Pensions investment outlook 2025: U.S. policy uncertainty clouds road ahead

The coming year will likely be characterized by three main drivers: the U.S.’s politically driven polices, structural economic 1 The implicit yield curve based on the floating rates associated with an interest rate swap. weaknesses and political uncertainty in Europe, and China’s restructuring of its troubled property market.

Overall, our forecasts suggest global growth looks set to continue its 2024 pace of 3.2% in 2025, before easing in 2026 to 2.9%.

This outlook could be compounded by the implementation of trade tariffs on China and Europe by U.S. President-elect Donald Trump, potentially leading to emerging countries’ growth suffering as a result.

Political uncertainty in major European countries such as Germany and France, coupled with growing nationalism in Europe, is expected to make it increasingly challenging to coordinate pan-European policies regarding economic reforms, migration, and European defence.

This uncertainty is becoming a significant driver of market sentiment. Increased government spending is leading to higher debt and government bond issuance in Europe. Notably, as of late November, German sovereign bonds (Bunds) had a positive spread versus the swap yield curve¹  for the first time, while France had already turned positive some time ago. The European Central Bank’s (ECB) reduced buying of sovereign debt is part of the equation to balance supply and demand.

German Bunds’ high yield is noteworthy in our opinion, considering the country's zero-tolerance policy towards a central government budget deficit. This might be one of the topics under discussion in the country’s upcoming elections in early 2025. In this environment, European sovereign bonds could potentially reach attractive yield levels in 2025, with the ECB expected to lower its policy rate, potentially leading to a steeper yield curve in Europe.

ESG headwinds

Sustainable investments could possibly face further headwinds in 2025, with the Trump administration driving a negative sentiment towards environmental, social, and governance (ESG) related investments in the U.S. This could potentially spill over into European markets, if it has not already done so, and global investors may be particularly aware of their sustainability ambitions vis a vis the U.S. and European investment landscapes. . Biodiversity is increasingly being viewed as the most important environmental theme, more than climate change, and one that also has great influence on social development topics.

Emerging market allocations 

Against this backdrop, pensions in Europe may be contemplating its strategic allocations towards emerging markets, including equities and debt denominated in local and hard currencies. 

However, investments in emerging markets could face challenges given the potential for slower global growth, trade wars between the U.S. and other countries, increasing geopolitical stress, and ambitious sustainability agendas. 

Local currency emerging market debt has not performed well over the last decade, and emerging market dollar denominated debt must compete with the U.S. high yield bond market. What’s more, excluding countries like China and Saudi Arabia from an emerging markets universe on sustainability grounds potentially leaves limited investment options. This also holds true for listed companies in emerging markets, apart from Taiwan and South Korea. Investors may consider emerging market equities, while excluding certain countries on sustainability grounds. 

U.S. equity market seems attractive 

Historically, the U.S. market has often acted as a perceived safe haven for capital in times of uncertainty, something that could well continue in 2025. The dollar is already on the rise compared to the euro – and hedging dollar assets will likely become more costly next year. 

U.S. companies’ profitability may underpin current equity market levels. Large-cap technology companies might be best equipped to weather an international trade storm, given strong momentum in artificial intelligence (AI) and U.S. companies’ leadership position in technology more broadly. It is unlikely that this will change in the near future, potentially positioning U.S. companies to benefit given the lower valuation of the domestic companies making the U.S. equity market still attractive. The risk is that the implementation of high trade tariffs on foreign goods would hit the exports of U.S. companies in 2025. 

Balancing risk and return 

Pension investors' appetite for U.S. high yield bonds may be influenced by their quest for income. The search for income-generating assets may lead pensions to consider high yield bonds as an alternative to traditional fixed income securities. 

However, pensions will carefully assess the credit quality, default risk, and market conditions associated with U.S. high yield bonds. While the potential for higher yields may be attractive, pension investors will likely remain vigilant about credit fundamentals, liquidity considerations, and the impact of economic cycles on high yield bond performance. Furthermore, ongoing monitoring of default rates and issuer-specific factors will be essential for pensions evaluating U.S. high yield bond opportunities as spreads are historically tight. 

We expect pension investors’ appetite for emerging markets equities, government bonds, and U.S. high yield bonds to be influenced by a balance of return potential, risk considerations, and diversification objectives in 2025. Pensions will likely seek to strike a balance between pursuing investment opportunities that offer attractive yields and managing the associated risks effectively while aligning their investment decisions with long-term objectives and risk management principles. Equities seem set to deliver more favorable returns in 2025 compared to bonds.