Navigating Uncertainty: Risk & Opportunity in 2025

As we step into 2025, the global economic landscape is fraught with uncertainty, shaped by an interplay of geopolitical tensions, evolving monetary policies, and market volatility. Investors and risk managers are facing a critical year, with a new Trump presidency, economic fragility in Europe, and rising concerns about global financial stability all contributing to a highly unpredictable environment. The year ahead presents both significant risks and opportunities - understanding these macro risks will be crucial for navigating the challenges and identifying potential turning points that could reshape market sentiment.

In this piece, we’ve outlined three key risks we believe could impact markets in 2025 and thus warrant close consideration:

President Trump – Pragmatic or Ideologic?

A second Trump presidency brings uncertainty and higher risk, but there is plenty of scope for recent market trends to reverse this year.

President Trump’s inauguration took place on 20th January. What happens next is anyone’s guess. Obviously, there’s a blueprint from his first term as president, but both the US economy and geopolitics, are in very different places to where they were in 2017. The known unknown’s regarding Trump’s actions are set to have a profound impact on markets and risk a sharp increase in volatility, and there is risk that these will be compounded by other unknown events during his term.

Unsurprisingly, the focus in recent months has been of tariffs directed primarily at China, Europe and Mexico, but goods from other countries will likely be included too. The uncertainty comes in the form of both the quantum and what’s captured. Will the tariffs be 20%, or 50% or more, and will it just be goods or will services be included too? Will tariffs be imposed on everyone or just the aforementioned?

Impact across the Atlantic

The euro in particular has been under pressure in recent weeks amid expectations that the Eurozone is a key target, and tariffs will strike a painful blow to the economy and curtail what little growth there currently is. The thinking is that the ECB will be forced to cut rates further to ease funding pressures and stimulate local demand. In turn, the prospect of lower rates weighs on the currency, particularly in the short term.

If Trump doesn’t follow through with his threats, or even if the tariffs are smaller and less severe than currently expected, there is plenty of scope for recent market trends to reverse. Despite local woes, including weak demand, competition from China and a rapidly changing automotive industry, the euro is extremely cheap on any purchasing power parity metric and given historical mean reversion tendencies, there appears plenty of scope for a recovery in the single currency. 

Potential for further inflation

The President’s second area of focus is the deportation of illegal immigrants, particularly those who have committed crimes. At first glance it might appear simple and fair enough, but after some more thought, it quickly becomes apparent that its easier said than done. Ultimately, there’s a scale and where the outcome falls on that scale will have huge implications, not just on Trump’s perceived success as president, but also on the US economy. If Trump were to deport a significant number of low paid workers, it would likely drive up inflation as labour costs rise in what is already a tight labour market close to full employment.

Ballooning budget risks straining Treasuries

Meanwhile, the US budget deficit continues to widen (the gap in 2024 was $1.83 trillion). For now, the US maintains its exorbitant privilege, and investors seem happy to plug the gap. However, if this ceases to be the case, which isn’t beyond the realms of possibility if Trump’s spending were to spiral, US Treasuries (and the dollar) could come under severe strain. Whilst the probability is low, the impact (and therefore risk) is very high.

Europe in crisis and a possible euro recovery

The risks resulting in continued euro weakness are multiple and well known, but we could see a bounce in the currency should any of the negative stories start to resolve themselves in 2025.

Over the last year we saw European economic fragility met with, as is often the case, political instability. French elections saw a sharp increase in popularity for the far-right parties and the fragile coalition of centrists and leftists, which kept Marine Le Pen out, has subsequently fallen apart. Germany’s position as powerhouse of Europe has taken a hit – narrowly escaping a technical recession, the economy once fuelled by the combustion engine is losing ground in a world pivoting toward electric vehicles. The nation is also squarely in the crosshairs of Trump’s European tariffs. Political instability has followed, with a vote of no-confidence leading to an election this coming February. The market implications have been significant – the single currency has weakened over 3% against sterling and over 5% versus the dollar, with parity once again in sight. As we move into 2025, a key question for any risk manager is where next for the euro – will we see a recovery or is there further weakness on the horizon?

