Resilience and returns in a shifting landscape

Market recap

The 2024 macroeconomic landscape has been marked by declining inflation, easing recession fears, and the increasing likelihood of soft landings in several regions. Central banks have made substantial progress toward achieving their 2% inflation targets after two years of persistent efforts. However, geopolitical risks, rather than traditional macroeconomic factors, are emerging as key concerns for institutional investors.

In the US, restrictive monetary policy has coincided with a favorable mix of robust GDP growth, easing labor market tightness, and falling inflation. While this suggests an effective "soft landing" engineered by the Federal Reserve, a deeper analysis attributes much of this success to supply-side factors, such as enhanced productivity and an expanding labor force. Despite these gains, emerging risks—such as trade tariffs and tighter immigration policies—could temper growth in 2025. Even so, the underlying strength of supply-side drivers provides resilience to the US economy.

Outside the US, economies have faced greater challenges. In Europe, inflation is near target levels but has come at the cost of stagnation. Weak productivity, tepid external demand, and the aftershocks of the energy crisis have constrained growth, with 2025 expected to deliver below-trend performance. The European Central Bank is anticipated to reduce rates to 1.75% by the end of 2025. Meanwhile, the UK is expected to maintain a more hawkish stance, with the Bank of England likely to end 2025 with rates around 4.10%.

As central banks ease policy, rates are expected to settle at levels higher than in the 2010s, ushering in an era of sound money characterized by positive real interest rates.

The gradual rate cuts anticipated in 2025 offer an investment window, where Money Market Funds (MMFs) can deliver stable returns while providing liquidity management solutions. For investors seeking to navigate the tension between risk asset overvaluation and momentum, cash allocations offer both a hedge and a potentially competitive return profile in a high-rate environment.

This evolving monetary policy landscape underscores the value of MMFs as a strategic allocation for Low volatility of capital and potential robust risk-adjusted returns, especially amid the transition to a more normalized interest rate regime.

Several key economic themes emerged in the euro area during the final quarter of 2024, shaping the outlook for both markets and monetary policy.

One of the most notable developments was the continued downtrend in inflation, which provided the European Central Bank (ECB) with increasing confidence that inflation would return below its 2% target within the next two years. As highlighted in Chart 2: Euro Area - Inflation, the average inflation rate for the quarter decelerated to 3.2%, down from 4.1% in the previous quarter. This steady decline reflects a combination of easing supply chain pressures, stabilizing energy prices, and weaker demand conditions across the region.

Despite the progress on inflation, the euro area’s economic growth prospects remained subdued. As shown in Chart 3: Euro Area Growth - GDP – QoQ, the region experienced a marginal contraction of 0.1% during the quarter.

Weak consumer sentiment, coupled with challenging external trade dynamics, contributed to the ongoing stagnation in output.

The persistently low Purchasing Managers' Index (PMI), illustrated in Chart 4: Euro Area - PMI – QoQ, remained below the 50-point threshold, indicating contraction in both the manufacturing and services sectors.

In response to these developments, the ECB implemented a significant 50 basis point rate cut during Q4, bringing its policy rate to 3.25%. This move marked a shift toward monetary accommodation, aimed at supporting economic growth amid heightened fragility. The ECB’s actions were justified by the need to balance its long-term inflation mandate with the immediate challenges of weak economic performance. However, the ECB remained cautious, emphasizing that the rate cut does not signal an abandonment of its restrictive policy stance, but rather a measured adjustment to evolving conditions.

As we look ahead to 2025, the interplay of declining inflation, subdued growth, and evolving monetary policy will remain critical factors.

The ECB’s decisions will likely reflect its commitment to ensuring inflation stability while fostering an environment conducive to economic recovery. These dynamics, along with the continued monitoring of key indicators, will shape the region’s economic narrative in the coming quarters.

*Quarter over quarter. **PMI stands for Purchasing Managers’ Indexes. PMI is an economic indicator that is derived from monthly surveys of private sector companies. An index level above 50 indicates an improvement in manufacturing activity, while an index level below 50 indicates a decline.

The final quarter of 2024 was marked by significant developments in the UK economy, particularly in inflation dynamics, monetary policy adjustments, and market expectations.

