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lnstitute for Fiscal Studies abrdn Financial Fairness Trust Nuffield Foundation Economic and Social Research Council IFS Report R340Benjamin NabarroUK economic outlook:navigating the endgameThe IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 1 1.UK economic outlook:navigating the endgameBenjamin Nabarro(Citi)Key findings 1.The UKs economic performance over the past two decades is hard to describeas anything other than a policy failure.Productivity growth has been dire with per-worker growth over the past decade the weakest on average since at least 1850.Theinnovative engine behind the UK economy seems to have stalled.In 2014,a littleunder 6%of all firms in the UK(14,000)were high-growth firms employing at least10 people and growing their headcount by more than 20%per annum for three yearsrunning.This has fallen to just under 4%now.Macroeconomic resilience also seems tohave suffered as low growth,low investment and weak income growth have all fedback into one another.2.The growing global challenges surrounding ecological and geopoliticaltransition should add to a sense of urgency.These imply further economicheadwinds to growth in the years ahead,alongside heightened volatility.More physicalinvestment will be required to ameliorate these effects.But this does not constitute astrategy for addressing the UKs existing growth shortfall.High debt levels,astructural external financing gap and elevated rates volatility mean the stock ofoutstanding debt is a growing vulnerability.In this sense,the UK likely finds itself ina worse position than the US or the Euro Area.3.The UK needs to lift growth despite these growing challenges,in the context of limitedpolicy space.Here we think the focus should be on boosting intangible and ICTinvestment,alongside broader efforts to improve diffusion from the technologicalfrontier.Both growth and resilience will need to be areas of focus.The UK,as asmall open economy,remains particularly exposed to future shocks.Efforts to bolsterresilience,as well as better coordinating monetary and fiscal policy,will be crucial tonavigating these shocks better in future.In our view,without countercyclical burdenUK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 2 sharing between monetary and fiscal policy,structural efforts to lift trend growth are unlikely to be successful.4.The cyclical outlook we present here is one of near-term sogginess and medium-term optimism.Globally,we think the near-term outlook is likely to remain somewhat weak.Supportive factors for demand in particular,significant fiscal support are beginning to fade.Continued structural uncertainties in China recent stimulus notwithstanding remain a headwind across Europe.And US growth exceptionalism does appear to be gradually fading as the impact of tighter monetary policy feeds through.We expect global activity to fall back in the second half of this year.This implies fading external support for UK growth as we move into 2025.External inflationary influences are also likely to continue to fade.5.The UK economy has surprised to the upside since the start of 2024.We now expect real GDP growth of 1.0%this calendar year,compared with a forecast of just 0.1ck in January.But these welcome improvements are not yet indicative of a secure economic recovery.Instead,they primarily reflect transient improvements in capacity as energy prices have fallen back.For now,the outlook for the core domestic demand engines for the UK remains subdued.A sharp improvement in real incomes since the start of the year has not yet translated into stronger consumer spending.Firm sentiment and investment intentions have improved but remain on the defensive side.And public consumption is likely to prove constrained.We expect growth to remain positive but weak in the near term,with real GDP increasing by 0.7%next year.6.A procyclical monetary policy approach risks slowing the recovery in our view.Structural changes have slowed the transmission of monetary policy into economic activity.The effects of higher interest rates may become more material as many parts of the economy are forced to borrow once more;around half of the cumulative effect of monetary policy is still to be felt.This will suppress demand,just as the supply side of the economy begins to recover.Better news in the latter case reflects lower energy prices,and rebalancing between labour and non-labour inputs in production.This is cause for optimism,although monetary headwinds will make it difficult to capitalise immediately.We expect growth to accelerate markedly through 2026 and 2027 as monetary and fiscal constraints are eased.7.The outlook for the household sector should improve modestly in the months ahead,although household sentiment remains somewhat defensive.Much will depend on developments in the household saving rate.The cash saving rate i.e.excluding the imputed equity of pension funds has climbed from 3.4%just before the pandemic to around 8%now.This has been pushed higher by a The IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 3 combination of uncertainty,consumption smoothing and balance sheet impairments.In the months ahead,we think the saving rate may come down modestly as uncertainty dissipates although we expect the rate to remain elevated as households overall are significantly less well off now than before the pandemic.We expect private consumption to increase by only 0.6%in 2025,compared with 1.5%in the Bank of Englands baseline estimate.The outlook for firms should improve as supply growth picks up and costs decline,though any gains will come from a weak base.Business investment should recover gradually as interest rates fall.8.Excess labour demand present through 2022 and 2023 has now been eliminated.We think most recent data suggest the labour market is continuing to loosen.Vacancies have continued to trend down over recent months,if perhaps at a more moderate pace than last year.Private employment dynamics also look weak,at least according to the PAYE data.As public sector employment growth slows,we think the unemployment rate will increase to 4.9%next year and 5.3%in 2026.The risks here seem broadly balanced,although a flattening in the Beveridge curve would,if anything,imply a faster pass-through from lower vacancies into higher unemployment from here.We expect a modest loosening of the labour market to weigh on wage growth and consumer confidence into 2025.9.The UKs inflation process over recent years has been primarily conflictual in that high wage growth and services inflation both reflect efforts to make up for large losses associated with an adverse terms-of-trade shock.This,we think,has contributed to sticky wage and services price inflation over recent months.But increasingly we think there are signs that these effects are beginning to fade,with the real income loss associated with the shock now having been more than fully absorbed.Evidence of further agitation around either inflation or nominal wage growth seems limited,and confined to a few specific quarters.And forward expectations for both wages and prices are now broadly consistent with the inflation target.The natural decay in the UKs inflation processes primarily reflects the relatively high cost of conflict rather than the demand-destructive impact of higher rates.Inflation seems to have broadly returned to target without much direct input from monetary policy.To the degree that the latter now weighs on demand and slack,we expect to undershoot the inflation target through 2026.10.The Monetary Policy Committee(MPC)remains in an inflation-averse state of mind.Having cut rates for the first time in August,we expect the committee to ease policy only gradually over the coming months as evidence around inflation continues to accumulate.However,if the labour market does loosen through the first half of next year,we think that is likely to signal the committee should pick up the pace.In our UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 4 view,a continued focus on the upside risks around inflation,while understandable,is increasingly inappropriate.We expect the MPC to cut rates into accommodative territory through 202526 as policy refocuses on the risks around the labour market,and monetary policy is forced to correct for a procyclical monetary and fiscal stance through 2023 and 2024.11.After two decades of stagnation,change is needed.The outlook is for a period of near-term sogginess,followed by a more robust cyclical acceleration as supply-side improvements continue to materialise.This may provide a window of opportunity.Already,in the past decade,the gap between what the UK economy can support,and what has societally been promised,has widened.This is combined with the potential for an intermittently binding external liquidity constraint that also poses more acute risks.In a context of growing international rates volatility,the UK does not have time to spare.1.1 Introduction The UKs economic performance over the past two decades can only be fairly described as a policy failure.In the wake of the financial crisis,trend productivity growth has decelerated more abruptly than elsewhere.That has been accompanied by acute fiscal policy error through the financial crisis and then the post-COVID period both of which have added further embedded losses.The result is increasingly pronounced economic weakness,constraints on fiscal policy and a widening gap between what the UK can produce and what society demands.The outlook presents opportunities for meaningful structural reform,but also reaffirms the risks associated with continued inaction.In the near term,the outlook is framed by underlying improvements around the supply side of the economy,but also continued sogginess on spending and demand.We expect growth to remain subdued into 2025,decelerating from 1.0%this year to 0.7%next,as policy headwinds continue to bear down on the recovery.However,we think this is likely to precede a fuller economic recovery through 2026 and 2027 as improvements in supply are realised.Unemployment,in the meantime,will increase to around 5.2%by early 2026 as a margin of excess labour demand emerges,before falling back thereafter.We expect inflation to remain in a 23%range in the near term before decelerating more fully through the end of next year as stronger energy effects fade and slack bears down on domestic prices.We expect an undershoot in headline CPI through much of 2026.Here,our outlook is framed by three themes.The IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 5 First,and on the more optimistic side,we do see potential for some catchup on the supply side after the recent shock-induced stupor.The large shocks that have buffeted the UK in recent years are either fading or reversing.Excess global manufacturing capacity seems to be increasingly feeding into lower UK import prices.Energy prices also seem likely to moderate further recent geopolitical news notwithstanding.In the UK,these supportive headwinds are then complemented by improving productivity as input prices fall,capacity comes back online and production rebalances in a more capital-intensive direction.The net implication is that near-term supply growth is likely to be around 2%or so stronger than the 1.41.5%long-term trend that is often assumed.Second,the outlook for the demand side of the economy is,if anything,deteriorating.Over recent years,fiscal policy has stimulated in response to supply shocks.Some adjustment will be required as this procyclical fiscal stance is gradually unwound.This has also brought fiscal policy increasingly into conflict with monetary policy which has been forced to be more aggressive to offset the impact of fiscal support.The implication is that the UK will likely see concurrent fiscal and monetary headwinds into the end of 2025 as the supply shocks that have so far driven this cycle begin to fade.Demand headwinds could be compounded by balance sheet impairments accrued during the pandemic,which we continue to think will keep household saving somewhat elevated.We think a rise in unemployment may be the result.The third factor is a lingering degree of inflationary aversion on the part of monetary policy.This is understandable given the experience of recent years,but perhaps no longer the right approach.As inflation has jumped in recent years,the scale of the monetary policy response has reflected a desire to weigh disproportionately against the risk of embedded inflation,as well as offsetting the impact of a procyclical fiscal stance.This has meant a more activist and hawkish stance.However,the balance of risks has materially shifted.Supply shocks are reversing.Fiscal policy is inflecting.Inflation is fading.And the labour market appears increasingly vulnerable.The full spectrum of risks should increasingly be incorporated into policy deliberations going forward,rather than simply those around inflation.In our view,the Monetary Policy Committee(MPC)is already too slow on the turn.This adds to the risk that policy is ultimately cut into accommodative territory in the years ahead to make up lost ground.Together,these points suggest that good economic news is coming,but its realisation may be deferred rather than immediate.In the very near term,the UK faces the legacy of the latest round of macroeconomic policy mistakes.But,once adjustments have been worked through,a window of opportunity should emerge.It is vital policy utilises that momentum to drive a more meaningful structural improvement.Below,we begin by discussing the structural challenges posed by the economic inheritance(Section 1.2).We then turn to the global and domestic outlook for activity(Section 1.3),before UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 6 turning to the labour market in Section 1.4,inflation in Section 1.5 and policy conclusions in Section 1.6.1.2 The economic inheritance On 28 February,Chancellor Rachel Reeves warned that the incoming Labour government would face the worst economic situation since Second World War.1 We would not go that far.But Ms Reeves does take the helm after two decades of chronic economic mismanagement.If the UKs 20th century economic experience was framed by three mistakes return to the gold standard and austerity in the wake of the 1929 crash(Eichengreen,1992;Gwiazdowski and Chouliarakis,2021;Heffer,2024);a failure to engage with Europe from a position of strength in the 1950s(May,1998);and the conflation of serious supply reform with expedient demand stimulus in the early 1970s(Morrison,1974)then all three errors have been repeated to some degree in the space of a decade and a half.The result has been abject economic performance.Trend UK productivity growth has collapsed to near-record lows.And various measures of public service performance and well-being including improvements in longevity have stalled(Health Foundation,2019).This should be a call to arms.Poor performance,when sustained,becomes harder to reverse and more uncertain in its institutional consequences(Eichengreen,2018).It is also likely that the global macroeconomic and financial environment is becoming more adverse.Lifting trend growth is likely to be essential if the UK is going to deal with the choppier waters ahead and make the economic transitions required by major ecological and geopolitical challenges.In this section,we consider what explains the slump in productivity and what might be needed for the UK to transition to higher growth.We then turn to some key issues with the UKs macroeconomic resilience,and to some legacy macro-financial risks which will constrain the Chancellors policy options.What will it take to get higher growth?UK economic activity is 36%lower than it would be had it continued to grow in line with its 19972008 trend.This compares with 31%in the Euro Area and 24%in the US,comparable countries that at least in the latter case have faced similar shocks.While most advanced economies have experienced slower trend growth,the decline in the UK has been particularly severe.This has been compounded by a further relative deterioration in the UKs post-COVID 1 https:/ IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 7 performance,with UK GDP now 6.1%short of its pre-pandemic(201419)trajectory,compared with 4.3%in the Euro Area.Figure 1.1.UK GDP versus historical trends Note:Pre-GFC trend here is calculated between 1960 and 2007 and post-GFC trend is 201019,where GFC is Great Financial Crisis.Source:ONS.Figure 1.2.UK potential growth in GDP per worker(10-year moving average of year-on-year%growth)Note:Potential GDP is measured here by taking observed GDP adjusted by an Okun rule.This is then divided by the number of workers.In more recent years,we have taken OBR estimations of potential.Average is taken over a 10-year rolling window.Source:ONS,OBR,Thomas and Dimsdale(2016).01002003004005006007008009001,000196019641968197219761980198419881992199620002004200820122016202020242028 billion,2022 pricesRealisedCiti forecastPre-GFC trendPost-GFC trend-2%-1%0%1%2%3%468187818881898190819181928193819481958196819781988199820082018%year-on-yearSpanish fluUK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 8 This slow growth in UK output is despite a material increase in labour supply.Productivity measured by output per worker,or per hour worked has therefore fared even worse(Van Reenen and Yang,2024).The recent decline in potential output per worker in the UK is unprecedented since the late 19th century(see Figure 1.2).Nicholas Crafts,before his passing last year,noted that the slump in productivity growth is unprecedented in the last 250 years(Crafts and Mills,2019).A simple growth accounting exercise is useful here.The decline in real GDP growth in the UK of around 1.8 percentage points(ppts)on average between 19952006 and 200719 can be decomposed into changes in:labour supply( 0.1ppt);human capital,as measured by average years of schooling(0.2ppt);2 physical capital(0.5ppt);and total factor productivity(1.2ppt).3 The last is by far the largest driver.According to these data,total factor productivity(TFP)in the UK was 4.6%lower in 2019 than in 2007(similar to the fall in France).Over the same period,TFP has increased by 2.2%in Germany and 5.1%in the US.What explains this weakness?Here it is worth taking the decomposition above with a pinch of salt.TFP is measured as a residual effectively describing those activity improvements that cannot be explained by physical capital,labour or human capital.The outcome is therefore heavily dependent on what kind of capital data are used.Using some more granular data,such as the OECD KLEMS data,suggests slower capital deepening has contributed to a more abrupt productivity slowdown here than it has in France,Germany or the US(Van Reenen and Yang,2024).But this faster slowdown is concentrated in either digital infrastructure or intangible assets,rather than major capital projects.We think this helps explain the faster fall in simpler measures of TFP,which are likely to reflect this deceleration in intangible investment as a residual.Decelerating digital and intangible investment fits with the pattern of UK growth after the financial crisis,with a faster slowdown in productivity in intangible-intensive sectors many of which faced a particularly abrupt credit crunch(Goodridge and Haskel,2022;Bailey et al.,2022).Ahn,Duval and Sever(2020)find there was a materially larger reduction in intangible investment in indebted firms than in less indebted equivalents or indeed in investment in tangible assets across OECD countries.The subsequent increase in many firms preference for internal liquidity seems to have been persistent,with a widening gap between the cost of capital 2 For details,see https:/www.rug.nl/ggdc/docs/human_capital_in_pwt_90.pdf.See also Feenstra,Inklaar and Timmer(2015).3 Decomposition of change in real GDP growth between 19952006 and 200719,assuming a CobbDouglas constant-returns-to-scale production function.Citi analysis based on Penn World Tables and ONS data.Compares the UK with a weighted average of France,Germany and the UK.Similar benchmark countries are used in other studies,such as Van Reenen and Yang(2024).The IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 9 and the rate of return required for firms to deem projects worthwhile their hurdle rate(Cunliffe,2017;Melolinna,Miller and Tatomir,2018).These more persistent effects have effectively strangled investment in digital and intangible assets over recent years.In fact,we think the impact has been twofold.First,these challenges have weighed heavily on investment in the first instance.Second,they have also limited firm entry and competition.For firms of a certain size,borrowing against cash flow is possible,enabling incumbents to continue to grow.But for smaller firms,the tyranny of collateral is more obviously binding(Cecchetti and Schoenholtz,2017 and 2018).For example,in the UK,a 2015 survey found that 90%of all lending to small and medium enterprises(SMEs)was secured against some kind of physical collateral(Haskel and Westlake,2022).This has limited reallocation,weighing on growth.This has also enabled a degree of strategic underinvestment on the part of incumbents.In an oligopolistic market,investment becomes something of a strategic game.If other firms dial back,this can quickly be perpetuated across the sector at large.The logic here is involved and difficult to prove.But a decline in reallocation and competition does fit the broad patterns we see in the data.We also know that the gap in firm productivity levels between sector leaders and laggards has been widening for some time(Andrews,Criscuolo and Gal,2015;Autor et al.,2020).While the contribution to growth of the 10%most productive firms outside of the financial sector has been roughly constant over time,the contribution of the upper middle(those between the 50th and 90th percentiles of productivity)has more than halved since the financial crisis(Office for National Statistics,2022).Given the associated concentration of the growth slowdown in more intangible-intensive sectors,it is plausible that financial constraints are weighing on both new entry and broader digital investment.What will it take to improve this picture?We think the focus should be on institutional arrangements for investment.For example,improving the tax treatment of certain kinds of equity finance could help,and also allow a better sharing of risk and reward between firms and lenders(Hosono,Miyakawa and Takizawa,2017).For now,the tax treatment continues to favour debt finance(Adam,Delestre and Nair,2022).Encouraging larger firms,which can borrow against proven intangible expertise,to finance smaller equivalents could also boost investment,as well as improving the sharing of expertise.4,5 Much more work will be needed here to shift the balance.4 Haskel and Westlake(2022)note that many larger firms are often able to borrow on the basis of cashflow covenants,but this is usually only available to larger firms.See also Lian and Ma(2021).5 The literature on foreign direct investment speaks to potential productivity benefit associated with investment agreements if also associated with knowledge sharing.See Baldwin(2016).UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 10 Aside from finance,a range of other challenges have impeded reallocation.Four stand out:Technological issues associated with frontier firms,and associated challenges around competition policy,as incumbency advantages count for more.Low labour mobility,as high housing costs have disincentivised workers from moving to more productive regions.Young renters are less likely to move than in the past,and rental prices have tended to grow more quickly than wages in faster-growing areas(Judge,2019).Weak transport infrastructure,particularly in large UK cities outside of London.Only 40%of the urban population can reach these city centres by public transport in 30 minutes,compared with 67%in continental Europe(Rodrigues and Breach,2021).This has stunted thick market effects that can otherwise boost the efficacy of local labour markets.Growing skills shortages,particularly in STEM subjects(Stansbury,Turner and Balls,2023).OECD analysis marks the UK out as suffering a particularly severe mismatch between workers fields of study and job requirements,and a greater extent of workers underqualified for their jobs(Deb and Li,2024).Falling spending on adult skills,from an already low base,will not have helped.In all cases,these effects risk inhibiting competition at the frontier,and more broadly limiting productivity growth.And their effect has been to gradually bear down on business dynamism i.e.the rate of firm turnover.Here the fall has been significant and consistent over recent years(see Figure 1.3).This,we think,is a function of both pull and push factors.On pull factors drivers that are pulling capacity from less productive areas a thinning in the number of growth opportunities has also meant a decline in the number of high-growth firms.6 In 2014,a little over 6%of all firms in the UK(14,000)were defined as high-growth firms.This has fallen to just under 4%now.Brexit may have played a role here,with many such firms historically utilising single market membership to boost their growth(Freeman et al.,2022).There have also been push factors i.e.capacity remaining trapped in suboptimal allocations for longer.Here the most obvious cases have been in the initial period after the financial crisis and in the post-COVID period.In the former case,weak financial institutions may have played a role,with weak financial balance sheets creating an incentive not to recognise losses.But increasingly through the pandemic the same effect has operated,even as financial institutions have remained robust.In part,this may reflect the direct impact of sweeping subsidies,which allowed some firms to cling on.It may also be that in a more intangible-intensive economy,6 Here we are defining these in terms of employment.High-growth firms are defined by the OECD as firms employing at least 10 people and enjoying employment growth of more than 20%per annum for three years running.The IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 11 firms have an incentive to protect sunk costs in the form of firm-specific assets until they become unviable from a cash-flow perspective.This can take some time.While less churn may sound like a good thing,a moderate rate of firm failure and creation is indicative of a healthy process of creative destruction that supports innovation and productive reallocation.The scale of the reduction here should be a growing cause for concern.Figure 1.3.UK job destruction and creation owing to firm turnover(%of total employment)Note:Measure reflects the share of total employment that is reallocated owing to firm creation or destruction per quarter.Source:ONS.Improving macroeconomic resilience The ability of the economy to recover from macroeconomic shocks is important.Supply shocks are as we note below growing more frequent.And the UK,as a small open economy,is often especially exposed.Unfortunately,the UKs performance in this respect seems to be getting worse.Its cumulative recovery from the pandemic has been comparatively underwhelming.And as shown in Figure 1.4,the cumulative recovery in real GDP since the pandemic has been weaker than the UKs recoveries from previous shocks,except for the Great Financial Crisis.Now,as then,we think the loss in the level of GDP is unlikely to be made up anytime soon.While the financial crisis and the pandemic were very different shocks,we think both episodes highlight some key macroeconomic vulnerabilities that may impede future economic recovery.0.0%0.5%1.0%1.5%2.0%2.5%3.0%Q4-1999 Q4-2002 Q4-2005 Q4-2008 Q4-2011 Q4-2014 Q4-2017 Q4-2020 Q4-2023%of total employmentCreationDestructionUK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 12 Figure 1.4.Real GDP recovery from various macroeconomic shocks Note:Figures show the cumulative GDP recovery,with the index linked to the pre-recession peak.The data for the latest cycle run to the end of 2024,with 2024 Q3 and Q4 numbers Citi nowcasts.Source:ONS.First,there has been a structural decline in macroeconomic flexibility.Sectoral reallocation,particularly in an acute context,seems to have slowed.The UKs recovery after the financial crisis,for example,was characterised by an unusually high dispersion of relative prices and capital returns(Broadbent,2012).This reflected challenges reallocating resources across different economic sectors(Barnett et al.,2014).Significant shifts in relative prices are evidence of similar challenges in the post-pandemic period.In recent years,these have also been accompanied by an increase in wage dispersion.In part,this may reflect some of the skills issues above,and an associated drop in intersectoral job mobility.In 2006,52%of all job moves were to a different industrial(SIC)sector,but this had fallen to 37%in the latest data.The gap between tasks in jobs that are being hired for,and those jobs that are being dissolved,is increasingly stark(Nabarro,2022a).For the UK,this is a particularly pressing issue,especially when it comes to reallocation between the tradable and non-tradable sectors.In a more volatile global supply and rates environment,one of the ways the UK can adjust to for example an adverse shock in global rates markets would be to devalue the currency,and reallocate more domestic production towards the tradable sector(Broadbent,2011).If that is becoming increasingly difficult,then more of the associated loss must be absorbed by domestic demand.That is a more painful process.7580859095100105110-1 0 12 34 56 78 9 10 11 12 13 14 15 16 17 18 19 20 21 22Index(pre-recession peak=100)Quarters since start of shockQ2-1920Q4-1925Q1-1930Q2-1973Q4-1979Q2-1990Q1-2008Q3-2019The IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 13 Second,the UK has suffered from a lack of systematic coordination between monetary and fiscal policy.Both in the period after the financial crisis,and in the response to the terms-of-trade shock in 202122,monetary and fiscal policy worked against one another.In the former,fiscal consolidation arrested balance sheet repair,limiting the impact of monetary loosening.In the latter,sweeping cash support limited the effective propagation of the original price shock,and also worked against tightening monetary policy.Early evidence suggests relative success at the height of the pandemic,with monetary and fiscal policy working hand in glove although there is an argument this went somewhat too far with the benefit of hindsight(and the efficacy of the vaccines).At best,this is self-defeating.But at worst,the UK macroeconomic response has not just been imbalanced,but often particularly poorly selected favouring the instrument that is least appropriate.As we note below,in recent history this has reflected the use of an instrument with a long outside lag interest rates to address an immediate inflationary risk,instead of an instrument with a much shorter outside lag acting in the opposite direction.That has forced monetary policy to do more in order to secure the necessary insurance.The implication is a weaker outlook now as further policy adjustment works through.Third is an absence of strategic economic leadership.At times of great uncertainty,providing some strategic clarity can be crucial to triggering an effective investment response.In a context of reallocation,this can be relatively powerful.One way of thinking about this is the effective cost of capital in an investment decision being a function of the rate of interest,the depreciation rate and the expected change in valuation.In the event of economic reconfiguration,at least a portion of the existing asset base is likely to fall in value.But the present value of new investment should,by contrast,be elevated.Appropriate policy interventions can protect investment by separating the former and the latter(Vines and Wills,2020).That,in turn,can help reduce scarring via capital deepening(Krugman,2009).Unfortunately,when confronted by this in the recent past,official silence has been deafening.Managing macro-financial risks and navigating new constraints In the face of the chronic growth challenge,the most obvious,and indeed tempting,response may be a large debt-financed programme of public investment a fiscal throw of the dice.We think this impulse should be resisted for two reasons.First,many of the challenges described above require reform,not only investment.That in turn requires care.And second,and perhaps more importantly,recommendations for such shock therapy pay insufficient attention to the risks the UK increasingly faces as a large dual-deficit economy one with both a government current budget deficit and a current account deficit.Looking forward,we think this will limit policys room for manoeuvre.The fundamental issue here is the combination of a high debt stock,increasing volatility on the supply side of the global economy,and the continued need for the UK to attract international capital.As we have seen in recent years,the risk of adverse supply and price shocks seems to be UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 14 increasing.Figure 1.5 shows the trend over recent decades,with supply generally a benign and mildly positive economic force through the 1990s and early 2000s.Since the financial crisis,however,this has changed.And rates volatility has begun to increase.The implication,we think,is that we now need to take the outstanding debt stock rather more seriously.The risk scenario is as follows.A further adverse supply shock such as a major increase in the price of tradable goods hits.Inflation begins to rise.Rates,globally and domestically,move(further)above nominal GDP growth.In response to a fall in growth and real incomes,the government feels compelled to offer sweeping support.As more capital is demanded,investors begin to wonder when and how the UK will move from a large primary budget deficit to a surplus sufficient to stabilise debt in the medium term particularly in a context of higher rates.Given higher existing debt levels,investors may be less patient,and increasingly demand a premium.As yields move higher,the underlying fiscal position worsens.This dynamic begins to feed back on itself.Figure 1.5.Decomposition of macroeconomic volatility,1970 to 2027 Note:Supply and demand shocks are identified using an agnostic identification procedure(Uhlig,2005).A positive demand shock is characterised as a positive shock to both output and inflation.A positive supply shock is a positive shock to output but a negative shock to inflation.A negative supply shock is characterised as a negative shock to output and a positive shock to inflation.A negative demand shock is characterised as a negative shock to both output and inflation.The bars show the net balance each year,on a three-year rolling-average basis.Figures for 2023 to 2027 are Citi forecasts.Source:Thomas and Dimsdale(2016),Uhlig(2005),ONS,Citi Research.