2025 GBP/USD Outlook Fundamental Preview

Economic

Forex

Summary:

See a technical preview of our 2025 GBP/USD Outlook!

GBP/USD showed resilience in 2024, falling just 1% across the year. The pair experienced strong gains between April to September, rising from a low of 1.23 to a high of 1.34. However, GBP/USD fell 5% in the final quarter of the year amid notable USD strength, pulling GBP/USD from 1.34 to the 1.25 level where it trades at the time of writing.

While the pound booked losses against the US dollar in 2024, GBP's performance against other major peers was impressive, rising solidly against EUR, CHF, CAD, AUD, and JPY.

GBP/USD has been supported across 2024 by the BoE cutting rates at a slower pace than the Federal Reserve and by the expectation that this trend would continue in 2025. However, Donald Trump's victory in the US election, combined with the Labour government’s Budget, means that the outlook for both economies has changed, potentially impacting the direction of monetary policy in 2025 for both central banks and GBP/USD.

GBP/USD outlook – UK economic factors

Growth

The UK economy is expected to continue to grow in 2025. However, GDP could be weaker than the 1.5% forecast by the BoE owing to several key factors, including uncertainty surrounding trade and a less expansionary UK budget.

Trump’s second term in the White House brings uncertainty, and UK trade will be under the spotlight. While the UK isn’t directly in the firing line for tariffs, the openness of the UK economy means a global shift towards increased tariffs could hurt growth prospects. However, should the UK pursue and achieve closer ties with the US or the EU, this could help growth but not to the extent of reducing the impact of Brexit.

The extent of the indirect impact of trade tariffs on the UK will depend on their magnitude. The UK is already experiencing depressed growth, which Trump’s action could exasperate.

The BoE forecasts GDP growth of 0% in Q4 2024 and 1.5% in 2025. The OECD forecasts 1.7% growth, and Bloomberg's survey of economists points to growth of 1.3%.

Inflation

In November, inflation in the UK was 2.6% YoY, rising for a second straight month and remaining above the Bank of England's 2% target as wage growth and service sector inflation remain sticky.

The labour market has shown signs of easing, but unemployment remains low by historical standards at 4.2%, and wage growth elevated at 5.2%. We expect some softening in the UK job market following the Labour government’s first Budget.

Chancellor Rachel Reeves placed a major tax burden on employers with a rise in employer National Insurance contributions and an increase in the minimum wage. A broad range of UK labour market indicators point to a weakening outlook, with surveys indicating that UK firms (especially smaller firms) are scaling back hiring plans.

Although wage growth and service sector inflation were slightly firmer than expected at the end of 2024, the disinflationary trend remains intact, with core inflation well below last year's highs.

The BoE projections show CPI could reach 2.7% in 2025 before easing to 2.5% in 2026. However, this could be lower if the labour market weakens further and if growth remains lacklustre.

2025 GBP/USD Outlook Fundamental Preview_1

Will the BoE cut rates in 2025?

At the final BoE meeting in 2025, the BoE left interest rates unchanged at 4.75%, in line with expectations. However, the vote split was more dovish than expected, at 6-3 compared to the 8-1 forecast. This suggests that dovish momentum is building within the monetary policy committee for a rate cut in February.

The central bank signaled gradual, rare cuts throughout 2025 amid sticky inflation, although policymakers are increasingly concerned over the growth outlook. The market is pricing 50 basis points worth of cuts in 2025, supporting the pound.

However, this could be conservative given that the labour market could weaken considerably following the Budget. A weaker labour market will lower wage growth and impact consumption, potentially cooling inflation faster. Uncertainty surrounding trade could ease inflationary pressures further in 2025, meaning deeper cuts from the BoE than the market is pricing in. As a result, GBP could come under pressure across H1 2025.

GBP/USD outlook - US economic factors

USD strength was nothing short of impressive in Q4. The USD index jumped 5% to reach a two-year high, supported by expectations that the Federal Reserve could cut rates at a slower pace in 2025. Despite the outsized move in Q4, we expect further USD strength in 2025.

At the time of writing, US CPI has risen for the past two months, reaching 2.7% YoY in November. Core PCE is also proving to be sticky, remaining above the Federal Reserve's 2% target. Earlier confidence at the Federal Reserve that inflation would continue falling to the 2% target appears to have faded amid ongoing US economic exceptionalism and a cooling but not collapsing labour market.

Signs of sticky inflation come as the US job market remains resilient. Nonfarm payrolls for November showed 227k jobs were added. Unemployment has ticked higher but is expected to end 2025 at 4.3%, down from 4.4% previously expected.

Meanwhile, economic growth in the US remains solid. The US recorded Q3 GDP as 3.1% annually, up from 2.8% in Q2. According to the OECD, the US is expected to see strong growth among the G7 economies, with 2.8% growth expected in 2024 and 2.4% forecast for 2025.

A combination of sticky-than-expected inflation, solid growth, and a resilient jobs market suggests that the US economy is on a strong footing as Trump comes into power.

