Deutsche Bank Outlook 2025: Both the economy and the market are unlikely to have surprises

After experiencing two consecutive years of unexpected performance, it may be difficult for the global economy and markets to deliver more surprises.

Deutsche Bank believes that strong economic growth expectations, interest rate cuts by central banks in Europe and the United States, and stabilizing inflation have already been priced in by the market. Coupled with high asset valuations, achieving extraordinary performance in 2025 will become more challenging. The market needs new, strong positive factors to drive growth, which currently do not seem apparent.

Deutsche Bank macro strategist Henry Allen stated in a research report released on Monday:

From a macro perspective, both 2023 and 2024 have exceeded expectations—avoiding a hard landing. Growth in the United States and the Eurozone has surpassed the consensus expectations at the beginning of each year. As a result, market performance has been very strong, with stock prices rising, credit spreads tightening, and overall volatility decreasing.

However, an important consequence is that this raises the bar for extraordinary performance again in 2025. After all, concerns about a hard landing have dissipated, and the consensus growth expectations for the United States and the Eurozone are stronger than they were at this time in 2023 or 2024. Additionally, the market has priced in some rather mild outcomes, including further interest rate cuts by the Federal Reserve and the European Central Bank, as well as inflation suppression.

More importantly, the Deutsche Bank report points out that the economic growth expectations for 2025 are stronger compared to 2023 and 2024. According to Bloomberg consensus forecasts, the U.S. economy is expected to grow by 2.1% in 2025, while the Eurozone is expected to grow by 1.2%, which is significantly higher than expectations a year ago.

The consensus probability of recession also indicates:

This increase in expectations means that merely avoiding an economic recession is no longer sufficient to constitute a positive surprise for the market. The market needs more positive stimuli to achieve extraordinary performance.

Considering that further interest rate cuts by the Federal Reserve and the European Central Bank have already been priced in, monetary policy is now approaching neutrality. The report states:

From the market pricing perspective, investors expect more rate cuts in the coming months. They anticipate that by June 2025, the Federal Reserve will cut rates by 55 basis points, and the European Central Bank will cut rates by 141 basis points. Therefore, this alone is unlikely to become a positive catalyst for the market, as it has already been priced in.

Furthermore, as many central banks have already begun to cut rates, we are approaching the point where central banks consider policy to be "neutral." This means that in a benign scenario of slowing inflation, there is now less room to lower rates to neutral. After all, lowering them below neutral into the easing territory is typically a response to insufficient demand or some growth shock.

Of course, the market may price in faster rate cuts, but when this happens, it is usually for unfavorable reasons. In fact, during the peak of market turmoil in the summer, the futures market priced in the possibility of the Federal Reserve cutting rates by 50 basis points consecutively twice. However, given concerns about growth prospects, this was accompanied by a significant decline in risk assets rather than a rebound At the same time, long-term inflation expectations, including market-based measures, have stabilized around target levels.

The report points out that the 5y5y forward inflation swap rate in the United States is 2.44%, down from 2.57% a year ago; in the Eurozone, it is 1.99%, down from 2.37% the previous year. The market generally expects inflation to remain at target levels in the coming years, so the stability of inflation is no longer a significant positive surprise.

Moreover, it is important to be cautious as the sustained increase over the past two years has made valuations in multiple asset classes higher.

The S&P 500 index has risen 20% for two consecutive years, while the CAPE ratio is now at levels only reached before major corrections, including the dot-com bubble and in 2021. Credit spreads have also reached their tightest levels since the global financial crisis. These factors limit the further upside potential for asset prices in the future.