-2.5-2.0-1.5-1.0-0.50.00.51.01.5197019741978198219861990199419982002200620102014201820222026Index(three-year moving average)Balance of demand shocksBalance of supply shocksForecastThe IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 15 To be clear,the vulnerability here is not the stock of debt per se but stems from the traded character of government bonds(gilts)and the UKs external financing gap.The former means that buyers of UK sovereign debt can exert some market power,effectively going on strike until they are happy with the level of yields.The latter means that in the event of such speculative stress,the UK cannot resort to more forceful forms of financial repression to act as a circuit breaker.As we saw in October 2022,market maker of last resort operations are viable but as the Bank was clear at the time can only arrest the violence of the move,and not offer an effective yield cap.Speculation could also see the currency devalued.But given the weakness of the initial response of the current account,this would do little to address the external financing need as trade values would likely not react.Specifically,as we discussed above,the response of domestic production to the exchange rate seems to have become increasingly muted.This means more adjustment is now pushed to domestic demand.At best,these dynamics can immediately demand a tightening policy response,with painful results.At worst,they could force the UK to close its external financing gap very quickly,with potentially disastrous results.These vulnerabilities are to some extent unique to the UK.In the US,reserve currency status limits the buyer power of bondholders.In the Euro Area,as in Japan,a large current account surplus enables a greater degree of domestic control,at least hypothetically.It is plausible that these governments could find the capital to fund domestic liabilities if they could find a means to direct them.In the UK,there is no such recourse.Structural changes in the gilt market are further adding to the vulnerability here.Domestically,traditional demand for longer-duration bonds seems to be falling as defined benefit pension schemes wind down.7 This leaves the overall debt servicing burden more sensitive to changes in market rates.And the UK remains dependent on foreign buyers of sovereign assets.As gilt holdings in the Bank of Englands Asset Purchase Facility wind down,this dependence is only likely to increase.This should engender caution surrounding further goodwill especially as global investment inflows move away from traditional allies.Fundamentally,alongside a solvency issue,there is a lingering liquidity issue that will stalk UK fiscal policy for some time to come.This,we think,is especially relevant to discussions around the public balance sheet.While it may be appropriate to pay greater attention to the balance sheet position in time,issuing gilts to build physical assets would still reflect an increase in fiscal risks for the UK(see Chapter 2).This needs to be both reflected and managed.For policy,we see three implications:7 https:/ economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 16 1 Higher and more volatile rates should mean more concern around outstanding debt,and stronger preferences for a smaller outstanding stock.Over recent decades,such concerns have been effectively rendered moot by the trend decline in rates.That is unlikely to be as supportive going forward.This should suggest some concern about a further ratchet up in outstanding debt,especially if supply shocks become more common.2 Creative solutions are needed to address investment demands,without accruing even more conventional debt.Here,the underlying risk emanates from the buying power of bondholders and their ability to go on strike.Other avenues of bolstering the asset base may offer better trade-offs from a liquidity point of view.Structures such as co-investment are by no means risk free but,to the extent they enable investment without adding to the stock of liabilities that could be speculated upon,they could create a better trade-off between risk and benefit than merely funding such schemes up front.3 The macroeconomic policy balance in the event of further cost shocks probably does need to be re-appraised.We would argue for fiscal policy to show some initial restraint in the event of shocks,and that monetary policy should be a little more passive.Fiscal expansion not only increases pressure on funding.But to the degree it forces monetary policy to be even more aggressive,this in turn can feed back into the medium-term rates profile.That can fuel speculation about the UKs capacity for fiscal pain.Not only is a rates-driven response to such shocks ineffective or painful economically,it is also financially risky at least if higher rates are expected to persist for some time.Summing up:charting a better path The UK is likely to face a series of strategic demands for resources in the years ahead for the net zero transition,in response to geopolitical risks or for investment in public services(particularly in health and social care as the population ages).While ignoring these demands would ultimately be economically harmful,these investments are unlikely to deliver meaningful growth.In fact,they are likely to cost.To meet these challenges,policymakers need to act urgently to boost growth and improve the UKs ability to recover from future shocks.Transitioning to a high-growth,high-investment equilibrium will require greater policy focus on:the treatment of intangible assets,improving skills,labour mobility and business dynamism.Such efforts will likely need to be accompanied by a more thoughtful playbook in terms of managing supply shocks,particularly when it comes to the balance between monetary and fiscal instruments.This reform agenda must now be delivered within more pronounced policy constraints,and in a context where the risks of overstepping those constraints are plausibly greater.This should temper the impulse to rely primarily on significant increases in debt-funded public investment.We are sure public investment will be part of the answer,but this will need to be funded partly The IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 17 via lower consumption i.e.some combination of higher taxes or lower day-to-day public spending and supported by structural reform.Gains cannot come without some initial pain.In this sense,the Chancellor does inherit some difficult challenges.If funding costs do normalise as expected and economic capacity begins to improve,it is essential that any resulting fiscal space is put to more productive use.But success will depend,first and foremost,on broader structural reform.1.3 The economic outlook:avoiding a hard landing After a period of subdued supply growth,we see potential for a modest degree of catchup in the years ahead.However,that supply-side optimism is checked somewhat in the near-term by lingering consumer caution,modest fiscal consolidation,and lagged effects from higher interest rates.We expect demand to remain somewhat subdued,and a margin of slack to emerge over time.Rate cuts,most likely into accommodative territory,are likely to follow.The risks remain substantial.Globally,there are some signs of labour market loosening in the US,although we anticipate only a modest slowdown,and a swift recovery in 2025.Structural uncertainties in China also remain a concern,generating we think a downside skew to the risks around external demand.The traded component of inflation looks likely to remain relatively soft,with goods prices likely easing in relative terms.Domestically,the key question increasingly surrounds the saving rate.On the household side,real income growth is not yet feeding through into higher consumption.Firms are also still cautious.We expect some modest improvement through the remainder of this year,as uncertainty continues to fade.But still high interest rates alongside a meaningful deterioration in household balance sheets suggest a more persistent increase in household saving.In our baseline scenario,we expect UK GDP to increase by 1.0%this year,but by only 0.7%next year,as shown in Figure 1.6.While we remain cautious into 2025,we expect growth to accelerate markedly through 2026 and 2027 as the monetary and fiscal constraints are eased back and catchup potential is subsequently realised,before normalising through the second half of the forecast horizon.UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 18 Figure 1.6.Real GDP under different scenarios Panel A.Real GDP,chain-linked volume measure(billion,2022 prices)Panel B.Real GDP growth(%year-on-year)Note:The graph shows our baseline forecast alongside the Bank of Englands modal,market-conditioned forecast for August,and our optimistic and pessimistic scenarios.The latter are discussed in Box 1.1.The OBR forecast is taken from the March 2024 economic and fiscal outlook.Historical forecasts in Panel A are indexed back to the last realised data point at the time the forecast was made.Source:OBR,Bank of England,ONS,Citi Research.620630640650660670680690700710 billion,2022 pricesOptimisticPessimisticBank of England August 2024Realised/CitiOBR March 2024Forecasts-1.0%-0.5%0.0%0.5%1.0%1.5%2.0%2.5%3.0%Sep2022Apr2023Nov2023Jun2024Jan2025Aug2025Mar2026Oct2026May2027Dec2027Jul2028Feb2029%year-on-yearBank of England August 2024OBR March 2024Citi-BaselineCiti-OptimisticCiti-PessimisticThe IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 19 Given the degree of uncertainty,we also present two alternative scenarios for real GDP in Figure 1.6.In the optimistic scenario,we assume that energy commodity prices fall more quickly.In the pessimistic,we model the impact of a large procyclical fiscal stimulus in the US,which under certain assumptions may weaken the UKs economic outlook.These are intended to illustrate the potential sensitivity of our baseline estimates to different shocks,and to give a sense of what scale of shock would be required to deliver economies of different sizes by the end of the forecast period.These alternative assumptions are discussed more fully in Box 1.1 later,and their impacts on the trade-offs facing the Chancellor at the upcoming Budget are addressed in Chapter 2.In this section,we begin with the recent UK recovery,then turn to the global economic outlook,trends on the supply side of the UK economy,the outlook for demand and for households and firms,and recent trade underperformance.How secure is the UKs economic recovery?The UK economy has surprised to the upside since the start of 2024.We now expect real GDP growth of 1.0%this calendar year,compared with forecasts of just 0.1ck in January.Revisions in the forecasts of the Monetary Policy Committee of the Bank of England have been equally dramatic:from year-on-year GDP growth of 0.2%to 1.2%as of August,at least in the MPCs market-conditioned baseline(Bank of England,2024b).Unfortunately,while welcome,we think these improvements are not yet indicative of a secure economic recovery.This is for three reasons.First,a reasonable share of the upside surprise in the year to date only compensates for a strikingly weak end of 2023.Second,and associated,the pickup in growth that has occurred has remained sectorally narrow and has been unusual.Specifically,most of the growth has been concentrated in the non-consumer,untraded,business-to-business services sector such as scientific research and development.As energy prices have fallen,we think many of these sectors have been turned back on.And third,those sectors that have driven the recent improvement have generally been those to lag,rather than lead,in a cyclical upswing.Indeed,it seems the underlying engines of demand in the UK are not yet obviously motoring.In recent quarters,public consumption has been surprisingly strong,perhaps reflecting in part the overspend noted by the new Chancellor in the 29 July spending audit(HM Treasury,2024).These effects,however,may not last.And there does not seem to be much scope for a sustained consumer-led economic recovery.The tradable sector is already contracting,with global demand likely to soften further.There is little in the data as yet that implies to us that there will be a sustained,demand-led economic upswing.We expect quarterly growth to fall slightly to 0.3%in Q3 and 0.2%in Q4 before falling further into 2025.Figure 1.7 shows a breakdown of the drivers of recent growth,as well as our nowcasts into the end of the year.A correlation-weighted UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 20 average of the soft data would suggest underlying quarterly activity growth of around 0.2 percentage points.Expectations remain a little more buoyant,although these too have softened in recent months.Figure 1.7.Nowcast of UK gross value added Note:BVAR and Midas nowcasts are products of a Baynesian VAR model and a mixed frequency sampling model respectively.Our main nowcast is based on a dynamic factor model(DFM)of roughly 120 survey indicators.Source:ONS,Citi analysis.The global outlook:subdued demand In this subsection,we consider the economic outlook for the worlds largest economic blocs China,Europe and the US in turn,and then what this may mean for the UK.China Chinas economic growth has slowed.We now forecast growth of 4.7%in 2024,versus 5.0%at the start of the year.Some of the softer data such as consumer confidence appear somewhat worse.Recent weakness is attributable to two main factors.1 Industrial misallocation.The decentralisation of government investment decisions,coupled with central direction,seems to have led to industrial duplication in several target areas.For instance,Liu(2024)argues that China can now produce almost twice the volume of solar panels that the global market can absorb.As higher rates have curbed demand for capital-1.0%-0.5%0.0%0.5%1.0b2022May2022Aug2022Nov2022Feb2023May2023Aug2023Nov2023Feb2024May2024Aug2024Nov2024%year-on-year change in 3-month average Private-strikesPublic-strikesUnderlying private sectorUnderlying public sectorGross value addedDFM forecastMidas nowcastBVAR nowcastThe IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 21 goods,a supply glut has emerged,and manufacturing PMI surveys reflect weak demand and falling prices.2 Domestic real-estate troubles.Residential property prices have been falling for nearly a year,undermining consumer confidence and increasing precautionary saving.Consumer confidence has suffered as a result,and much of the consumption data such as retail sales have remained soft.Stimulus is crucial to turning around Chinas woes.With CPI hovering just in inflationary territory,the longer it takes for a more forceful reaction to emerge,the greater the probability the Chinese economy finds itself caught in some kind of deflationary trap.Recent interventions have provided some limited relief in the property market,but have thus far been predominantly monetary.8 To date,fiscal support to the consumer appears modest with policymakers still seemingly minded to do as little as possible rather than whatever it takes.We expect growth to remain soft into 2025,and global goods inflation to remain subdued.Europe We expect real GDP growth in the Eurozone to average around 1%,although with a clear divide between core and peripheral economies.Spain and Greece are growing at 23%,driven by strong service sectors.German growth is much weaker,reflecting weaker external demand from China,and domestic competition from Chinese imports,which are increasingly competitive(rather than complementary).Europes trade challenges are both structural and cyclical.Structurally,European manufacturers are grappling with increasingly direct competition from China and high unit costs,especially for energy.European households pay some of the highest electricity costs globally,which is eroding market share.Unit costs in March 2023 were$0.21 per kWh in France but$0.52 in Germany,compared with$0.18 in the US,$0.08 in China and$0.47 in the UK.Mario Draghi,former Prime Minister of Italy,has called for a significant increase in public investment to address some structural issues(Draghi,2024),but political barriers make this unlikely.Cyclically,the question is for how long services output can be sustained while manufacturing growth falters.This will depend primarily on the labour market.Softening in manufacturing hiring has so far been offset by public sector strength,and falling structural unemployment in the periphery.However,there is a risk the labour market will loosen further,especially as fiscal 8 In May,multiple steps were taken to stabilise the property market.These included the removal of the mortgage rate floor,a provident fund loan rate cut and a cut to the minimum downpayment ratio.Subsequent government direction included the establishment of a local government buy-back programme,where unsold property would be converted to social housing,and a Peoples Bank of China relending programme for social housing.Four months on,it is clear that the intervention has had a limited impact,with recent research questioning whether it was even net stimulative(Sheets,2024).However,more recent measures could have a larger impact.UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 22 tightening continues in the European core a similar potential concern in the UK.This risk will be compounded by slowing growth in the US.US After stronger-than-expected growth in the first half of the year,the outlook for the US is finely balanced between a hard landing with a weakening labour market and a soft landing where activity remains stable even as inflation eases.Historical comparisons might suggest a hard landing,with the Sahm Rule an early recession indicator linked to a loosening labour market already triggered,as shown Figure 1.8.But this cycle has been anything but typical,and consumer spending has been fairly robust,countering recession fears for now.Figure 1.8.Recessions and permanent job losses in the US since 1967 Source:BLS.We do expect US economic growth to slow toward the end of the year.A further softening in labour demand is a key concern,if this increases the household saving rate.For now,we anticipate a modest slowdown and a swift recovery through 2025,although the outcome could be less benign.Commodity prices and interest rates Recent events and associated risks notwithstanding,commodity prices are expected to come down near-term political risks notwithstanding.Oil prices have already fallen by 17%since April,in part reflecting the tepid outlook for aggregate demand.Prices have increased sharply in recent days as the geopolitical temperature has increased.Uncertainty has increased as a result.0%1%2%3%4%5%66719721977198219871992199720022007201220172022Share of labour forceRecessionsPermanent job lossThe IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 23 Nonetheless,in the medium term,we expect an expansion of supply,with continued pressure from OPEC members for a lifting of production quotas and non-OPEC production continuing to outpace forecast aggregate demand growth.Citis commodities team expects oil prices to fall to as low as$60/bbl over 2025 as these effects feed through.We expect gas prices in Europe to remain broadly stable(barring further shocks).We also expect shipping prices to normalise,after another period in which prices have been unusually elevated.For instance,the WCI Shanghai to Rotterdam index an estimate of the cost of container freight climbed sharply through 2024,peaking at four times the 2023 rate.Attacks in the Red Sea have driven a large-scale rerouteing around the Cape of Good Hope,elongating journey times and cutting capacity.But prices have begun to fall once again.On interest rates,much will depend on the outcome of the US presidential election at the start of November,but the global picture is one of improving supply and somewhat subdued demand.All three major transatlantic central banks have now begun to ease policy.The Federal Reserve cut rates in September from 5.3%to 4.8%and pencilled in two more quarter-point rate cuts in 2024.We anticipate the Fed will seek to return to a neutral policy rate fairly quickly over the coming months to minimise the risk of a further labour market deterioration.We expect the European Central Bank to seek further reassurance around wage and price setting,and to cut rates more gradually,although later rate cuts may ultimately prove larger overall.What might this mean for the UK?Altogether,demand tailwinds globally are beginning to fade.This reflects demand-based uncertainty in the US and structural concerns in China,and subdued manufacturing and consumer demand in Europe.Our earlier forecasts reflected an anticipated recovery in Chinese domestic output and some associated spillovers in European production.The former has proven disappointing and US growth exceptionalism has become more pronounced.As a result,we have revised down our forecasts for global growth in 2025.In our baseline assessment,global activity falls back in the second half of the year.External inflationary influences are also likely to be fading.We now expect UK-trade-weighted global GDP growth of 1.8%this year and 1.5%next,before a gradual recovery to an annual rate of 2.0%in the medium term.This implies little external support for UK growth as we move into next year,and indeed tradable support fading somewhat.Otherwise,our UK forecast is conditioned on the following assumptions:UK-trade-weighted global real GDP growth of 1.5%in 2025,1.6%in 2026 and 1.9%in 2027,a little softer than other recent official forecasts.UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 24 Oil prices to fall to around$70/bbl,based on the oil futures curve.Here we see risks skewed to the downside given the views of our commodity team above.Gas prices to fall gradually to 73.4 pence per therm over the forecast horizon.UK-weighted export prices to fall by a further 2%next year,before recovering through 2026.Trade-weighted sterling to settle in an 8283 range,2.53.0%higher than earlier in the year.Box 1.1.Alternative scenarios As in previous years,we complement our baseline forecast with two alternative scenarios,in this case based primarily on differences on the conditioning assumptions.In our optimistic scenario,we assume that global commodity prices fall more quickly.Global oil prices fall to a little over$50/bbl,a further 25cline from current levels,and compared with$70/bbl in our baseline scenario.We assume European gas prices follow a similar profile,perhaps reflecting a more accommodative deal around the transit of gas through Ukraine.We assume that a 10%supply-driven reduction in oil and gas prices boosts medium-term capacity by 0.150.2%and 0.3%respectively.We also assume a modest front-loaded benefit from lower household saving as residual inflation-related uncertainties fade.In this scenario,we would expect real GDP to end up around 1.8%stronger than our baseline forecast,as shown on Figure 1.6.Our pessimistic scenario focuses on the UKs external financial vulnerabilities.We model the impact of a large(5%),procyclical,permanent tax cut in the US.We have opted for a deliberately large move here to explore the risks associated with a shift in global interest rates;we are interested in this,rather than the impact of the tax cut per se.On the spillovers to the UK,we assume a 0.35 spillover from US to UK real GDP a relatively high real economic effect.But we then assume that the scale and procyclical nature of the stimulus mean a larger sell-off at the longer end of the US curve as inflation concerns grow,with associated spillovers into UK rates.We assume UK funding costs increase by around 1%at a five-year horizon,less than half the increase in the US.And we assume that the Federal Reserve responds to the associated stimulus,resulting in a fully offsetting rate-hiking cycle.We assume the Federal Reserve would increase Fed Funds rates by 2.53.0ppt,weighing on subsequent US GDP.We assume that much of the effect of the funding shock must be absorbed via domestic demand reflecting the inelastic nature of the UKs external account.We expect that by the end of the forecast horizon,real UK GDP would be around 2.4%lower under this scenario than in our baseline.Improvements on the supply side In the near term,we think the supply side of the UK economy will continue to recover.Three supportive trends are continuing to work though.The IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 25 First,the last remnants of temporary labour matching issues have diminished.In recent years,extensive cash support for firms and the continuation of the furlough scheme through much of 2021 locked workers into existing employment,even as the shape of the economy changed.This led to a severe tightening of the labour market especially in sectors with high churn in normal times and a sharp deterioration in labour market matching overall(Nabarro,2022a).This has also resulted in a period of discretionary labour hoarding as firms grew more uncertain about their ability to hire.As these effects have gradually faded,the reallocation of labour has improved,enhancing underlying capacity.Second,there have been reductions in energy and food prices facing firms.Here,supply losses result from function-specific capital and from belated price adjustments.This can make it more challenging to adjust to sudden,large asymmetric or technology-specific shocks,such as a surge in energy prices.Take the example of a takeaway pizza shop.If gas prices suddenly double,but output prices adjust only slowly,then the firm may choose to reduce capacity temporarily in order to minimise the loss at least until such time as output prices and input costs are in better balance.Capacity utilisation becomes a dimension of capacity adjustment.The PMI data illustrate this shift(see Figure 1.9):during the energy crisis,outstanding business grew very quickly relative to the overall volume of new orders,consistent with firms cutting back on capacity.Since then,the gap between these growth rates has widened again.With energy prices facing many parts of the commercial economy only just beginning to fall,further improvements are expected.Figure 1.9.Percentage point gap between growth in outstanding business and new business Source:IHS Markit.-15-10-5051015Dec 2015Dec 2016Dec 2017Dec 2018Dec 2019Dec 2020Dec 2021Dec 2022Dec 2023Percentage point gapMore outstanding business growthMore new business growthUK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 26 Third,the relative price of labour and non-labour inputs is shifting again.In 2022,as input prices increased sharply,labour became relatively cheap.Alongside discretionary labour hoarding,this is one reason firms did not reduce staffing in 2022 despite cutting back on capacity.Such shifts are particularly important in the UK and,historically,they explain why unemployment fell less than expected after the financial crisis but by more than anticipated in the early 1990s,for example.9 Over the past 18 months,the relative cost of labour initially fell,incentivising labour-intensive production.This trend has since reversed as energy prices fell and wages increased.We expect the relative price of labour to continue to rise in the coming months as costs continue to fall back at least relative to wages.This should drive productivity enhancements as production becomes more capital intensive.But this suggests aggregate demand must grow more strongly if the labour market is to be kept on an even keel.Historically,this has not been the norm.Figure 1.10.Year-on-year growth in potential GDP,UK Note:Grey bars cover periods of several years.Source:ONS,Bank of England,OBR,Citi analysis.Currently,we estimate the UKs long-term potential growth rate at around 1.41.5%.This is consistent with the ONSs latest population estimates,alongside our view of trend productivity growth.In the near term,however,we think capacity can grow somewhat faster than this as 9 The UK is a small open but also services-orientated economy.As a result,the relative price of labour can move around significantly.The production side of the economy is also relatively sensitive to associated changes as labour and capital are more easily substituted.0.0%0.5%1.0%1.5%2.0%2.5%year-on-yearHistoricalBank of England,February 2024OBR,March 2024CitiThe IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 27 these supply shocks wane,as shown in Figure 1.10.Unfortunately,substantial scarring remains likely.But we think modest catchup effects are more likely than not.Compared with the Bank of England,we anticipate stronger potential growth through 2025 and 2026 as these benefits materialise.Monetary and fiscal policy are both likely to depress demand With the supply side improving,we expect the constraint on economic activity to shift to the demand side,primarily due to the legacy of policy during the pandemic.The current challenge is the result of two factors.First was a procyclical fiscal approach during the energy and cost shocks of 202223,with fiscal policy effectively offering sweeping support in response to a supply shock.Second,and associated,was the anti-inflationary insurance taken out by monetary policy over the same period.In both cases,the UK economy faces a period of adjustment ahead with policy headwinds likely continuing to build.The key debate centres on the transmission of monetary policy.One view holds that the overall macroeconomic effects of the rate increases of recent years have been limited.While by no means the collective view of the MPC,Bank staff did note in August that the majority of the impact of previous rate rises on real GDP may already have been felt(Bank of England,2024b).Others have noted the risk that rates may be even less restrictive than the MPC had thought(Greene,2024).While not the intention of policy 18 months ago,that would suggest that in fact policy has not been hugely powerful,with relatively little further effect to come.While this view remains plausible,we think it sits at one(optimistic)end of a wide range of plausible outcomes.Estimates of Bank staff,for example,are based on a 2015 model(Cloyne et al.,2015)which itself is sensitive to modest specification changes(such as the period over which the model is estimated).And this is only one model among many.Other approaches over the same period such as an event study approach(shown in purple on Figure 1.11)would suggest a greater effect to come.And with respect to the recent data which show some signs of life in the housing market and a slight uptick in credit growth these continue to be buffeted by some of the oddities of the recent cycle,in particular the large increase in monetary holdings through the early part of the pandemic.This has sheltered large swathes of the economy from higher capital costs,as households and businesses had accumulated internal liquidity between 2020 and 2022.With holdings now back at trend,credit growth is beginning to increase.But so too are effective interest rates.Indeed,as we see it,the risk around any historical estimate of policy transmission is probably skewed towards a longer lag rather than a shorter one.Five key structural changes are notable and relevant in our view:UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 28 Figure 1.11.Modelled impact of changes in Bank Rate since 2020 on UK GDP(%of GDP)Note:The Bank of England Baseline here is based on Cloyne et al.(2015),incorporating the changes in rates only.The purple line shows an event study approach based on MPC announcements and speeches by MPC members.The series is then orthogonalised against the subsequent data themselves,as suggested by Bauer and Swanson(2022).The event study series is based on a two-hour window around these announcements.The Citi Baseline estimate is based on a five-variable SVAR model,estimated 19712019.Source:ONS,Bank of England,Cloyne et al.(2015),Bauer and Swanson(2022),Citi analysis.1 The proliferation of fixed-rate lending.Fixed-rate mortgages accounted for 95%of new mortgage lending in 2019,compared with 40%in 2010.This shift has slowed the impact of higher rates on cash flow and provided greater near-term security for households,slowing transmission into the household sector.2 Larger financial asset holdings.Both households and firms are generally carrying more interest-bearing assets.Respectively,this reflects an older population and recent government-backed support for businesses.This meant households and firms enjoyed an up-front boost from stronger interest income as rates rose.3 Improved household equity.Greater equity in the housing market has provided a buffer against deteriorating credit conditions,even as house price growth has stalled.Lower household debt and a concentration of that debt among those with more cash assets has ameliorated any precautionary saving response.4 Declining business creation.The UK has experienced a long-term decline in business dynamism,as discussed in Section 1.2,resulting in lower net new corporate lending for the-4.0-3.5-3.0-2.5-2.0-1.5-1.0-0.50.00.51.01.5Mar 2020Sep 2020Mar 2021Sep 2021Mar 2022Sep 2022Mar 2023Sep 2023Mar 2024Sep 2024Mar 2025Sep 2025Mar 2026Sep 2026Mar 2027Percentage point difference from March 2020Bank of England-baselineCiti-baselineCiti-event studyThe IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 29 same level of activity.This,and the fact that existing firms often have substantial cash reserves,has slowed the impact of rising borrowing costs on activity and employment.5 Increased substitutability between labour and capital.Over the past decade,the UK economy has become more specialised in sectors where the effects of rate changes on employment tend to manifest more slowly,reflecting a greater degree of substitutability between capital and labour.The initial impact of rate hikes may be to lower productivity,with impacts on employment coming later.All of this to us implies lower,slower transmission from rates to activity.The changes here can be roughly grouped into three structural changes.First,in an equilibrium sense,there is less probably demand for new credit at any single point in time.Historically,this has tended to be how most of the demand-destructive effects of policy materialised,and often at a relatively rapid pace(Bernanke and Gertler,1995).We think this mechanism is less powerful now.On the firm side,that reflects the trend reduction in business dynamism we noted above,and the shift towards intangible assets that are more often financed via internal liquidity(Caggese and Prez-Orive,2020).On the household side,that also reflects the shift towards older age groups,who consume fewer durables and have less demand for housing credit(Guerrn-Quintana and Kuester,2019;Wong,2019).Among this group,there may also be more target savings behaviour,which offsets the traditional savings boost from higher rates.Second,the precautionary response associated with higher debt and interest rate volatility also seems truncated.This also reflects the shift towards an older population.We know that historically in the UK,indebted households have tended to have a more violent reaction to changes in debt servicing as binding liquidity constraints loom(Cloyne,Ferreira and Surico,2020).Today,fewer households are in this position,with fewer mortgaged households and a larger offsetting base of financial assets.And similarly,corporate deleveraging over recent years and self-funding of an increasing share of investment leave investment less responsive to changes in rates.Third,just as transmission has grown more dependent on cash-flow effects,changes in mortgage structure and asset holdings have attenuated their impact.Hence initially both households and firms have enjoyed something of an income boost from higher rates as the rate of return on assets accelerated but debt servicing costs were unchanged.In more recent months,that has begun to reverse,implying a growing headwind to income growth in the months ahead.This would suggest policy transmission overall may be a little lower,but crucially also slower.Here we think it is useful to think about policy transmission as reflecting three separate steps:the transmission from Bank Rate to financial conditions,the transmission from financial UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 30 conditions directly to activity,and then the rebalancing of activity in response to the shock to financial conditions.The second and third steps are likely to take time.Alongside headwinds from monetary policy,fiscal policy is also likely to exert downward pressure on activity.The details will depend on what the new Chancellor does in her inaugural Budget on 30 October,but the fiscal inheritance(discussed more fully in Chapter 2)suggests some fiscal consolidation is to be expected over the coming years.The combination of fading prior support(including energy grants and similar)with a further tax increase of 1520 billion in the autumn even if this was focused in areas with low fiscal multipliers and was accompanied by top-ups to day-to-day spending(5 billion)and investment(10 billion)would still suggest a headwind from fiscal policy into next year.The combined policy impulse is shown on Figure 1.12.Figure 1.12.Combined impact of monetary and fiscal policy on UK GDP level(percentage point deviation from trend)Note:Monetary policy impact here is based on the Bank and associated market rates modelled through a SVAR impulse response.This has been discounted to reflect some of the structural changes listed above.It has also been pushed back by a quarter reflecting the arguments above.The fiscal impulse is based on the cumulative impact of all discretionary changes since the onset of the pandemic.Here we have excluded the Energy Price Guarantee and the Energy Bill Relief Scheme.Some of the public spending during the height of the pandemic has also been discounted,reflecting reported waste.Source:ONS,Bank of England,OBR,Wolf(2020),Citi analysis.