2025 GBP/USD Outlook Fundamental Preview_2

Political factors

Trump is widely expected to implement inflationary measures, including tax cuts and trade tariffs. Inflationary policies at a time when US inflation is starting to heat up again could create more of a headache for the Federal Reserve continuing with its easing cycle.

Will the Federal Reserve cut rates in 2025?

At its last meeting of 2024, the Federal Reserve cut interest rates by 25 basis points, marking the second consecutive 25-basis-point cut and following a 50-basis-point reduction in September, when it kicked off its rate-cutting cycle.

However, the Fed also signaled slower and shallower rate cuts in 2025. Fed Chair Powell’s press conference and policymakers’ updated projections confirm that the Fed will be much more cautious next year.

The Fed increased its inflation forecast to 2.5% YoY, up from 2.1%, and isn’t expected to reach 2% until 2027.

The market is pricing in just 35 basis points worth of cuts next year, and the first rate cut isn’t expected until July.

However, Trump’s policy plans will be the most significant determinant of the Fed's decisions regarding rates next year.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Bruegel

Economic

Introduction

The European Forum Alpbach is an annual conference, staged since the 1940s in Austria, where the challenges faced by Europe and the European Union are discussed. At the 2024 forum (17-30 August 2024) , Bruegel participated as a Track Reporting Partner covering the finance and economy track. This article summarises the discussions relating to six issues within that track. The six issues, which are in line with Bruegel’s Research Programme 2024/2025, were:

The evolution of inequality

Within-country inequality has been increasing for the last two to three decades. Meanwhile, convergence between poorer and richer countries may have slowed because of conflicts or the impact of automation and technological change. Different levels of inequality within market economies show that some governments are more willing to deploy the tools to address this challenge. While still very limited, wealth taxation is often seen as a possible tool to tackle the problem.

Financing the green transition

Europe has a long-term strategy for the green transition and is starting to implement it. The strategy requires significant investment, which neither the public nor private sector can provide alone. The European Union needs to complete its capital markets union and increase the attractiveness of investment through better regulation.

The future of work: artificial intelligence and automation

Employment rates remain high, and the predictions that technological change will destroy jobs have yet to materialise. Given the rapid take-up of new technologies in recent years, Europe should focus on regulations that protect consumers and their personal rights, while protecting innovation and economic growth.

Defence

Russia poses the biggest threat to the security of democratic European countries. European defence needs greater transnational cooperation and more integration, so that European defence companies can achieve bigger scale and remain competitive globally. Unified capital markets will again be important in stimulating greater levels of short- and long-term investment.

Finance

Demographic change challenges the sustainability of European pension systems and welfare states more generally. Governments must design systems that guarantee both intergenerational fairness and fiscal sustainability, while encouraging financial literacy.

Digital currencies, specifically the digital euro, present new challenges and opportunities. Europe could reduce its reliance on foreign providers through the use of digital currencies. New digital payment methods may play a geopolitical role by making it easier to circumvent international financial sanctions.

Making economics useful for the modern world

Economists seek to anticipate and understand socioeconomic interactions. In the modern, data-rich world, the field has developed rigorous quantitative tools to improve fact-based policymaking. However, economists should also work collaboratively with other social scientists to offer more holistic approaches to complex problems.

Inequality

Challenges

The COVID-19 pandemic deepened inequality. The world’s five richest people have doubled their wealth since 2020, and the richest 20 percent own 80 percent of total wealth. Inequality can lead to undesirable social outcomes and have negative effects on economic growth. It is linked to the rise of extremism and social backlash. It also affects socioeconomic indicators such as childhood poverty rates, affecting future economic growth and productivity.

Among the drivers of inequality, one factor explaining wealth inequality is different investment returns across the income distribution. People at the top own financial assets, those in the middle own houses, and the poorest households own barely anything. Risk preferences explain part of these differences: poorer households have a greater chance of being affected by unemployment, so they do not want risk buying a house and being unable to pay for it. Wealth inequality is thus self-reinforcing: returns are higher for those who already have substantial assets. Other factors deepening inequality include the rise of monopolistic markets, the non-mobility of labour and the anti-union movements in certain countries.

Inequality is growing within countries, and some factors may be slowing down the convergence between poorer and richer countries that has taken place in the last few decades. Within countries, demographic change affects inequality and wealth, as people live longer and their descendants inherit their assets later in life. Between countries, military conflicts stop growth for some emerging economies, widening the gap between high- and low-income countries. Changes in AI and robotics might also constrain the convergence of developing countries as some growth opportunities may no longer need to be located in poorer countries.

Potential solutions

High inequality is not an inherent characteristic of market economies. This is shown by the existence of market economies with both higher (United States) and lower (Nordic countries) levels of inequality. Governments have tools to reduce inequality. Advances in economic research and the availability of rich data can help address these issues. Leading institutions and organisations are developing new projects with this purpose.

