Events don’t obey the convenient constraints of calendar years.
As 2025 appears on the horizon, fund managers, traders, central bankers, and retail investors are discovering that “higher for longer” may mean years not months.
European Equity Markets: Opportunity or Risk?
There is plenty of optimism around. Not least from the analysts and portfolio managers at Morningstar Investment Management, whose 2025 Investor Outlook Report supports the view that falling interest rates will buoy equity valuations.
“The relative picture is even more compelling with Europe—the UK in particular—making it the most attractive developed markets region globally,” it says.
“Add to this the macroeconomic tailwinds of rising gross domestic product, falling inflation, and lower interest rates, and the picture looks even brighter.”
Even the Bank of England’s own governor, Andrew Bailey, thinks four rate cuts are on the cards next year. But whether this will happen is wholly uncertain.
The most recent inflationary trend is upwards across Europe and the wider Western world. Even if that is a marginal increase by historical standards, it’s a reminder that the days of ultra-low interest rates are probably over.
Fixed Income: Falling Rates, Difficult Decisions
But events are events. Economic dislocation, conflict, and the effect of tariffs and trade wars could really upset the hopeful in 2025.
That could make central banks even more cautious about lowering rates. The raising of rates feel like an impossibility.
“Given the rise in government debt levels following the covid-19 pandemic, any increase in interest rates would make the cost of servicing that debt more challenging, forcing governments to cut spending, increase taxes, or both, to bring their debt under control,” Morningstar’s report says.
Nowhere is this more important than in the world of fixed income. If interest rates are indeed falling, holding cash suddenly looks less attractive, prompting questions about where investors can best get decent returns.
In bonds, falling interest rates will drive up the price of bonds, but generally drive down yields.
“Should our core federal-funds rate forecasts play out, investors would benefit by holding longer-term fixed-income bonds to maintain higher income levels,” Morningstar’s report says.
“For example, the 10-year Treasury yield stands at 4.3%. If we assume a 1% term spread (the difference between shorter and longer-term bond yields to account for the risk of longer-term investments), that implies an expected average federal-funds rate of 3.3% over the next 10 years.
“By contrast, we expect the federal-funds rate to average 2.3% over the next 10 years. Consequently, longer-term government bonds appear to offer an unusually high return relative to cash deposits.”
Macroeconomics and Geopolitics
There could be some serious geopolitical turbulence in the next 12 months. At the moment, the impact of a second Donald Trump term (from January) looks uncertain in the longer-term, but we already know the potential short-term knock-on effects of US tariffs on global trade, international relations, and equity valuations.
Nowhere will this be more obvious in the supply chains for the world’s semiconductor stocks, which, in the US, have driven spectacular returns, albeit with some volatility.
In Ukraine, there are limited suggestions of negotiations beginning, but for now the war grinds on. And in the Middle East, where centuries of tension are playing out in this latest chapter of grief, alliances and hostilities are likely to have a knock-on effect on commodity prices and wider macroeconomic confidence.
Throughout, it’s important for UK equity investors to remember the FTSE 100 is a globally-diversified index of companies that derive around 75-80% of their revenue from markets outside the UK.
What We’ll be Discussing Next Week
Readers can look forward to a plethora of articles next week—answering some key questions about the investing environment they can expect in the next 12 months.
Monday 9 December 2024:
What to Expect From The UK Stock Market in 2025
Tuesday 10 December 2024:
What Investors Can Expect From The Euro in 2025
The Crypto Outlook Next Year
Video: In Conversation With Our European Equity Market Strategist
Wednesday 11 December 2024:
Our European Equity Outlook For 2025
Three Investment Mistakes to Avoid in 2025
Thursday 12 December 2024:
Andrew Bailey is Expecting 4 Rate Cuts Next Year. Fund Managers Are Divided
Which Property Funds Are Still Open to Investors in 2025?
Friday 13 December 2024:
Top US Equity Funds for 2025
What Will Your Financial Goals be Next Year?
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
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