-5-4-3-2-101234Dec 2020Jun 2021Dec 2021Jun 2022Dec 2022Jun 2023Dec 2023Jun 2024Dec 2024Jun 2025Dec 2025Jun 2026Dec 2026Percentage pointsFiscal impulse202020212022202320242025Total monetary policyTotal policy(fiscal monetary)The IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 31 Further headwinds to demand,as we note below,increase the risk of a rise in the unemployment rate in the months ahead.This,we think,could have been avoided with policy that was more appropriately calibrated previously and that reflected a better-balanced policy mix.As many of the MPCs more dovish members noted through 2022,hiking rates in the face of recent supply shocks risked weighing on demand just as the effect began to ebb(Tenreyro,2023).Nonetheless,monetary policy was forced to take out an increasing degree of insurance as fiscal policy became more and more stimulative.The resulting drag speaks to the limitations of using an instrument with a long lag to address a near-imminent inflation concern a feature that often requires monetary policy to overshoot,but also risks dragging at precisely the wrong time.Consumption still subdued with households not dissaving yet Household consumption remains the single most important component of UK GDP.It has also been central to the UKs post-COVID economic underperformance.Private consumption is now 8.7low its pre-pandemic trend,well above the shortfall seen in the Euro Area,and 1.3low its pre-pandemic level.The hope for 2024 was that falling inflation and rebounding real incomes would drive a recovery in consumption.This has yet to materialise.Consumers seem to be shifting their spending rather than increasing it.Recent figures show a modest improvement in retail sales as goods prices fell,but offset by slowing momentum in the consumer services sector.This is supported by industry trackers such as the Coffer Peach Index,which remained subdued over the summer,with nominal growth in the low single digits.10 While business-to-business services have continued to grow,growth in consumer-facing services has stalled.Looking ahead,we expect consumer spending to strengthen,particularly retail spending.Consumer confidence has improved,although the upward trend seen through late 2023 and early 2024 has paused as real income growth stabilised.As real income gains feed through,they should begin to boost consumption more noticeably.Some surveys,such as recent PMI data,indicate improving consumer demand at least in the anecdotes and we expect growth to pick up by the end of the year(S&P PMI,2024).However,the scope for a sustained consumer-led economic recovery seems to be narrowing.Most of the recovery in real incomes has already occurred.Annual growth in real household disposable income(RHDI)has hovered at around 34%since 2023 Q2,as faster nominal wage growth has accompanied slower price growth.We anticipate some additional momentum in the fourth quarter as public sector pay deals are finalised.Beyond that,we expect nominal wage 10 Nominal growth across hospitality establishments is estimated to have fallen from 5.2%year-on-year in March to 1.3%now,suggesting further reductions in volumes.UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 32 growth to slow and interest income to fall.As shown in Figure 1.13,growth in RHDI is expected to steadily decline through 2025 and turn negative in 2026.Figure 1.13.Real household disposable income growth,UK(%year-on-year)Source:ONS,Citi analysis.As consumption has remained subdued,even as household incomes have grown,household saving rates have climbed sharply.The headline saving rate was 9.8%in Q2,compared with 6%on the eve of the pandemic.The cash saving rate i.e.excluding the imputed equity of pension funds,and once the adjustments in the 2024 Blue Book have been accounted for has climbed from 23fore the pandemic to around 8%now.This is shown in Figure 1.15 later.The degree of optimism about consumer spending hinges on how quickly saving rates might fall.We expect only a gradual normalisation of saving rates,driven by three factors.1 A decline in precautionary saving.Households tend to increase savings in the face of inflation uncertainty.In particular,as inflation first surges,households may save more as they are cognisant of the erosion of nominal asset values but may overlook the reduction in nominal liabilities(Schnorpfeil,Weber and Hackethal,2023).This was evident as consumer confidence plummeted in 2022,but this effect seems to have diminished,with consumer confidence now aligned more closely with current real wage,unemployment and inflation figures.-15%-10%-5%0%5 %Mar 2007Mar 2009Mar 2011Mar 2013Mar 2015Mar 2017Mar 2019Mar 2021Mar 2023Mar 2025%year-on-yearWagesMixedTaxesSocial contributionsBenefits and subsidiesInterest incomeDeflatorOverall RHDIForecastThe IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 33 Figure 1.14.Net worth of the private non-financial sector:percentage point change since 2007 Q1(%of GDP)Note:The graph shows the change in net worth of the private non-financial sector since 2007 Q1,measured as a share of GDP.In both the US and UK cases,pension entitlements have been excluded from the calculation on grounds of relevance.In the UKs case,corporate real assets have been calculated by taking the total nominal value of the market sector and multiplying it by the GOS share of non-financial corporates.Housing wealth is calculated via the total number of privately owned dwellings,multiplied by the average house price.UK data are taken from the ONS accumulation accounts;US data are from the Federal Reserve system.Source:BEA,Federal Reserve,ONS.2 Consumption smoothing.Households typically save during income spikes and dissave when incomes fall,so that large swings in real income growth have large but short-lived impacts on inflation.We observed this in 202223,as rising costs led to households dissaving,followed by an increase in saving rates in recent quarters as incomes recovered.This dynamic should stabilise as real income growth slows,pushing the saving rate down somewhat from recent highs.3 Household balance sheets.During past inflationary periods,households typically held real assets financed by nominal liabilities.An older population now holds more financial assets,often in deposits or bond-based investments,and these have performed poorly,impacting household balance sheets.Indeed,household(and firm)balance sheets appear to be weaker as we emerge from the pandemic.Figure 1.14 shows the development of net worth in the private non-financial sector(which includes both households and firms,excluding those in the financial sector),incorporating both real and financial assets and liabilities.In the UK,net worth is now nearly 90%of GDP lower than it was in 2007 falling from 630%to-150%-100%-50%0P00 0%Mar 2007Sep 2008Mar 2010Sep 2011Mar 2013Sep 2014Mar 2016Sep 2017Mar 2019Sep 2020Mar 2022Sep 2023Change since 2007 Q1,%of GDPUSUKUK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 34 542%of GDP.This is in contrast to the experience in the US,for example,where net worth is now nearly 60ove up from 521%to 580%of GDP.One argument holds that as interest rates fall and income drivers shift from interest income to wages in the coming months,the household saving rate will start to come down.We agree with this to some extent.However,as shown in Figure 1.15,our modelling suggests that a sharp drop in the ratio of household net worth to real incomes explains some of the recent rise in saving rates.These effects should be somewhat more persistent.And to the degree real rates fall,we think these will remain higher than on the eve of the pandemic.We expect cash saving rates to fall modestly as real income growth slows,but remaining perhaps 5%of income above the rate in 2019.We see the main upside risk as a significant rally in nominal house prices,which is plausible as interest rates fall.For now,most soft data suggest nominal house price growth remains at or slightly below inflation,and we expect growth to remain in the low single digits.But a stronger recovery could mean a faster consumption recovery in the months ahead.Figure 1.15.Changes in households cash saving rate:percentage point change since 2019 Q1 Note:Model here consists of unemployment,real household income growth,real lending rates,consumer confidence and the income to wealth ratio,and is estimated as a simple OLS model based on data from 1996 to 2019.Source:ONS,Bank of England,GfK,Citi analysis.-10-5051015Mar 2019Sep 2019Mar 2020Sep 2020Mar 2021Sep 2021Mar 2022Sep 2022Mar 2023Sep 2023Mar 2024Sep 2024Mar 2025Sep 2025Mar 2026Sep 2026Mar 2027Sep 2027Percentage point change since 2019 Q1Consumer confidenceIncome to wealth ratioReal lending ratesReal household income growthUnemploymentModelledRealisedForecastThe IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 35 The combination of falling real household disposable income growth and only a slow decline in saving rates suggests that consumption growth is likely to be weak into 2025.We expect private consumption to increase by only 0.6%in 2025,compared with 1.5%in the Bank of Englands baseline estimate.Firm profitability and the prospects for investment The outlook for firms should improve as supply growth picks up and costs decline,though any gains will come from a weak base.Profitability and viability challenges are expected to persist.Business investment has been underwhelming recently.After rebounding in 202223,it has since stagnated,with transport investment stabilising but machinery,construction and intangible investments remaining flat.The reasons for this underperformance primarily relate to uncertainty and the rising cost of capital which,on a weighted average basis,is up about 4 percentage points since interest rate hikes began.This latter increase would historically have reduced business investment by 1015%,all being equal.We think this has now largely passed through.Other challenges,such as higher energy prices and issues with key capital imports,may also have contributed.But these should now be beginning to fade.As costs ease and interest rates fall,we expect business investment to recover gradually.However,rates are still high,and many firms,particularly in the CBI survey,cite the cost of capital as a major barrier to investment.And although investment intentions have risen slightly,the recovery has been weaker than anticipated,especially given the UKs historically low investment levels.While larger firms are more optimistic,smaller businesses remain cautious(Xero,2024).Overall,sentiment remains somewhat defensive.While the sequential picture is improving,we think such benefits will come through only gradually.This is for two reasons.First,firms have been tapping into internal funds,limiting the pool of available capital remaining for intangible investment.To the extent that firms were using internal liquidity often financed at lower rates to stay afloat,they are now facing the expiration of these effective subsidies.Those relying on liquid deposits may face renewed challenges as their capital costs rise.These effects have been material.The government-backed corporate loan schemes left corporate deposits in early 2022 around 80 billion above their pre-COVID trend.These are now around 30 billion below.Second,there continues to be pressure on profit margins.ONS data suggest private non-financial corporate profit shares are about 23%of GDP lower than pre-pandemic.Survey and ONS data suggest that the picture here has stopped getting worse but nonetheless the level has deteriorated.The latest business demography data suggest that roughly the same number of jobs are being lost UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 36 to firm destruction as are being created by firm formation.This is in contrast to the period prior to the pandemic,where more jobs were created,and suggests some challenges remain.On the private residential side,we are more optimistic,expecting investment growth of 1.8%in 2025 and 6.4%in 2026.This optimism is based on stronger housing market activity and potential support from new government planning reforms.Our forecast assumes the annual construction rate of new dwellings will rise from a current run rate of around 200,000 to 300,000 by the end of the parliamentary term.While lower than Labours manifesto pledge which was for 1.5 million homes over the parliament a more gradual increase seems plausible given the sectors concerns over skill shortages.Since new home construction represents 20%of sector output and 6%of GDP,this would contribute about 0.5%to overall activity over five years,accounting for offsetting increases in imports.Overall,while the UK is expected to converge slightly with G7 investment levels,this recovery will take time,especially until interest rates fall more significantly.Trade underperformance On trade,the UK continues to underperform relative to international benchmarks.Since 1980,the UKs trade intensity(imports and exports,as a share of GDP)has increased by 33%,compared with an average of 57ross other G7 countries.As shown in Figure 1.16,this gap is much wider than in 2019 and comes despite advantages such as a strong UK services trade,which has generally recovered better post-pandemic.The UKs trade dynamics have been heavily buffeted by global developments over recent years.Goods trade,particularly to the EU,initially fared relatively well through 202122.This was likely due in part to global supply chain challenges associated with the end of pandemic lockdowns.In the period since,UK goods exports to both EU and non-EU countries have slumped back,particularly relative to G7 comparators,as shown in Figure 1.17.The symmetrical weakness in exports to both the EU and non-EU may reflect the importance of EU trade as a complement to UK goods exports elsewhere.Turning to services,there have been striking differences in trends by sector particularly when it comes to trade with the EU.Intellectual property exports to the EU have grown by 56%since 2019 Q4.Construction and travel exports to the EU have fallen while increasing strongly to non-EU destinations.Overall,services growth has been marginally stronger to non-EU destinations,but by less than expected.The exception is the financial sector,where exports to the EU have grown at a marginally faster rate than exports elsewhere.11 11 Here the data are somewhat complicated by firm relocations,particularly of US-headquartered entities.The IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 37 Figure 1.16.Trade intensity since 1980,UK and G7 Note:Graph shows trade intensity measured as imports and exports divided by GDP.The level is then indexed back to an average over 1980.Source:National statistical offices.Figure 1.17.Goods exports since 2017 Note:The graph shows four-quarter average levels.The UK series excludes erratics such as non-monetary gold.Source:ONS,national statistical offices.5075100125150175198019851990199520002005201020152020Index(1980=100)G7-rangeG7-averageUK6080100120140160Jan 2017 Jan 2018 Jan 2019 Jan 2020 Jan 2021 Jan 2022 Jan 2023 Jan 2024Index(2017=100)G7-rangeUK-non-EUUK-EUUK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 38 On imports,there is growing evidence that additional UKEU trade frictions have hurt the UK consumer over recent years.The import price deflator on food from the EU has increased by almost 50%since 2019,while the equivalent for food imports from non-EU destinations has increased by around 18%.If EU food import prices had increased at the same rate as their non-EU equivalents,this would amount to a 273 reduction in the annual food bill of the average UK household,if fully passed on by retailers and producers.12 Altogether,the UK does seem to be struggling with international competitiveness.The tradable sector contracted 1.0%in the four quarters to 2024 Q2.13 The UK current account deficit has widened again to around 4%,although we expect this to shrink through 2025 due to lagging domestic demand.For now,we remain less immediately concerned about the capital account deficit than in previous years,with more currently financed via net direct investment.Although risks remain,this somewhat reduces the UKs reliance on potentially volatile portfolio inflows.1.4 Labour market risks The labour market has loosened over the past two years,and labour supply and demand are now broadly in balance.However,the economic outlook suggests the labour market is likely to continue to weaken as labour demand remains subdued.That adds to the risk of a further increase in unemployment ahead.Our concerns stem from three observations.First,as labour demand has fallen back,there are signs of something of a deterioration in labour matching as thick market effects have dissipated.That suggests a faster transmission from further reductions in vacancies into unemployment.Second,high labour costs at least relative to non-labour equivalents increase the risk of a more abrupt period of labour shedding particularly when paired with weak corporate balance sheets.And third is the continued,and prominent,role of public sector employment growth in propping up the employment aggregates.As we move into next year,we are unsure this is likely to last.Indeed,we currently expect the unemployment rate to increase to 4.9%next year and 5.3 26.In this section,we look at the dynamics of labour demand and supply,changes in employment and the degree of slack,and consider the recent role of changes in the National 12 The latest edition of the family spending bulletin from ONS(Office for National Statistics,2024a)shows the average UK household spends 63.50 on food and non-alcoholic beverages per week.This is 3,302 on an annualised basis.Around 40%of all foodstuffs are imported.Assuming a 20.9%reduction in the price of these imports,that would suggest an 8.3%reduction in food costs overall.That equates to 273.13 This figure takes the year-on-year change in tradable sector GDP for 2024 Q2.Here,the tradable sector is defined by the share of imported and exported content in the supply and use tables,a definition that is borrowed from Broadbent et al.(2019).The IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 39 Living Wage.A softer labour market is neither necessary to return inflation to target,nor affordable in the context of a lacklustre recovery.For the Bank of England in particular,that suggests remaining attentive to the risks around the real side of the economy.Further softening of labour demand Labour demand in the UK has fluctuated in recent years.Following a near-total shutdown during COVID-19,hiring rebounded sharply in 202122.In the latter half of 2021,vacancies were increasing by about 280,000 per quarter,even as the furlough scheme worked against labour separation.Since then,much of the hiring backlog has been addressed,but underlying demand has also decreased.Despite increased activity at the start of this year,there are few signs that labour demand is ticking up again.Currently,there are 857,000 open vacancies,down from 1.3 million in mid-2022.The latest three-month change shows a decrease of 39,000 job advertisements per quarter just under half the peak rate of decline during the Great Financial Crisis.Thus,while the rate of decline may have moderated,it remains high.We believe the headline vacancy figure likely overstates labour market strength for two reasons.First,there has been a trend increase in overall job postings in recent years as online recruiting has become more common,lowering advertising costs.Our structural model suggests that a 10%reduction in the cost of advertising a vacancy can lower the equilibrium vacancy rate by 0.20.3 percentage points.14 Since 2018,we estimate that the expansion of online platforms has reduced the average advertising cost by around 15%,implying a 105,000 reduction in the equilibrium vacancy level.Adjusting for this,vacancies are currently below the level seen in 2019,as shown in Figure 1.18.Second,tighter labour market conditions are now mainly a public sector phenomenon.The latest headline vacancy data(not adjusting for the trend discussed above)show 33,000 more overall vacancies than in 2019,but that includes 41,000 more vacancies in public administration,education and healthcare.Given the limited substitution between public and private sectors,this suggests the private sector labour market is already somewhat looser than in 2019.14 This is based on the UKs pre-COVID Beveridge curve and a structural search and matching model.See Yashiv(2007).UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 40 Figure 1.18.Adjusted vacancy measures,UK Note:The adjusted measure reflects the impact of a 15%drop in the average cost of advertising a vacancy on the headline vacancy rate.Private sector excludes public administration,education and health.Source:ONS.Looking ahead,much of the soft data suggest continued declines in labour demand in the coming months.Daily vacancy data from I have trended down recently,while Adzunas figures have stabilised at a lower rate than the ONS headline numbers indicate.Most survey indicators of labour demand and workforce growth indicate stagnation or further reductions.Established surveys such as the KPMGREC report show ongoing contractions in both temporary and permanent listings.The Decision Maker Panel(DMP)employment growth index has also moderated to 1.1%year-on-year,down from 1.7%at the years start.With aggregate demand likely to remain soft,we expect labour demand to continue to weaken gradually into next year.Labour supply continuing to rise While labour demand appears to be weakening,there are signs that underlying labour supply is continuing to recover.In addition to an improvement in labour matching as post-COVID distortions have eased(as discussed in relation to supply-side improvements in Section 1.3),underlying aggregate labour supply has also continued to normalise.-600-400-2000200400600800Jan 2019Jul 2019Jan 2020Jul 2020Jan 2021Jul 2021Jan 2022Jul 2022Jan 2023Jul 2023Jan 2024Jul 2024Vacancies,thousandsAdjustment to private sectorPublic sectorPrivate sectorTotalTotal private(incl adjustment)The IFS Green Budget:October 2024 The Institute for Fiscal Studies,October 2024 41 There have been two main drivers.The first has been both an increase and a shift in the composition of net immigration.Higher-than-expected overall immigration has resulted in stronger workforce growth.The latest ONS population projections suggest cumulative workforce growth of 5.2tween 2021 and 2026,for example,versus 2.6%in 2023 Q1 estimates.Immigration flows into the UK are also becoming more conducive to supply.For instance,Figure 1.19 shows the net impact of changes in visa applications through the tourist,student,dependant and worker routes weighting each by their propensity to work.In 202122,a strong recovery in tourism alongside large refugee flows likely added more to demand in the first instance.Increasingly,that balance is shifting in favour of supply.Figure 1.19.UK entry visa approvals,weighted by propensity to work Note:Data based on numbers of entry clearance visas.Source:HM Government.Second,on the domestic front,the participation rate seems to have stabilised.It has declined since the onset of the pandemic,with more than 673,000 more people reported by the Labour Force Survey(LFS)as being inactive owing to ill health than in January 2020 and an increase of 311,000 in the number of economically inactive students.15 But the participation rate does seem to have stopped falling,despite some increases in those out of work owing to caring 15 Note these LFS estimates are somewhat dated.The headline LFS aggregates are still based on out-of-date population estimates from late 2023.-600,000-500,000-400,000-300,000-200,000-100,0000100,000200,000300,000400,0002007 Q12008 Q12009 Q12010 Q12011 Q12012 Q12013 Q12014 Q12015 Q12016 Q12017 Q12018 Q12019 Q12020 Q12021 Q12022 Q12023 Q12024 Q1Demand-conduciveSupply-conducive(workers)UK economic outlook:navigating the endgame The Institute for Fiscal Studies,October 2024 42 responsibilities.With the working-age population set to continue growing,that suggests overall labour supply will pick up.Employment levelling off In contrast,much of the employment data suggest that growth is slowing,particularly in the private sector,although different sources conflict somewhat.The Labour Force Survey indicates that employment growth is now picking up,but only after a prolonged period of flat or falling growth.We give more weight to payroll and workforce job estimates given the sampling issues with the LFS.As shown in Figure 1.20,these suggest stronger growth in 2022 and 2023,but weaker growth more recently.Figure 1.20.Measures of UK employee growth(viation since January 2020)Note:In all three cases,the focus is on employee growth.The graph shows the cumulative percentage change since January 2020.Source:ONS.As with the vacancy data,the headline overall trends may paint a rosier picture than the detail.Both the PAYE and LFS data,once adjusted for classification changes,indicate a significant decline in private employment in recent months.As shown in Figure 1.21,the PAYE data show that the three-month rate of private employment growth has fallen to its lowest level since 2020 Q2,with 14 sectors reporting a decrease in PAYE employment the highest number since August 2020.The adjusted LFS data also reflect this decline,showing a quarter-on-quarter drop of 190,000 in private employment again the weakest growth since 2020,matched o
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Implications of Trump 2.0Quarterly Global Outlook 1Q 2025Executive SummaryImplications of Trump 2.0GDP Growth TrajectoryFX,Interest Rate&Commodities ForecastsKey Events In 1Q 2025Japan FocusSnapshot of Japans political scene post electionFX StrategyWill Trump 2.0 make the USD great again?Rates Strategy10Y UST yield to stay above 4ross 2025 amidst a shallower Fed easing cycleCommodities StrategySafe haven demand for gold to stay strong amidst Trump 2.0 economic uncertaintiesFX TechnicalsCommodities TechnicalsGlossaryGroup Research Team041415161719263253596162CONTENTNew ZealandUnited StatesUnited KingdomOutlook by EconomiesClick on the economy to view insightEurozoneAustraliaJapanChinaVietnamSouth KoreaHong KongTaiwanPhilippinesSingaporeIndiaIndonesiaMalaysiaThailand .sg/researchGlobalEcoMktResearchUOBBloomberg:NH UOB Information as of 28 November 2024Research InsightsExplore moreContact usUOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q20254Implications of Trump 2.0The Tariff Man returns and moreAfter 4 years of absence,Donald Trump is back in the hot seat as the president of the most powerful nation in the world.And with the Republican clean sweep of the control of the US Senate and House of Representatives,this means it will be easier to implement policies for Trump.Our economic outlook for 2025 will now need to put a heavy dose of consideration for the myriad of policies that Trump has planned for US and their implications for the rest of the world.We admit a lot of the Trump policy measures(announcements,threats and/or projections)are highly speculative and unpredictable at this juncture and will be subject to significant changes once Trump officially comes into office on his 20 Jan(2025)inauguration.We broadly highlight a few categories of policy measures Trump campaigned for during the run-up to the Presidential election which,in our view,will have material macro-economic impact to the US and globally,including tax cuts,deregulation,tariffs,immigration(with mass deportation of undocumented migrants&border security),the independence of the US Federal Reserve(Fed),green policy(rollbacks)and foreign policy.Bottom-line,the impact of Trumps various policies are likely to be inflationary with mixed effect on growth.The extension of current tax cuts and introduction of new cuts,coupled with the deregulation drive will likely reignite animal spirits,boost business confidence and investment sentiment for US economy and therefore positive for US growth and productivity,but is likely to add to inflationary pressures and worsen the federal fiscal deficit.That said,fiscal policy issues are likely to take some time and probably be debated in the US Congress only in 2H 2025.Trumps tough immigration policy proposals are another area of concern and may come sooner than fiscal policy issues with the expected negative implications for US GDP growth.The inflationary impact is less clear,as large-scale deportation may lower the workforce numbers and drive demand for the remaining workers and thus lead to higher wages and inflation.But at the same time,the reduced workforce could also lead to lower domestic consumption in the US and create deflationary effects.On green policies,it is expected that Trump will follow his past actions,such as withdrawing from the Paris Agreement,repealing Inflation Reduction Act which supports clean energy projects and electric vehicles,relaxing environmental regulations and enacting policies that favour conventional fossil fuel extraction.This will potentially see higher US output for crude oil&gas,while missing its carbon neutral pledges.On foreign policy,if Trump does see through his promise to end all wars,then one of the impacts could well be lower prices of commodities(excluding gold)for 2025.“Things we lose have a way of coming back to us in the end,if not always in the way we expect.”-Luna LovegoodEXECUTIVE SUMMARYOur economic outlook for 2025 will now need to put a heavy dose of consideration for the myriad of policies that Trump has planned for US and their implications for the rest of the world.Bottomline,the impact of Trumps various policies are likely to be inflationary with mixed effect on growth.Trumps tough immigration policy proposals are another area of concern and may come sooner than fiscal policy issues with the expected negative implications for US GDP growth.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q20255Scenarios for Trumps trade tariff 2.0 Base case:25%tariff rate on China,10%tariff on selected countries that benefited from Chinas trade diversion,no blanket tariffs.Here comes the tariff man(again).To be fair,the Biden administration did not shy away from tariffs as they kept the tariffs imposed during the first Trump administration and added a few targeted tariffs of their own.The stark difference is perhaps Trumps sensational way of delivering news/threats of trade tariffs.Trump brandished his tariff man credentials again on 26 Nov when he pledged to impose 25%tariff on all imports from Canada and Mexico,and 10%tariffs(on top of additional tariffs)on all imports from China in an executive order on his first day in office(20 Jan)for drugs(fentanyl)and border security issues.Using Section 232 or the International Emergency Powers Act(signed into law in 1977),Trump can exercise executive power to impose these tariffs on the basis of an“unusual and extraordinary threat”to national security,foreign policy or the US economy.And he did use this power and threatened countries(including Mexico)during his first term in office.But equally important,he never invoked that power to enact tariffs once countries acceded to his terms.So what can we expect on US trade policy in 2025?The short answer is more tariffs and frictions.That said,it is difficult to say at this point what tariffs will be enacted,to whom,and what will the amount be.The reason is that Trump has floated various tariff proposals since he officially started his bid for the White House in Sep 2023,from baseline 10%-20%tariff rates on all imports,and as much as 60%on imports from China,to 25%or even as much as 100%on Mexican-made goods,to 100%tariffs on countries that want to shift away from using US dollar.Trump has named credible nominees for his economic team(US Treasury secretary,NEC director),which now included Jamieson Greer for the US Trade Representative(as of 27 Nov,subject to Senate confirmation).Greer previously served as the chief of staff for Robert Lighthizer,who was Trumps Trade Representative for the full 4-year term and oversaw the imposition of billions in tariffs.Long seen as a protg of Lighthizer,Greer will be tasked with“reining in the Countrys massive Trade Deficit,defending American Manufacturing,Agriculture,and Services,and opening up Export Markets everywhere.”We also believe that Trump will use tariff threats as a bargaining chip or negotiation ploy to eventually gain concessions from China and key trade partners,rather than being laid out as an immediate policy action.Regarding Trumps tariff implementation,we foresee three scenarios based on the tariff proposals touted so far,and our estimated implementation timelines.These will have their respective impact on the macroeconomic outlook for the US,China and the worlds economy and translate into different outlook for the FX and Interest Rates spaces.TaxesImpact on each of the indicatorsReal GDPPotential impact of Trumps policiesInflationFed fundsOther impactsmild impactSource:UOB Global Economics&Markets Researchmoderate impactmajor impact /- /- /- /- /- -ImmigrationGreen policyTariffUS FedForeign policyWorsen fiscal deficitNegative for domestic spendingGreater output for US oil and gasSubject to retaliation from China&othersUpside risks to UST yields,capital outflowLower commodity pricesSo what can we expect on US trade policy in 2025?The short answer is more tariffs and frictions.