Inequality and technological developments are leading to a rethink of the role of taxation and wealth taxation specifically. Wealth taxation has changed significantly over recent decades. While previously a number of Organisation for Economic Co-operation and Development countries had wealth taxes, currently only about four do. In Austria, for example, capital gains taxation has been rather flat for the last 20 years. Most wealth is concentrated at the top of the distribution. Even at the top, wealth is skewed towards the very rich.

Labour income used to be enough to climb the income ladder, but now reaching the top of the income distribution only with labour revenues would take more than a lifetime. Capital income has become more important, but taxing wealth is different to taxing labour income, and it might be difficult to make it effective. Assets are sometimes highly illiquid, and it is often possible to restructure assets to avoid taxation (eg through investing in art).

Wealth taxation is thus an instrument to consider when trying to reduce inequality. However, difficulties arise in terms of the practical details of taxing capital in ways that are both effective and economically efficient.

Financing the green transition

Challenges

Climate change is already being felt and the cost of inaction is huge. No short-term solution will work, so Europe needs to effectively and efficiently implement its long-term strategy: the European Green Deal.

The European Green Deal lacks the resources required to deliver this transition. Some estimates, cited at the forum, point to €700 billion needed per year, while the Green Deal has around €170 billion per year. The big investment gap needed to be filled from both public and private sources. Europe therefore needs to attract more private capital, and to develop fully a capital markets union, while also changing the investment culture and moving to long-term money.

Some aspects of the green transition do not necessarily carry a cost. For example, evidence is lacking for the assumption that the transition will have an overall negative impact on labour markets. The green transition affects labour markets in different ways, creating opportunities for green jobs but also destroying or modifying carbon-intensive jobs.

Potential solutions

The EU should prioritise the completion of the capital markets union so funding stays in Europe and remains available to European companies and to meet European needs. Governments need to maintain their efforts to increase levels of financial literacy, so that new financing channels will open up and be used by private individuals. The EU should also deploy its soft power and EU regulation as a global standard for climate finance, while easing bureaucracy.

AI and automation

Challenges

The predicted collapse of the labour market because of AI has not materialised yet. Employment has actually increased in companies with high AI exposure. Furthermore, employees in these sectors tend to have a positive view of AI: it helps their work and makes them more productive.

However, the pace of AI development and adoption is very fast. Implementation of these technologies will happen sooner or later in every sector or application, and companies will need to integrate these technological advances wherever they can.

Policymakers must navigate this trade-off. While AI can lead to productivity and welfare gains, the fast pace of AI development and adoption also shows the importance of protecting both people and innovation. Innovation must not be undermined by allowing AI to carry out tasks that might breach social rights and European values, such as surveillance or propagation of biases based on race or gender.

Potential solutions

EU regulation should aim at increasing trust in AI, which in Europe is currently lower than in other major economies including India and China. Effective regulation can increase trust and encourage consumers and businesses to use AI.

Similarly, the risks of AI and its possible undermining of privacy or personal rights should be addressed through smart regulation. This would allow users to use AI tools confidently, while protecting an innovative and productive business environment.

The future of work is uncertain, but so far, employment levels remain at record highs in many economies. It seems that as long as there are problems to solve, jobs will be needed.

Defence

Challenges

Russia’s invasion of Ukraine threatens European democratic countries, and should be a wake-up call. It requires a European response but most European countries still take national approaches to the problem. This is mostly reflected on the production side, with countries usually preferring to buy military products from their national companies. The EU does not have common public procurement for defence, resulting in 27 different procurement systems. As pointed out in several discussions, European nations need to show greater willingness to defend Europe and European values, including through military means.

Underinvestment in the defence sector has lasted for decades. Furthermore, the fragmented defence market means the EU does not have the scale and level of specialisation necessary to spend money efficiently, make essential investments and achieve higher productivity. Underinvestment is even more worrying on the R&D side, in particular startups and venture capital.

Collaboration with the US within NATO is indispensable, especially given the immediate threat from the war in Ukraine. However, Europe is still too reliant on foreign providers, especially the US. Even for some European products (eg drones), manufacturing takes place abroad (for instance in China), posing risks to economic security.

Potential solutions

European defence needs new reliable and long-term frameworks for common procurement, together with better integration of national defence sectors. This would increase the attractiveness of the European defence market and facilitate the scale and necessary investments needed to increase national and continental security.

Europe needs to maintain its cooperation with international partners, especially within NATO. Deepening the single market for defence would be a way to increase Europe’s competitiveness and production, resulting in less security reliance on foreign providers and enhancing Europe’s strategic autonomy.

Finance

a. The future of pension systems

Challenges

Demographic change poses a considerable challenge to the sustainability of public pensions and the overall welfare state if necessary measures are not taken. The current labour force might receive significantly lower pensions than current retirees. This gap between current and future pensions is expected to keep increasing over time.

European consumers are rather risk averse in relation to investment, with their savings mainly in banks and housing. This behaviour should change; consumers should also consider investing in other financial instruments. It is no coincidence that countries with greater risk appetite also have better funded investment and pension systems.

Within the EU the full inter-country mobility necessary to have a real single market in Europe for pensions is still lacking – another missing layer from the capital markets union. Countries should learn from each other and see what has been done wrongly and what could have been done better in other countries.

