we'll see come through as decumulation products across the course of the year.

Third, one what I’d probably say is in terms of the market itself, the consolidation. Will it run at the pace that we expect it to, will we see the different forms of pension schemes that are available to individuals and to corporates actually change over the course of the year. And sort of expedite that consolidation.

So I'd say those are the three main topic areas for me across the course of the year.

Louise Doherty: And I think these are three topic areas that we're going to explore in other episodes coming up on the podcast. If you as listeners have other topics that you'd like us to cover, as always, please do get in touch.

Thank you Anthony so much for joining us today. It's always such an education and hopefully you will be back again with more predictions. Right or wrong.

Anthony O’Brien: It's up to you though.

Louise Doherty: Yes. Oh well maybe it will be. Yeah, maybe it won't be you. Oh, there you go.

As always, you can catch up on previous episodes and articles online. Just search Standard Life Thinking Forward. Thanks again for joining us today.