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q20256Trump 1.0 trade tariffTrump 2.0 proposed tariff policiesProbability 10%“anti-drug”tariff on all imports from China scrapped if China commits to significantly increase fixed amount of purchases from the US and to clamp down on drugs.Prospect of targeted tariff increases on strategic industries in China which affect a smaller amount of US importsAs early as 2Q25Reduce trade tensions as US reviews progress of its new trade deals.Growth is more positive than previous projection,with trade seeing a robust rebound.10Y UST to settle at around 3.80%at the end of Fed easing cycle.Term risk premiums see modest upside.USD weakens anew as markets unwind tariff-related premium and refocus back to Feds rate-cut plan.Dec 24-25bps 2025-100bps 1Q26-25bps(terminal rate of 3.25%)3.5%2.2%4.6ditional tariffs imposed on China(25%instead of 60ter investigation)and 10%tariffs on economies that increased in trade surplus with US due to trade diversion from China.Tightened measures related to technology transfer and on high tech industries in China.No blanket tariff(of 10%)imposed on all imports.Assume China retaliates by imposing similar tariffs on US goods but limited retaliatory responses from other economies.Staggered implementation from 2Q25.Likely to start with List 4b(mostly consumer goods).Investigations could take 6 months to 1 year.Full implementation by 1H26.Growth still positive but moderates slightly on the measures imposed.Uneven recovery,differences in sectoral outcomes caused by different tariff changes and differentiated between economies.Moderate rise in US CPI inflation(2025: 0.3ppt to 2.4%).10Y UST to settle at around 4.10%(potentially 4.50%if term premiums repricing is front loaded)at the end of Fed easing cycle.Term risk premium see moderate upside from higher uncertainty over Fed path and upside inflation risk.USD to strengthen against most G-10 peers in 1H25 before moderating in 2H25.DXY to rise to 111.1 by mid-2025 before easing off to 107.6 by end-2025.Asia FX to weaken for the first three quarters of 2025 before rebounding in 4Q25.USD/CNY to test key 7.35 level in 1Q25 and trade to as high as 7.60 in 3Q25.USD/SGD to rise modestly to 1.38 in 3Q25 before pulling back to 1.36 in 4Q25.Dec 24-25bps 2025-75bps(terminal rate of 3.75%by 3Q25)3.1%1.8%4.3%“Anti-drug”tariff-10%on all imports from China and 25%on all imports from Mexico&Canada.200%tariff on auto imports from Mexico.Subsequently,10-20%tariffs on all imports,and 60%on China imports.Higher tariffs(20%)on imports from economies(including ASEAN)deemed to have benefitted via trade diversion from China.Tightened measures related to technology transfer&on high tech industries to China.Assumes tit-for-tat(retaliatory)responses from China and other affected economies.To begin“anti-drug”10%tariff on all imports from China as early as Jan 2025,further tariffs in 2Q25 on half of Chinese goods including List 4b and 4a.Intermediate and capital goods likely to reach additional 60%tariff rate first while taking longer for consumer goods.Full implementation by 1H26.Trump may bring forward the implementation.Sub-par global growth for full year,re-emergence of some supply chain disruption and demand destruction.One-time US inflation spike in 2H25 1H26(2025: 0.5ppt to 2.6%).10Y UST to settle at around 4.50%(potentially 4.90%if term premiums repricing is front loaded)at the end of Fed easing cycle.Term risk premium see pronounced upside risk from Fed path uncertainty and bond buyers strike.USD to appreciate sharply against most G-10 peers.DXY to potentially test 2022s high near 115.Asia FX to depreciate sharply against the USD due to potential portfolio outflows.USD/CNY to potentially test the psychological 8.00 level though countercyclical policies to prevent one-sided speculative moves can be expected.USD/SGD to potentially trade above 1.40.Dec 24-25bps Early 2025-25bps rate cuts to resume in 2026 on growth concerns but limited to just two 25bps cuts due to one-time inflation spike&higher inflation expectations(terminal rate of 4%by 1Q26)2.5%1.3%3.5%Tariff measures that may be implemented under different scenariosTariff implementation timelineGlobal economy outlookRates viewCurrency viewChanges in Fed funds rate2025 GrowthGlobal economyUSChinaSource:UOB Global Economics&Markets ResearchBase caseOptimistic PessimisticScenariosScenarios for tariff in 2025Trump 2.040U%5seline 10%-20%tariffs on all imports,and as much as 60%on imports from China 25%or even 100%on Mexican-made goods and 200%or 500%on autos imports from Mexico 100%tariffs on countries that want to shift away from using US dollar 25%“anti-drug”tariff on all imports from Mexico&Canada,10%“anti-drug”tariff(additional)on all imports from China Trade diversion from China to ASEAN to bypass tariffs could be pursued by Trump,although details are lacking at this stage Imposed additional tariffs of up to 25%on about US$370 bn of Chinese imports in 2018-19UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q20257Our Base Case scenario,which we ascribe a 55%probability,calls for more measured imposition of tariffs(Additional 25%tariff on China,instead of the claimed 60%,10%tariffs on economies that recorded increase in trade surplus with US due to trade diversion from China,and no blanket tariff on all US imports),with a staggered implementation pace from as early as 2Q 2025 and fully completed by 1H 2026.Ahead of the tariff implementation,there is a consensus view that growth(especially for exporter economies)may be lifted as US importers may frontload purchases in early 2025.That early lift is expected to be short-lived and the global economy will eventually see a slight growth moderation to 3.1%in 2025(versus IMF forecast of 3.2%),albeit with an uneven recovery differentiated across sectors and countries that are targeted by the tariffs.The rise in tariffs could weigh on US GDP growth which is expected to be lower at 1.8%for 2025(versus a projected 2.7%for 2024)while tariffs are also likely to push US inflation higher above the Feds 2%target in 2025 and 2026.A revised Fed policy trajectory:lesser cuts in 2025 with a higher terminal rateWe continue to hold the view the Fed will reduce the Fed Funds Target Rate(FFTR)by another 25-bps to 4.25-4.50%in the Dec 2024 FOMC.However,we are revising our 2025 rate cut trajectory to a total 75 bps of cuts(i.e.three 25-bps cuts,one in each quarter of 1Q,2Q and 3Q 2025)and end the rate cycle to bring the terminal rate to 3.75%(upper bound of FFTR).Prior to Trumps election victory,we had projected 100bps of cuts in 2025 and one last 25-bps cut in 1Q 2026 to bring the terminal rate to 3.25%.The reduced number of cuts reflect the higher inflation pressures from the projected tariff implementation during the latter part of 2025.It should be noted that for our pessimistic scenario which we ascribe a significant probability of 40%,reflects our view that the risk for US trade policy this time round is tilted towards a more negative outcome of higher tariffs(60%tariff rate for China as claimed),coupled with the imposition of a blanket tariff for all US imports(10-20%)and an earlier and shorter implementation timeline,starting on Trumps Day 1(20 Jan)and fully implemented by 1H 2026.The impact of this scenario will be weaker growth outlook accompanied by higher inflation outturns,which implies even fewer Fed rate cuts in 2025.Though we include an optimistic scenario(with an ascribed 5%probability),we see a very low likelihood of such a benign outcome where Trump will change his mind,and decide to only impose targeted tariffs and result in a significant de-risking of the trade friction between US and China.How would China respond?Similar to the 2018 episode,China is unlikely to take pre-emptive actions against US before actual tariffs are implemented.At the same time,China could retaliate with corresponding measures,potentially escalating trade tensions as seen in the earlier trade war(2018).We also note that since the trade war of 2018,US exports to China has risen significantly(23%increase to US$148 bn in 2023 from US$120.3 bn).This increase in dependence implies that more US industries may be vulnerable to Chinese retaliation in the event of a tit-for-tat trade conflict.Ahead of the tariff implementation,there is a consensus view that growth(especially for exporter economies)may be lifted as US importers may frontload purchases in early 2025.We are revising our 2025 rate cut trajectory to a total 75 bps of cuts and end the rate cycle to bring the terminal rate to 3.75%(upper bound of FFTR).How would China respond?Similar to the 2018 episode,China is unlikely to take pre-emptive actions against US before actual tariffs are implemented.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q2025806 Jul 201823 Aug 201824 Sep 201801 Sep 201925%(raised to 25%from 10 May 2019)15%(cut to 7.5%from 14 Feb 2020)25%(raised to 10-25%from 01 Jun 2019)5-10%(halved from 14 Feb 2020)US$34bn(List 1*)US$16bn(List 2*)US$200bn(List 3*)US$120bn(List 4a*)US$160bn(List 4b*initially scheduled from 15 Dec 2020 was scrapped)US$34bn(some were rolled back in Sep 2019-2020)US$16bn(some were rolled back in Dec 2019-2020)US$60bn(some were rolled back in 2020)US$75bn machinery,cars,hard disks and aircraft partssemiconductors,iron and steel products,electrical machinery,railway equipment,instruments and apparatustelecom equipment,computers&parts,furniture,electric appliances,metals,plastics,travel bags and agricultural&food productsSome consumer goods such as footwear,textiles,clothing,food products,smart watches,dishwashers,and flat-panel televisionstoys,cell phones,laptop computers,video game consoles,computer monitorsList 4a&4b excludes some pharmaceuticals and medical goods,rare earth and critical minerals*Details can be found at https:/ustr.gov/issue-areas/enforcement/section-301-investigations/tariff-actionsSource:USTR,UOB Global Economics&Markets Research545 goods including agricultural products,automobiles and aquatic products114 goods including motorcycles,bourbon,orange juice,chemicals,medical equipment and energy products such as coal and crude oil5,207 goods including food stuff,industrial minerals and chemicals,textiles and clothing,jewelry,metal products,machinery parts,and a wide range of consumer products5,078 goods ranging from agricultural products to crude oilAmountAmountAdditional tariff rateAdditional tariff rateGoods involvedGoods involvedEffective dateImplemented by USImplemented by ChinaA lookback in history-Tariff size and timeline 2018-2020Trump 1.0UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q20259US exports to China rose by 22.8tween 2018 and 2023Source:Macrobond,UOB Global Economics&Markets ResearchChina Stimulus measures insufficient for meaningful turnaround while Trump adds downside challenges to growthOne key difference for China when comparing the 2018 trade war(Trump 1.0)and upcoming Trump 2.0,was that China was coming into Trump 1.0 from a position of strength.However,China is now facing significant domestic headwinds and weak domestic demand.Looking back at September 2024,the stimulus measures announced by Chinese authorities involved minimal“new and actual spending.”,and mostly through monetary measures such as interest rate reductions,loosening of home purchase restrictions,and swap of local government debt,among others.While the announced quantum appears substantial,it is relatively small,amounting to about 8%of GDP compared to the 2008 stimulus package which,amounted to the 12.5%of GDP at that time.Notably,there has been no fresh direct stimulus spending aimed at boosting consumption,while the amount earmarked to resolve the local government debt looked woefully inadequate.Housing market in China remains a big challenge and the current stock of housing inventory will likely take some years to clear.The missing growth contribution from real estate activities,will likely cap Chinas GDP growth to well below 5%in the next few years.(Moodys estimated real estate activities contributed about 25%of Chinas GDP in 2022,and the direct contribution could languish at around 18%by 2030).While the developed economies have brought inflation back under control,China faces the opposite problem as deflation remains a key threat as consumer and business confidence has remained weak.Based on the above,we are lowering Chinas GDP growth forecast to 4.3%for 2025(previous:4.6%)on the extra burden imposed by Trumps tariffs on top of the soft domestic fundamentals.In terms of monetary policy response,PBOC focus in the coming months is likely to be on RRR(reserve requirement ratio)as the main tool for easing instead of interest rate cuts.There is ample room for PBOC to ease RRR further in 2025(as the US Fed progressively cuts rates while Chinas domestic deflation worsens).PBOC already signalled another 25-50 bps RRR cuts in 4Q 2024,and we expect further RRR cuts in 2025.In our view,further LPR cuts will be less likely if the CNY comes under increasing depreciation pressure.One key difference for China when comparing the 2018 trade war(Trump 1.0)and upcoming Trump 2.0,was that China was coming into Trump 1.0 from a position of strength.However,China is now facing significant domestic headwinds and weak domestic demand.In our view,further LPR cuts will be less likely if the CNY comes under increasing depreciation pressure.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202510Hereafter is a brief synopsis of key Focus pieces as well as key FX and Rates views.We wish our readers a peaceful end to the year,a happy new year in 2025!FX STRATEGYWill Trump 2.0 make the USD great again?Our base case for incoming trade tariff outlook under Trump 2.0-at 55%probability sees additional 25%tariffs imposed on China and 10%tariffs imposed on economies that increased in trade surplus with US due to trade diversion from China.We also assume China will retaliate by imposing similar tariffs on US goods but limited retaliatory responses from other economies.The clear consequence of trade tariffs is higher US inflation of 0.3ppt in 2025 for this base case.As such,the Fed will be on guard against any sign of building up of price pressures.We think this will translate to lesser Fed rate cuts,at just 75bps of cuts across 2025 and a higher terminal rate of 3.75%by 3Q25 for base case.As compared to our previous outlook before the elections of cumulative 125 bps of cuts to come and a terminal rate of 3.25%by 1Q26.As a result of this base case for trade tariff outlook,we now expect USD to strengthen further against most Major FX peers in 1H25 as tariff uncertainties dominate.In 2H25,USD strength may start to moderate and as most of the repricing for Trumps tariffs(base case)may have already been done and our downward trajectory in US rates could start to exert downward pressure on the USD.Overall,we expect the DXY to rise to 111.1 by mid-2025 before easing off to 107.6 by end-2025.We also expect FX volatility to stay elevated as investors digest incoming tariff headlines and the ensuing Fed response.Consequently,we turn negative in our outlook for EUR,GBP and AUD as we see more weakness to come in 1H25,before stabilizing somewhat in 2H25.Risk is for EUR/USD,GBP/USD and AUD/USD to drop further to 0.99,1.21 and 0.61 respectively by 2Q25 before modest recovery thereafter to 1.03,1.25 and 0.64 by 4Q25.Similarly,we see potentially higher USD/JPY at 157 by 2Q25 before pulling back to 152 by 4Q25.As a result of the incoming trade tariffs,we expect most Asia FX to weaken alongside the CNY for the first three quarters of 2025 before rebounding in 4Q25.In the event that the pessimistic scenario comes to pass where a maximum of 60%tariffs(instead of 25%tariffs in base case)are imposed on the Chinese goods,the fallout on Asia FX is likely to be considerably stronger and more enduring compared to the base case.The key message is that Asia FX are more sensitive to the tariffs and may have to endure a slightly longer period of weakness compared to Major FX.It is teeing up to be yet another difficult year for both Chinas economy and the CNY in 2025.Trumps tariffs are likely to exacerbate the existing concerns about Chinas economic slowdown.As a result,our macroeconomic team have downgraded 2025 GDP growth forecast to 4.3%from 4.6%as we factor in some tariffs on Chinese goods to become effective in 4Q25.On top of a weaker domestic growth outlook,the CNY is likely to fall further against the USD as a shorter and shallower Fed rate-cut cycle helps support the USD.Overall,we now see upside risk to USD/CNY in the coming few quarters and our updated USD/CNY forecasts are 7.35 in 1Q25,7.50 in 2Q25,7.60 in 3Q25 and 7.45 in 4Q25.Asian currencies are expected to weaken in tandem with the CNY across 2025.As such,we see potential highs in 3Q25 for USD/SGD,USD/MYR,USD/THB,USD/IDR,USD/VND at 1.38,4.65,35.7,16,400,26,200 respectively.As a result of this base case for trade tariff outlook,we now expect USD to strengthen further against most Major FX peers in 1H25 as tariff uncertainties dominate.In 2H25,USD strength may start to moderate.The key message is that Asia FX are more sensitive to the tariffs and may have to endure a slightly longer period of weakness compared to Major FX.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202511RATES STRATEGY10Y UST yield to stay above 4ross 2025 amidst a shallower FED easing cycleCompared to our previous update at the end of Oct,our base case for Fed funds has been adjusted higher.We have removed 50bps of cuts from the previous easing cycle estimates and now project only three cuts in 2025 for an easing cycle bottom in Fed funds of 3.75%.Risk is that Trump 2.0 fiscal policy proposals may skew even more inflationary if enacted in full and we expect the Fed to calibrate its approach as actual policies are made known.In our base case for end 1Q25,we forecast the 3M compounded in arrears Sofr at 4.35%.Thereafter,short term rates are then expected to drift lower across 2025 in tune with our expectations of a further 75bps rate cuts from the Fed.Eventually the 3M compounded in arrears Sofr could drop to 3.61%by 4Q25.As for Sora,in our base case for end 1Q25,we forecast the 3M compounded in arrears Sora at 2.77%and thereafter to 2.23%by 4Q25.Sora can be expected to drop to a lesser extent than declines in US rates.Our base case forecasts for 10Y UST have been marked higher compared to the previous month largely in view of the substantial upward shift in our Fed funds baseline.Contributing to a lesser extent,we have also built in a higher end state term premium estimate as well as incorporated a more front-loaded adjustment path to the end state into our 10Y UST forecast.This is due to the uncertainties surrounding the follow through of fiscal policy proposals,how these ultimately plays out on the inflation front and how deftly the Fed adjusts its policy stance to emerging realities which we expect is likely to play out as higher yields to compensate investors for assuming such risks.In our base case for end 1Q25,we now forecast the 10Y UST at 4.20%(vs our pre-US election forecast of 3.80%for 1Q25).Thereafter,10Y yield is expected to drift slightly lower in tune with our expectations of a further 75bps rate cuts from the Fed.Eventually the 10Y UST could settle at 4.10%by 4Q25.In summary,10Y UST yield post Trumps re-election is now expected to stay above 4ross 2025,albeit with a mild downward sloping bias mainly due to anticipated Fed rate cuts across 2025.As UST goes so goes the SGS.We have marked our forecast for 10Y SGS higher but with a smaller increase compared to that in UST.In our base case for end 1Q25,we forecast the 10Y SGS at 2.80%and thereafter settle at 2.70%by 4Q25.This updated forecast is modestly higher compared to our previous forecast of 2.70%for 1Q25 followed by a mild drift lower towards 2.60ross 2025.Overall,SG yields may see some stickiness from a gentler MAS policy slope.Yield upside potential may be more limited because US term premium risks do not map 1 to 1.As for Sora,in our base case for end 1Q25,we forecast the 3M compounded in arrears Sora at 2.77%and thereafter to 2.23%by 4Q25.Sora can be expected to drop to a lesser extent than declines in US rates.Overall,SG yields may see some stickiness from a gentler MAS policy slope.Yield upside potential may be more limited because US term premium risks do not map 1 to 1.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202512COMMODITIES STRATEGYSafe haven demand for gold to stay strong amidst Trump 2.0 economic uncertaintiesGold:Positive safe haven drivers remain intact ahead of Trump 2.0.From a longer-term perspective,the positive drivers from on-going Emerging Market(EM)and Asian central bank allocation into gold,as well as strong physical gold and jewellery demand from the retail sector remain intact.It is important to note the common thread between both positive long-term demand from central banks and retail sector alike.Both are driven by safe haven needs to diversify away from rising geopolitical concerns and uncertainties around the US Dollar ahead of disruptive trade and fiscal policies from Trump 2.0.Specifically,the strong retail sector demand for gold is driven by on-going substantial depreciation of domestic currencies like INR,CNH and VND,which amplify the gains in gold prices in local currency terms.Overall,we keep our positive view for gold as long-term safe haven demand needs will likely stay strong amidst further rise in geopolitical risks and economic risks from Trump 2.0 policies.Our forecasts for 2025 are USD 2,700/oz for 1Q25,USD 2,800/oz for 2Q25,USD 2,900/oz for 3Q25 and USD 3,000/oz for 4Q25.Brent:Trump 2.0 tariffs to keep oil prices pressured around USD 70/bbl.One major worry overhanging oil price is the much uncertainty over the global growth outlook as well as Chinas economic recovery after the possible large tariff hikes from Trump 2.0 across 2025.This risk of further growth slowdown from renewed tariffs in 2025 appears to be nullifying any rise in geopolitical risk from the on-going Russia-Ukraine war.In short,while most of the negative factors like global demand downgrade are now apparent,we acknowledge the further downside risk from negative impact from Trump 2.0 tariffs on China and global energy demand.As such,we now adopt a negative outlook for Brent crude oil forecasting USD 75/bbl for 1H25 and USD 70/bbl for 2H25.If global trade conflict worsens,the risk of further sell-off below USD 70/bbl cannot be ruled out later in 2025.LME Copper:Downgrading Copper outlook further to negative as Trump 2.0 tariffs loom.Over the longer run,the risk of further supply disruption from aging copper mines remains a key concern.However,this supply risk is now completely overtaken by more immediate concerns of the risk of global trade contraction and manufacturing slowdown due to the incoming Trump 2.0 tariffs later in 2025.As a result of risks from Trump 2.0 tariffs,our macroeconomic team has downgraded the base case estimate of Chinas economic growth in 2025 to 4.3%.Depending on the intensity and pacing of the incoming Trump 2.0 tariffs,it is likely that China,Asia as well as the rest of the world will suffer yet another round of trade and export contraction across 2025 and further into 2026.This will likely weigh down on LME Copper prices.As a result of immediate risks to global trade and production from incoming Trump 2.0 tariffs,we downgrade LME Copper outlook further from neutral to negative.Updated forecasts are USD 8,000/MT for 1H25 and USD 7,500/MT for 2H25.JAPAN FOCUSSnapshot of Japans political scene post election Prime Minister Ishiba and the Liberal Democrat Party(LDP)survived the Oct election drubbing and is now ruling as a minority government.PM Ishiba managed to pass the JPY21.9 trillion stimulus package with the help of opposition DPP in return for including the measure to raise the threshold for tax-free income which may improve labour supply and increase consumption spending but will invariably widen the fiscal burden.Political stability and continuity cannot be assumed,if the loose coalition with DPP breaks down,or the LDP loses ground further in the upper house elections in 2025.Specifically,the strong retail sector demand for gold is driven by on-going substantial depreciation of domestic currencies like INR,CNH and VND,which amplify the gains in gold prices in local currency terms.In short,while most of the negative factors like global demand downgrade are now apparent,we acknowledge the further downside risk from negative impact from Trump 2.0 tariffs on China and global energy demand.As such,we now adopt a negative outlook for Brent crude oil.Political stability and continuity cannot be assumed,if the loose coalition with DPP breaks down,or the LDP loses ground further in the upper house elections in 2025.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202513Global FXUSD/JPY:Despite tariff uncertainties probably anchoring the USD for a while longer,further gains in USD/JPY may be held back by the persistent monetary policy divergence between the Fed(easing bias)and the Bank of Japan(BOJ)which we still forecast a rate hike in the coming Dec meeting.Also,traders may also turn cautious ahead of previous intervention levels near 160.Overall,our updated USD/JPY forecasts are 155 in 1Q25,157 in 2Q25,154 in 3Q25 and 152 in 4Q25.EUR/USD:While markets scale back expectations for Fed rate cuts due to the inflation spillover of Trumps tariff policy,they intensified pricings for more aggressive easing from the ECB to bolster the regions economy after Euro-area business activity unexpectedly shrank in Nov.Political crises in Germany and France and escalating Russia-Ukraine war which now included long-range missile in the warfare also add to the perfect storm against the EUR.An over 50%chance of a half-point ECB rate cut in Dec weighed further on EUR/USD while futures markets have flipped to a net short EUR/USD position since late Oct.With the multitude of headwinds,it seems inevitable that EUR/USD would test the well-watched parity level in the coming months.Overall,our updated EUR/USD forecasts are 1.02 in 1Q25,0.99 in 2Q25,1.01 in 3Q25 and 1.03 in 4Q25.GBP/USD:GBP is likely to face lesser headwinds compared to other Major FX peers such as the EUR.Most importantly,the monetary policy gap between the Fed and the Bank of England(BOE)remains reasonably small.Both central banks are expected to guide rates lower to a similar 3.75%by end-2025.Futures traders also kept to a modest net long GBP/USD position amidst the pullback in spot.Taken together,while the path of least resistance is likely for a lower GBP/USD,further losses from here may be limited.Overall,our updated GBP/USD forecasts are 1.23 in 1Q25,1.21 in 2Q25,1.23 in 3Q25 and 1.25 in 4Q25.AUD/USD:Going forth,AUDs close correlation to the CNY meant that a potential repeat of the 2018-2020 US-China trade war may see AUD underperform within the G-10 FX space,as it did during the first year of trade war in 2018.At the same time,a hawkish RBA rhetoric relative to the Fed may counteract part of the depreciation pressures on the AUD.Overall,our updated AUD/USD forecasts are 0.63 in 1Q25,0.61 in 2Q25,0.62 in 3Q25 and 0.64 in 4Q25.NZD/USD:While New Zealand is unlikely to be in direct crosshair of Trumps upcoming trade tariffs,RBNZ keeping to a slightly faster rate-cut pace relative to the Fed is likely to keep the pressure on the NZD.Like other G-10 peers,we now expect NZD to weaken further against the USD in 1H25 before rebounding in 2H25.Our updated NZD/USD forecasts are 0.57 in 1Q25,0.55 in 2Q25,0.56 in 3Q25 and 0.57 in 4Q25.Asian FXUSD/CNY:Referencing the 2018-2020 trade war,it is likely that USD/CNY will test recent key highs of 7.35 in the coming months as tariff uncertainties build.A pickup of hedging demand upon the breach of 7.35 may lead to USD/CNY beginning a new trading range above that level.To maintain an orderly devaluation,the PBOC may guide markets expectations via the daily CNY fixing and warns against one-sided speculative bets on its currency.Overall,our updated USD/CNY forecasts are 7.35 in 1Q25,7.50 in 2Q25,7.60 in 3Q25 and 7.45 in 4Q25.The risk is skewed to further downside for CNY if larger or sooner tariffs are implemented compared to our base case.USD/SGD:Notwithstanding a“slight”reduction to the slope in the coming Jan 2025 MPS,a still-positive S$NEER slope may underpin SGD-crosses.To this point,the recent dip of S$NEER below the policy midpoint(according to our model)may offer opportunities for investors to reload on selected SGD-crosses to hedge for Trump tariffs.Volatility of USD/SGD is likely to be checked by the SGDs reputation as a regional safe-haven currency.Currently,we do not see USD/SGD rising beyond 1.40 in our base case scenario.Overall,our updated USD/SGD forecasts are 1.36 in 1Q25,1.37 in 2Q25,1.38 in 3Q25 and 1.36 in 4Q25.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202514USD/HKD:Alongside our expectations that USD is likely to stay bid in the coming quarters as Trumps tariff policy takes shape,we expect USD/HKD to normalise further towards the middle of its 7.75 7.85 trading band.As such,we reiterate our USD/HKD forecasts of 7.80 for the next four quarters in 2025.USD/TWD:With the return of Trump and trade tariffs looming,we argue that the path of least resistance is still for TWD to weaken further against the USD,mirroring similar moves in other Asian peers.That said,favourable factors such as the ongoing AI upcycle underpinning demand for Taiwans chips and CBCs stable rate outlook may limit TWDs downside.Overall,our latest USD/TWD forecasts are 32.8 in 1Q25,33.0 in 2Q25,33.2 in 3Q25 and 32.9 in 4Q25.USD/KRW:2025 may continue to be a challenging year for the KRW.Trumps proposed trade tariffs against China is likely to weigh on the CNY and spill over negatively to the KRW.Being a higher beta currency,we accord a higher drawdown of the KRW in 2025 compared to regional peers.The key high of 1,450 in USD/KRW will probably be tested in 2025 as Trumps tariff policy takes shape.Overall,we expect USD/KRW to trade higher across most part of 2025 and our latest forecasts are at 1,420 in 1Q25,1,440 in 2Q25,1,460 in 3Q25 and 1,430 in 4Q25.USD/MYR:Despite sound economic and financial fundamentals,the MYR is vulnerable to external developments,especially the potential upcoming Trump tariffs which is expected to weigh on Asia FX as a whole.The MYR which is closely correlated to the CNY will likely take direction from the latter.We expect the CNY and hence MYR to weaken against the USD for the first three quarters of 2025 as Trumps tariff plan takes shape before rebounding in 4Q25.Overall,our USD/MYR forecasts are now at 4.53 in 1Q25,4.60 in 2Q25,4.65 in 3Q25 and 4.55 in 4Q25.USD/IDR:Going forth,while further USD strength is the likely path of least resistance,BIs emphasis on rupiah stability may slow USD/IDRs ascent.Overall,our updated USD/IDR forecasts are 16,000 in 1Q25,16,200 in 2Q25,16,400 in 3Q25 and 16,200 in 4Q25.USD/THB:It is worth noting that the THB was the most resilient Asia FX in the last trade war(2018-2020)as investors took refuge in the safe-haven currency.This time round,favourable factors similar to 2018 include Thailands current account surplus,low inflation and a stable benchmark rate outlook.Overall,we expect THBs currency fluctuation to be lesser than regional peers in our base case scenario.Our updated USD/THB forecasts are 35.2 in 1Q25,35.5 in 2Q25,35.7 in 3Q25 and 35.2 in 4Q25.USD/PHP:In 2025,the PHP is likely to be on the defensive,taking direction from Trumps tariff policy as it takes shape as well as the CNY.A faster pace of rate cuts by the BSP relative to the Fed in 2025 is likely to weigh on the PHP as well.It appears that the record low of 59.33/USD will be tested in the near term as external headwinds build.Overall,we forecast USD/PHP to be at 59.5 in 1Q25,60.0 in 2Q25,60.5 in 3Q25 and 60.0 in 4Q25.USD/VND:Going forth,the VND is likely to take direction from Trumps tariff policy and the CNY.Currently consolidating near the record low of 25,463/USD,the VND looks set to trade to a new low given the external headwinds.Overall,our updated USD/VND forecasts are 25,800 in 1Q25,26,000 in 2Q25,26,200 in 3Q25 and 26,000 in 4Q25.USD/INR:Going forward,further outflows from the local bond and stock markets may continue to be a drag on the INR.On the other hand,a shallower RBI rate cut cycle this time round may maintain the INRs rate advantage over the Fed,buffering the currency.The RBI may continue to draw upon its big stockpile of forex reserves to limit currency volatility as INR trades to a new record low against the USD.Overall,our updated USD/INR forecasts are at 85.0 in 1Q25,85.5 in 2Q25,86.5 in 3Q25,and 85.5 in 4Q25.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202515y/y%change20232024F2025F1Q242Q243Q244Q24F1Q25F2Q25F3Q25F4Q25FChina5.24.94.35.34.74.65.04.74.54.14.0Hong Kong3.32.52.02.83.21.82.01.01.32.82.8India(FY)7.08.26.88.28.18.67.86.76.37.17.0Indonesia5.15.25.35.15.15.05.55.35.25.45.2Japan1.7-0.31.0-0.8-1.10.20.51.41.30.70.8Malaysia3.65.34.74.25.95.35.84.94.74.64.6Philippines5.55.56.05.86.45.24.75.66.16.26.1Singapore1.13.52.53.03.05.42.73.53.70.62.2South Korea1.42.22.03.32.31.51.81.42.32.22.0Taiwan1.34.33.06.65.14.02.02.53.12.83.3Thailand1.92.72.91.62.23.04.13.43.32.62.4Vietnam5.06.46.65.97.17.45.26.56.56.66.8Australia2.01.12.01.31.01.01.21.62.02.12.2Eurozone0.40.81.20.50.60.91.11.01.21.11.3New Zealand0.70.11.70.5-0.5-0.10.20.61.52.22.5United Kingdom0.41.01.40.30.71.11.81.51.41.41.4United States(q/q SAAR)2.92.71.81.63.02.82.01.11.22.21.5For India,full-year and quarterly growth are based on its fiscal calendar(Apr-Mar)Source:Macrobond,UOB Global Economics&Markets Research ForecastReal GDP growth trajectoryFORECASTUOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202516Source:UOB Global Economics&Markets Research EstimatesFX27 Nov1Q25F2Q25F3Q25F4Q25FUSD/JPY152155157154152EUR/USD1.061.020.991.011.03GBP/USD1.271.231.211.231.25AUD/USD0.650.630.610.620.64NZD/USD0.590.570.550.560.57DXY106.1108.9111.1109.2107.6USD/CNY7.257.357.507.607.45USD/HKD7.787.807.807.807.80USD/TWD32.5432.8033.0033.2032.90USD/KRW1,3931,4201,4401,4601,430USD/PHP58.7259.5060.0060.5060.00USD/MYR4.444.534.604.654.55USD/IDR15,93016,00016,20016,40016,200USD/THB34.5935.2035.5035.7035.20USD/VND25,39425,800 26,000 26,200 26,000USD/INR84.4585.0085.5086.5085.50USD/SGD1.341.361.371.381.36EUR/SGD1.421.391.361.391.40GBP/SGD1.701.671.661.701.70AUD/SGD0.870.860.840.860.87SGD/MYR3.313.333.363.373.35SGD/CNY5.415.405.475.515.48JPY/SGDx1000.890.880.870.900.89POLICY RATES27 Nov1Q25F2Q25F3Q25F4Q25FUS Fed Fund Rate4.754.254.003.753.75JPY Policy Rate0.250.500.500.500.50EUR Refinancing Rate3.402.902.652.402.15GBP Repo Rate4.754.504.254.003.75AUD Official Cash Rate4.354.003.753.503.25NZD Official Cash Rate4.254.003.503.003.00COMMODITIES27 Nov1Q25F2Q25F3Q25F4Q25FGold(USD/oz)2,6382,7002,8002,9003,000Brent Crude Oil(USD/bbl)7375757070LME Copper(USD/mt)9,0208,0008,0007,5007,500CNY 1Y Loan Prime Rate3.103.103.103.103.10HKD Base Rate5.004.504.254.004.00TWD Official Discount Rate2.002.002.002.002.00KRW Base Rate3.252.752.502.502.50PHP O/N Reverse Repo6.005.505.255.004.75MYR O/N Policy Rate3.003.003.003.003.00IDR 7D Reverse Repo6.005.505.004.754.75THB 1D Repo2.252.002.002.002.00VND Refinancing Rate4.504.504.504.504.50INR Repo Rate6.506.005.755.755.75INTEREST RATES27 Nov1Q25F2Q25F3Q25F4Q25FUSD 3M SOFR(compounded)4.934.353.993.743.61SGD 3M SORA(compounded)3.242.772.412.292.23US 10Y Treasuries Yield4.264.204.104.104.10SGD 10Y SGS2.822.802.702.702.70FX,interest rate&commoditiesFORECASTUOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q2025171Q 2025KEY EVENTS02US20US20-24GlobalLikely 01 FebIndiaMarMalaysia23 FebGermanyFebHong KongUS debt ceiling limit-the debt ceiling has been suspended since 3 Jun 2023 and will be reinstated on 2 Jan 2025.This is likely to be a non-event,as the unified government under the Republican party will ensure the suspension will be extended without causing any debt ceiling“tantrum”.Inauguration of the 47th US President,Donald J.Trump.World Economic Forum 2025-The meeting will take place in Davos Klosters,SwitzerlandUnion Budget FY2025-2026-The focus will remain on fiscal consolidation where the government has pledged to reduce the fiscal deficit to 4.5%of GDP by FY26 with a target of 4.9%for FY25.BNM to release its Bank Negara Malaysias Economic&Monetary Review 2024 and Financial Stability Review 2H24.Germany Federal Election to elect the members of the 21st Bundestag.It was originally scheduled for 28 September 2025 but was brought forward following the collapse of Chancellor Olaf Scholzs troubled three-party coalition.Hong Kongs FY2025-26 Budget.The government will unveil support measures for its economic and social priorities along with the official GDP forecast for 2025.Likely mid-FebSingaporeMarChinaBudget 2025-It will be of paramount importance as Singapore marks its 60th year of independence in 2025 and likely the last Budget in the current term of government.In our view,Budget 2025 will continue to build on the previous measures to address the heightened cost-of-living,enhance skills training and improve job security.This budget will serve as a prelude to the General Elections which must be held by 23 Nov 2025.Premier Li Qiang will deliver the annual Government Work Report at the opening of the National Peoples Congress(NPC).The key economic targets for 2025 will be announced with the focus on the growth and fiscal deficits as external headwinds intensify.2025 is a key year for formulating the 15th Five-Year Plan(2026-2030).JANUARYFEBRUARYMARCHUOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202518Snapshot of Japans political scene post electionThe lower house election outcomeLeadership transitionIshiba re-electedChallenges aheadRuling LDP and its coalition partner,Komeito won just 215 seats down from 291 previously-failing to secure a majority for the first time since 2009.In contrast,main opposition-Constitutional Democratic Party(CDP)saw a jump in the seats won to 148 from 96.Shigeru Ishiba was elected as the president of Liberal Democratic Party(LDP)on 27 Sep and took over as the nations prime minister on 1 Oct.Ishiba quickly called for a snap election of the lower house to be held on 27 Oct-a year ahead of the expiration of the current term.Japanese lawmakers voted for PM Ishiba to stay on as leader in a special parliamentary voting session on 11 Nov.Liberal Democratic Party(LDP)Constitutional Democratic Party(CDP)Japan Innovation Party(JIP)Democratic Party For the People(DPP)CDP now controls the chairmanship of the chambers Budget Committee(the first time in 3 decades),known as the main forum for policy debate The opposition CDP and DPP have an increased presence in the lower house raising the bar for Ishiba in seeking parliamentary approval Japan will hold elections for the upper house in Jul 2025 the ruling coalition holds a slim majority.Half of the 248 seats will be up for election,and the potential loss of the Upper House majority will make it even more difficult for Ishiba to govern effectively.A no-confidence motion will be called by then(or even earlier).JAPAN FOCUSUOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202519House of Representatives(lower house-465 seats)House of Councilors(upper house-248 seats)Composition of the National DietEconomic implicationsAbout the chamberNext electionLength of termSource:The National Diet of Japan,newswires,Global Economics&Markets ResearchLDP-191LDP-113Komeito-24Komeito-27BEFORERuling coalitionRuling coalitionOppositionOppositionAFTERCDP-148CDP-42JIP-18JIP-38DPP-12DPP-28Others-20Others-24Independent-8Independent-28Vacant-8 We still expect BOJ to normalize policy further via a 25bps hike in Dec this year which we believe will be the terminal rate.Market probability for a rate hike is at 68%for Dec,a higher 84%for Jan 2025,and fully priced in by Mar 2025 MPM(as of 27 Nov).PM Ishiba may propose an extra budget of JPY13 tln(US$85 bn)to fund a JPY21.9 tln economic stimulus package to help households cope with higher costs of living via energy subsidies and one-off financial aid to low income households.However,as a minority government,Ishiba needed the backing of smaller parties to have enough votes to pass legislation.The DPP,voted together with the LDP coalition to pass the stimulus package after one of their key demands-to raise the tax-free income ceiling from JPY1.03 mn to JPY1.78 mn,was included in the package.This increase in the ceiling may encourage part-time workers to extend their working hours without the fear of higher tax burden(therefore boosting Japans labour supply).It may also increase consumption by households as the income rise is seen to be permanent.But the measure is expected to worsen Japans