CIO Market Outlook 2025: Europe under pressure to take action

Although global economic growth is likely to remain subdued for the foreseeable future, Zürcher Kantonalbank's CIO Office does not currently anticipate a recession. According to its market outlook, a gradual, sustained recovery is expected in Europe and the emerging markets outside China in 2025. Growth in China remains lower than in the past.

Inflation is likely to remain stable in most countries, giving central banks scope for further interest rate cuts. However, geopolitical tensions, potential trade conflicts and high levels of national debt are making price trends more volatile. In particular, the new US government's potentially inflationary policy could result in fewer interest rate cuts and rising interest rates again.

Private consumption dynamic in America, subdued in Europe

What is striking: The economic divergence between the US and Europe continues to widen. In the US, private consumption is growing strongly and is even outperforming the trend that was already apparent before the pandemic. The situation in the eurozone is quite different. Here, private consumption is well below the pre-pandemic trend and has barely grown in the past two years. While US private households are saving even less than before the pandemic, the savings rate in the eurozone is even higher than usual. Despite rising household incomes and low unemployment, the mood remains depressed.

But there are also differences on the corporate side: The US tends to stand for dynamism and innovation, while European companies have to deal with more and more new regulations, increasing bureaucracy, and high taxes and electricity prices. The latent trade conflict has put additional pressure on Europe. The structural divergence is not expected to end for the time being. With its competitiveness at stake, Europe is under pressure to take action. “Although the US market is already highly valued, it is still difficult to find better regions to invest at the moment,” says Christoph Schenk, Chief Investment Officer at Zürcher Kantonalbank.

Switzerland: Is the pharmaceuticals sector becoming a cluster risk?

Switzerland has stood out for decades for having an extremely competitive economy, but this should not be taken for granted. As a small, open economy, Switzerland has been able to develop well in a multilateral environment. If market conditions change or the most important trading partners come under severe economic pressure, the question of their resilience also arises in Switzerland.

While the traditional Swiss industrial sector remains closely intertwined with the EU and Germany in particular, Switzerland has also focussed on intercontinental relations in high-tech and future-oriented sectors. The pharmaceuticals industry ensures that Switzerland – unlike most other industrialised countries – has not experienced deindustrialisation. The manufacturing industry's value-added share of GDP has hardly changed over the last 30 years due to the growth of the pharmaceuticals industry. And since pharmaceuticals products are not cyclically sensitive goods, the Swiss economy has become more resilient to fluctuations in the global economy.

There is a risk for 2025 with “Trumponomics”: If drug prices in the US were to be capped, the Swiss export industry would be hit disproportionately hard. With a 65 per cent share of total exports to the US, the pharmaceuticals sector could be targeted by US trade policy. As a countermeasure, the previously advanced negotiations on a free trade agreement with the US could be resumed and brought to a swift conclusion. Switzerland could thus remove itself from the firing line of US economic policy.

Swiss franc remains strong, but no longer so decisive

In addition to the pharmaceuticals industry as a cluster risk, the strong Swiss franc is the second weak point of the Swiss economy. There is no doubt that the Swiss franc plays an important role in the growth of the Swiss economy – but it is becoming less important. On the one hand, innovative, high-quality goods such as precision instruments and medicines are subject far more to technological competition than price competition. As exports of such goods are growing in Switzerland, the appreciation of the Swiss franc no longer has the same significance as for exports of price-sensitive goods. Secondly, factors other than the Swiss franc exchange rate are also becoming increasingly important for service exports. In the tourism sector, the proportion of intercontinental guests, who are less price-sensitive than European client groups, is increasing rapidly.

We expect the Swiss franc to remain firm in 2025. According to the forecast given by the CIO Office, one euro will cost CHF 0.91 in twelve months’ time and the US dollar will stabilise at CHF 0.87 after its current high. The weakness of the euro nevertheless raises the question of whether the Swiss central bank (SNB) is heading back towards negative interest rates. Inflation rates have fallen significantly of late and the SNB’s conditional inflation forecast assumes medium-term inflation of around 0.5 per cent.