Potential solutions

Pension systems should build up the different pillar structures: public pensions, private pensions and complementary pensions or private savings and investments, to guarantee the sustainability of pension systems and the adequacy of pensions. Options such as making work and retirement compatible, or incentives for worker to invest, should also be considered and encouraged by public policies.

Governments should increase financial literacy across different socioeconomic groups. Financial literacy is a tool for intergenerational justice that can serve as a catalyst for investment, while also addressing gender and income inequalities.

b. Central bank digital currencies (CBDCs) and the digital euro

Challenges

The digital euro is still in the preparation phase. Different questions are being asked about the EU’s digital currency and CBDCs in general.

The geopolitical component of CBDCs remains under-examined. Recent conflicts have shown the important role played by the international financial system in imposing sanctions. The development of new digital payment systems could allow countries such as Russia to circumvent Western sanctions.

CBDCs can be a way for payment systems to reduce reliance on foreign providers. In Europe for instance, there can security risks if the payment system market is dominated only by non-European companies.

Many people still do not understand what CBDCs are, and how they can or cannot be useful, suggesting a communication deficiency from the institutional side. The same problem applies to anonymity and privacy, as there seems to be no understanding on these aspects of the difference, for example, between cash or private money and the digital euro. The degree of success in communicating to and instilling trust in the public will ultimately determine the usage of digital currencies by consumers.

Potential solutions

European and particularly euro-area institutions should take into account the geopolitical component of digital currencies. It should be possible to continue to enforce international regulations via new digital payment systems – for example the correct application of financial sanctions.

Making economics useful

Challenges

Economics is about anticipating and understanding interactions between different agents that might have opposite interests. Economists need numbers to justify what they say, and every policy recommendation should be fact-based – this is the value added that economic analysis brings.

The task for economists, however, is often not easy. Given the complexity of modern economies, and the difficulties underlying politics, understanding and anticipating the relevant interactions is challenging.

Economists need to remind policymakers that there are usually trade-offs between objectives. This is not always an easy task. Economists need to be innovative and bring new ideas to the trends currently shaping the world, such as the influence of China in developing countries as a global geopolitical player, or the threat of gas shortages in the EU. Economics can provide rigorous quantitative approaches that help tackle such problems, as it did during the energy crisis.

The modern world is data-rich, and data and quantitative skills are key. These allow economics and economists to be more precise and provide critical evidence for modern fact-based policymaking.

Potential solutions

Economists should continue to be rigorous in advising policymakers, so that effective and efficient policies are put in place. Quantitative work is key in a data-rich world, in order to anticipate and understand economic interactions.

Better communication would help both policymakers and the general public to understand the findings and proposed solutions.

Finally, collaboration with other social sciences is important, so that economic analyses improve policies in a holistic manner.

Conclusion

Europe and the EU face multidimensional crises, adding extra layers of difficulty to the rather recent recovery from the financial and euro crisis. Meanwhile, the climate crisis is worsening and action needs to be accelerated, starting with financing for climate policies. The fast pace of development and adoption of new technologies such as AI could bring considerable benefits and growth opportunities, but also poses risks to personal rights. Russia has brought war back to Europe, threatening national and continental security. And demographic change and the digital economy imply challenges to financial systems, affecting the sustainability of welfare states and the structures of payment systems.

Part of the response to the challenge should be European. Economic analysis offers tools that modern policymaking needs. Quantitative and rigorous approaches, combined with inputs from other fields, will help address the complex problems Europe faces in 2024.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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CEPR

Economic

Bond

The ‘doom loop’ describes the spillovers between fiscal sustainability risk and financial stability risk, arising from the government and financial sectors each being exposed to stress in the other sector. Specifically, if sovereign bonds lose value because the government’s creditworthiness is declining, the balance sheets of financial institutions suffer, because they hold large amounts of domestic government bonds. Weakened financial institutions, in turn, may force the government to bail out the financial system. Such bailouts entail expenses for the government, casting a further shadow over their finances. This vicious circle can exacerbate economic downturns (Acharya et al. 2014, Farhi and Tirole 2018) or even trigger purely panic-driven crises (Brunnermeier et al. 2016, 2017;, Cooper and Nikolov 2018). This is why sovereign crises can develop suddenly – and can easily spiral out of control.

The ‘Doom Loop’ and Default Incentives_1

To break the doom loop, a common policy recommendation is to sever the link between the financial system, or banks for short, and the government. How can this be done? One way is to limit banks’ exposure to domestic sovereign debt – for example, through regulatory requirements. Another way is to stabilise bond prices near their fundamental value by providing a central bank backstop through bond purchases. Indeed, such policy proposals have emerged as lessons learned from the euro area debt crisis (e.g. Bénassy-Quéré et al. 2019).