fiscal outlook,with government estimating the tax revenue losses could amount to JPY7 to 8 tln annually.Political stability and continuity cannot be assumed,if the LDPs loose coalition with DPP breaks down,or the LDP loses ground further in the upper house elections in 2025.USD/JPY grinded higher to a four-month high of about 155 amidst a broad USD resurgence as markets priced in lesser Fed rate cuts in a Trump 2.0 scenario.The above mentioned uncertain political landscape in Japan also added to the JPY weakness.Going forward,traders may also turn cautious on the USD against the JPY ahead of previous intervention levels near 160.In line with expectations of another BOJ rate hike,we see USD/JPY topping out but still staying above 150.Overall,our updated USD/JPY forecasts are 155 in 1Q25,157 in 2Q25,154 in 3Q25 and 152 in 4Q25.Cannot be dissolved,and terms are staggered so that only half of its membership is up for election every 3 years.For treaties,budget,and the selection of the prime minister,the House of Councillors can only delay passage,but not block the legislation.Before 27 Jul 20256 yearsCan be dissolved by the prime minister or the passage of a non-confidence motion.The House of Representatives can override the decision of the House of Councillors by a two-thirds vote in the affirmative.Before 22 Oct 20284 yearsUOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202520Will Trump 2.0 make the USD great again?The USD surged in 4Q24,tracing higher US Treasury yields in the immediate aftermath of the Trumps victory in the US elections.Investors quickly priced in the risk that Trumps potential trade tariffs,expansionary fiscal stance and stricter immigration policy may derail the US disinflation process and the Feds plan to lower interest rates.While it appears clear that the USD may stay bid in the near term as Trumps policy uncertainties linger,the bigger question is whether this USD recovery is sustainable?Asia FX posted steep losses and slipped against the USD in 4Q24 on worries of a repeat of the 2018-2020 US-China trade war.The Asia Dollar Index reversed strong gains from the prior quarter and now nears the key support level which has held during previous stress periods such as steep Fed rate hikes(2022)and China slowdown concerns(2023-2024).Would the level hold again this time round?Or would trade war 2.0 trigger an extended period of Asia FX weakness?Major FX StrategyUSD to strengthen further in 1H25 before moderating in 2H25Market expectations of Trumps trade tariffs will be the predominant driver for USD in 2025,at least in the first half of the year.Since Trumps victory in early Nov,the US Dollar Index(DXY)has rallied about 4%to 107.6,the highest level in two years.The move reflected market expectations that some form of trade tariffs will be threatened or imposed on US trade partners in 2025.While it appears clear that the USD may stay bid in the near term as Trumps policy uncertainties linger,the bigger question is whether this USD recovery is sustainable?The Asia Dollar Index reversed strong gains from the prior quarter and now nears the key support level which has held during previous stress periods such as steep Fed rate hikes(2022)and China slowdown concerns(2023-2024).Would the level hold again this time round?Or would trade war 2.0 trigger an extended period of Asia FX weakness?FX STRATEGYChart 1:Most Major and Asia FX fell against the USD across Oct Nov as markets repriced for less Fed rate cuts in Trump 2.0 eraSource:Bloomberg,UOB Global Economics&Markets Research-10-5051015NZDJPYGBPAUDEURMajor FX performance in 4Q24 vs 3Q243Q24(%)4Q24 to date(%)-10-5051015MYRTHBKRWPHPIDRSGDVNDCNYTWDINRHKDAsia FX performance in 4Q24 vs 3Q243Q24(%)4Q24 to date(%)UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202521Our base case-at 55%probability sees additional 25%tariffs imposed on China and 10%tariffs imposed on economies that increased in trade surplus with US due to trade diversion from China.We also assume China will retaliate by imposing similar tariffs on US goods but limited retaliatory responses from other economies.In addition,we accord a significant 40%probability for a pessimistic scenario whereby the Trump administration imposes additional 10%“anti-drug”tariff imposed on all imports from China,additional 25%“anti-drug”tariff on all imports from Mexico and Canada with effect from Jan 2025 on executive order.Subsequently,the administration will also make good of its election pledge to impose 10-20%tariffs on all imports,and 60%on China imports.The clear consequence of trade tariffs is higher US inflation of between 0.3ppt(base case)and 0.5ppt(pessimistic case)in 2025.As such,the Fed will be on guard against any sign price pressures are again building.We think this will translate to lesser Fed rate cuts in 2025(75bps for base case,25 bps for pessimistic)and a higher terminal rate(3.75%by 3Q25 for base case,4%by 1Q26 for pessimistic)as compared to our previous outlook before the elections.In our base case,we now expect USD to strengthen further against most Major FX peers in 1H25 as tariff uncertainties dominate.In 2H25,USD strength may start to moderate as most of the repricing for Trumps tariffs(base case)may have already been done and our downward trajectory in US rates could start to exert downward pressure on the USD.Overall,we expect the DXY to rise to 111.1 by mid-2025 before easing off to 107.6 by end-2025.We also expect FX volatility to stay elevated as investors digest incoming tariff headlines and the ensuing Fed response.EUR was one of the biggest casualties within G-10 FX due to the US elections,falling about 4%from 1.08 to 1.04 across Nov,the lowest level in two years.Underscoring the sharp move was the stark monetary policy divergence between the Fed and the European Central Bank(ECB).While markets scaled back expectations for Fed rate cuts due to the inflation spillover of Trumps tariff policy,they intensified pricings for more aggressive easing from the ECB to bolster the regions economy after Euro-area business activity unexpectedly shrank in Nov.Political crises in Germany and France and the escalating Russia-Ukraine war which now included long-range missiles in the warfare also add to the perfect storm against the EUR.Interest rate swaps now indicate 138 bps(as of 22 Nov)of additional ECB rate by Jun 2025 compared to 115 bps at the start of Nov.An over 50%chance of a half-point ECB rate cut in Dec weighed further on EUR/USD while futures markets have flipped to a net short EUR/USD position since late Oct.With the multitude of headwinds,it seems inevitable that EUR/USD would test the well-watched parity level in the coming months.Overall,we now turn negative in our outlook for the EUR and our updated EUR/USD forecasts are 1.02 in 1Q25,0.99 in 2Q25,1.01 in 3Q25 and 1.03 in 4Q25.Overall,we expect the DXY to rise to 111.1 by mid-2025 before easing off to 107.6 by end-2025.We also expect FX volatility to stay elevated as investors digest incoming tariff headlines and the ensuing Fed response.With the multitude of headwinds,it seems inevitable that EUR/USD would test the well-watched parity level in the coming months.Overall,we now turn negative in our outlook for the EUR.Chart 2:DXY to rise in first half of 2025 before pulling backSource:Macrobond,UOB Global Economics&Markets ResearchUOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202522Chart 3:Futures positioning in EUR/USD flipped to a net short since late OctSource:Bloomberg,UOB Global Economics&Markets Research1.021.041.061.081.101.12-10-50510152025Dec 23Feb 24Apr 24Jun 24Aug 24Oct 24CFTC EUR/USD non-comm positioning(USDbn)EUR/USD-RHSWeighed by broad USD strength,GBP/USD dipped below 1.25 in late Nov,the lowest level in six months.That said,the GBP is likely to face lesser headwinds compared to other Major FX peers such as the EUR.Most importantly,the monetary policy gap between the Fed and the Bank of England(BOE)remains reasonably small.While we have pared expectations of Feds easing from 100 bps to 75 bps in 2025,we kept to expectations of 100 bps from the BOE as a result of still-sticky wage growth.Both central banks are expected to guide rates lower to a similar 3.75%by end-2025.Futures traders also kept to a modest net long GBP/USD position amidst the pullback in spot.Taken together,while the path of least resistance is likely for a lower GBP/USD,further losses from here may be limited.Overall,we now view GBP negatively as well and our updated GBP/USD forecasts are 1.23 in 1Q25,1.21 in 2Q25,1.23 in 3Q25 and 1.25 in 4Q25.USD/JPY grinded higher to a four-month high of about 155 amidst a broad USD resurgence as markets priced in lesser Fed rate cuts in a Trump 2.0 scenario.Despite tariff uncertainties probably anchoring the USD for a while longer,further gains in USD/JPY may be held back by the persistent monetary policy divergence between the Fed(easing bias)and the Bank of Japan(BOJ)which we still forecast a rate hike in the coming Dec meeting.Already,the 10-year USD-JPY rate spread has narrowed modestly in Nov,owning to a bigger rise in the 10-year JGB yield compared to the US equivalent.Traders may also turn cautious ahead of previous intervention levels near 160.Overall,our updated USD/JPY forecasts are 155 in 1Q25,157 in 2Q25,154 in 3Q25 and 152 in 4Q25.Chart 4:USD/JPY feels the drag of a falling rates spreadSource:Bloomberg,UOB Global Economics&Markets Research1051201351501651.001.502.002.503.003.504.004.50Apr 21Dec 21Aug 22Apr 23Dec 23Aug 2410Y US-Japan rates spread(%)USD/JPY-RHSWhile the path of least resistance is likely for a lower GBP/USD,further losses from here may be limited.Despite tariff uncertainties probably anchoring the USD for a while longer,further gains in USD/JPY may be held back by the persistent monetary policy divergence between the Fed(easing bias)and the BOJ which we still forecast a rate hike in the coming Dec meeting.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202523Overall,we expect most Asia FX to weaken alongside the CNY for the first three quarters of 2025 before rebounding in 4Q25.In the event that the pessimistic scenario comes to pass where 60%(instead of 25%in base case)tariffs are imposed on the Chinese goods,the fallout on Asia FX is likely to be considerably stronger and more enduring compared to the base case.It was a roller-coaster ride for AUD/USD in the past couple of months.Soaring to 0.69 in late Sep after China announced its latest monetary stimulus package,the pair has since reversed all its gains in the 3Q24 as the USD strengthened anew across Oct Nov.Going forth,AUDs close correlation to the CNY meant that a potential repeat of the 2018-2020 US-China trade war may see AUD underperform within the G-10 FX space,as it did during the first year of trade war in 2018.At the same time,a hawkish Reserve Bank of Australia(RBA)rhetoric relative to the Fed may counteract part of the depreciation pressures on the AUD.Overall,it will be difficult for AUD to counter the USDs renewed strength as well and our updated AUD/USD forecasts are 0.63 in 1Q25,0.61 in 2Q25,0.62 in 3Q25 and 0.64 in 4Q25.Asia FX StrategyAsia FX to weaken further for the first three quarters of 2025 before rebounding in 4Q25Asia FX posted steep losses and slipped against the USD in 4Q24 as market sentiment soured in the face of looming trade tariffs imposed on Chinese goods next year.Losses in the region were largely led by currencies which rose the most in 3Q24,namely MYR(-7.5%in 4Q24-to-date)and THB(-6.8%).A Trump 2.0 scenario is a key risk to our sanguine outlook on Asia FX,as we highlighted in the latest FX&Rates Monthly published 29 Oct(For more details,pls refer to report here).A potential repeat of the 2018-2020 US-China trade war would undermine Asias exports,growth outlook,sentiment and eventually Asia FX.The 2018 playbook saw Asia FX start to depreciate about three months into the first tariffs imposed on Chinese goods in Jul 2018 and continue to stay weak for couple of months after which.Having a precedent probably means that much of the expected Asia FX weakness may be front-loaded this time round,as compared to 2018.A nuance this time is that the Fed is in the midst of an easing cycle now as opposed to a tightening cycle previously which may translate to lesser headwinds on Asia FX in the current episode.Chart 5:USD/CNY and USD/SGD both rose before and after the first tariffs were imposed on China in Jul 2018Source:Macrobond,UOB Global Economics&Markets ResearchAUDs close correlation to the CNY meant that a potential repeat of the 2018-2020 US-China trade war may see AUD underperform within the G-10 FX space,as it did during the first year of trade war in 2018.Having a precedent probably means that much of the expected Asia FX weakness may be front-loaded this time round,as compared to 2018.A nuance this time is that the Fed is in the midst of an easing cycle now as opposed to a tightening cycle previously which may translate to lesser headwinds on Asia FX in the current episode.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202524It is teeing up to be yet another difficult year for the CNY in 2025.Trumps tariffs are likely to exacerbate the existing concerns about Chinas economic slowdown.As a result,our macroeconomic team have downgraded 2025 GDP growth forecast to 4.3%from 4.6%as we factor in some tariffs on Chinese goods to become effective in 4Q25.On top of a weaker domestic growth outlook,the CNY is likely to fall further against the USD as a shorter and shallower Fed rate-cut cycle helps support the USD.Referencing the 2018-2020 trade war,it is likely that USD/CNY will test recent key highs of 7.35 in the coming months as tariffs uncertainties build.A pickup of USD hedging demand upon the breach of 7.35 may lead to USD/CNY beginning a new trading range above that level.At the same time,it is worth noting that the USD/CNY strength back in 2018 was more pronounced as it was the first time a trade conflict was waged between the two countries and that USD was also drawing strength from a Fed rate hike cycle at that time.In comparison,this time round the Fed is expected to keep to its rate cuts plan even as tariffs loom.To maintain an orderly devaluation,the Peoples Bank of China(PBOC)may guide markets expectations via the daily CNY fixing and warns against one-sided speculative bets on its currency.Overall,we now see upside risk to USD/CNY in the coming few quarters and our updated USD/CNY forecasts are 7.35 in 1Q25,7.50 in 2Q25,7.60 in 3Q25 and 7.45 in 4Q25.The risk is skewed to further downside of CNY if the larger or sooner tariffs are implemented compared to our base case.In the last trade war,a positive-sloping S$NEER helped buffer the SGD against external headwinds and underscored gains against most of its regional trading peers.In the first year(2018),the SGD fell a modest 2%against the resurgent USD,one of the most resilient Asia FX.This time round,history may repeat again.Notwithstanding a“slight”reduction to the slope in the coming Jan 2025 MPS,a still-positive S$NEER slope may underpin SGD-crosses.To this point,the recent dip of S$NEER below the policy midpoint(according to our model)may offer opportunities for investors to reload on selected SGD-crosses to hedge for Trump tariffs.Volatility of USD/SGD is likely to be checked by the SGDs reputation as a regional safe-haven currency.Currently,while we see more upside risk to USD/SGD,we do not see USD/SGD rising beyond 1.40 in our base case scenario.Overall,our updated USD/SGD forecasts are 1.36 in 1Q25,1.37 in 2Q25,1.38 in 3Q25 and 1.36 in 4Q25.Chart 6:S$NEER rarely trade below the policy midpoint in recent years whilst having a positive slopeSource:Bloomberg,UOB Global Economics&Markets Research122127132137142Jul 21Nov 21Mar 22Jul 22Nov 22Mar 23Jul 23Nov 23Mar 24Jul 24Nov 24UOB S$NEERMid-pointUpper bandLower bandIt is worth noting that the USD/CNY strength back in 2018 was more pronounced as it was the first time a trade conflict was waged between the two countries and that USD was also drawing strength from a Fed rate hike cycle at that time.Notwithstanding a“slight”reduction to the slope in the coming Jan 2025 MPS,a still-positive S$NEER slope may underpin SGD-crosses.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202525Chart 7:Will investors take refuge in the THB again,like they did in the 2018 trade war?Source:Bloomberg,UOB Global Economics&Markets Research29.530.531.532.533.56.26.36.46.56.66.76.86.97.07.17.2Jan 18Jul 18Jan 19Jul 19USD/CNY-InverseUSD/THB-Inverse,RHSWe expect the CNY and hence MYR to weaken against the USD for the first three quarters of 2025 as Trumps tariff plan takes shape before rebounding in 4Q25.While we see further THB weakness ahead,we expect THBs currency fluctuation to be lesser than regional peers in our base case scenario.Reversing a large part of its outsized 12.6%gain against the USD in 3Q24,the MYR weakened back to 4.45(as at late Nov)as a second Trump presidency fueled concerns over protectionist trade measures and fewer Fed rate cuts,as well as escalating military conflict in Russia-Ukraine pushed the USD higher.The broad USD strength has prompted foreign investors to readjust their MYR portfolio funds through hedging activities since early Oct.Despite sound economic and financial fundamentals,the MYR is vulnerable to external developments,especially Trump tariffs which is expected to weigh on Asia FX as a whole.The MYR which is closely correlated to the CNY will likely take direction from the latter.We expect the CNY and hence MYR to weaken against the USD for the first three quarters of 2025 as Trumps tariff plan takes shape before rebounding in 4Q25.Overall,in line with our expectations for higher USD/Asia in first three quarters of next year,our USD/MYR forecasts are now at 4.53 in 1Q25,4.60 in 2Q25,4.65 in 3Q25 and 4.55 in 4Q25.After jumping 12%in 3Q24,the biggest quarterly gain since 1998,the THB has pared about half of the gains across Oct Nov.A confluence of factors contributed to the THBs slump,including a surprise 25 bps Bank of Thailand(BOT)rate cut by in Oct,broad USD strength and an outsized bond outflow(USD 2bn across Oct Nov,on track for largest quarterly outflow since 1Q20).Going forward,the THB is likely to weaken alongside the CNY and regional peers as Trumps tariff policy takes shape in the coming months.It worth noting that the THB was the most resilient Asia FX in the last trade war(2018-2020)as investors took refuge in the safe-haven currency.This time round,favourable factors similar to 2018 include Thailands current account surplus,low inflation and a stable benchmark rate outlook.Overall,while we see further THB weakness ahead,we expect THBs currency fluctuation to be lesser than regional peers in our base case scenario.Our updated USD/THB forecasts are 35.2 in 1Q25,35.5 in 2Q25,35.7 in 3Q25 and 35.2 in 4Q25.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202526USD/IDR rebounded from a low of near to 15,000 in late Sep to 15,800 in late Nov alongside higher US Treasury yields which dent the appeal of local government bonds.Uncertainties are also building up on Trumps tariff policy which had investors turn cautious about Emerging Market(EM)exposure.Inflows to Indonesias government bonds have grinded to a standstill in 4Q24 after registering the biggest inflow since 2019 in the prior quarter(USD 4bn).To temper with the depreciation pressures,Bank Indonesia(BI)has intervened in the spot and domestic non-deliverable forwards in the last month.Going forth,while further USD strength is the likely path of least resistance,BIs emphasis on rupiah stability may slow USD/IDRs ascent.Overall,our updated USD/IDR forecasts are higher at 16,000 in 1Q25,16,200 in 2Q25,16,400 in 3Q25 and 16,200 in 4Q25.It was a roller coaster ride for the VND in the last couple of months.After registering the largest quarterly gain(3.5%)on record dating back 1993 in 3Q24,the VND has since reversed all its gains across Oct Nov.Despite resilient fundamentals,the VND is held hostage by external factors such as a resurgent USD as markets repriced for fewer Fed rate cuts in a Trump 2.0 era.Going forth,the VND is likely to take direction from Trumps tariff policy and the CNY.Currently consolidating near the record low of 25,463/USD,the VND looks set to trade to a new low given the external headwinds.Overall,our updated USD/VND forecasts point to a stronger USD over the coming quarters and are 25,800 in 1Q25,26,000 in 2Q25,26,200 in 3Q25 and 26,000 in 4Q25.Going forth,while further USD strength is the likely path of least resistance,BIs emphasis on rupiah stability may slow USD/IDRs ascent.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q20252710Y UST yield to stay above 4ross 2025 amidst a shallower Fed easing cycleYields further out on the curve will have to contend with uncertainties over the impact on US bond demand either from the fraying of international relationships quickening diversification out of US Treasuries,or from indigestion in response to expected higher coupon supply.RATES STRATEGYChart 1:Fed funds forecastsSource:Bloomberg,UOB Global Economics&Markets Research3.751.002.003.004.005.006.00Jun 22Mar 23Dec 23Sep 24Jun 25Mar 26Dec 26%UOBConsensusFF FuturesTis the season for casting our sights into the new year,and it appears to us that the conduct of monetary policy will be driven by answers to a couple of big questions.Will US economic exceptionalism continue in 2025?To what degree will actual fiscal policies resemble proposed policies?In addition,yields further out on the curve will also have to contend with uncertainties over the impact on US bond demand either from the fraying of international relationships quickening diversification out of US Treasuries,or from indigestion in response to expected higher coupon supply.At the same time,we inherit financial asset valuations which are on the rich end of history.A confidence shock will elicit a significant price response,which is something that we have already experienced on multiple occasions in 2024.Accounting for the above and marrying our macro-economic teams forecasts,our base case outlook can be described as cautiously optimistic on the extension of goldilocks conditions into 2025.Specifically,our base case assumes that the“worst of”scenarios will be managed such that a soft landing to growth remains a plausible outcome.Our FOMC viewCompared to our previous update at the end of Oct,our base case for Fed funds has been adjusted higher.We have removed 50bps of cuts from the previous easing cycle estimates and now project only three cuts in 2025 for an easing cycle bottom in Fed funds of 3.75%.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202528Underlying our Fed funds base case is an assumption that the policy rate still has some room to adjust lower towards more neutral settings.We are not alone in adjusting our Fed funds expectations higher.Measured from 9 Oct when prediction markets flipped in favour of Trump,US yields have moved higher largely due to investors repricing for a less aggressive easing stance from the Fed going forward.To be clear,even after easing,we have the SG$NEER policy slope still staying positive in 2025.This means that divergence scenarios(i.e.US rates down but SG rates up)are primarily consigned to tail events and are not our base case.Chart 2:Repricing measured from 9 Oct Trump flip in prediction marketsSource:Bloomberg,UOB Global Economics&Markets Research-0.070.260.12-0.100.19-0.09-0.30-0.20-0.100.000.100.200.300.400.50Inflation expectationsMonetary policyTerm premiumfore election dayAfter election dayWe are not alone in adjusting our Fed funds expectations higher.Measured from 9 Oct when prediction markets flipped in favour of Trump,US yields have moved higher largely due to investors repricing for a less aggressive easing stance from the Fed going forward.At this point,we think that it is premature to advocate for leaning against the crowd despite prices being more hawkish than our projection.Our foremost concern lies with fiscal policy uncertainty which renders risk reward assessments particularly amorphous.In our base case for end 1Q25,we forecast the 3M compounded in arrears Sofr at 4.35%.Thereafter,short term rates are then expected to drift lower across 2025 in tune with our expectations of a further 75bps rate cuts from the US Federal Reserve.Eventually the 3M compounded in arrears Sofr could drop to 3.61%by 4Q25.Our MAS viewWe have the MAS easing monetary policy via a slope reduction in early 2025.Our base case sees Singapores economic growth,measured via the output gap,hugging to its potential next year thus offering room for a gentler currency appreciation path.In our base case,short term SG yields will track lower alongside an expected decline in the US Fed funds rate.However,the pass through into SG yields may be smaller when we account for a more modest appreciation path in the SG$NEEER.To be clear,even after easing,we have the SG$NEER policy slope still staying positive in 2025.This means that divergence scenarios(i.e.US rates down but SG rates up)are primarily consigned to tail events and are not our base case.Underlying our Fed funds base case is an assumption that the policy rate still has some room to adjust lower towards more neutral settings.This move towards neutral is warranted on the basis on our expectation that US economic growth may continue to soften in the near term.We also acknowledge that upside risk to inflation has firmed on the back of fiscal and trade policy proposals by the incoming US administration.The Fed will not be able to ignore this which accounts for our truncated easing cycle and higher cycle bottom in the Fed funds rate.Our current Fed funds forecasts tracks in line with Bloombergs analyst consensus for rate cuts over the first 3 quarters of 2025.Thereafter,we hold a more hawkish end cycle Fed funds projection of 3.75%compared to the consensus take of between 3.25%to 3.50%.That said,the Fed funds futures market(as of 26 Nov close)is even more hawkishly placed,pricing in a monetary policy easing profile that is around 25bps shallower.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202529Chart 3:SGD weakened against NEER basketSource:Bloomberg,UOB Global Economics&Markets Research-1.00-0.80-0.60-0.40-0.200.0009 Oct16 Oct23 Oct30 Oct06 Nov13 Nov20 Nov%US ElectionsUOB S$NEERAmongst the policy proposals by the new US administration,those pertaining to trade and tariffs are of the most relevance here.Aside from the impact on the volume of trade activity,which is widely regarded as being negative in aggregate,there is also the question of how currency markets will adjust to the new realities.The markets assessment thus far has been to mark down the SG$NEER(measured from 9 Oct when prediction markets flipped in favour of Trump).It follows that the risk scenario for SG yields is that they could experience more pronounced underperformance versus US yields if the SG$NEER decline was to accelerate and extend towards the weak side of the policy band.In our base case for end 1Q25,we forecast the 3M compounded in arrears Sora at 2.77%.Thereafter,short term rates are then expected to drift lower across 2025 but to a lesser extent than declines in US yields.Eventually the 3M compounded in arrears Sora could drop to 2.23%by 4Q25.Our wider monetary policy viewsOur monetary policy views on major developed markets(DM)sees central bankers there positioned to continue cutting their own policy rates led by the RBNZ.In 2025,both the ECB and the BOE are expected to cut interest rates,albeit for slightly different reasons and at potentially different paces.The ECB is likely to continue its rate-cutting cycle due to a favorable inflation outlook,with projections showing inflation moving closer to its 2%target,modest economic growth forecasts,and a well-progressing disinflationary process.Global economic uncertainties,including potential protectionist policies from a new U.S.administration and weak eurozone growth,may further prompt the ECB to maintain an accommodative stance.The BOE,while also expected to cut rates,may adopt a more cautious approach due to persistent inflation concerns,with expectations of inflation rising to 2.8%by the third quarter of 2025 before easing.However,factors such as moderating wage growth,and global economic considerations could still support rate cuts.On the other end,BOJ was the exception to the easing trend in 2024 but we have penciled in a pause next year alongside a downgrade to our Japan 2025 GDP forecast.In our base case for end 1Q25,we forecast the 3M compounded in arrears Sora at 2.77%.Thereafter,short term rates are then expected to drift lower across 2025 but to a lesser extent than declines in US yields.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202530Chart 4:Year to date policy rate changesSource:Bloomberg,UOB Global Economics&Markets Research-1.50-1.25-1.00-0.75-0.50-0.250.000.250.50NZEUUSHKSI*PHUKSKCNTHAUINMYVNIDTWJP%Change in past mthTable 1:Further changes in policy rates(UOB forecast%)Developed marketsAsiaEconomy30 Nov 2024-31 Dec 20252026Economy30 Nov 2024-31 Dec 20252026New Zealand-1.25-Philippines-1.25-0.25Eurozone-1.25-Indonesia-1.25-Australia-1.10-Hong Kong-1.00-United Kingdom-1.00-0.75India-0.75-United States-1.00-Singapore*-0.670.02Japan0.25-South Korea-0.50-Thailand-0.25-China-Taiwan-Malaysia-Vietnam-*Represented by the change in 3M OIS rateSource:UOB Global Economics&Markets ResearchIn the Asian region,the brief virtuous cycle of currency appreciation and foreign inflows in 3Q24 came to a halt as we approached the US elections.Weve seen a few central banks utilizing this window to lower their policy rate.Although further easing from selected Asian central banks in 2025 remains our base case.We are cognizant that faced with the prospect of less cuts in Fed funds rates as well as the uncertainties around trade and tariff policies,Asian currencies have an increased potential to become more volatile.As such,Asian central banks may decide to tread more cautiously when it comes to future monetary policy easing.Our 10Y UST viewOur base case forecasts for 10Y UST have been marked higher compared to the previous month largely in view of the substantial upward shift in our Fed funds baseline.Contributing to a lesser extent,we have also built in a higher end state term premium estimate as well as incorporated a more front-loaded adjustment path to the end state into our 10Y UST forecast.This is due to the uncertainties surrounding the follow through of fiscal policy proposals,how these ultimately plays out on the inflation front and how deftly the Fed adjusts its policy stance to emerging realities which we expect is likely to play out as higher yields to compensate investors for assuming such risks.Our base case forecasts for 10Y UST have been marked higher compared to the previous month largely in view of the substantial upward shift in our Fed funds baseline.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202531Chart 5:UOB vs concensus forecast(10Y UST)Source:Bloomberg,UOB Global Economics&Markets Research4.204.104.104.104.104.204.204.204.302.503.003.504.004.505.005.506.00Q1 25Q2 25Q3 25Q4 25Q1 26Q2 26Q3 26Q4 26Q1 27%Forecast QuartersAverage Analyst ForecastHigh/Low Analyst ForecastUOBChart 6:US term premiumSource:Bloomberg,UOB Global Economics&Markets Research-2-1012345620406080100120140196819731978198319881993199820032008201320182023%US Debt%GDP10Y ACM TP-RHSLong Term TrendAnother commonly cited reason for higher term premiums is rising deficit concerns.On this point we lean towards its impact being cyclical in nature rather than structural.From a big picture perspective the increases in the term premium has been on a declining trend since the 1970s,albeit with large historical oscillations around this long term trend line.In the background,US debt has continued to grow ever larger as a percentage of GDP.If we assume markets to be efficient,then the ebb and flow of deficit concerns over time maps better to the oscillations in term premium rather than having a permanent impact on the long term trend.As such,we do not think that the current Trump fiscal deficit concerns are any different.In our base case for end 1Q25,we now forecast the 10Y UST at 4.20%(vs our pre-US election forecast of 3.80%for 1Q25).Thereafter,10Y yield is expected to drift slightly lower in tune with our expectations of a further 75bps rate cuts from the US Federal Reserve.Eventually the 10Y UST could settle at 4.10%by 4Q25.In summary,10Y UST yield post Trumps re-election is now expected to stay above 4ross 2025,albeit with a mild downward sloping bias mainly due to anticipated Fed rate cuts across 2025.In our base case for end 1Q25,we now forecast the 10Y UST at 4.20%(vs our pre-US election forecast of 3.80%for 1Q25).Thereafter,10Y yield is expected to drift slightly lower.