Zürcher Kantonalbank's CIO experts expect the SNB to lower its key interest rate by 25 basis points in both December 2024 and March 2025 to 0.5 per cent. The baseline scenario of the ZKB experts is not a new era of zero or even negative interest rates given the global economic situation. Nevertheless, negative interest rates cannot be ruled out in the future. If, for example, the US government were to put Switzerland back on the list of currency manipulators, the SNB would probably have to allow a stronger Swiss franc. In addition to the threat of tariffs, this would have an additional negative impact on export-oriented companies, which would increase the likelihood of zero or negative interest rates.

Private consumption underpinning Swiss economy

The most important leading indicators for the Swiss economy continue to point upwards. Private consumption will remain an important pillar of growth in 2025 thanks to real wage increases and high immigration, even though the latter will not reach the record year of 2023. “The risks are – as always – manifold, but the economy has proven to be more resilient in Switzerland than in other countries in the past,” says David Marmet, Chief Economist Switzerland at Zürcher Kantonalbank. Despite possible disruptive factors, the restoration of normality – i.e. solid economic growth, controlled inflation and a slightly positive key interest rate – appears to be the most likely scenario for Switzerland in 2025.

Markets caught between fear of reflation and a desire for disruption

The Republicans under Donald Trump will determine US politics over the next two years. In economic terms, they are likely to largely follow the narrative of Trump’s first term in office: lower taxes, less regulation and tough announcements on trade and migration policy. How much of this will be realised is uncertain, but unlike in 2016, Trump and his followers are better prepared.

Global investors are focussing primarily on the fiscal and trade policy of the new US administration. The prospects of tax cuts and a wave of deregulation are fuelling the US stock market. Lower corporate taxes increase profit expectations and the targeted deregulation gives US companies further competitive advantages. Less bureaucracy boosts private investment and investors are ready for more disruptive engagement from the US administration. This increases its lead, particularly in promising sectors. China is keeping pace technologically, but the property crisis is absorbing resources and weighing on investor confidence. With 440 million consumers, a high level of education and a highly developed democratic identity, the European Union has the best prerequisites for a competitive economy. However, the crumbling of the multilateral trade order is increasingly affecting the EU’s growth model, which is geared towards foreign trade. Trump’s tariff threats are underlining the reluctance to invest in the old continent.

However, the timing of Trump’s supply-side reflation of the economy is not ideal. An economic “sugar rush” will fuel inflation and possibly limit the Federal Reserve System’s (Fed) plans to cut interest rates. A pronounced interest rate advantage is strengthening the US dollar, representing an economic risk for the US and the rest of the world. A trend towards a stronger US dollar makes global trade more expensive and means renewed tightening of financing conditions in and outside the US.

Overall, Zürcher Kantonalbank's CIO Office assumes that Trump’s reorganisation plans will only lead to weaker growth and higher inflation in the medium term compared to current policy. In the longer term, business-friendly elements of the reorganisation plan could strengthen the private sector worldwide, which would, among other things, increase the productivity of the US economy again. The economic environment therefore remains constructive for investors despite geopolitical and trade policy uncertainties.

Diversification effect in the mixed portfolio increases again

The mix of moderate growth and interest rate cuts will also create a constructive equity environment in 2025. “However, valuation levels on the global equity markets, especially in the US, are high and the asset class is competing with the equally higher bond yields, which is reflected in a modest risk premium,” says Manuel Ferreira, chief strategist at Zürcher Kantonalbank. Corporate earnings growth will therefore be the main driver of share performance and the market is likely to gain breadth.

The CIO experts do not expect bond yields to fall significantly for the time being due to persistent inflation and fiscal policy pressure. Interest rate cuts are already realistically priced into today’s yield levels. As a result, a negative correlation between equities and bonds is expected again, which improves the diversification effect in mixed portfolios. Within the equity and bond asset classes, we see particular opportunities in the increasing market breadth of the equity markets. Diversification within the regions and sectors will be decisive in this context. The US market will not lose its competitive edge quickly, Europe must switch the mood to positive in order not to miss the boat. China will implement selective fiscal and monetary policy measures, but will not solve all the problems in one go. When it comes to bonds, the CIO experts favour regions with higher yields and the potential for surprises in the event of interest rate cuts. In the case of Swiss bonds, they are focussing on high-quality corporate bonds. The Swiss franc and the US dollar remain safe assets in the portfolio – at least at the start of the year.