However, this reasoning overlooks a critical aspect: how the identity of the government’s creditors shapes its default incentives and ultimately the sustainability of its debt. Lowering domestic banks’ exposure to sovereign debt can weaken a government’s incentives to avoid default in two ways (Bolton and Jeanne 2011, Gennaioli et al. 2014). First, if domestic banks hold lower volumes of domestic sovereign bonds, a greater share needs to be held by foreigners. Governments are typically less inclined to repay foreign lenders than domestic ones, so this increases the likelihood of default. Second, if banks are shielded from a sovereign debt crisis, the fallout of a sovereign default will be less severe, which can also increase the likelihood of default. We refer to these two effects as the ‘temptation channel’ and the ‘commitment channel’, respectively. Through these channels, policies reducing the exposure of domestic banks to domestic sovereign debt may inadvertently undermine fiscal sustainability.

In Rojas and Thaler (2024), we explore this tension between the detrimental effects of banks’ exposure to domestic sovereign debt (the doom loop) and the beneficial effects related to governments’ default incentives (the temptation and the commitment channels). We use a simple three-period model of sovereign debt and banking that incorporates multiple equilibria – similar to the frameworks used in the aforementioned studies. We focus on the strategic nature of sovereign default. Our analysis reveals the unintended consequences of interventions aimed at breaking the doom loop and highlights unexpected benefits of non-interventionist approaches.

Unintended consequences of limiting banks’ exposure

Limiting banks’ holdings of domestic sovereign bonds deactivates the doom loop by breaking one link in the chain: domestic banks’ balance sheets are no longer negatively affected if the price of sovereign bonds falls, which prevents further financial stress.

However, it entails other risks and costs. In most countries, the domestic financial sector is a major holder of domestic sovereign bonds. As Figure 2 shows, in 2023 the domestic financial sector held more than 50% of sovereign debt in countries like Spain, Italy and Germany. So, a limit would cause a significant shift of sovereign debt from domestic to foreign holders.

The ‘Doom Loop’ and Default Incentives_2

This shift can affect the likelihood of default through the temptation and commitment channels. The lower the holdings by domestic banks, the greater the temptation for that government to default, as a higher fraction of debt is held by foreigners. Simultaneously, the less the domestic financial sector would suffer from a government default, the weaker that government’s implicit commitment to repay. So where is the problem, as long as the sovereign does not actually default? In fact, while limiting banks’ exposure can reduce the likelihood of a panic driven by the doom loop, the associated higher risk of fundamental default would increase risk premia and therefore public sector financing costs during normal times. These costs must be weighed against the benefits of eliminating the doom loop. If the risk of a doom loop is sufficiently low, why pay to insure against it?

Benefits of debt renationalisation during panics

During financial turmoil, governments often incur significant fiscal expenses – such as bailouts – which force the government to issue additional debt. If all of the new debt is bought by foreign investors, then the government’s temptation to default increases, fuelling the doom loop. Conversely, if domestic banks purchase the additional debt, the temptation to default does not rise and sovereign debt prices do not fall in response to a bailout – effectively disabling the doom loop.

In other words, debt renationalisation can act as a stabiliser in times of sovereign stress by preventing self-reinforcing fears of default. Both the European sovereign debt crisis and, more recently, the COVID-19 crisis featured debt renationalisation. While such shifts in investor composition are often seen as a problem, our theory suggests they may actually be beneficial – and should not be restricted by regulation.

Policies in a monetary union

At the EU level, two policy proposals have attracted particular attention: first a central bank backstop such as the ECB’s Transmission Protection Instrument (TPI) and, second, the European Safe Bonds (ESBies) proposal by Brunnermeier et al. (2016, 2017). By analysing the interplay between investor composition and government default, we uncover important lessons for both policy approaches.

The Transmission Protection Instrument

As yields on European debt climbed at the start of the COVID crisis, sparking fears of a return of the doom loop, the ECB launched the Transmission Protection Instrument (TPI). It enables the ECB “to make secondary market purchases of securities issued in jurisdictions experiencing a deterioration in financing conditions not warranted by country-specific fundamentals” (ECB press release, 21 July 2022). The doom loop produces just such non-fundamental variation in sovereign bond prices.

In our set-up, the TPI can indeed be an effective tool to avoid the panic-driven doom loop. Flooring sovereign debt prices limits the potential losses of financial institutions, avoiding large bailouts and consequently the spillover from fiscal to financial risk.

However, the policy must be carefully calibrated to avoid the risk of a new self-fulfilling panic. Imagine that all private investors sell off the bonds of one particular government. Bond prices drop until they reach the threshold at which the ECB intervenes by buying debt to stabilise the price. This insulates banks from any further losses in case of a subsequent default, reducing the government’s incentive to repay its debts through the commitment channel. And to the extent that part of the default losses faced by the ECB are shared across the member states, it also reduces the repayment incentive through the temptation channel. Consequently, the perceived risk of a sovereign default increases. If the ECB buys the bonds at prices above the levels justified by the higher default risk due to a change in investor composition, the initial sell-off to the ECB is rational from an investor’s perspective. The sell-off thus becomes self-fulfilling.

