Charting a new compass amid fragmentation

Tariffs and broader heightened policy uncertainty are weighing on the global economy, and the early months of 2025 have seen economists slash growth forecasts and financial markets reassess risk premia. Although periods of slow growth and recession risks are a normal feature of global cycles, the present situation exhibits distinct characteristics that point to lasting structural shifts in a more fragmented World order.

Top of the list, we observe that US exceptionalism, which has been a driving force for the global economy, is now being questioned. While the US Administration’s promise of deregulation offers upside, the fear is that the tariff driven reorganisation of global value chains, along with a slump in immigration inflows, will result in structurally lower US growth and higher inflation.

Upside risks to inflation, at a time of weakening labour markets, present a particular challenge for the Federal Reserve in balancing its mandate of maintaining full employment, stable prices and moderate long-term interest rates. Perceived threats to central bank independence and concern that the US Administration aims to depreciate the dollar, mark further headwinds that have seen the traditional safe-haven status of US Treasuries, and the Greenback eroded.

For China and Europe, this newfound situation means that they can no longer rely on the US economy to provide a lift to otherwise lacklustre growth trends, focusing attention on new growth drivers.

In China, the slow unwind of the real estate bubble is nearing completion, but significant industrial overcapacity still poses a challenge. The key resides in encouraging Chinese consumer to spend more, but beyond a near-term fiscal boost this requires a deeper rethink of safety nets to allow consumers the confidence needed to lower structurally high savings.

Turning to Europe, the new EU Competitiveness Compass builds on three transformational imperatives identified in the Draghi Report, namely (1) closing the innovation gap, (2) setting a joint roadmap for decarbonisation and competitiveness and (3) reducing excessive dependencies and increasing securities. Policy measures are already underway, seeking simplification, a deeper Single Market, a boost to skills and job quality, stronger co-ordination and financing competitiveness, not least with the Savings and Investment Union. At the national level, member states with fiscal room, and not least Germany, which aims to further boost both defence and infrastructure.

While delivery of the EU Competitiveness Compass will no doubt see hurdles and take time, the roadmap offers a welcome vision for future sustainable growth. This, combined with a strong independent central bank, no doubt helps explain the favourable shift in investor sentiment towards Europe, reflected in the relative performance of equity markets and a strong euro. Cyclical recession risks remain, but there are clearly structural opportunities to be found.