Inflation trends during Q4 highlighted a renewed challenge for the Bank of England (BoE). After several months of disinflation earlier in the year, headline inflation rose sharply from 1.7% in October to 2.6% in November, surpassing the BoE’s 2% target. Core inflation, which excludes volatile components such as food and energy, also climbed to 3.5%. This resurgence, as shown in Chart 5: Inflation, signaled that underlying price pressures remained more persistent than anticipated, complicating the inflation outlook for policymakers.

The UK’s Purchasing Managers' Index (PMI) for the quarter further illustrated the fragility of economic activity. Averaging below the 50-point threshold, the PMI readings, highlighted in Chart 6: PMI, confirmed a contraction in both manufacturing and services. Businesses continued to face headwinds from softening demand, tighter financial conditions, and elevated costs, creating a cautious environment across key sectors of the economy.

The UK’s economic growth remained subdued in Q4, reflecting the impact of higher interest rates and weaker external demand. Preliminary GDP estimates indicated marginal growth of just 0.1% during the quarter, as consumer spending and business investment continued to face constraints. Chart 7: UK Growth - GDP – QoQ underscores this limited expansion, painting a picture of an economy grappling with a challenging domestic and global environment.

In terms of monetary policy update, the BoE lowered its benchmark interest rate from 5% to 4.75% in Q4. This marked the first rate cut in over a year and reflected a measured approach to supporting the economy without exacerbating inflationary pressures. The monetary easing was met with mixed market reactions, as evidenced by movements in the yield curve. Shorter-term rates, including those for maturities up to six months, declined during the quarter, while longer-term rates rose, leading to a steepening of the yield curve. The one-year Sonia swap rate, for instance, increased by 16 basis points, reflecting market adjustments to changing expectations for the BoE’s monetary policy trajectory.

By the end of December, market forecasts for the BoE base rate one year ahead had risen to 4.11%, up from 3.50% in September. This upward revision reflected renewed caution over inflation’s persistence and its implications for future policy decisions.

As the UK economy transitions into 2025, policymakers face a delicate balancing act. The BoE will need to navigate the twin challenges of managing inflationary pressures while fostering conditions conducive to economic growth. Incoming data on inflation, growth, and labor market trends will play a pivotal role in shaping monetary policy decisions in the months ahead, as the economy continues to adjust to the evolving landscape.

Ongoing efforts by the Federal Open Market Committee (FOMC) to normalize monetary policy amid persistent inflation dynamics and a relatively stable labor market characterized the final quarter of 2024.

Over the quarter, the FOMC reduced the federal funds rate at each of its meetings, adopting a cautious and data-dependent approach to monetary adjustments.

In October, the FOMC implemented a significant 50 basis point rate cut, followed by smaller reductions of 25 basis points in both November and December. By the end of the quarter, the federal funds rate range stood at 4.25–4.50%. These decisions were aimed at balancing the need to support economic growth with the broader objective of achieving price stability. Chair Powell reiterated the committee's cautious stance, emphasizing that additional rate cuts would be contingent upon further progress toward the 2% inflation target.

Despite progress in reducing inflation earlier in the year, persistent inflationary pressures remained a central concern during Q4. As shown in Chart 9: Inflation Rate, the Federal Reserve’s preferred inflation measure, the core Personal Consumption Expenditures (PCE) price index, indicated elevated levels that continued to challenge policymakers. While headline inflation reflected significant improvements, with the annual inflation rate measured by the Consumer Price Index (CPI) reaching 2.7% for the 12 months ending November 2024, the core inflation measure suggested that disinflationary momentum might be stalling above the target level.

Economic data released throughout the quarter played a crucial role in shaping FOMC policy decisions. The relatively healthy labor market provided some room for cautious monetary easing, but inflation's persistent dynamics tempered the pace of rate cuts. Market expectations aligned with the FOMC's measured approach, reflecting fewer anticipated rate reductions over the coming year. This adjustment underscores the Federal Reserve’s commitment to a carefully calibrated path toward a neutral monetary stance, ensuring economic growth is not jeopardized while maintaining focus on stable inflation.

The Federal Reserve’s careful and data-driven approach highlights its commitment to long-term economic stability. As Chair Powell noted, the decision to slow the pace of rate reductions reflects the importance of ensuring that inflationary pressures are fully under control before concluding monetary tightening. This strategy aims to provide a stable and predictable environment for economic growth, even as uncertainties around inflation and labor market dynamics persist.