Such a panic can be avoided if the ECB sets a floor for bond prices far enough below their fundamental value. However, the floor must not be too low, or it will fail to curb the original doom loop panic. Picking the right intervention threshold is therefore a delicate balancing act.

The risk-sharing arrangements among the individual national central banks and the rest of the Eurosystem play an important role in finding this balance. The less risk-sharing there is, the larger the range of desirable intervention thresholds for the bond price. In other words, less risk-sharing makes it easier to successfully calibrate the TPI.

European Safe Bonds

The proposal for European Safe Bonds (ESBies) consists in a macroprudential policy restricting the sovereign bond holdings of euro area banks to ESBies, which would be the senior tranche of a bundle of European bonds. This way banks would avoid large exposures to their own government and would have a ‘safer’ asset. However, this policy could have two unwanted side effects.

First, as mentioned earlier, this could increase financing costs due to weakened incentives to repay. Second, while the doom loop at the national level would disappear, a new doom loop could emerge: sufficiently widespread panic about euro area countries’ ability to repay their debts could trigger a repricing of the senior tranche, destabilising the financial system Europe-wide. This, in turn, could force several countries to bail out their banks – creating a new, even larger doom loop at the European level.

To stay updated on all economic events of today, please check out our Economic calendar

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PIMCO

Economic

Bond

As post-pandemic disruptions to markets and economies recede, long-term trends are reasserting themselves. One key signal that markets are returning to historical patterns appeared in November, when a common yield measure on the Bloomberg US Aggregate Index climbed above the Federal Reserve policy rate for the first time in more than a year.

It’s difficult to overstate how extraordinary it was to have a benchmark bond yield running below – sometimes well below – the federal funds rate for such an extended period. Prior to the pandemic, this had only happened four times in this century, and never for more than a few weeks at a stretch (see Figure 1).

From Cash to Bonds: A Strategic Shift in Post-Pandemic Investing_1

This prolonged reversal in the usual market trend reflected not only the Fed’s restrictive policy, but also investors’ response to the extreme inflation spike and other consequences of the pandemic. Many investors retreated into cash – which offered yields not seen in decades along with perceived safety – and stayed there.

Changed circumstances

Two years later, the market landscape has transformed. Now that the Fed has embarked on a rate-cutting path, over-allocating in cash creates reinvestment risk as the assets rapidly and repeatedly turn over into lower-yielding versions of themselves.

At the same time, we witnessed a profound shift higher in bond yields from pandemic-era lows. Relative to cash, where yields are dwindling as interest rates drop, bonds offer a more compelling opportunity: Consider the same core bond index yield measured against another common proxy for cash, the yield on the 3-month U.S. Treasury (see Figure 2). Both cash and bonds offered attractive yields over the past two years, but cash investors by nature can’t lock in those yields for longer time periods – and since September, when the Fed cut its policy rate by 50 basis points (bps), the outlook for cash yields relative to core bonds has diminished sharply.

From Cash to Bonds: A Strategic Shift in Post-Pandemic Investing_2

The Fed’s trajectory is not a foregone conclusion, and indeed we may see some upward revisions in officials’ rate projections following the December meeting, but the data and the communications to date suggest the most likely scenario is one of gradually lower rates. The Fed is looking to secure a soft landing for the U.S. economy – with labor markets healthy and inflation near target – and it has flexibility to pursue its goals despite expected or unexpected obstacles (e.g., trade policy, geopolitics, price surprises). This rate environment is highly favorable for bonds.

Bonds for the long run

Based on current relative valuations and market conditions, we believe there is compelling value in high quality, liquid public fixed income. Starting yields are attractive compared with other assets across the risk and liquidity spectrum – including cash – and historically, starting yields have been a strong indicator of long-term fixed income performance.

Also, bonds are well-positioned to withstand a range of scenarios outside the baseline. Historically, high quality bonds tend to perform well during soft landings – and even better in recessions, should that scenario play out instead. Bonds also have performed well historically across a range of different rate-cutting scenarios (like snowflakes, no two monetary cycles are alike) – see Figure 3. Whether the Fed took a very gradual (“higher-for-longer”) approach, or initiated a drastic drop, or took a downward path somewhere between those extremes, bonds subsequently outyielded cash in each of those historical rate environments.

From Cash to Bonds: A Strategic Shift in Post-Pandemic Investing_3

Hedge and diversify risk

The bond market is effectively paying investors to hedge and diversify risk. Equity markets have a more checkered history with rate-cutting cycles, and indeed generally higher volatility over time – and we are in a period of heightened geopolitical unrest, along with leadership changes in major economies around the world.

Bonds and equities are negatively correlated today, after moving more in tandem during the post-pandemic inflation shock. A negative stock/bond correlation amplifies bonds’ potential to be a stable anchor for portfolios.

Historical trends also support bonds as an attractive risk hedge. Looking back at bond and equity markets on average since 1973, during periods when U.S. core bonds are yielding around 5% or greater while U.S. equities’ earnings ratios are above 30 – as they are today – bonds have offered higher five-year subsequent returns (see Figure 4), and with potentially lower volatility.