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202532Our 10Y SGS viewAs UST goes so goes the SGS.Weve marked our forecast for 10Y SGS higher but with a smaller increase compared to that in UST.The smaller yield upside for 10Y SGS stems from two reasons.Firstly,part of the uplift in 10Y UST is due to cyclical fiscal deficit fears.This feature does not apply to the SGS market.Secondly,demand for SGS overall in 2024 has been healthy.SGS auction bid-to-cover ratios this year has been above their five-year average(except for the 50Y tenor).Given that we still expect a Fed easing cycle in 2025,demand for SGS should remain supportive which will help keep a lid on domestic yields.In our base case for end 1Q25,we forecast the 10Y SGS at 2.80%.Thereafter,10Y yield is expected to drift slightly lower to settle at 2.70%by 4Q25.This updated forecast is modestly higher compared to our previous forecast of 2.70%for 1Q25 followed by a mild drift lower towards 2.60ross 2025.Chart 7:2024 SGS auction bid-to-cover vs past 5YSource:Bloomberg,UOB Global Economics&Markets Research-0.50.00.51.01.52.02.53.0251015203050Z-scoreTenorTable 2:Summary table of rates forecastsRates27 Nov 24Forecast1Q25F2Q25F3Q25F4Q25FUS Fed Funds Target4.75Current4.254.003.753.75Previous4.254.003.753.503M Compounded SOFR4.93Current4.353.993.743.61Previous4.233.983.733.4810Y UST 4.26Current4.204.104.104.10Previous3.803.703.603.603M Compounded SORA3.24Current2.772.412.292.23Previous2.622.442.282.2010Y SGS2.82Current2.802.702.702.70Previous2.702.602.602.60Source:UOB Global Economics&Markets Research forecasts Weve marked our forecast for 10Y SGS higher but with a smaller increase compared to that in UST.UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202533Safe haven demand for gold to stay strong amidst Trump 2.0 economic uncertaintiesThe commodities complex encountered very interesting divergent price action over the past month around the US Presidential election.Following Trumps successful re-election,gold saw elevated volatility.Brent crude oil strengthened instead while LME Copper weakened further.Gold endured a heavy sell-off in early November,tumbling from USD 2,750/oz to USD 2,550/oz in the immediate aftermath of the US Presidential election.That sell-off made sense as both the USD and long-term Treasuries yield surged after Trump won his re-election and investors start to price in renewed inflation risk from higher trade tariffs and stickier Treasuries yield from higher deficits.After this latest round of volatility across November,are the long-term prospects of gold still positive?As for Brent crude oil,after repeatedly testing the key USD 70/bbl support across Sep,Oct and early Nov,prices rebounded by late Nov as futures climbed back up towards the USD 75/bbl level.Some argued that most of the weak demand news has been digested while rising conflict between Russia and Ukraine,with both parties now expanding warfare to include long range cruise missiles have pushed oil prices back up.In addition,there are initial signs of stabilizing of Chinas economy after the massive round of stimulus across Sep and Oct.Is this counter trend rebound in Brent crude oil price sustainable?Finally,LME Copper prices continued to head south.From its pre-election level of USD 9,500/MT in early Nov,LME Copper price fell further to just under USD 9,000/MT by end Nov.What is interesting is that the downshift in LME Copper price is contrary to the relatively better performance in Brent crude oil and this was despite various news of renewed supply disruption from key copper mines.Will LME Copper price suffer further sell-off once the Trump 2.0 tariffs materialize?Following Trumps successful re-election,gold saw elevated volatility.Brent crude oil strengthened instead while LME Copper weakened further.After this latest round of volatility across November,are the long-term prospects of gold still positive?There are initial signs of stabilizing of Chinas economy after the massive round of stimulus across Sep and Oct.Is this counter trend rebound in Brent crude oil price sustainable?COMMODITIES STRATEGYGold outshines Brent and Copper with its strong 32%rally for the yearSource:Bloomberg,UOB Global Economics&Markets Research90100110120130140Jan 24Mar 24May 24Jul 24Sep 24Nov 24Gold YTD normalized return(%)Brent YTD normalized return(%)LME Copper YTD normalized return(%)UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202534Gold endured renewed selling across Nov.Following the surge in the USD after Trumps renewed election win,gold was sold off from USD 2,750/oz in early Nov,to a low of about USD 2,550/oz by mid Nov.Thereafter,gold rebounded equally swiftly to trade back near USD 2,700/oz by end Nov.This month end rebound in gold was remarkable given that the USD continued its strong rally with the USD Index(DXY)breaking higher to a new high for the year of 107.50.It would appear that despite the near-term volatility,gold had shaken off the negative spillover from a stronger USD and rising US Treasuries yield as well.From a longer-term perspective,the positive drivers from on-going Emerging Market(EM)and Asian central bank allocation into gold,as well as strong physical gold and jewellery demand from the retail sector remain intact.It is important to note the common thread between both positive long-term demand from central banks and retail sector alike.Both are driven by safe haven needs to diversify away from rising geopolitical concerns and uncertainties around the US Dollar ahead of disruptive trade and fiscal policies from Trump 2.0.Specifically,the strong retail sector demand for gold is driven by on-going substantial depreciation of domestic currencies like INR,CNY and VND,which amplify the gains in gold prices in local currency terms.Overall,we keep our positive view for gold as long term safe haven demand needs will likely stay strong amidst further rise in geopolitical risks and economic risks from Trump 2.0 policies.Our forecasts for 2025 are USD 2,700/oz for 1Q25,USD 2,800/oz for 2Q25,USD 2,900/oz for 3Q25 and USD 3,000/oz for 4Q25.Worth noting that gold futures trading on Comex are pricing in further gold strength to about USD 2,800/oz by mid-2025.UOBs Forecast1Q252Q253Q25 4Q25Gold(USD/oz)2,700 2,800 2,900 3,000Gold manage to recover from post US election sell-offSource:Bloomberg,UOB Global Economics&Markets Research1001011021031041051061071082,4002,4502,5002,5502,6002,6502,7002,7502,8002,850Aug 24Sep 24Oct 24Gold Spot(USD/oz)USD Index(DXY)-RHSNormalized gain in gold price magnified by domestic currency depreciationSource:Bloomberg,UOB Global Economics&Markets Research100120140160180200220240Jan 20Sep 20May 21Jan 22Sep 22May 23Jan 24Sep 24XAU spot(USD/oz)XAUINR spot(INR/oz)XAUCNH spot(CNH/oz)XAUVND spot(VND/oz)Gold futures are pricing in USD 2,800/oz by mid 2025Source:Bloomberg,UOB Global Economics&Markets Research607080901001,9002,1002,3002,5002,7002,900Jan 24Apr 24Jul 24Oct 24Generic 1st Gold Futures(USD/oz)Generic 5th Gold Futures(USD/oz)Spread between 5th and 1st Gold Futures(USD/oz)GoldPositive safe haven drivers remain intact ahead of Trump 2.0UOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202535Crude oil bulls would argue that all the bad news against oil price are now apparent.Over the past few months,OPEC has repeatedly cut its global oil demand outlook.At its latest Nov update,OPEC has further cut its global oil demand growth outlook for 2025 to 1.54 mio bpd from 1.64 mio bpd at the previous monthly estimate.In addition,there remains skepticism as to how much further can the returning Trump administration expand on US oil production and fracking.This is because under Trump 1.0 and the Biden administration as well,the US has vastly expanded its oil production.US is now the worlds largest producer of crude oil,pumping about 13.5 mio bpd,almost 50%higher than the 9.0 mio bpd from Saudi Arabia.And with the weak oil price,it is likely that Saudi Arabia will continue to exercise restrain and further extend its production cuts deeper into early 2025.Another positive sign of note is that amidst the on-going strength in the US economy,both US and OECD oil inventory have been drawn down further.And there are initial hopeful signs that Chinas implied oil demand may be stabilizing after the massive round of stimulus from Sep.However,one major worry overhanging oil price is the much uncertainty over the global growth outlook as well as Chinas economic recovery after the potential large tariff hikes from Trump 2.0 across 2025.This risk of further growth slowdown from renewed tariffs in 2025 appears to be nullifying any rise in geopolitical risk from the on-going Russia-Ukraine war.Overall,while most of the negative factors are now apparent,we acknowledge the further downside risk from negative impact from Trump 2.0 tariffs on China and global energy demand.As such,we now adopt a negative outlook for Brent crude oil forecasting USD 75/bbl for 1H25 and USD 70/bbl for 2H25.If global trade conflict worsens,the risk of further sell-off below USD 70/bbl cannot be ruled out later in 2025.UOBs Forecast1Q252Q253Q25 4Q25Brent crude oil(USD/bbl)75757070US now produces almost 50%more crude oil than Saudi ArabiaSource:Bloomberg,UOB Global Economics&Markets Research891011121314Nov 14May 16Nov 17May 19Nov 20May 22Nov 23US crude oil production(mio bpd)Saudi Arabia crude oil production(mio bpd)Trump 1.0BidenOil prices yet to response positively to draw down in global inventorySource:Bloomberg,UOB Global Economics&Markets Research0204060801001201409009501,0001,0501,1001,1501,2001,250Nov 19Jul 20Mar 21Nov 21Jul 22Mar 23Nov 23Jul 24OECD Total Crude Oil Stock(inverse,mio bbl)Brent crude oil(USD/bbl)-RHSHas Chinas oil demand stabilized after the latest round of stimulus?Source:Bloomberg,UOB Global Economics&Markets Research10111213141516-20-100102030Aug 18Feb 20Aug 21Feb 23Aug 24China implied oil demand(y/y)China implied oil demand(mio bbl)-RHSBrent Crude OilTrump 2.0 tariffs to keep oil prices pressured around USD 70/bblUOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202536In the previous quarterly report,we downgraded our LME Copper outlook from positive to neutral and lowered the forecasts from USD 10,000/MT to USD 9,000/MT by 4Q24.That proved to be the prudent approach given that LME Copper price did weaken further in the final few months of 2024.After a brief China stimulus inspired surge to USD 10,000/MT in late Sep,prices fell back to USD 9,500/MT by late Oct.Thereafter,prices fell further after the US election and has now dipped below USD 9,000/MT by end Nov.Over the longer run,the risk of further supply disruption from aging copper mines remains a key concern.However,this supply risk is now completely overtaken by more immediate concerns of the risk of global trade contraction and manufacturing slowdown due to the incoming Trump 2.0 tariffs later in 2025.As a result of risks from Trump 2.0 tariffs,our macroeconomic team has downgraded the base case estimate of Chinas economic growth in 2025 to 4.3%.Depending on the intensity and pacing of the incoming Trump 2.0 tariffs,it is likely that China,Asia as well as the rest of the world will suffer yet another round of trade and export contraction across 2025 and further into 2026.This will likely weigh down on LME Copper prices.Amidst worries from incoming Trump 2.0 tariffs,inventory level of LME Copper,as well as other industrial metals like Nickel and Lead have risen over the past few months.The LME Copper cash vs 3 month spread,a key proxy of near-term demand has yet to recover and remains at a significant discount of USD 120/MT.As a result of immediate risks to global trade and production from incoming Trump 2.0 tariffs,we downgrade LME Copper outlook further from neutral to negative.Updated forecasts are USD 8,000/MT for 1H25 and USD 7,500/MT for 2H25.UOBs Forecast1Q252Q253Q25 4Q25LME Copper(USD/mt)8,0008,0007,5007,500Asian and Global trade risk another round of contraction under Trump 2.0 tariffsSource:Bloomberg,UOB Global Economics&Markets Research-100-50050100150200-40-20020406080Nov 14May 16Nov 17May 19Nov 20May 22Nov 23TaiwanSouth KoreaSingaporeIndonesiaMalaysiaChina-RHSmonthly export growth(y/y)Trump 1.0Copper and other industrial metals inventory on the LME continue to rise across 2024Source:Bloomberg,UOB Global Economics&Markets Research050,000100,000150,000200,000250,000300,000350,000Nov 14May 16Nov 17May 19Nov 20May 22Nov 23LME On-Warrant NickelLME On-Warrant CopperLME On-Warrant LeadDiscount in spot vs 3M Copper price now signfiicantly worse than during Trump 1.0Source:Bloomberg,UOB Global Economics&Markets Research-200-1000100200300400Nov 14May 16Nov 17May 19Nov 20May 22Nov 23Trump 1.0CopperDowngrading Copper outlook further to negative as Trump 2.0 tariffs loomUOB Global Economics&Markets ResearchQuarterly Global Outlook 1Q202537ECONOMY Stimulus stabilized near-term outlook but looming trade war poses significant downside risks Chinas economy stabilized in Oct following the strong dose of policy support.This was the first full-month of data after the governments stimulus package announced in late-Sep.The rebound in retail sales and drop in the unemployment rate signalled an improvement in private consumption while industrial production growth held up.The real estate outlook remained weak as prices continued to fall albeit at a smaller pace and recovery continued to be led by tier-1 cities.New medium/long-term household loans,which indicate mortgage demand,have eased from Sep.The prospects of yet another trade war with the US are dampening Chinas outlook in 2025 and beyond.However,frontloading of exports to the US will be positive in the near-term,offset somewhat by cuts in Chinas export levy rebates for some commodities to ease the industrial overcapacity.The acceleration in investments diversification offshore will remain negative for Chinas economy.Trump has already threatened additional 10%“anti-drug”tariff on China and previously called for 60%tariff on all Chinese goods.It is too early to assess the impact with the specifics still unknown and the timing of implementation depends on the course of legal actions needed.To maximise the leverage for negotiations,Trump is unlikely to implement the maximum tariffs at the onset of his presidency even if he could.As such,the uncertainties will keep markets on edge,at least in 1Q25.The National Peoples Congress(NPC)Standing Committee in Nov approved a CNY10 tn package to refinance local governments off-balance-sheet debt over 2024-2028.This came short of expectation as there was no new direct stimulus spending to raise consumption demand and the long period of debt resolution suggest that the fiscal boost will be very limited in the near-term.Looking ahead,the Politburo meeting and Central Economic Work Conference in Dec will map out the economic work and set key targets which will then be announced at the annual NPC in Mar where the focus is also on additional stimulus measures,particularly for consumption and the housing market to cushion the negative impact of a trade war and promote household consumption as an engine of growth.Next year will be important as China formulates the 15th Five-Year Plan(2026-2030)and it will also be the last year of the 14th Five-Year Plan(2021-2025).The focus will stay on mitigating risks,stabilising growth and the promotion of new growth engines.FX&Rates1Q25F2Q25F3Q25F4Q25FUSD/CNY7.357.507.607.45CNY 1Y Loan Prime Rate3.103.103.103.10Economic Indicator202220232024F2025FGDP(%)3.05.24.94.3CPI(avg y/y%)2.00.20.40.9Unemployment Rate(%)5.55.15.25.3Current Account(%of GDP)2.51.41.81.5Fiscal Balance(%of GDP)-4.7-4.6-4.9-5.2CHINAWe maintain our GDP growth forecast for China at 4.9%this year,factoring in an uptick in the growth rate to 5.0%y/y in 4Q24 from 4.6%in 3Q24 as the recent stimulus stabilizes outlook in the near-term.Our concerns for the looming trade conflict ahead has led us to downgrade our 2025 GDP growth forecast to 4.3%(from 4.6%)as we factor in staggered increase in additional tariff to 25%on Chinese goods starting from 2Q25.Risk is to the downside if tariffs are more punitive than our base case.CENTRAL BANK Monetary policy to focus on RRR cuts Weak demand and trade tensions will be deflationary for China.In Jan-Oct,the headline and core inflation averaged only 0.3%y/y and 0.5%y/y respectively.Chinas Producer Price Index(PPI)deflation entered into its 25th consecutive month,worsening to-2.9%y/y in Oct.We expect the headline CPI to average 0.4%and 0.9%in 2024 and 2025 respectively.Our forecast for PPI is at-2.2%for 2024 and-1.2%for 2025.This will keep the PBOC on its easing bias although anticipated depreciation pressure on the CNY due to the trade war may limit room for rate cuts.Chinese banks have lowered their LPR by a larger-than-expected 25 bps in Oct and PBOC indicated another 25-50 bps reduction to banks reserve requirement ratio(RRR)by year-end.The lower interest rates will also support higher government debt issuances ahead.Keeping in mind the limits of progressively lower interest rates,the PBOC is likely to stay focused on reducing the RRR instead which releases long term liquidity and may also replace the large amount of maturing 1Y medium-term lending facility(MLF)in the next few months.As such we see another 50-100 bps cut to the RRR in 2025.CURRENCY USD/CNY to trade above 7.35 Trumps tariffs are likely to exacerbate the existing concerns about Chinas economic slowdown.On top of a weaker domestic growth outlook,the CNY is likely to fall further against the USD as a slower and shallower Fed rate-cut cycle helps suppor
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December 2024By Torsten SlkApollo Chief Economist2025 Economic Outlook:Firing on All Cylinders 2024 Apollo Global Management,Inc.All Rights Reserved.The information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.KEY TAKEAWAYS The outlook for the US economy remains strong with no signs of a major slowdown going into 2025.We continue to see interest rates staying higher for longer on a relative basis,regardless of the Federal Reserves ongoing monetary easing campaign.It is too early to assess the impact of potential new policies following Donald Trumps election as US president.That said,if implemented,his key policy objectiveslower taxes,higher tariffs,and reduced immigrationcould increase rates,boost asset prices,drive inflation,and strengthen the dollar.The US economy has charted its own path in the post-pandemic world,and it is diverging from both its own historical performance in a context of higher rates as well as its historical correlation to other developed economies,especially Europe and Japan.Why?Because:The US economy has proven to be much less sensitive to the Feds interest rates hikes than in years past due to key idiosyncrasies(i.e.,large,liquid,and long-duration fixed-rate markets for mortgages and corporate bonds),which have allowed both individuals and corporations to“lock in”rock-bottom interest rates for periods of up to 30 years.The US is experiencing a surge in corporate and research spending on the back of the Artificial Intelligence(AI)revolutiona dynamic not seen in other developing nations or even China.This“AI boom”is structural,widespread and pervasive,ranging from investments by tech giants in the development of AI itself to the infrastructure supporting it,from semiconductor design and manufacturing to the building of data centers,increased energy generation needs,and further automation of supply chains.The US was unique on its way out of the Covid pandemic in terms of fiscal support to the economy.It has outspent other developed nations by a large margin,providing strong tailwinds to economic growth through the enactment of key pieces of legislation,such as the CHIPS and Science Act(2022),the Inflation Reduction Act(2022),the Infrastructure Investment and Jobs Act(2021),and others.The Federal governments investments in green energy and infrastructure,along with private-sector investments in AI,have been crucial to the nations economic resilience.Fiscal policy is easy with a current 6%budget deficit.(continued on next page)ATLWAA-20250103-4129350-1304567622025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.What can this divergence mean for key economic indicatorsand Fed policygoing forward?Our baseline scenario is as follows:GDP growth:Gross domestic product continues to grow at a steady,above-historical average pace in the USGDP expanded 2.8%in Q3 2024,well above the Congress Budget Offices(CBO)2%estimate for long-run growth.We believe GDP growth will end 2024 at 2.8%.We see real GDP growth at 2.3%in 2025,mostly in line with consensus estimates as of this writing.Employment:Employment remains strong.The labor market added 227,000 jobs in November,a big rebound from October,when two destructive hurricanes and a strike at Boeing hampered job growth.The unemployment rate rose just slightly,to 4.2%.We expect the unemployment rate to edge higher in 2025,to 4.4%.Inflation:Price increases have been mostly tamed compared to the peak levels of 9.1%seen in 2022.But inflation remains above the Feds 2%annual targetit was up 2.6%for the year through Octoberand,due to reasons we explain in this paper,we believe it will take longer than expected for the Fed to travel the last mile toward its goal.We expect the Consumer Price Index(CPI)and Core Personal Consumption Expenditure Price Index(PCE)to come in at 2.4%and 2.3%,respectively,in 2025.Monetary policy:We believe the Fed will continue to lower the fed funds rate beyond its current range of 4.5%to 4.75%,but at a slower pace than the market expects.As of this writing,the market is pricing in four 25-basis-point cuts in 2025.We think we will get fewer cuts than that.We see a fed funds rate of 4.0%by year-end 2025.Consumer spending:Consumer spending remains robust in the aggregate,growing at 3.7%in Q3.The Conference Boards Consumer Confidence Index hit 111.7 in November,up from 109.6 in October.The Expectations Indexwhich reflects consumers short-term outlook for income,business,and labor market conditionsrose to 92.3,well above the recession-signaling threshold of 80.We expect consumer spending to moderate in 2025,with 2.0%growth for the year.Corporate spending:Businesses stepped up investments in equipment and intellectual property in Q3,a sign of demand for chips and software that run AI.Bankruptcies,as well as defaults for levered loans,are down.The combination of locked-in low interest rates and strong corporate earnings has meant that net interest payments as a share of operating surplus have also been declining.That said,we see important risks to our baseline scenario that could lead to a substantial economic slowdown and alter the inflation outlook in the US.As of this writing,financial markets are placing the odds of a recession in 2025 at 25%,a declining but still meaningful chance.Chief among these risks are:Ongoing geopolitical challenges around the world,such as the wars in Ukraine and the Middle East,and rising US trade tensions with China and other nations.The large and expanding size of the government deficits and overall debt in the US,which could force interest rates to stay higher for much longer,especially at the long end of the curve.A too-hasty easing of monetary policy and conditions by the Fed,which could re-ignite price pressures and push inflation back up again.(continued on next page)ATLWAA-20250103-4129350-1304567632025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.In light of a benign yet not riskless outlook,we see a number of implications for capital markets.In a nutshell:Public equities:Too lofty valuations.High concentration remains.Risk premia is virtually nil.Looking at the historical relationship between the S&P 500 forward P/E ratio and subsequent three-year returns in the benchmark index shows that the current forward P/E ratio at almost 22 implies a 3%annualized return over the coming three years.1 In other words,when stocks are overvalued like they are today,lower future returns can be expected.Public fixed income:Spreads are super tight,mostly because the long end of the curve is seeing higher rates(despite Fed easing),a potential sign of market concern regarding large deficits and debt.Spreads are tight not because interest rates have fallen on corporate bonds but because government rates have gone up on the long end of the curve.The tightening in credit spreads has been driven by a combination of robust economic growth,strong fixed income technical demand,and the US election outcome.Private equity:Lower rates could spark a new wave of deals as,on the one hand,sponsors seek to deploy capital raised in the past three years and,on the other,managers may be willing to part with existing investments as cheaper borrowing costs may bolster valuations.Secondaries remain attractive.Structured finance,including hybrid strategies,is particularly attractive as well.Private credit:Higher rates for longer can translate into higher yields in private credit,especially for newer vintages as investors seek potential substitution for on-the-run bonds(which,given tight spreads,are expensive).We see better value in private credit with the private-public spread still elevated,and find more attractive opportunities high in the capital structure,with first-lien,first-dollar opportunities.Middle-market opportunities are still plentiful.We also see opportunity in direct lending and origination,especially in the asset-backed finance world.Portfolio allocation:Ongoing worries about the future long-term success of traditional allocation strategies(i.e.,60%stocks/40%bonds)are unlikely to dissipate.We see potential for depressed long-run returns in the public markets(both equity and bonds)and,taking into consideration current expectations,future real returns of the 60/40 portfolio may be disappointing in the coming years.We believe the potential for long-term alpha generation remains more attractive via further diversification of portfolios with the inclusion of private markets(both equity and credit).We believe the potential for long-term alpha generation remains more attractive via further diversification of portfolios with the inclusion of private markets.1 Sources:Bloomberg,Apollo Chief EconomistATLWAA-20250103-4129350-1304567642025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.The US economy remains strongWe see continued strength in the US economy in 2025,primarily because:The economy has been less sensitive to the Fed raising rates in this cycle,Strong demand for data centers and AI has generated a strong corporate spending wave,and Fiscal policy is stimulative.Largely as a result of the above three factors,US economic data has been very solid,and we would expect that to continue to be the case for the next several months.It is,you might say,quite an unusual situation compared to years past.Your economist cut his teeth at the International Monetary Fund(IMF),where we learned over the course of several decades that when the US economy was good,the European economy would be likewise good.When the US economy was sluggish,the same would be the case for Europe.In other words,there seemed to be one global business cycle.But times have changed.As we enter 2025,the US economy is benefitting from not just one or two but three unique tailwinds.We have disconnected from the rest of the global economy,at least for now.As a result,we are seeing very strong growth in the US but relatively weak growth elsewhere.The European economy did not prove insensitive to the European Central Bank(ECB)rate hikes.There is no AI boom in Europe.And fiscal policy is not easy in Europe.On top of all that,Europe is also facing headwinds to growth from geopolitical risks occurring in its own backyard.In the remainder of this section,we take a deep dive on the three tailwinds propelling the US economy today.1.The US economy is less sensitive to rate hikesWhen the Fed started raising interest rates in March 2022,a lot of Fed speeches and market conversations focused on the long and variable lags of monetary policy,i.e.,the time it takes before Fed hikes begin to slow down the economy.Historically,it has taken 12 to 18 months before tighter monetary policy begins to slow the economy down.However,as Exhibit 1 shows,it has been 30 months since the Fed started raising interest rates(as of this writing),and we have still not seen any sign of a slowdown.Car purchases have not slowed down.Home sales and home prices didnt crash when interest rates rose.Nor did capex spending by firms.THE TRUMP EFFECTWhile its still early days to fully assess the potential macro-economic impact of the policies of President-Elect Donald Trumps incoming administration,the election brought three key areas into focus,namely tariffs,taxes,and immigration.Trumps stated policy goals on those fronts are higher tariffs,lower taxes,and restrictions on immigration up to and including deportations.At the end of November,Trump announced that upon taking office,he would immediately impose a 20%tariff on imports from Canada and Mexico,unless they clamped down on illegal drugs(particularly fentanyl)and migrants crossing the US border.At the same time,he outlined an additional 10%tariff“above any additional tariffs”on imports from China.These tariffs,if implemented,would mark a reversal in the liberalization of trade that began following World War II.Higher tariffs present risks to large importers(e.g.,retailers)as well as large exporters due to the prospect of retaliation from trading partners.Higher tariffs also risk derailing the Feds fight against inflation,as some of the cost of higher tariffs will be borne by consumers in the form of higher prices.Overall,the net result of raising tariffs would likely be higher inflation and lower GDP growth.At the same time,the net result of lowering taxes tends to be higher inflation and higher GDP growth.Restrictions on immigration would point to higher wage inflation and lower GDP growth.While the above outcomes are split between being stimulative and restrictive to GDP growth,all three point to more upside pressure on inflation.Our preliminary forecast,then,of the effect of Trumps election is to reaffirm the outlook we had before the election:We see higher rates for longer.In the days following the election,two key components of this“Trump trade”played out in the markets:higher ratesboth on the long-and short-end of the curveand a higher dollar,which posted its best day since 2022.The implication for the Fed is that the market expects it to cut rates a little slower relative to what was priced-in before the election.And while two-year rates serve as a reflection of Fed expectations,10-year rates reflect a wider discussion,one that includes fiscal sustainability and investors appetite to buy long-duration government bonds.ATLWAA-20250103-4129350-1304567652025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.We believe one of the key reasons why we havent seen a slowdown relates to the US economys low sensitivity to lower rates in this cycle.How so?Home buyers in the US,for example,locked in low long-term mortgage rates during the period of rock-bottom interest rates.In fact,some 95%of mortgages in the US today have a 30-year fixed rate.2 So when the Federal Reserve began to raise interest rates in 2022,it didnt have much of an impact on the cost consumers face to service their existing mortgages(which is traditionally the largest loan US households hold).Consider Exhibit 2,which shows both the current mortgage rate and the“effective”mortgage rate on debt already Exhibit 2:The effective rate on all outstanding mortgages is lower than youd thinkData as of October 2024.Note:The effective interest rate(%)reflects the amortization of initial fees and charges over a 10-year period,which is the historical assumption of the average life of a mortgage loan.Sources:Freddie Mac,BEA,Bloomberg,Apollo Chief Economist0246810121986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 20240-YR CONVENTIONAL MORTGAGE RATEEFFECTIVE RATE ON MORTGAGE DEBT OUTSTANDINGExhibit 1:What happened to the long and variable lags?Data as of September 2024.Sources:BEA,Haver Analytics,Apollo Chief Economist-1.0%0.3%2.7%3.4%2.8%2.5%4.4%3.2%1.6%3.0%2.8%Mar-22Jun-22Sep-22Dec-22Mar-23Jun-23Sep-23Dec-23Mar-24Jun-24Sep-24%QoQ SAAR5431-20-12March 2022:Fed startshikingUS REAL GDP GROWTH2 Source:IMF World Economic Outlook(https:/www.imf.org/en/Publications/WEO/Issues/2024/04/16/world-economic-outlook-april-2024.html)outstanding.It is true that if you were to apply for a mortgage today,you would have to pay about 7%.But that is only for new borrowers.For those already holding mortgage debt,the effective rate is 3.9%or 4%.The Fed raised interest rates,but it didnt have much impact on the vast majority of people who already had a mortgage and have locked in low interest rates.Similarly,corporate borrowing is now dominated by fixed-rate debt.Companies locked in low interest rates during the pandemic,so the Fed hikes did not have much of a negative consequence for firms either.ATLWAA-20250103-4129350-1304567662025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Exhibit 3 shows the total value of investment grade bonds outstanding.This chart is crucial for understanding the weaker transmission mechanism of the Fed rate cuts.There is about$9 trillion in investment grade debt outstanding today.In 2015,there was only$3 trillion.Why is that important?Because both investment grade and high-yield debt are almost always fixed rate.Loans are floating rate.So when the Fed started raising rates,it affected a much smaller fraction of the overall market for corporate credit than it did in previous cycles.Another way to see that is in Exhibit 4,which shows that Fed hikes have not had the desired effect on firms.One would normally expect that when interest rates go up,corporates would see an increase in debt-servicing costs.But the combination of locked-in low interest rates along with strong corporate earnings has meant that net interest payments as a share of operating surplus have been going down.In short,the transmission mechanism of monetary policy has been much weaker this cycle than the economics textbook would have predicted.This is because both consumers and firms locked in low interest rates during the pandemic.As a result,the economy never slowed down when the Fed raised rates.Its interesting to note that the effect has also been a lot weaker than what we see in Canada,Australia,France,or the UK.Consider the UK:When the Bank of England raises interest rates,it has an immediate impact because mortgage payments by households go up.But we just dont see that in the US,where the vast majority of rates are fixed.Exhibit 4:Nonfinancial corporate business net interest payments are near record lowsData as of June 2024.Sources:Federal Reserve Board,Haver Analytics,Apollo Chief Economist1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 2018 2022%of operating surplus4035302050151025Fed startshikingUS NONFINANCIAL CORPORATE BUSINESS NET INTEREST PAYMENTSExhibit 3:The public investment grade market has exploded in sizeData as of October 31,2024.Note:Ticker used for HY is H0A0 Index,for IG it is C0A0 Index,for Loans it is SPBDALB Index.Sources:ICE BofA,Bloomberg,PitchBook LCD,Apollo Chief Economist01234567891019911993199519971999200120032005200720092011201320152017201920212023$trillionHY BONDSIG BONDSLEVERAGED LOANSMARKET VALUE OUTSTANDINGATLWAA-20250103-4129350-1304567672025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.2.The US is experiencing an AI boomLets now turn to investment in AI,another idiosyncratic dynamic that is keeping the US economy afloat.There is no AI boom in Europe,Canada,Australia,or Japan.This is a very unique tailwind to the US economic outlook.The US is spending a lot on AI,on data centers,and on energy transition(to help power this revolution).To exemplify the dimension of current investments in this field,consider capital expenditures by the Magnificent Seven(Apple,Microsoft,Alphabet,NVIDIA,Amazon,Meta,and Tesla),companies that are the forefront of the AI revolution.As shown in Exhibit 5,their combined capex is rapidly approaching a combined$50 billion a year,an incredibly strong number.We believe this spending is relatively inelastic,as investments in new,productivity-enhancing technologies have not traditionally been hampered by higher rates.