Following a bumper 2024, what’s next for the U.S. economy and market?

The U.S. has dominated financial markets this year. The economy has been stronger than expected with GDP growth running at an annualized rate of 3.0% in the second quarter (Q2).¹

The blue-chip benchmark S&P 500 index has enjoyed a total return of some 22% and U.S. fixed income markets have delivered strong returns because of the apparent success the Federal Reserve (Fed) had in dealing with inflation. Interest rates have begun to lower, and credit markets have reflected the strength of the U.S. corporate sector. A 50:50 allocation to the S&P 500 Growth equity index and the ICE US High Yield bond index would have returned close to 18% year to date.

November's presidential election will clearly be important as we look to 2025. One potential outcome is likely to see something of a continuation of the economic policies which have helped growth since the recovery from the pandemic.

The Joe Biden-Kamala Harris administration oversaw the implementation of several Acts of Congress that have subsequently boosted investment in the U.S. with a focus on infrastructure and securing the U.S.'s leadership role in technology.

Gross fixed investment spending grew at an annualized rate of 8.3% in Q2 – a sign of corporate confidence.²  The alternative outcome is likely to see some combination of tax cuts and protectionist trade policies that could be disruptive to the macroeconomic outlook in the coming years.

The fiscal challenge

In terms of November’s upcoming presidential election, one topic that has not been addressed by either Kamala Harris or Donald Trump is the long-term fiscal outlook. The Congressional Budget Office’s baseline expectation is the deficit will remain close to 6% of GDP for the next decade and the level of federal debt will reach 122% of GDP in 10 years’ time.³

Some bond investors worry about this – and worry even more that postelection economic policies will cause the debt and deficit numbers to exceed current projections. In short, the fear is that long-term interest rates will be pressured higher as government borrowing rises, and that this will mean fiscal policy is dominant over monetary policy decisions.

Today, concerns about the deficit are reflected in the bond market – not through the yield levels which have come down through 2024 – but in the relative pricing of Treasury bonds and interest rate swaps⁴ . This is evident across the yield curve and most pronounced for long-term maturities. Essentially, this is the market saying that investors need more of a premium for holding long-term Treasuries given the fiscal concerns. Treasuries’ risk premium is still relatively modest. The broader picture suggests concerns among investors are limited – after all, financial markets have performed well. Even the dollar, which has weakened a little against the euro and the yen this year, remains above levels that prevailed in the immediate aftermath of the pandemic.

The U.S. is rich enough to deal with its budget deficit if the political will exists, and it may take more market concern for that to become evident enough to provide that political focus. It will be a theme during the next president’s term and could pose a risk to markets over that period if the fiscal outlook continues to be ignored.

AI and technology remain potential key drivers