From Cash to Bonds: A Strategic Shift in Post-Pandemic Investing_4

A fixed income allocation offers attractive yields, potential for price appreciation, and a liquid hedge against the risk that equities or other more volatile assets see a sustained contraction.

Takeaway

Market signals and Fed moves mean that bond yields have turned a corner. The combination of high starting yields and anticipation for lower rates creates an attractive outlook for a wide variety of bonds. Investors lingering in cash may want to consider fixed income.

To stay updated on all economic events of today, please check out our Economic calendar

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FOREX.com

Commodity

Economic

Gold looked to end 2024 with its second consecutive monthly loss, casting a small shadow over an otherwise strong year. Despite the late-year weakness, the precious metal was managing a stellar 26% year-to-date (YTD) gain as of 19th December, when this report was written. Its performance outpaced key stock market benchmarks like the DAX (+19% YTD) and kept pace with the Nasdaq 100 (+26%), though Bitcoin’s extraordinary surge (130%) stole the spotlight. As we move into 2025, the gold outlook remains modestly positive, with a potential rally to $3,000 still on the horizon. However, near-term headwinds could weigh on its performance in the early months.

Strong dollar and yields: Potential obstacles for gold

One of the key drivers of gold’s rally in 2024 was the expectation that global central banks would ease monetary policy as inflationary pressures receded. While rate cuts materialised, their impact on gold was moderated by lingering inflation concerns. In December, the Federal Reserve enacted an expected rate cut but caused a bit of volatility as it signalled caution for the year ahead due to persistent inflation risks, driven partly by expected US policy shifts, including tax cuts and tariffs under the Trump’s presidency. Similarly, the European Central Bank and Bank of England adopted a cautious approach, citing strong wage growth and inflationary stickiness. As a result, monetary policy is likely to remain tight in early 2025, potentially supporting bond yields and the US dollar—two factors that often work against gold’s appeal.

Elevated bond yields are particularly significant as they increase the opportunity cost of holding non-yielding assets like gold. Concurrently, the US dollar’s resilience, bolstered by hawkish central bank policies and surprisingly strong economic data, has made gold relatively more expensive for buyers using weaker currencies. These dynamics could limit gold’s upside potential in the year’s first half.

Demand concerns in key markets: China and India

Gold’s two largest consumer markets, China and India, are facing challenges that could dampen demand. In China, a depreciating yuan and a sluggish post-pandemic recovery have made gold less affordable. The yuan’s recent slide to its lowest levels since the COVID-19 pandemic has effectively weighed on demand from an important region, particularly ahead of the Chinese Spring Festival, a period traditionally associated with robust gold purchases. With jewellery accounting for 65% of China’s gold consumption, the combination of weaker consumer purchasing power and economic uncertainty could constrain demand in early 2025.

India, the second-largest gold consumer, is experiencing similar pressures. A recent currency devaluation has eroded their purchasing power, making buck-denominated gold more expensive domestically. This is particularly concerning as India accounts for over 25% of global jewellery demand. The impact of higher gold prices is likely to manifest in reduced consumer spending on the shiny metal, especially among middle-income households, which form a significant portion of the market.

Beyond currency-related challenges, geopolitical risks also loom large. Potential US tariffs on Chinese goods could exacerbate economic pressures, while increased haven demand stemming from global uncertainties may only partially offset these headwinds.

Can gold decouple from risk assets?

Investor sentiment in 2024 leaned heavily toward riskier assets, initially fuelled by rate-cut hopes and then optimism following Trump’s re-election. Bitcoin, XRP, and other cryptocurrencies enjoyed meteoric rises, while equity indices like the S&P 500 and German DAX reached all-time highs. This shift in risk appetite reduced the allure of safe-haven assets like gold towards the end of the year, which typically thrive during periods of economic uncertainty – although in more recent years both gold and the S&P 500 have been going in the same general direction. Therein lies the problem with gold: can it decouple from risk assets?

Regardless of the stock market direction, gold’s long-term appeal remains intact. Inflation continues to erode the purchasing power of fiat currencies, reinforcing gold’s status as a store of value. Moreover, geopolitical tensions—from the Middle East to potential trade wars—could rekindle haven demand, providing a counterbalance to last year’s risk-on sentiment.

Can gold rally to $3,000 in 2025?

Despite short-term challenges, a $3,000 gold price target remains feasible. Corrections or consolidations in the early part of the year could set the stage for a renewed rally. Thanks to gold’s strong performance in 2024, any significant price declines could attract bargain hunters and long-term investors, who either took profit or missed out on the big rally. These factors should help to stabilise the market and pave the way for future gains.

Geopolitical risks and macroeconomic shifts are likely to play pivotal roles in shaping gold’s trajectory. For instance, the unwinding of the “Trump trade”—a phenomenon characterized by a strong US dollar and robust equity markets—could weaken the dollar and bolster gold prices. Additionally, central banks, which slowed their gold purchases as prices peaked in 2024, may resume buying if prices correct meaningfully in 2025.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Justin

Economic

Central Bank

Now that US legislators have agreed to continue spending and avoid a government shutdown, the next issue coming up is the debt ceiling. Two years ago, it was suspended for a set period of time in order to avoid the kind of spending debates under pressure as seen over the last couple of weeks. But the ceiling is set to snap back into effect with the end of the year.