Instability continues to undermine euro

The risks resulting in continued euro weakness are multiple and well known – the political situation in the bloc’s two largest economies create uncertainty which of course hurts the currency. But worse than that, the outcomes could be the start of existential issues for the currency. In France, we have Marine le Pen gaining popularity and in Germany it is the AfD – though neither party are currently calling to exit the Eurozone, which has, in recent past, been a pillar of both parties. Adding to the political instability is the ongoing war on the bloc’s east. While President Trump has called for an end to the war, Russia and Ukraine are, at time of writing, no closer to finding a resolution. The effects have been felt recently as the flow of Russian gas to Europe via Ukraine came to a halt, leaving countries dependent on other more expensive alternatives to replace the shortfall.

Additionally, economic indicators are showing no signs of a reversal – figures released in January showed German factory orders and retail sales growing far weaker than economists had forecast. Cyclical issues in the bloc’s biggest economy have started to give way to structural concerns – even though unemployment continues to grow, firms continue to struggle to fill roles due to a lack of skilled labour. If Germany’s economy continues to struggle, who will be creditor of last resort should a weaker southern nation get into trouble?

Can it get any worse?

As mentioned, these issues are well known, and maybe therein lies the secret for the new year. The recent weakness is driven by a deluge of negativity, some of which we’ve outlined – if one of these stories were to resolve themselves, we could see a bounce in the currency. Le Pen and AfD’s popularity could wane as quickly as it spiked, or indeed they could come to power and govern in a pragmatic and pro-business manner, adding a boon to the currency whilst removing the uncertainty risk. And, of course, incoming President Trump claims to have the solution to the Russia-Ukraine conflict at his fingertips. With so much bad news already in the price for the euro, and speculative positioning as short as it has been since pre-Covid, we believe the risks are currently skewed towards a move higher in euro.

How close are we to another Global Financial Crisis?

Are we starting to see the early signs of another 2008-style crisis ahead?

The strength of the US economy in the last 18 months has surprised many including the Fed. In early 2024, the question among experts focused on whether we would see a recession or a soft landing by year end. The Fed started the cutting cycle with a 0.50% cut, probably in part to preempt the effects of high interest rates and a potential slowdown.

Not only did an economic slowdown not materialize, but the continued strength of the US consumer accompanied by strong equity markets - which usually benefit the high-income earners’ wealth creation - surprised many in the fourth quarter of 2024 and pushed the Fed to adopt an increasingly patient or even hawkish tone.

Rate rises threaten

Despite the start of a rate cut cycle, US long-term yields continue to rise resulting, in our view, in an important divergence that might not be sustainable. With the rates at present levels or rising further, the early signs of weakness that can be observed in some credit markets and less robust corporate balance sheets will likely accentuate and, at some point, affect negatively both consumer behaviour and corporate investments.

It is always challenging to estimate the degree of leverage in the system and how sensitive the overall economy can be to a deleveraging or readjustment because of persistent higher rates. However, usually any such correction is not smooth and can be rather disruptive, as past episodes of financial or credit crisis have shown over the last few decades.

Add to this predicament the uncertainties stemming from President Trump's economic policies at home and abroad and their potential effects including on inflation, as well as lingering geopolitical risks, and the probabilities of undesired outcomes or a crisis of some kind are far from negligible.

While the macro risks outlined present formidable challenges for risk managers, they also highlight the importance of staying agile and well-informed in an ever-changing environment. Market participants must carefully assess both the downside risks and the potential for upside surprises, such as a more pragmatic approach from President Trump or a stabilizing European economy. With so much uncertainty already reflected in market pricing, even modest positive developments could trigger sharp reversals. Ultimately, successfully navigating the year ahead will require a keen focus on risk management, strategic positioning, and an openness to evolving market dynamics.