UBS Unpacks the Economic and Investment Outlook for 2025

The UBS Chief Investment Office report, helmed by Paul Hsiao and Jason Draho, Ph.D., offers a comprehensive macroeconomic and investment outlook for 2025, setting a stage of cautious optimism amidst a changing geopolitical and economic backdrop. Their insights highlight the resilience of the U.S. economy, the challenges of elevated rates, and the nuanced interplay between consumer strength, corporate dynamics, and fiscal policies under the incoming administration.

The Economy: Roaring or Tapering?

The U.S. economy appears poised to continue its remarkable post-pandemic performance. "Real GDP growth continues its above-trend pace," the report notes, with 2024 expected to close at a robust 2.6%, exceeding the 1.8% trend rate. While growth in 2025 may slow marginally, Hsiao and Draho emphasize that the U.S. will outpace its developed market peers. “Higher productivity, less exposure to energy prices, and resilience to high interest rates have helped the U.S. grow faster after the pandemic,” they write.

However, the incoming Trump administration’s fiscal policies, such as proposed tariffs and tax cuts, could create divergence. While they may stimulate domestic activity, the report warns that tariffs are "stagflationary" and could amplify inflation while dampening global trade, particularly for net exporters like Europe and China.

The Consumer: Holding the Line

Consumers have been the bedrock of economic strength, defying gloomy sentiment with continued spending. The UBS team attributes this to healthier-than-expected balance sheets and real wage growth that outpaces inflation. They note, “Americans in the middle quintile of incomes saw their net worth increase around 50% compared to pre-pandemic levels.”

Still, cracks are forming. Rising delinquencies, especially among lower-income households, signal fragility. “Delinquencies tend to be focused on lower-income consumers who have an undersized effect on overall consumption,” the report states, offering a tempered reassurance that broader consumer trends remain intact.

Labor Market: Cooling Without Cracking

The once red-hot labor market is finding balance. The unemployment rate has edged up from its post-pandemic lows, but the report is clear: "Layoffs aren’t a concern yet." Employers remain cautious about hiring but are reluctant to shed workers in a still-robust economic environment.

A wildcard is immigration policy. The report notes that the labor supply has been buoyed by immigration flows in recent years, but under Trump 2.0, this trend may reverse. “Since limiting immigration has been a key campaign issue, immigrant hiring is likely to slow or even reverse,” UBS predicts.

Rates and Financing: The Cost of Capital

The Federal Reserve’s trajectory is clearer, with 100 basis points of cuts expected in 2025, bringing rates to 3.5% by year-end. However, the pace of easing has moderated post-election, with markets now pricing fewer cuts. Hsiao and Draho caution that the "red sweep" election outcome could stoke inflationary pressures, limiting monetary policy flexibility.

For small businesses, relief may be on the horizon. “Credit conditions for smaller firms to ease with rate cuts,” the report states, though the scars of the 2023 regional banking crisis linger.

Housing: Still a Steep Climb

Affordability remains elusive, with mortgage rates hovering above 7% for much of 2024. While lower Treasury yields could offer some reprieve, UBS warns that rates need to drop below 5.5% to unlock meaningful demand. “72% of homeowners say 5.5% is the highest acceptable mortgage rate for a new home,” the report highlights.

Investments: Tactical Optimism

For equities, UBS projects the S&P 500 will reach 6,600 by the end of 2025, buoyed by AI-driven advancements and policy tailwinds. Technology, utilities, and financials are favored sectors, with AI infrastructure spending providing a durable growth driver. Yet, tariffs could temper earnings in tech, underscoring the need for selective exposure.

In fixed income, the outlook for the 10-year Treasury yield is more favorable, with easing rates expected to bring yields down. The U.S. dollar, however, may face headwinds, as current levels are deemed "overvalued and overstretched."

Corporate Activity: Green Shoots Emerging

The election's resolution has cleared some uncertainty for corporate America. UBS sees "a broad improvement in corporate activity" across IPOs, M&A, and private equity transactions. However, venture capital remains sluggish outside of marquee AI deals.

Risks and Rewards: Navigating 2025

The UBS report is unflinching about the risks. Tariffs loom as a double-edged sword, potentially destabilizing trade while inflating domestic prices. The federal deficit, set to balloon under Trump 2.0’s policies, may constrain future fiscal maneuverability. Yet, the resilience of the U.S. consumer and the adaptability of its corporate sector offer reasons for optimism.

In summarizing their outlook, Hsiao and Draho encapsulate the delicate balance that defines 2025: “Expect higher stocks, lower yields, and a weaker USD.” The path forward may be uneven, but the undercurrents of innovation and resilience could drive opportunity for those willing to navigate the complexities.

Key Takeaways:

1. Economic Resilience: The U.S. economy is set to grow above trend, supported by strong consumer fundamentals and productivity gains.
2. Policy Dynamics: Fiscal policies under Trump 2.0 could spur domestic growth but also introduce inflationary and trade-related risks.
3. Investment Outlook: Equities are expected to perform well, with tactical opportunities in AI and financials, while fixed income offers a reprieve from high rates.
4. Labor Market: Cooling but not cracking; immigration policy changes may shift dynamics further.
5. Risks: Tariffs, a widening deficit, and geopolitical uncertainties remain key threats.

In 2025, the challenge for investors will be to balance optimism with pragmatism, navigating an environment where opportunities abound but risks are never far behind.

Copyright © AdvisorAnalyst, UBS