That means that starting on January 1st, 2025, the US federal government will not be able to increase its debt. It still will be able to borrow money, and has a calendar in place to auction off new bonds as part of its routine operations. But, I won’t be able to borrow more money. New Treasury issuance will be used to pay off existing obligations, but the net amount of borrowing will (theoretically) remain the same.

There’s a Lot of Accounting

But, that doesn’t mean the debt will stop increasing. The bulk of the US government’s debt is in “mandatory spending”, which are things that Congress has already authorized to be spent but hasn’t provided the means to obtain the funds. Those include health care and pensions. Also – of special interest for forex traders – interest. Just the main mandatory spending elements amount to over 53% of the government’s spending.

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But, that’s fine because the government won’t immediately run out of money. As of writing, it has over $775 billion in cash, which amounts to 42% of the annual projected deficit. In other words, the US government can keep functioning for at least the next quarter, if not as far as June. And then it can start taking so-called “extraordinary” measures to conserve cash. Hitting the debt ceiling isn’t an immediate problem for the government.

Where Is the Problem

That headroom assumes continued income and spending around the same level. If Trump as President wants to enact policy that, for example, reduces tax income, then that window gets smaller. If the economy grows faster than anticipated, then the government will collect more revenue, and the window widens.

However, the main issue for forex traders is how this affects interest rates. After all, it’s the interest rate that drives the relative demand for the dollar. But, if investors start to seriously worry that the government will default, then a “risk premium” is added to the interest rate. That means the nominal rate is higher, the dollar could weaken as traders factor in the risk that the debt they are buying won’t be fully paid off.

The Interest Rate Moves

If there is a particularly fiery political debate over the debt ceiling, credit agencies could lower their rating for US debt. That would increase borrowing costs, widening the interest rate gap with other currencies, also making the dollar stronger. But, if the situation is resolved with the inevitable increase in the debt ceiling, then the extra spending will likely be deemed inflationary, also raising the interest rate.

Overall, the debate over the debt ceiling next year is likely to be one of the factors contributing to a stronger dollar, at least in the first quarter. With plenty of funding still available, the issue might be kicked forward for a month or two initially. Just like it was last time the debate came up. Then the situation would be expected to normalize.

Source:Daniel John Grady

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Warren Takunda

Cryptocurrency

Bitcoin (BTC) still risks falling to $80,000 in a bull market correction, the latest prediction from a popular chart analyst warns.

In X posts on Dec. 26, Chartered Market Technician Aksel Kibar revealed a BTC price target near old all-time highs.

BTC price teases uptrend reversal pattern

Bitcoin has failed to recover $100,000 support over the past week, and downside BTC price targets range from $90,000 to as low as the mid-$60,000 range.

For Kibar, the reality could lie somewhere in the middle.

Analyzing daily timeframes, he flagged what could become a head-and-shoulders pattern — a classic feature marking an uptrend breakdown.

“Breakout from the broadening chart pattern that completed on $BTCUSD... the pullback can take place with a possible short-term H&S top. (IF) the right shoulder becomes better defined…,” he commented.

“Keep this possibility on your watchlist.”

Another post mapped out how low BTC/USD could go should such a scenario play out.

Kibar added:

“If the pattern acts as a H&S top, the price target is at 80K. This can be the pullback to the broadening pattern that completed with a breakout above 73.7K.” Bitcoin 'Head and Shoulders' Pattern Risks $80K BTC Price Dip_1

Bitcoin 'Head and Shoulders' Pattern Risks $80K BTC Price Dip_1

BTC/USD 1-day chart. Source: Aksel Kibar/X

Responses to the analysis suggested that the majority believes that the correction could not end up being so deep — something Kibar said reinforced his position.

Bitcoin whales hint at bull market return

Meanwhile, Bitcoin bulls have yet to gain sufficient momentum to fend off snap rejections at levels such as the 21-day simple moving average, currently at $99,425.

News of erroneous TradingView data showing Bitcoin market dominance at 0% caught traders’ attention during a Boxing Day sell-off.

However, despite the lack of bullish progress, there are signs of a crypto market comeback.

“After the post-Christmas market-wide dip, crypto markets are seeing an encouraging trend of whales moving stablecoins to exchanges,” research firm Santiment revealed in its latest analysis uploaded to X on Dec. 27.

Referencing one of its proprietary analytics tools, Santiment described monitors as “being dominated by stablecoin deposits to exchanges.”

“Though it's not a guarantee that these whales plan to put this dry powder to use right away, consider this a bullish sign as 2024 sees its final days,” it concluded.

As Cointelegraph reported, the US spot Bitcoin exchange-traded funds (ETFs) squeezed out a net inflow day after four “red” days where net outflows passed $1.5 billion.