Morgan Stanley: 2025 Economic and Investment Outlook
Morgan Stanley & Co, the multinational investment bank and financial services firm, forecasts global economic growth of 3.0% in 2025, with a decline to 2.9% in 2026, according to its latest economic outlook.
Policy Changes to Shape Markets
“The outcome of the US election is going to usher in policy changes with implications that will reverberate through the global economy,” says Seth Carpenter, Morgan Stanley's Chief Global Economist.
The extension of the 2017 Tax Cuts and Jobs Act will maintain current fiscal conditions rather than stimulate additional growth. The provisions set to expire in 2026 will likely be extended under the Republican administration, avoiding a tighter fiscal outcome while maintaining the status quo.
The implementation of new tariffs will begin with Chinese imports before expanding to goods from other countries. These changes are projected to increase consumer prices in the second half of 2025, with a typical lag of two to three quarters before tariffs impact economic activity.
Consumer spending, which has driven US economic growth since the pandemic, will face pressures as trade policies affect prices for imported goods, including clothing, automobiles, and steel.
Global Monetary Policy and Inflation
Inflation continues to normalise globally, though progress varies by region. In the US, inflation may rebound in late 2025 due to higher prices and labour costs from new tariff and immigration policies, before resuming its downward trend in 2026 as growth slows to 1.6%, below the economy's potential.
The Federal Reserve is expected to implement rate cuts beyond current market expectations before pausing by mid-2025.
The European Central Bank and Bank of England may continue their rate-cutting trajectory throughout the year as inflation in these regions recedes steadily amid underlying growth risks.
Europe's growth may be reaching a cruising speed of around 1%, though global trade disruptions could create a drag.
In Japan, where deflation has dominated economic policy for decades, inflation is expected to fall marginally below the Bank of Japan's 2% target in 2026. The central bank is forecast to implement two rate increases in 2025, as the economy distances itself from its deflationary decades with a wage inflation trend now established at around 2%.
China continues to face deflationary pressures, with the GDP deflator predicted to barely reach positive territory amid trade disruptions and excess manufacturing capacity in the industrial sector. Consumption and stimulus may remain insufficient to counter these pressures.
“The outcome of the US election is going to usher in policy changes with implications that will reverberate through the global economy”
Investment Opportunities and Market Outlook
Fixed-income markets may benefit in early 2025 as central banks continue monetary easing. US Treasury yields are expected to decline with further rate cuts.
Corporate credit markets show particular strength in the first half of the year, with investment grade and high yield spreads reaching their tightest levels in 25 years. Leveraged loans offer attractive risk-adjusted returns compared to investment grade and high-yield bonds.
The sequence of policy implementation will prove crucial for markets. If potential tax cuts come first, equities could move higher, while prioritising tariffs could bring inflation and corporate margin concerns to the fore.
The timing of announcements versus implementation may provide a period of benign macroeconomic conditions well into 2025.
The US market leads Morgan Stanley's regional preferences, with Japanese equities warranting strong consideration as central bank policy has steered their economies through soft landings.
European equities receive a neutral stance, given the region's exposure to Chinese economic conditions, slower growth rates compared to the US, and potential trade restrictions.
Emerging market equities remain out of favour, with potential trade tensions further dampening their appeal.
“There's an array of alternative policy outcomes that could drive more positive or more negative macroeconomic impacts”
Global stock valuations, measured by the ACWI P/E ratio, have reached 18.3 times forward earnings, a post-pandemic peak surpassing the 80th percentile of historical valuations. This elevation reflects increased certainty about US economic conditions and company fundamentals.
The potential easing of specific regulatory requirements in the US financial sector may create opportunities for increased merger and acquisition activity.
This regulatory change may be one of the more immediate policy changes having a positive impact on companies and markets.
Labour market conditions would shift during the second half of 2025 as new immigration policies take effect.
These changes would reverse the recent trend of elevated immigration levels that enabled employment growth without significant inflationary pressure. The drag on growth becomes evident in 2026.
“There's an array of alternative policy outcomes that could drive more positive or more negative macroeconomic impacts,” says Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. “We're watching for signals from key policymakers.”
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