Three important insights from 2024

We learned a lot during 2024, including three important insights that we believe investors should keep in mind as we move into 2025.

As we entered 2024, concerns lingered about the strength of economic growth, both globally and in the U.S. The primary reason for these doubts was the potential impact of rate hikes by the U.S. Federal Reserve and other key central banks in 2022 and 2023. Aggressive rate-hiking cycles typically lead to recessions, with the impact being felt most acutely one to two years after a hiking cycle begins.

However, economic growth proved very resilient in 2024, and, as the year progressed, growth expectations for both 2024 and 2025 moved higher. Forecasted growth for the U.S. experienced the sharpest uptick, while growth expectations for China and Europe rose during the spring and summer but moved sideways in the second half of the year. Growth expectations for Europe in 2025 have been a notable exception to this improving trend, reflecting ongoing industrial weakness in Germany and political concerns in France.

“U.S. exceptionalism” has become more extreme

Unfortunately, inflation concerns were reignited in the latter part of 2024. While inflation measures fell through most of the year, that trend reversed in the fourth quarter. This was partially due to concerns about the potential impact of U.S. President-elect Donald Trump’s campaign promises of higher tariffs and tighter immigration controls.

But there is also evidence that inflation rates have already stopped falling. An examination of the three-month moving average for the U.S. consumer price index reveals a clear upward trend since July of 2024. Notably, services inflation has remained somewhat sticky, while goods inflation—particularly for food and core goods—has begun to show hints of rebounding.

The implication for investors is that they should consider whether their portfolios are properly hedged against inflation risks. Bonds—particularly longer-duration, investment-grade bonds—historically have offered effective hedges against recession but have been vulnerable to inflation. As a result, investors may want to consider adding exposure to asset classes such as commodities and commodity-related stocks that historically have responded well to higher inflation.

One persistent trend that reasserted itself with a vengeance in 2024 was “U.S. exceptionalism”—the idea that the U.S. enjoys unique structural advantages over other global markets. Not only did the U.S. economy experience one of the sharpest upticks in growth expectations among the major economies, but earnings expectations for U.S. companies also grew at an even faster rate.

Initially, this surge in growth optimism was fueled by strong capital expenditures on infrastructure to support artificial intelligence applications. But, more recently, expectations have been raised by the incoming Trump administration’s promises to relax regulatory burdens and seek lower corporate tax rates.

Currency effects also contributed to U.S. outperformance in 2024. The U.S. dollar strengthened against most currencies during the year, making returns on U.S. stocks higher than in the rest of the world when measured in U.S. dollar terms.

The Fed’s rate-cutting cycle will be modest

While we believe there are clear fundamental justifications for higher returns on U.S. stocks, the magnitude of this outperformance during the most recent run appears somewhat extreme, in our view. Since the end of 2010, U.S. stocks consistently have over-earned and outperformed their counterparts in the rest of the world, primarily due to the dominance of U.S. mega-cap technology companies. From December 31, 2010, to December 17, 2024, the average one-year outperformance of the Russell 3000 Index relative to the MSCI All Country World Index ex-US was +6.18%. But over the past year, that difference ballooned to 13.89%.

The bottom line is that stock markets have already priced in a great deal of U.S. exceptionalism. So, a partial reversal of that overperformance trend could be on the horizon if elevated U.S. earnings expectations are not met in 2025.

Conclusion

At the end of 2023, the Fed “pivoted,” as comments from Chairman Jerome Powell made it clear that further rate increases were off the table and that rate cuts were likely to begin sometime in 2024. This led many investors to increase their allocations to longer-duration U.S. Treasury bonds in anticipation that Treasury yields would fall significantly as the Fed cut rates alongside a slowing U.S. economy.

However, the U.S. economy proved much more resilient than expected in 2024 and progress on curbing inflation appears to have stalled out. As a result, expectations for the length and magnitude of the Fed’s cutting cycle have turned considerably more modest. As of December 19, 2024, futures markets were pricing in an end point of 3.97% for the key federal funds rate. That would equal a total reduction of only 1.4 percentage points from the most recent rate peak.

This change in interest rate expectations had numerous implications for asset class performance in 2024, including disappointing results for longer-duration investment-grade bonds. Meanwhile, cash once again proved to be king. Very short duration bonds not only were sheltered from the impact of rising rates but also maintained healthy yield levels throughout the year. Should inflation remain stubborn going forward, that might again be the case in 2025.

T. Rowe Price’s Asset Allocation Committee will closely monitor these and other key issues as we move forward in 2025 and will update investors accordingly as they play out.

January 1, 2024, to December 17, 2024.
L=Left axis. R=Right axis. Break-even yield = The yield difference between an inflation protected bond and an equivalent nominal bond with the same maturity. Break-even yields provide a forecast of expected inflation. There is no guarantee that any forecast will come to pass.
Sources: Bloomberg Finance L.P., U.S. Bureau of Labor Statistics/Haver Analytics.

December 31, 2021, to December 19, 2024.
There can be no assurance that the projected results will be achieved or sustained. They are not indicators of future results.
Source: Bloomberg Finance L.P.