(And AI is certainly seen by many as the future of computing,with large 05101520253035GW1Hyperscaledata center 6New York City power demand(2022)Data center power demand(2030)18Capacity thatneeds to be added:17Current Capacity:Exhibit 6:We need to add the equivalent of three NYCs to the power grid by 2030Note:Current capacity as of 2022,Investing in the Rising Data Center Economy|McKinsey,Systems NYC Mayors Office of Climate and Environmental Justice,Data Center Power:Fueling the Digital Revolution,US data center power consumption to double by 2030 DCD.Sources:NYISO 2022,McKinsey,Nextgen,Apollo Chief EconomistExhibit 5:The Magnificent Seven are approaching$50 billion in combined capital spendingData as of June 2024.Sources:Bloomberg,Apollo Chief Economist AMAZONNVIDIAALPHABETMETAMICROSOFTAPPLETESLA05101520253035404550$billionMar-20Jun-20Sep-20Dec-20Mar-21Jun-21Sep-21Dec-21Mar-22Jun-22Sep-22Dec-22Mar-23Jun-23Sep-23Dec-23Mar-24Jun-24CAPITAL SPENDING OF THE MAGNIFICENT SEVENpotential beneficial impacts on productivity.)That future isnt going to come cheap,either.As shown in Exhibit 6,data center energy demand is going straight up,and fast.This is again very unique to the US and different from what can be seen in the rest of the world.There is no AI boom in other developed countries.As shown in Exhibit 7,there are more data centers in the US than in all other major countries combined.3.US fiscal policy is very supportivePolicies such as the CHIPS Act,the Inflation Reduction Act,and the Infrastructure Act have been extremely supportive for the US economy,as they have created a boom in the construction of everything from semiconductors to electric vehicles,batteries,solar panels,and windmills.Producing all this domestically has had an effect on the economy that is also very unique.Just as with the first two reasons above,these conditions do not really exist outside the US,leaving us with another unique economic tailwind.ATLWAA-20250103-4129350-1304567682025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Exhibit 8 shows US construction spending on manufacturing.For a long time,the trend line in manufacturing spending was fairly boring to watch,because manufacturing had all been outsourced to China,Mexico,and the like.But that changed when the US decided to implement the CHIPS act,the Inflation Reduction Act,and the Infrastructure Act.As a result,we saw a major rise in construction spendingindeed,the largest surge in manufacturing-related construction spending on record.This marked quite a significant change in US policy making and has been a very important source of the industrial renaissance in the US,the final significant tailwind to the US economy.In other words,when monetary policy(i.e.,the Fed)stepped on the brakes and started raising rates,fiscal policy stepped on the accelerator.The winner of this tug-of-war?Fiscal policy.Consider,finally,the size of the post-Covid stimulus programs as compared to those implemented as countercyclical measures during the Great Recession.In 2008,the US government passed the Economic Stimulus Act,a$153 billion injection designed to stave off a recession.It followed that with the$787 billion American Recovery and Reinvestment Act of 2009.The fiscal policy response to the pandemic,which included,among other provisions,enhanced unemployment benefits,direct assistance to local governments,health care spending,direct payments to households,and the Paycheck Protection Program(PPP)amounted to some$5.2 trillion.3 It is no wonder that the US finds itself off on its own economic island as we enter 2025.3 Source:https:/www.brookings.edu/articles/the-fiscal-policy-response-to-the-pandemic/Exhibit 8:The positive effects of fiscal policy are dominating the negative effects of Fed hikesData as of April 2024.Sources:Census Bureau,Haver Analytics,Apollo Chief Economist05010015020025020022003200420052006200720082009201020112012201320142015201620172018201920202021202220232024$bn,SAARFiscal boost beginsCHIPS Act,IRA,Infrastructure ActFed startshikingUS CONSTRUCTION SPENDING ON MANUFACTURINGExhibit 7:No one even comes closeData as of March 2024.Sources:Statista,Cloudscene,Apollo Chief Economist53815215144493363153073072972510100020003000400050006000UnitedKingdomGermanyChinaCanadaFranceAustraliaNetherlandsRussiaJapanUnitedStatesNUMBER OF DATA CENTERSATLWAA-20250103-4129350-1304567692025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.2025 Outlook:No signs of a slowdown What does this divergence mean for key economic indicatorsand Fed policygoing forward?No matter which way you look at the economy,the outlook is much the same:There is no slowdown on the horizon.In the remainder of this section,we dissect the outlook for consumer and corporate spending,and provide our expectations for Fed action,economic growth,inflation,and employment.How strong is the US consumer?The US consumer continues to defy predictions and remains a powerful source of economic strength.To grasp the importance of the consumer to the economy,we need look no further than the contribution of personal consumption expenditures to GDP(Exhibit 9).As we can see in Exhibit 10,consumer spending is also strong and broad-based across most categories.Exhibit 9:The Feds hikes have not slowed down the US consumerExhibit 10:Consumer spending remains strong and broad-basedData as of September 2024.Sources:BEA,Haver Analytics,Apollo Chief EconomistData as of September 2024.Sources:Census Bureau,Haver Analytics,Apollo Chief Economist0.6%Mar-221.7%Jun-221.0%Sep-220.8c-223.3%Mar-230.7%Jun-231.7%Sep-232.3c-231.3%Mar-241.9%Jun-242.5%Sep-24%pt,SAAR3.53.02.52.00.50.01.51.0March 2022:Fed startshiking4.01.51.11.01.00.50.40.40.40.30.30.20.0-1.4-1.6-3.3Miscellaneous Stores RetailersClothing&Accessory StoresHealth&Personal Care StoresFood Services&Drinking PlacesFood&Beverage StoresGeneral Merchandise StoresNonstore RetailersRetail Sales&Food ServicesRetail Sales:Total Excl Motor Vehicle&Parts DealersRetail Sales:TotalSporting Goods,Hobby,Book&Music StoresBuilding Materials,Garden Equipment&Supply DealersMotor Vehicle&Parts DealersFurniture&Home Furnishing StoresGasoline StationsElectronics&Appliance StoresCONTRIBUTION OF PERSONAL CONSUMPTION EXPENDITURES TO GDPSEPTEMBER RETAIL SALES BY CATEGORY(%MoM)ATLWAA-20250103-4129350-13045676102025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.To further understand the breadth of consumer spending,let us consider some high-frequency databoth daily and weekly indicatorsthat provide a nearly real-time window into the health of the economy,particularly regarding discretionary spending(weakness in which is traditionally a harbinger of a slowdown).Are people eating out?Yes,they are.Exhibit 11,using data from restaurant reservation site OpenTable,shows that people are still going out to restaurants.There is no sign of a slowdown in this daily data.Are people still traveling on airplanes?Yes,they are.While the red line for 2024 in Exhibit 12 shows a decline from the peak of summer,this follows a seasonal pattern.There are no signs in the daily data that there are fewer people flying on airplanes.Rather,air travel data is still looking quite strong.Exhibit 11:Were still going out to restaurantsExhibit 12:Were still flying to placesData as of November 2024.Sources:TSA,Bloomberg,Apollo Chief EconomistData as of November 6,2024.Sources:OpenTable,Apollo Chief Economist20202021202220232024 19,7-day MA-100-80-60-40-200200.00.51.01.52.02.53.0JanFebMarAprMayJunJulAugSepOctNovDecmn,7-day MA201920202021202220232024UNITED STATES SEATED DINERSUS TSA CHECKPOINT NUMBERS TOTAL TRAVELER THROUGHPUTATLWAA-20250103-4129350-13045676112025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Are people still spending cash?Yes,they are.Exhibit 13 shows how many people use their debit card every day.While there is some discussion that this could be a sign of distress that people are using debit cards because they cannot get a credit cardthe daily volume of debit card transactions remains healthy.Lets now turn to the weekly indicators.Exhibit 14 offers a window into retail sales,courtesy of Redbook,a research firm that asks Walmart,Target,TJ Maxx,big sporting goods stores,and other retailers about their sales each week relative to the same week a year previous.Same story here:The US consumer is doing fine.Exhibit 13:Were still pulling out our debit cardsExhibit 14:We still love retailData as of October 30,2024.Note:Consists largely of debit card transactions.Sources:Bloomberg,Apollo Chief EconomistData as of November 2,2024.Sources:Redbook,Haver Analytics,Apollo Chief Economist-2-101234Mar-24Apr-24May-24Jun-24Jul-24Aug-24Sep-24Oct-24%YoY,28-day MA-15-10-50510152025201920202021202220232024%YoYBLOOMBERG CONSUMER SPENDINGREDBOOK RESEARCH:SAME-STORE,RETAIL SALES AVERAGEATLWAA-20250103-4129350-13045676122025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Exhibit 15 shows weekly data of hotel demand.The occupancy rate for hotels,revenue per available room,and average daily rates are all trending upward.Exhibit 16 looks at attendance of Broadway shows in New York City.Tickets to a show can easily exceed$200,and the latest data shows that consumers are still happy to pay this discretionary expense.If the economy were weakening,we would expect to see these lines trend downward.If anything,they are doing the opposite.Again:no signs of a slowdown.Exhibit 15:Were still staying at hotelsExhibit 16:Were still going to showsData as of November 3,2024.Sources:Internet Broadway Database,Apollo Chief EconomistREVENUE PER AVAILABLE ROOM(US$)AVERAGE DAILY RATEOCCUPANCY RATE(%)02040608010012014016018020172018201920202021202220232024Data as of November 2,2024.Sources:STR,Haver Analytics,Apollo Chief Economist201920202021202220232024050000100000150000200000250000300000350000400000JanFebMarAprMayJunJulAugSepOctNovDecNumberBROADWAY ATTENDANCEATLWAA-20250103-4129350-13045676132025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Finally,Exhibit 17 shows weekly data of movie theater visits.From this perspective,the economy appears to be moving at“Cruise velocity,”as in as fast as Tom Cruise can sprint in many of his famous blockbusters.How has the consumer remained so healthy during this period of higher interest rates?The“wealth effect”offers one explanation:US households have experienced significant gains in stock prices and home prices over the past 15 years,and the Fed hikes have actually generated significantly higher cash flows to owners of fixed income.As a result,the debt-to-income ratio of US households looks much better than their Canadian and Australian counterparts(Exhibit 18).Exhibit 17:Were still going to the moviesExhibit 18:Household finances look great,relatively speakingData as of November 2024.Sources:B,Apollo Chief EconomistData as of June 2024.Sources:Statistics Canada,Reserve Bank of Australia,Bloomberg,Apollo Chief Economist202420192023202020212022WEEK01002003004005006001 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53$millionUSCANADAAUSTRALIA801001201401601802002000200220042006200820102012201420162018202020222024%BOX OFFICE OVERALL WEEKLY GROSSESHOUSEHOLD DEBT TO DISPOSABLE INCOMEATLWAA-20250103-4129350-13045676142025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Whats more,the ratio of credit card debt to disposable income is also at very low levels for US households(Exhibit 19).In other words,US household balance sheets are in excellent shape.Combine that with strong job growth,solid wage growth,rising asset prices,and lower inflation,and it becomes difficult to see a recession on the horizon.Although the aggregate numbers continue to paint a bright picture for consumption going forward,we do see some weak spots.As we discussed in previous Economic Outlooks,younger households have indeed been negatively affected by higher rates.That remains true today.Exhibit 20 shows credit card delinquency rates across age cohorts.The hardest hit have been consumers in their 20s.Why is that?Because when youre young,you have more debtdebt on your car,debt on your credit card,debt on your house.When interest rates go up,you get hit harder.See also Exhibit 21,for similar dynamics in auto loans.Those in their 20s have been hit the hardest.Exhibit 19:Were not stretched too thin,credit-wiseData as of June 2024.Sources:Federal Reserve Board,BEA,Haver Analytics,Apollo Chief Economist2002200120002003200420052006200720082009201020112012201320142015201620172018201920202021202220232024Ratio(%)78910654US:REVOLVING CONSUMER CREDIT OWNED AND SECURITIZED SHARE OF DISPOSABLE PERSONAL INCOMEExhibit 20:Younger households are feeling the pinch in their credit cardsData as of June 2024.Sources:New York Fed Consumer Credit Panel/Equifax,Apollo Chief Economist02468101214162002200120002003200420052006200720082009201020112012201320142015201620172018201920202021202220232024lance,4Q moving sumFed startsraising rates70 50-5930-3918-2960-6940-49CREDIT CARD TRANSITIONS TO SERIOUS DELINQUENCY(90 ),BY AGEATLWAA-20250103-4129350-13045676152025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Its interesting to note that delinquencies for borrowers in their 20s are now higher than they were in 2020,and nearly as bad as they were in 2008.Why is that important?Because in 2008,the unemployment rate was 10%.Today,it is 4.2%,and still more and more people are falling behind on paying their bills.We can see a similar dynamic playing out when it comes to savings across the income distribution.As shown in Exhibit 22,low-income households have aggregate savings that are lower than where they were in 2019.On the other hand,those households at the top of the income distribution are benefiting from increases in both stock prices and home prices.On top of that,high-income households that own fixed income instrumentsboth public and privateare also benefitting from rising cash flows due to high interest rates.Considering that the top 20%of incomes account for 40%of consumer spending,its no surprise that the economy is holding up well.So we continue to have a very bifurcated outlook for the consumer:Folks to the right in Exhibit 22 have a lot of assets,while those on the left have a lot of debt.Both high income and older households are benefiting from rising prices and rising rates,while lower income and younger households are experiencing distress with delinquency rates on the rise.Exhibit 21:as well as their auto loansExhibit 22:Household savings are concentrated at the top of the income spectrumData as of June 2024.Sources:FRBNY Consumer Credit Panel,Equifax,Haver Analytics,Apollo Chief EconomistData as of June 2024.Sources:FRB,Haver Analytics,Apollo Chief Economist01234562002200120002003200420052006200720082009201020112012201320142015201620172018201920202021202220232024lance,4Q moving sumFed startsraising rates70 50-5930-3918-2960-6940-490.01.02.03.04.05.06.07.00-20 percentile20-40 percentile40-60 percentile60-80 percentile80-99 percentiletop 1 percentile$trnQ419Q122Q222Q322Q422Q123Q223Q323Q423Q124Q224AUTO LOAN TRANSITIONS TO SERIOUS DELINQUENCY(90 ),BY AGEDEPOSITS HELD BY INCOME PERCENTILEATLWAA-20250103-4129350-13045676162025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.As we continue to watch the incoming data,we see that households to the right are still dominating in the economy,outweighing the negative distress that youre seeing for the households to the left.All-told,consumer spending grew 3.7%in the third quarter of 2024,consumer confidence remains healthy,and expectations remain well above levels that typically point to recession.We expect consumer spending to moderate in 2025,with 2.0%growth for the year.How strong are corporates?If we were only given space for one chart to answer this question,it would be Exhibit 23.American businesses are in the midst of an historic profit boom.As is the case with the aggregate consumer picture,corporate profits,as a whole,have not felt the pinch of Fed rate hikes to any remarkable degree.To be sure,firms with weak earnings,weak revenue,and weak cash flows have been hit by Fed hikes.But from a macro perspective,the effects of Fed hikes on corporates have been small.Exhibit 24 shows four-and 12-week moving averages of bankruptcy filings.When the Fed started raising rates in March of 2022,bankruptcy filings went up because there were a lot of companies that didnt have any earnings.Venture capital companies,by definition,have no earnings.Biotech,fintech,enterprise software,and mid-and small-cap companies generally have weaker earnings than their large-cap Exhibit 24:Weekly bankruptcies dont point to a recessionData as of November 2024.Sources:Bloomberg,Apollo Chief Economist0.02.55.07.510.012.515.017.520.022.501234567892004200520062007200820092010201120122013201420152016201720182019202020212022202320252024%NumberBANKRUPTCY FILINGS(12-W MA)(LS)HY CREDIT SPREAD(3-M LEAD)(RS)Exhibit 23:Corporate profits are near all-time highs as a share of GDPData as of June 2024.Note:Corporate profits are before tax and after inventory valuation adjustment(IVA)and capital consumption adjustment(CCAdj).Sources:BEA,Haver Analytics,Apollo Chief Economist71086591112131415199019921994199619982000200220042006200820102012201420162018202020222024%GDPCORPORATE PROFITSATLWAA-20250103-4129350-13045676172025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.counterparts.In recent weeks,however,bankruptcies have been declining.Likewise,Exhibit 25,which shows that the default rate for levered loans has also been declining.If we were truly knocking on the door of a recession,bankruptcies and loan defaults would not be going down,they would be going up.Exhibit 26 shows the maturity wall for corporate debt.Many commercial real estate(CRE)loans are five-year maturities,which means that CRE loans that were underwritten when the fed funds rate was zero in 2020 and 2021 will need to be refinanced in 2025 and 2026.This gives the maturity wall a downward sloping shape for CRE,with a lot of refinancings over the next few years.This is different from investment grade(IG),high yield(HY),and leveraged loans,where the maturity walls are spread over time;most companies that refinanced in 2020 and 2021 at very low interest rates do not need to refinancein the near future.Exhibit 25:default rates for levered loans dont eitherExhibit 26:The maturity wall doesnt show cause for concernData as of July 2024.Sources:PitchBook LCD,Apollo Chief EconomistData as of October 2024,except CRE,which is December 2023.Sources:ICE BofA,Bloomberg,PitchBook LCD,MBA,Apollo Chief Economist20172018201920202021202220232024%LTM$OF DEFAULTS/TOTAL OUTSTANDINGLTM#OF DEFAULTS/TOTAL ISSUERS5432100200400600800100020242025202620272028202920302031$bnUS HYLEVERAGED LOANSUS IGCREMORNINGSTAR/LSTA LEVERAGED LOAN INDEX DEFAULT RATESMATURITY WALLATLWAA-20250103-4129350-13045676182025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.With rates higher for longer,what matters for markets is the profile of the maturity wallthat is,is it downward sloping,upward sloping,or flat?What we see here is that the maturity wall is front-loaded for CRE,back-loaded for HY and loans,and flat for IG.(The IG bars are taller in the chart because,as explained above,IG is a much bigger asset class.)The chart makes clear the fact that while interest rates going up did have an impact,it was concentrated among those balance sheets that are more sensitive to interest rates going up,such as commercial real estate.Why did the models get it wrong?One hallmark of the post-pandemic economy in the US is how wrong economic models,including the Feds,have been in forecasting future performance.Akin to Samuel Becketts play“Waiting for Godot,”members of the Federal Open Market Committee(FOMC),the Feds policy setting arm,kept expecting a recession that never arrived(Exhibit 27).They were not alone.Exhibit 28 shows the survey of Wall Street economists and their forecasts for the probability of recession in the US,UK,Europe,and China.Exhibit 27:How many times can the same models be wrong?Exhibit 28:Theres still a non-zero chance of a recessionSources:Federal Reserve Board,Bureau of Economic Analysis,Haver Analytics,Apollo Chief EconomistData as of November 2024.Sources:Bloomberg,Apollo Chief Economist0.00.51.01.52.02.53.03.54.04.5Mar-22Jun-22Sep-22Dec-22Mar-23Jun-23Sep-23Dec-23Mar-24Jun-24Sep-24Dec-24%y/yACTUAL GDPFOMC PROJECTIONFed startsraisinginterest rates20CNEUUSUK040608010020202021202220232024%PROBABILITY OF RECESSIONATLWAA-20250103-4129350-13045676192025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.When the Fed started raising interest rates in March of 2022,the prediction of the likelihood of recession shot up immediately.And it stayed at 65%or so for most of 2023.Those forecasts were all wrong.As it turns out,the Fed was able to raise policy rates to curtail inflation without prompting a recession for the first time in 60 years.The percentage likelihood of a recession in the US in 2024 has come down significantly,but still sits at 25%,a not-insignificant proportion.It seems like many economists are still waiting for Godot.We believe there will be no recession in 2025(more on that and the risks associated with this forecast later).This time is different,at least in the US,for the strikingly powerful idiosyncratic reasons outlined previously in this paper.In our view,the reason why the models failed is because they didnt capture the profound post-pandemic shifts in the US economic situation.Outlook for Inflation,Employment,and GDPPrice increases have been mostly tamed compared to the peak levels of 9.1%seen in 2022.But as shown in Exhibit 29,inflation remains stubbornly above the Feds 2%annual target.Is 2.3%the same as 2%?Can the Fed declare victory because inflation has fallen from 9.1%in the summer of 2022 to 2.3%today?Were not so sure about that.We believe it will take longer than expected for the Fed to travel the last mile toward its goal.In fact,we may even see inflation head in the other direction.Additionally,housing inflation has been hard to tame,a situation that might be made more difficult as the Fed maintains its easing cycle and mortgage rates decline in tandem.We still see lower mortgage rates despite the fact that the long end of the Treasury yield curve has remained resilient(more on that later).Exhibit 29:Inflation has been sticky above the Feds 2%targetData as of October 2024.Sources:BLS,Haver Analytics,Apollo Chief Economist-20246810201020112012201320142015201620172018201920202021202220232024%YoYHEADLINE CPIFeds 2%inflation targetATLWAA-20250103-4129350-13045676202025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.In fact,we have begun to see upticks in housing already.Big-city rents have started to increase relative to small-city rents.Home builder sentiment has been moving higher.4 We still see very low inventory,as well.When there are imbalances in the economy,something usually corrects.But when it comes to housing inventory,we are reminded of the joke:If Im already lying on the floor,I cant fall any further.If we consider the fact that housing has a weight of roughly 35%to 40%in the CPI index,what were talking about here is the biggest component of the CPI basket staying sticky.Combine the historical supply situation with immigration of five and a half million people since January 2020,and you have a lot of people that are demanding housing.We think the Fed is going to have a difficult time running the last mile toward 2%(Exhibit 30)and runs the risk of making a policy mistake in the interim.We expect CPI and Core PCE to come in at 2.4%and 2.3%,respectively,in 2025.Employment also remains strong.Job growth bounced back in November,with employers adding 227,000 jobs,and the unemployment rate rose just slightly,to 4.2%.We expect the unemployment rate to edge higher in 2025,to 4.3%.Add together all of the above,and one can easily appreciate why US gross domestic product continues to grow at a steady,above-historical average pace.GDP grew at 2.8%in the third quarter,down just slightly from 3%in the second quarter.The Atlanta Feds GDP estimate for the fourth quarter is 3.3%,well above the CBOs 2%estimate for long-run growth.Consensus estimates have the economy growing at 2.1%in 2025.We agree,and think that after 2.8%growth in 2024,real GDP will grow 2.3%in 2025.We expect to see strong GDP growth for the next several years.We see a soft landing ahead.Outlook for Monetary PolicyOur outlook for monetary policy is not in line with the consensus.Given the pronouncedand uniquestrength in the US economy,both on an absolute basis and relative to the rest of the global economy,we believe the Fed will continue to lower rates,but at a slower pace than the market expects.The market is currently pricing in four more cuts in addition to the 50-basis point cut in September and the 25-basis point cut in November.We think we will get fewer cuts than that.We see a fed funds rate of 4.0%by year-end 2025 and reaffirm our long-held prediction that US rates are going to stay high for longer.Exhibit 30:Is core inflation stabilizing at 2%or starting to move higher again?Data as of September 2024.Sources:BEA,Haver Analytics,Apollo Chief Economist201920202021202220232024%,annualizedYOY6-MONTH ANNUALIZED CHANGE3-MONTH ANNUALIZED CHANGE1-MONTH ANNUALIZED CHANGE86420-2-4CORE PCE4 As measured by NAHB/Wells Fargo Housing Market Index.ATLWAA-20250103-4129350-13045676212025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Exhibit 31 shows the historical and forecasted fed funds rate.The right-hand side of the chart shows the markets expectation of where the fed funds rate will be going forward.The current consensus is that it will remain in the 3.5%to 4%range for the next five to seven years.The election of Donald Trump is another key factor weighing on monetary policy going forward.As of this writing,it is too early to assess the impact of potential new policies to be enacted by the President-elect.However,if implemented,his key policy objectiveslower taxes,higher tariffs,and reduced immigrationcould increase rates and drive inflation.In that comes to pass,there is the potential that the Fed may have to hike rates again to ward off inflation.That being said,there are those who see a recession on the horizon and the possibility that rates will actually have to come down more,and faster.We will keep a close eye on those developments.What are the risks to our outlook?We see a handful of important risks to our baseline scenario that could lead to a substantial economic slowdown and alter the inflation outlook in the US.As of this writing,financial markets are placing the odds of a recession in 2025 at 25%,a declining but still meaningful chance.Chief among these risks are:1.GeopoliticsWhile we hesitate to prognosticate on things geopoliticalour expertise is economics,not geopoliticswe are concerned about three pressing issues:China/Taiwan,Russia/Ukraine,and Israel/Hezbollah/Iran/Middle East.We also see rising US trade tensions with China as a potential source of economic instability.Any or all could be the source of a further dramatic shock to the global economy and,by extension,our outlook.2.Large budget deficit and ballooning debtThe large and expanding size of the government deficits and overall debt in the United States could force interest rates to stay higher for much longer,especially at the long end of the curve.In 2024,interest payments on the federal debt in the US exceeded defense spending for the first time in history:Net interest payments hit$870 billion,compared to$822 billion spent on defense.The overall federal debt has more than doubled over the past decade,to nearly$36 trillion.Starting in 2025,net interest costs will be greater in relation to GDP than at any time since at least 1940.Exhibit 31:Interest rates are expected to remain permanently higherData as of November 2024.Sources:Bloomberg,Apollo Chief Economist-101234567200020022004200620082010201220142016201820202022202420262028D FUNDS RATESOFR FUTURESECB POLICY RATEEURIBOR FUTURESMarkets pricingFed funds tobottom at 3.5%ATLWAA-20250103-4129350-13045676222025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Indeed,as of early November,US long rates were disconnecting from Fed expectations and oil prices.Despite a decline in oil prices alongside the market still expecting four Fed cuts over the coming 12 months,long rates have begun moving higher.This suggests that long rates are rising because of emerging worries about fiscal sustainability.And it seems that there will be higher budget deficits and more Treasury issuance in the years ahead.In late October,the Committee for a Responsible Federal Budget estimated5 that President-elect Trumps tax and spending plans would increase US government debt by anywhere from$1.65 trillion to$15.55 trillion from FY2026 through 2035,with a central estimate of a$7.75 trillion increase.If these estimates are correct,they raise the risk of even more upward pressure on long-term interest rates because of a looming supply-demand imbalance that will eclipse even the short-term pressures detailed in Exhibit 32.A central question:Who is going to buy all that debt?Exhibit 33 shows that foreign holdings of US Treasuries as a share of total outstanding debt have been falling,especially after China slowed its purchases due to several reasons,but mainly because their economy is weak.5 Source:https:/www.crfb.org/papers/fiscal-impact-harris-and-trump-campaign-plans/Exhibit 32:Treasury auction sizes have increased on average 29ross the yield curve in 2024Exhibit 33:Foreign ownership of US government bonds has been declining since 2015Note:Estimates from November 2024 to Dec 2024 from the Treasury Borrowing Advisory Committee and 2025 annualized using 1Q data from TBAC.Sources:SIFMA,TBAC,Haver Analytics,Apollo Chief EconomistData as of July 2024.Sources:Treasury,Haver Analytics,Apollo Chief Economist010020030040050060070080090010002s3s5s7s10s20s30s$bn20132018202320242025580W7019731976197919821985198819911994199720002003200620092012201520182021202435302510201550TREASURY ISSUANCE ACROSS TENORSFOREIGN HOLDINGS OF US TREASURY SECURITIES AS A SHARE OF OUTSTANDING PUBLIC DEBTATLWAA-20250103-4129350-13045676232025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.When the Chinese economy was strong,as it was for many years,the potential for a strong RMB led Chinese policymakers to buy dollars and sell RMB,so as to protect global demand for Chinese goods.Up until 2015 or 2016,they intervened in currency markets to limit the appreciation of their own currency.A weak Chinese economy,on the other hand,takes the need to artificially depress the RMB off the table.Today,the Chinese economy is weaker and the exchange rate of the RMB has been falling.So now theyre buying RMB and selling dollars.In short,China has turned from a buyer of Treasuries to a seller of Treasuries.Who has picked up the slack?As we can see in Exhibit 34,its mainly been American households and institutional money,such as pension funds and insurance companies.Both of those buyers are very sensitive to interest ratesthe reason they are buying Treasuries is because interest rates are higher.In other words,we have shifted from a yield-insensitive buyer(China)to yield-sensitive buyers(households,institutional money).That raises an obvious question:What if the Fed insists on interest rates coming down?At what level of yields do these investors stop buying Treasuries or T-bills or even money market funds?Exhibit 34:US households and real money are buying TreasuriesData as of June 2024.Sources:FFUNDS,Haver Analytics,Apollo Chief Economist-1012345678919971999200120032005200720092011201320152017201920212023$trillionFEDERAL RESERVEHOUSEHOLDSREAL MONEYFOREIGNBANKSFed startsraising ratesDo households and institutional money stop buying Treasuries if interest rates come down too much?HOLDERS OF US TREASURIESATLWAA-20250103-4129350-13045676242025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.One notable dynamic of late has been the fact that a great deal of recently issued debt has been T-bills.Governments typically issue short-dated instruments during a recession,but recent issuance has come on the heels of strong economic performance(Exhibit 35).Why has the Treasury issued so many T-bills when it could have issued 10-or 30-year government bonds?We can see two potential reasons:1)The Treasury is concerned about whether there would be enough demand to absorb the supply of bonds,and 2)it might be trying to avoid“locking in”higher fixed interest rates for such long duration.All-told,some 89%of US government debt outstanding is fixed rate22%of which is Bills,50%are Notes,and 17%are Bonds(Exhibit 36).Exhibit 35:The Treasury normally issues a lot of T-bills during recessionsData as of June 2024.Sources:Haver Analytics,Apollo Chief Economist2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024%of GDP,4Q MALONG-TERM ISSUANCEBILL ISSUANCERecessionRecessionNorecession252015100-5-105Exhibit 36:72%of US government debt is bills or notesData as of August 2024.Sources:Fed,Monthly Statement of Public Debt(Monthly Statement of the Public Debt(MSPD)|U.S.Treasury Fiscal Data),US Treasury Department,Apollo Chief EconomistNON-MARKETABLE2.1%MARKETABLE97.9%FIXED RATE88.6%VARIABLE RATE9.3%BILLS21.7%FLOATING RATE NOTES2.1%NOTES50.4%BONDS16.5%US DEBT100%TIPS7.2%ATLWAA-20250103-4129350-13045676252025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Debt service is another key factor influencing the future of interest rates.As shown in Exhibit 37,the US government is now spending$3 billion per day on interest expenses,a result of the combination of higher rates and higher debt levels.That means that total interest expenses on public issues is nearing$1 trillion a year(Exhibit 38).Were now spending more on debt servicing costs than we do on Medicare or defense.It is remarkable to note that interest expenses of roughly$900 billion annually are nearly triple the levels of 2019.While it doesnt always work this way,the more debt one has typically leads to higher interest charges on each new dollar of borrowings.The more we borrow,the more expensive its likely to get.Exhibit 37:The US spends$3 billion a day on interest expensesData as of October 2024.Sources:US Treasury,Haver Analytics,Apollo Chief Economist0.51.01.52.02.53.02004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024$billion,12-M MAMONTHLY INTEREST EXPENSE PER DAY ON PUBLIC DEBTExhibit 38:Total US government interest expenses are nearing$1 trillion a yearData as of July 2024.Sources:US Treasury,Haver Analytics,Apollo Chief Economist300400500600700800900201920202021202220232024$billion,12-month sumTOTAL INTEREST EXPENSE ON PUBLIC ISSUESATLWAA-20250103-4129350-13045676262025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Finally,we consider the most technical chart in this paperthat of the 10-year bond auction tail(Exhibit 39).When upcoming Treasury auctions are announced,the Treasury issues a so-called“when-issued”bond which starts trading immediately.That bond is supposed to tell you where the auction will come in.If the when-issued bond trades at,say,4.10%,but the auction results come in at 4.15%,that means that the when-issued market was wrong in gauging demand.In the parlance,the auction taileddemand was weaker than expected,and yields were higher.That has been happening more often of late,meaning there has been less demand for Treasuries than expected.3.The Fed eases too quicklyPut simply:If the Fed lowers interest rates too much too quickly,it runs the risk of reigniting a run-up in inflation.The Fed wants to achieve a soft landing by calibrating a decline in interest rates at the right pace.The market thinks the Fed needs to cut rates significantly and soon.We disagree.We think well get fewer cuts because the economy will just continue to be fine.Another point to consider:Should the Fed even be cutting rates at all?If you look at consumption,there seems to be no need to do so because we still have strong spending Exhibit 39:Too many tails means not enough demandData as of November 2024.Note:Bloomberg ticker USN10YTL Index.Sources:US Treasury Department,Bloomberg,Apollo Chief Economist-4-3-2-101234Jan-20Mar-20May-20Jul-20Sep-20Nov-20Jan-21Mar-21May-21Jul-21Sep-21Nov-21Jan-22Mar-22May-22Jul-22Sep-22Nov-22Jan-23Mar-23May-23Jul-23Sep-23Nov-23Jan-24Mar-24May-24Jul-24Sep-24Nov-24Auction tail10-YEAR BOND AUCTION TAILATLWAA-20250103-4129350-13045676272025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure ing from households.If youre looking at GDP growth,there also seems no need to do so2.8%growth is quite robust.If youre looking at inflation,on the other hand,it has come down very nicelyfrom 9.1%to 2.3%and offers an argument in support of cuts.Likewise the employment situation.While employment has remained quite strong,it has nevertheless shown a few signs of weakening in recent months.The Fed is tasked with keeping inflation around 2%,along with full employment.Inflation has almost been tamed,and employment is showing a few signs of weakness.In its statement after cutting rates by a quarter percentage point last month,the FOMC stated that it“judges that the risks to achieving its employment and inflation goals are roughly in balance.”That is why the Fed is cutting rates.Heres the issue,though:If the risk in 2022 was that inflation was going to choke the economy to a standstill,the risk today is that lower rates begin to overheat the economy again,and we see continued strong job and wage growth,the key drivers of housing demand.As previously discussed,a rebound in housing prices(Exhibit 40)would push inflation back up,away from the Feds 2%target.Exhibit 40:There may be a rebound coming in housing prices-20-15-10-50510152025-10123456789%YoY%YoYCPI-U:RENT OF PRIMARY RESIDENCECPI-U:OWNERS EQUIVALENT RENT OF RESIDENCESS&P CORELOGIC CASE-SHILLER HOME PRICE INDEX(14-MONTH LEAD)(RHS)20002002200420062008201020122014201620182020202220242026Data as of September 2024.Sources:Haver Analytics,BLS,S&P,Apollo Chief EconomistATLWAA-20250103-4129350-13045676282025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Cutting interest rates always comes along with upside riskthat the cuts may stimulate the economy too much.It would seem to be a particularly acute risk when the economy remains as strong as it has today.Keep in mind,too,that the stock market has been close to its all-time highs for much of 2024.Has the Fed ever cut 50 basis points when the stock market was this close to its all-time highs?As you can see in Exhibit 41,the answer is“no.”We would argue that there is no need to ease financial conditions when the stock market is at all-time highs.But the Fed decided to cut interest rates anyway.Why?Because after spending the last several quarters obsessing over the level of inflation,they have begun,of late,to shift the focus of their concern to the unemployment rate.Exhibit 42 shows the number of FOMC members who think the risk to the unemployment rate is weighted to the upside versus those who see it as weighted to the downside.Its only natural that with inflation falling that policymakers might find themselves wondering about the health of the economy and,by extension,the possibility of rising unemployment.Exhibit 42:Fed officials are much more worried about rising unemployment than falling unemploymentExhibit 41:It is very unusual for the Fed to cut 50 basis points when stocks are at all-time highsData as of October 2024.Sources:FRB,Bloomberg,Apollo Chief Economist-1.00-0.75-0.50-0.250.00S&P 500 RELATIVE TO HIGH IN THE PAST YEAR(%)FED RATE CUT(%)0-5-10-15-20-25-30-35-40-45Sep-18Dec-18Mar-19Jun-19Sep-19Mar-21Dec-19Mar-20Jun-20Sep-20Dec-20Jun-21Sep-21Dec-21Mar-22Jun-22Sep-22Dec-22Mar-23Jun-23Sep-23Dec-23Mar-24Jun-24Sep-24WEIGHTED TO THE UPSIDEWEIGHTED TO THE DOWNSIDE232332120112911311127012122132800131801701601100991414012002468101214161820CountNUMBER OF FOMC MEMBERS WHO THINK THE RISK TO THEIR UNEMPLOYMENT RATE FORECAST IS:Data as of September 2024.Note:No survey was conducted in March 2020.Sources:Federal Reserve,Apollo Chief EconomistATLWAA-20250103-4129350-13045676292025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Whats striking in the chart is the fact that the Fed is almost always more worried that the risk to their unemployment forecast is to the upside rather than to the downside.If youre constantly concerned that unemployment could be about to rise,then of course you will be inclined toward cutting interest rates at the first reasonable opportunity.To be clear:We do not wish to see an increase in unemployment ourselves.But we do find it interesting that FOMC members almost always see an upside risk to their unemployment forecasts,and rarely,if ever,think that they may be too optimistic.Let us also consider the Feds view that interest rates would normalize at around 3%.What would that mean in the Feds own framework for the forecast for GDP?As illustrated in Exhibit 43,it can be 2%higher over the next several quarters.And what would that mean to inflation?As illustrated in Exhibit 44,inflation could be 1%higher over the next several quarters.Exhibit 43:The Fed normalizing interest rates to 3n boost GDP by 2.2%Exhibit 44:The Fed normalizing interest rates to 3n boost inflation by 1ta as of November 2024.Note:Monetary policy shock includes a 150bps decrease in forward guidance and a 100bps decrease in policy rate.Sources:Bloomberg SHOK Model,Apollo Chief EconomistData as of November 2024.Note:Monetary policy shock includes a 150bps decrease in forward guidance and a 100bps decrease in policy rate.Sources:Bloomberg SHOK Model,Apollo Chief Economist0.00.51.01.52.02.53Q244Q241Q252Q253Q254Q251Q262Q263Q264Q261Q272Q273Q274Q27%pts0.00.20.40.60.81.01.23Q244Q241Q252Q253Q254Q251Q262Q263Q264Q261Q272Q273Q274Q27%ptMONETARY POLICY SHOCK TO GDP LEVEL,COMPARED WITH BASELINE FORECASTMONETARY POLICY SHOCK TO INFLATION,COMPARED WITH BASELINE FORECASTATLWAA-20250103-4129350-13045676302025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.We do believe that there may be cause for a serious discussion about the actual level of R*,or the neutral interest ratethat is,the level of interest rates where monetary policy is neither easy,meaning supporting the economy,nor restrictive,meaning slowing down the economy.The Fed thinks R*is about 3%.We think it is closer to around 4.5%.Heres the issue:If R*really is 3%,then the current level of rates of 4.5%should probably strike us as fairly restrictive.If monetary policy is too tight,in other words,we should be seeing data that reflects that imbalancea drop-off in people buying cars and houses and,likewise,a drop-off in corporate investment.The problem with that argument is that we have been seeing nothing of the sort.Inflation is coming down,to be sure,but upward pressure,as previously discussed,remains.This is a quandary that raises an interesting question,namely:Is the estimate of the long-run fed funds rate of 3%too low?Perhaps there have been structural changes in the economy that mean that the long-run fed funds rate will be closer to 4.5%or 5%.If that were the case,then 4.5%would not be overly restrictive.In which case,the danger would be cutting too much,too soon.While we are not suggesting that the Fed has made a policy mistake by lowering rates,we do think that there is an important discussion to be had about the speed and magnitude of further rate cuts from here since there is still a risk that the Fed cutting too much too soon is going to boost both GDP and inflation,thereby starting the clock all over again on the prospect of a soft landing.What are the potential implications for financial markets?In light of a benign yet not riskless outlook,we see a number of implications for capital markets and portfolio allocations.We will wrap up this paper with an overview of our outlook for various asset classes,from public equities to private credit,as well as a discussion about portfolio management in the years ahead.Public equitiesPublic equities are trading at too lofty forward valuations.The historical relationship between the S&P 500 forward P/E ratio and subsequent three-year returns in the benchmark index shows that the current forward P/E ratio of almost 22 implies a 3%inflation-adjusted annualized return over the coming three years(Exhibit 45),way below historical averages of around 6.4%.The risk premium for holding public stocks the difference between the S&P 500 earnings yield minus the 10-year Treasury yieldis currently negative.In other words,investors are paying to take risk as opposed to being paid to do so.Exhibit 45:The forward P/E ratio of 21.8 implies just 2.9%returns over the next three yearsData as of October 2024.Sources:Bloomberg,Apollo Chief Economist101214161820222426FORWARD P/E RATIO3-YEAR SUBSEQUENT ANNUALIZED RETURN(%)403020100-10-20%S&P 500ATLWAA-20250103-4129350-13045676312025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Add to this analysis the fact that concentration remains high and valuations at the top are even higher:As of early November,the average trailing P/E ratio of the 10 largest companies in the S&P 500 in terms of market capitalizationAlphabet,Amazon,Apple,Berkshire Hathaway,Broadcom,EliLilly&Co.,Meta,Microsoft,NVIDIA,Teslawas almost 50(Exhibit 46),basically twice the overall markets ratio.Another area of concern in the public market is the small-and mid-sized market.More than 50%of debt for Russell 2000 companies is floating rate.For the S&P 500,it is 24%(Exhibit 47).With interest rates higher for longer,small-cap companies remain more vulnerable than large-cap companies.More generally,companies and capital structures with no earnings,no revenues,and no cash flows will continue to struggle with high debt servicing costs(Exhibit 48).Exhibit 46:The average P/E ratio of the top 10 companies in the S&P 500 is almost 50Exhibit 47:Russell 2000 companies are more vulnerable when rates stay higher for longerData as of November 4,2024.Sources:Bloomberg,Apollo Chief EconomistData as of October 2024.Note:Includes bonds and loans(tranches)and excludes financials.Sources:Bloomberg SRCH,Apollo Chief Economist118.266.563.462.440.936.733.625.723.522.249.339.026.1020406080100120140TeslaBroadcomNVIDIAAmazonAppleMicrosoftMetaAlphabetBerkshireHathawayTop 10averageTop 4averageS&P 500Eli Lilly&CoTrailing P/E ratioS&P 500Russell 2000%FLOATINGFIXED(MATURITY IN 2024 AND 2025)FIXED(MATURITY 2026 )100908070605040302010024.2R.7i.3E.0%6.5%2.2%TRAILING P/E RATIO OF THE TOP 10 COMPANIES IN S&P 500 BY MARKET CAPDEBT BY MATURITY(EXCLUDING FINANCIALS)ATLWAA-20250103-4129350-13045676322025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Public Fixed IncomeCredit spreads continued to tighten in the wake of the US election,with US investment grade(IG),high yield corporates(HY),emerging market corporates(EM),and CLO A-BBB tranches trading at or near post-Covid tights.The rally has been driven by a combination of robust economic growth,strong fixed income demand technical,and,most recently,the election outcome.We expect credit fundamentals to remain robust.This,combined with elevated all-in yields and steep yield curves,can continue to attract inflows into the asset class.We believe this should support valuations even as the room for further compression is increasingly limited.Given the combination of tight valuations and beta compression,we do not see attractive risk-reward trade-offs in extending spread duration or moving down the rating spectrum.We also see better value in private credit(see next section)with the private-public spread still elevated.A Republican administration can offer a more favorable regulatory backdrop,leading to a pickup in deal-making and M&A activity in the year ahead.At the same time,trade policy and tariffs may have disparate impacts across the credit market.We see elevated single-name dispersion in credit outcomes in the year ahead.Further,most of the recent spread tightening came the heels of rising government rates on the long end of the curve,rather than a substantial drop on corporate bonds yields.As a result,just as there are low risk premia in the public stock markets today,dynamics in public credit can suggest there are fewer and fewer places for investors to hide.We see a muted opportunity in public credit,which has implications for the prognosis of the 60/40 portfolio as well(see last section).In short,liquidity risk premia in public credit markets has declined,especially in high yield,where it is at or near five-year lows.This argues for a reallocation away from illiquid parts of public credit to either liquid public credit or private markets.Exhibit 48:The share of Russell 2000 companies with negative earnings continues to riseData as of June 2024.Sources:Bloomberg,Apollo Chief Economist101520253035404550199519971999200120032005200720092011201320152017201920212023%PERCENTAGE OF COMPANIES IN RUSSELL 2000 WITH NEGATIVE EARNINGS(12-MONTH TRAILING EPS)ATLWAA-20250103-4129350-13045676332025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Private EquityLower rates could spark a new wave of deals as,on one hand,sponsors seek to deploy capital raised in the past three years and,on the other,managers may be willing to part with existing investments as cheaper borrowing costs may bolster valuations.Opportunities in the private equity secondary market remain interesting.Specifically,GP-led dealsthose through which general partners negotiate asset sales directly with secondary buyershave been the fastest growing segment of private equity secondaries since 2018,and accounted for almost half of all secondary transactions in 2022 and 2023.6 This increase is a result of continued innovation as well as a slowdown in traditional exit avenues such as initial public offerings(IPOs)and mergers&acquisitions(M&A)during a period of higher interest rates.We believe that GP-led deal volume will remain strong even in a more normalized environment,as secondary transactions have become a key component of the private market ecosystem.Just as with the broader secondaries market,we see the potential for GP-led deals as a function of a)an investment managers relationships with general partners,b)the size and flexibility of the investment platform,especially as regards innovative capital solutions,and c)the deep industry expertise that accrues to large direct investors.We believe the secondaries market can offer excess return per unit of risk when compared to other private market strategies due to a variety of factors,including a rapidly evolving secondary investment landscape.7Structured finance,including hybrid strategies,remains particularly interesting as well,and we currently see an opportunity to identify hybrid opportunities with credit-like downside protection and equity-like upside.In the heyday of low rates,which were characterized by a low single-digit cost of debt,investors moved up the risk spectrum in search of strong equity returns.In todays more normal rate environment,with high single-digit costs of debt,equity returns are being squeezed and investors are moving down the risk spectrum toward hybrid opportunities.A hybrid approach can fit in between the traditional private credit and private equity portions in a portfolio,with the potential to decrease volatility while increasing downside protection.Hybrid investors have a variety of vehicles at their disposal,including mezzanine debt,preferred equity(with warrants),convertible preferred,and structured common equity.There is plentiful demand for hybrid solutions,including M&A financing and capital for growth,re-equitization of over-levered balance sheets,owner and sponsor liquidity solutions,and financing to support public company growth initiatives.Estimates suggest that companies will require significant capital to fund growth in the years ahead,including$30 trillion to$50 trillion for energy transition,$30 trillion for power and utilities,and$15 trillion to$20 trillion in digital infrastructure.8Market inefficiencies have generated a supply-demand imbalance for hybrid capital,dry powder for which is less than 25%that of private debt and less than 10%that of private equity.As of March 2024,hybrid capital strategies sat on an estimated$78 billion of dry powder,versus$333 billion in the private debt space and$1,055 billion available for buyouts.96 For more on this,see:Expanding the Toolkit:How GP-Led Transactions can Enhance Secondary Strategies,by Steve Lessar,Veena Isaac,and Konnin Tam,Co-Heads of Apollo S3 Sponsor&Secondary Solutions,September 20247 For more on this,see PE Secondaries:Evolving Landscape Can Expand Opportunities,by Steve Lessar,Veena Isaac,and Konnin Tam,Co-Heads of Apollo S3 Sponsor&Secondary Solutions,April 20248 Market sizing reflects the views and opinions of Apollo analysts based on expected aggregate investment/capex demands over the next 10 years.9 Dry powder per Preqin as of March 31,2024.ATLWAA-20250103-4129350-13045676342025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.Private CreditBuoyant equity markets,tighter credit spreads,and a cheaper cost of debt capital can lead to more corporate transactions in coming months.Default rates remain low in most cases.We continue to see a clear delta between credit spreads in the public and private marketsthat is,investors can earn a premium for lending in the private markets(Exhibit 49).We see the most attractive opportunities in lending to businesses with recurring revenue streams that generate a lot of cash flow,that have variable expense structures,and low capex spending-to-revenue ratios.The above attributes lead to stronger leveraged borrower profiles,in our opinion.We point toward one of our primary factors behind the strength of the US economythe data center buildout.Data centers are typically financed using asset-backed securities,project finance,and private credit,and this macro trend can be a significant source of opportunity.While leveraged buyout(LBO)activity has picked up in the public marketsthe third quarter of 2024 saw the highest level of LBO volume since the first quarter of 2022LBO volume in the private markets was 50%greater than in the public markets during the first nine months of 2024.There are a lot of opportunities to lend.A high wall of maturities in 2027-2028 can also provide a fresh source of refinancing opportunities.Higher rates for longer can translate into higher yields in private credit,especially for newer vintages as investors seek potential substitution for on-the-run bonds(which,given tight spreads,are trading at lofty valuations).That said,given the risks we see on the horizon,we believe it is paramount to seek first-lien,first-dollar,senior-secured,good covenants,top of the capital structure opportunities.Middle market opportunities are still plentiful.We also see opportunity in direct lending and origination,especially in the asset-backed finance world.Higher rates have certainly laid bare some of the weaknesses in business models that were dependent on a cheaper cost of debt capital,especially those that are capex intensive.Thats created particular stress in industries that are also seeing increased competition,such as telecom and cable.This has led to individual opportunities to buy secured,downside-protected positions in companies that are going through a change in their business model and an evolution in their cost of capital.We see opportunities to get capital to companies that are good businesses in good competitive positions in their subsectors but are going through a change in their funding models.Exhibit 49:BDC yields are higher than those of high-yield bondsData as of August 2024.Sources:Bloomberg,Apollo Chief Economist35791113151719201920202021202220232024%VANECK BDC INCOME ETF INDICATED DISTRIBUTION YIELDBLOOMBERG US CORPORATE HIGH YIELD INDEX YIELD TO WORSTATLWAA-20250103-4129350-13045676352025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.We also continue to see increased convergence of private and public markets with respect to partnerships between alternative investment managers and banks that are focusing on origination.Although often portrayed as adversaries in the media,the reality is that banks and asset managers are increasingly working together.More than a dozen banks have partnered with private credit firms in the last 12 months,a significant increase from the two partnerships announced the previous year.10 We believe these partnerships should bolster the volumes of private credit origination and expand the breadth of companies accessing the private market.They may also be a source of existential questions:If a deal is originated by a bank but financed by an alternative managers balance sheet,is it is public or a private deal?Does it even matter?We also see more opportunities for direct lending in the year ahead,on the heels of enormous growth in 2024.Companies are pivoting to the private credit markets not so much as a response to the level of rates but more as a reaction to how sponsors and management teams are looking to finance their business.Lastly,if rates do remain higher,as we expect,and the terminal fed funds rate stays higher than where it has been historically,then credit we believe can be an attractive asset class in the near-to medium-term.With opportunities in credit to create attractive return profiles that are downside-protected,we see private credit as an attractive alternative to overvalued public equities.Portfolio allocationOngoing worries about the long-term success of traditional allocations strategies(i.e.,60%stocks/40%bonds)are unlikely to dissipate.Based on our views expressed above,we see potential for depressed long-run returns in the public markets(both equity and fixed income).At the same time,public and private markets are converging.Public markets can be safe and risky,and private markets can be safe and risky.High levels of concentration and still-lofty valuations have combined to narrow the risk premium in public equities.At the same time,still-tight spreads in public fixed income have made it increasingly difficult to find attractive yields at reasonable risk levels.We believe that private markets can offer an alternative to the muted risk premia in public markets and provide potential for long-term alpha generation.11As such,we continue to believe that parts of the 60/40 portfolio invested in public markets can be replaced with private fixed income and private equity.10 Source:Oliver Wyman11 For more on this,see Portfolio Allocation Views:The Search for Risk Premia,Alexander Wright,August 9,2024ATLWAA-20250103-4129350-13045676362025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.ABOUT THE AUTHORTorsten Slk joined Apollo in August 2020 as Chief Economist,and he leads Apollos macroeconomic and market analysis across the platform.He is also an Apollo Partner.Prior to joining,Mr.Slk worked for 15 years as Chief Economist at Deutsche Bank where his team was top ranked in the annual Institutional Investor survey for a decade.Prior to joining Deutsche Bank,Mr.Slk worked at the IMF in Washington,DC and at the OECD in Paris.Mr.Slk has a PhD in Economics and has studied at the University of Copenhagen and Princeton University.Torsten Slk,PhDPartner,Apollo Chief EconomistATLWAA-20250103-4129350-13045676372025 ECONOMIC OUTLOOK:FIRING ON ALL CYLINDERSThe information herein is provided for educational and discussion purposes only and should not be construed as financial or investment advice,nor should any information in this document be relied on when making an investment decision.Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change.Please see the end of this document for important disclosure information.To learn more,visit ApolloA.2024 APOLLO GLOBAL MANAGEMENT,INC.ALL RIGHTS RESERVED.Important Disclosure InformationAll information herein is as of December 2024 unless otherwise indicated.This presentation is for educational and discussion purposes only and should not be treated as research.This presentation may not be distributed,transmitted or otherwise communicated to others,in whole or in part,without the express written consent of Apollo Global Management,Inc.(together with its subsidiaries,“Apollo”).The views and opinions expressed in this presentation are the views and opinions of Apollo Analysts.They do not necessarily reflect the views and opinions of Apollo and are subject to change at any time without notice.Further,Apollo and its affiliates may have positions(long or short)or engage in securities transactions that are not consistent with the information and views expressed in this presentation.There can be no assurance that an investment strategy will be successful.Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially,and should not be relied upon as such.Target allocations contained herein are subject to change.There is no assurance that the target allocations will be achieved,and actual allocations may be significantly different than that shown here.This presentation does not constitute an offer of any service or product of Apollo.It is not an invitation by or on behalf of Apollo to any person to buy or sell any security or to adopt any investment strategy,and shall not form the basis of,nor may it accompany nor form part of,any right or contract to buy or sell any security or to adopt any investment strategy.Nothing herein should be taken as investment advice or a recommendation to enter into any transaction.Hyperlinks to third-party websites in this presentation are provided for reader convenience only.There can be no assurances that any of the trends described herein will continue or will not reverse.Past events and trends do not imply,predict or guarantee,and are not necessarily indicative of future events or results.Unless otherwise noted,information included herein is presented as of the dates indicated.This presentation is not complete and the information contained herein may change at any time without notice.Apollo does not have any responsibility to update the presentation to account for such changes.Apollo has not made any representation or warranty,expressed or implied,with respect to fairness,correctness,accuracy,reasonableness,or completeness of any of the information contained herein,and expressly disclaims any responsibility or liability therefore.The information contained herein is not intended to provide,and should not be relied upon for,accounting,legal or tax advice or investment recommendations.Investors should make an independent investigation of the information contained herein,including consulting their tax,legal,accounting or other advisors about such information.Apollo does not act for you and is not responsible for providing you with the protections afforded to its clients.Certain information contained herein may be“forward-looking”in nature.Due to various risks and uncertainties,actual events or results may differ materially from those reflected or contemplated in such forward-looking information.As such,undue reliance should not be placed on such information.Forward-looking statements may be identified by the use of terminology including,but not limited to,“may”,“will”,“should”,“expect”,“anticipate”,“target”,“project”,“estimate”,“intend”,“continue”or“believe”or the negatives thereof or other variations thereon or comparable terminology.The Standard&Poors 500 Index(S&P 500)is a market-capitalization weighted index of the 500 largest US publicly traded companies and one of the most common benchmarks for the broader US equity markets.Index performance and yield data are shown for illustrative purposes only and have limitations when used for comparison or for other purposes due to,among other matters,volatility,credit or other factors(such as number of investments,recycling or reinvestment of distributions,and types of assets).It may not be possible to directly invest in one or more of these indices and the holdings of any strategy may differ markedly from the holdings of any such index in terms of levels of diversification,types of securities or assets represented and other significant factors.Indices are unmanaged,do not charge any fees or expenses,assume reinvestment of income and do not employ special investment techniques such as leveraging or short selling.No such index is indicative of the future results of any strategy or fund.Additional information may be available upon request.Past performance is not necessarily indicative of future results.ATLWAA-20250103-4129350-13045676
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FEBRUARY 2025SUPPORTING THE U.S.ECONOMY THE ECONOMIC IMPACT OF RECKITT IN THE U.S.The economic impac.
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University of Michigan,Ann Arbor Department of Economics 611 Tappan Avenue Ann Arbor,MI 48109-1120 lsa.umich.edu/econ/rsqe 734-764-2567 For Release:11/21/2024 The Michigan Model Gabriel M.Ehrlich,Director George A.Fulton&Saul H.Hymans Directors Emeriti The U.S.Economic Outlook for 20252026 Jacob T.Burton,Gabriel M.Ehrlich,Kyle W.Henson,Daniil Manaenkov,Niaoniao You,and Yinuo Zhang University of Michigan Executive Summary All Things Considered As the Fed proceeds with its cutting cycle amid a cooling labor market,we expect real GDP to grow at an annualized pace of 2.3 percent and the unemployment rate to average 4.2 percent in 2024Q4.We project a modest deceleration of economic growth to accompany the less dynamic labor market over the near term.However,the solid momentum of real final sales to private domestic purchasers,helped by growth in real income,is likely to persist,supporting solid real GDP growth.As the stimulative effects of the expected tax cuts dominate the drag from the anticipated new tariffs,we project quarterly GDP growth to accelerate modestly during 2026,reaching a 2.5 percent annualized pace by 2026Q4.Consumption Momentum:Revised and Reinforced The recent large upward revision of personal income data since 2022 explains the resilience of consumption growth in the face of higher interest rates.Higher income and meaningful real wage gains going forward will likely support robust spending growth in the near term.No Halloween Haunt for the Labor Market The labor market is looking less worrisome after some jump scares in the third quarter.The unemployment rate dipped to 4.1 percent in September and held there in October,down from the recent high of 4.3 percent in July.However,the trend pace of job gains is likely still decelerating even after accounting for the negative impacts of recent hurricanes and strikes.Job openings have continued to soften.We expect private sector job gains to decelerate moderately through most of 2025,while government sector employment also grows at a slower pace.Prelude to the Super Bowl of Tax Many previously low-probability fiscal scenarios surfaced following the Republicans trifecta victory in the November elections.We expect an extension of most expiring provisions of the Tax Cuts and Jobs Act of 2017,a lower corporate tax rate of 15 percent for domestic manufacturers,and a higher cap on the state and local tax deduction.We also anticipate sizable but incomplete tax cuts on Social Security benefits,tips,and overtime income.Consumer incentives for purchases of electric vehicles,on the other hand,are likely to be unplugged quickly.Tariffs on China are very likely to surge.We project average tariff rates on Chinese goods to grow eventually to triple the size of those implemented during the first Trump Administration.We expect President-elect Trumps fiscal agenda to come into effect in 2026.With roughly 200 billion dollars in tax cuts against 85 billion dollars in new tariff revenue,the federal deficit climbs from 6.1 percent of GDP in fiscal 2024 to 6.8 percent of GDP by fiscal 2026.That level would be unprecedented outside of wars,the recent pandemic,and severe recessions.Inflation Trends:Very Demure,Very Mindful Progress on bringing inflation trends down has stumbled recently.The 3-month annualized core CPI inflation rate came down from 4.5 percent in March to 1.6 percent in July,but it has re-accelerated to 3.6 percent in October.Although the deceleration in inflation trends has cleared the way for the Fed to start easing,the recent uptick reduces the urgency to cut rates quickly in the forecast.We continue to believe that inflation remains on a path of gradual deceleration toward the Feds target,largely because shelter inflation has plenty of room to decelerate further.2 The Fed Stands Watch The long-awaited Fed pivot to rate cuts has arrived.After sitting in a 23-year high range of 5.255.5 percent for 14 months,the fed funds rate was reduced by 50 basis points in September and by 25 basis points in November,bringing it to the 4.54.75 percent range.The pace of cuts to follow is likely to be data dependent.Provided that labor market conditions remain stable,we project another 25-basis point cut at the FOMCs December meeting before the pace of cuts slows next year.We anticipate four more cuts of 25 basis points in 2025,bringing the fed funds rate to its terminal range of 3.253.5 percent for this cycle by the end of the year.In our view,the temporary uptick of inflation related to tariffs will not prompt the Fed to tighten policy in 2026.We believe that risk management concerns related to the potential negative growth effects of tariffs,which played a role in the 2019 rate cuts,will balance the upside risks from new tax cuts,prompting the Fed to stand pat.The 20252026 Outlook We project that real GDP growth will slow from a Q4-to Q4 pace of 2.4 percent in 2024 to 1.9 percent in 2025.Long-term interest rates have increased meaningfully in recent months,which will limit potential consumption growth in the near term by making financing for big-ticket purchases less affordable.We expect looser monetary policy to work through the economy sufficiently to lift quarterly growth to a 2.1 percent pace in the second half of 2025.As personal income tax cuts kick in,the quarterly pace of growth ramps up during 2026,reaching an annualized rate of 2.5 percent in 2026Q4.Calendar year real GDP growth picks up to 2.2 percent in 2026.The unemployment rate ticks up from 4.2 percent in 2024Q4 to 4.3 percent in 2025Q1 and then stabilizes at 4.4 percent for the remainder of 2025 before declining back to 4.2 percent by 2026Q4.Monthly payroll job gains continue to slow,averaging 108,000 jobs from 2025Q2Q4.As looser monetary policy works its way through the system,job gains ramp up slowly during 2026.The economy adds 1.3 million jobs in 2026.We expect PCE inflation to continue its decline toward the Feds 2.0 percent target,as shelter cost growth decelerates.Year-over-year PCE inflation settles around 2.1 percent in 2025.We expect the price effect of the new import tariffs to be modest,with 12-month PCE inflation ticking up to 2.3 percent by the end of 2026.The reacceleration is a bit larger for core PCE inflation.With plenty of supply already for sale,new single-family home construction remains soft,averaging a pace of 991,000 units from 2024Q4 to 2025Q2 before climbing to a 1,080,000 unit pace by 2026Q4.The annual pace of multi-family starts bottoms at 350,000 in 2024Q4 before recovering to 449,000 units by 2026Q4 as financing costs drop.We expect auto loan rates to step down as long-term rates decline and auto delinquencies drop.As the CPI for new light vehicles continues to decrease,we think vehicle affordability will improve noticeably as measured by monthly payments and transaction prices relative to income.We project that the annualized pace of sales will edge up to 16.1 million in 2025.We expect the anticipated early phase-out of the electric vehicle credits to have minimal impact on total light vehicle sales,as consumers are likely to shift toward vehicles with other drivetrain types.As a result,vehicle sales total 16.2 million in 2026.3 The Current State of the Economy The U.S.economy continues to expand at a solid clip.Real GDP expanded at an annualized pace of 2.8 percent in the third quarter of 2024,a touch below the 3.0 percent pace in the prior quarter.Chart 1 shows the growth rate of real GDP and the growth contributions of its major components over recent quarters.The government sectors contribution rebounded to 0.9 percentage points in the third quarter on the strength of defense-related expenditures.Consumption expenditures contribution to headline growth rose to 2.5 percentage points,benefiting from jumps in purchases of pharmaceutical products and election-related services.However,the contribution of private fixed investment slipped to only 0.2 percentage points.The sum of the latter two componentstogether known as the contribution of real final sales to private domestic purchasersregistered over 2.0 percentage points for the seventh quarter in a row.The recent annual revisions to the National Product and Income Accounts(NIPAs)resulted in considerably higher estimates of Gross Domestic Income growth over the 201923 period,largely stemming from higher estimates of personal income.Chart 2 shows the current and pre-revision personal saving rates.With revised data showing a fairly steady reading of around 5 percent disposable personal income,the recent pace of consumption expenditure growth appears more sustainable than previously thought.4 As of early September,the labor market situation was looking worrisome.The unemployment rate jumped by 0.4 percentage points between April and July to 4.3 percent,then barely edged down to 4.2 percent in August.Payroll job gains as reported on September 6 averaged only 116,000 per month from June to August.It was no wonder the Federal Reserve decided to cut the range for the fed funds rate by 50 basis points(bps)in mid-September.Subsequent data have been far less alarming.The unemployment rate dipped further to 4.1 percent in September and October.September payroll job gains came in initially at 254,000 along with a 72,000 combined upward revision to the JulyAugust job gains.The October payroll job gains were only 12,000,but the job growth count was reduced by about 38,000 striking International Association of Machinists union workers and was further lowered temporarily by the disruptions that Hurricane Milton and Helene caused in parts of Florida and North Carolina.We are expecting a significant rebound in employment growth in November.Still,even factoring in the recent dip,both the headline unemployment rate and the broader measure of labor market slack known as the U6 unemployment rate appear to be following a slow upward trend.1 We also think that payroll job gains are likely to continue slowing gradually.Based on the preliminary data,the annual benchmark revision of payroll employment is likely to lower payroll gains from April 2023 to March 2024 1 In addition to the traditional measure of unemployment known as the U3 rate,the U6 unemployment rate includes people working part-time for economic reasons and those outside of the labor force who are willing and able to work and have looked for work at some point over the prior 12 months.5 by 818,000,making the slowdown during this year look far less dramatic.The continued pace of labor market softening is well illustrated by Chart 5.The private sector job openings rate in the Bureau of Labor Statistics(BLSs)Job Openings and Labor Turnover Survey(JOLTS)has been trending down since early 2022 and,as of the most recent data for September,has fallen back to the level observed at the end of January 2020.While the number of job openings in the I data remains about 10 percent above its level on February 1,2020,the readings in October and early November suggest job openings continue to soften.The 3-month average of private sector weekly hours has also declined from a peak of 35.0 in May 2021 to around its pre-pandemic level of 34.3 in October.As shown on Chart 6,however,aggregate private sector weekly hours have been holding up reasonably well,expanding at a pace of above 1.0 percent year-over-year for most of 2024.The measures of compensation shown in Chart 7 are continuing to moderate but remain high enough to sustain real compensation growth.6 Overall,labor market strength remains reasonable,with total payroll growth conducive of continued consumption growth in the near term.Progress on bringing trend inflation down,very evident between late spring and mid-summer,has sputtered recently.The year-over-year core CPI inflation rate has remained around 3.3 percent since June.The 3-month annualized core inflation came down from 4.5 percent in March to 1.6 percent in July,but has re-accelerated to a 3.6 percent reading as of October.Personal Consumption Expenditures(PCE)price index inflation(only available through September as of the writing of this report)has exhibited a qualitatively similar dynamic.The annualized 3-month inflation rate of the highly-watched supercore metricthe PCE price index for core services excluding housingimproved from 5.3 percent in March to 2.3 percent in July but rebounded to 2.9 percent in September.PCE Housing inflation,however,continues to trend down,albeit slowly.Average PCE shelter costs had risen more than 5.0 percent year over year in September,despite measures of new tenant rent inflation that have long since moderated.Overall,we continue to believe that inflation remains on a path of gradual deceleration toward the Feds target,largely because shelter inflation has plenty of room to decelerate further.The Fed cut the target range for the fed funds rate by 50 bps in mid-September and a further 25 bps in early November.Yet long-term Treasury interest rates have exploded higher since mid-September,returning to levels seen in July.The 10-year note yield rose by 6070 bps through early November.About two-thirds of the run-up can be attributed to the increase in the 10-year Treasury Inflation-Protected 7 Security(TIPS)yield,with the rest due to higher inflation compensation.While it is tempting to attribute the run-up to shifts in election outcome probabilities and the increasingly more costly campaign promises in the lead-up to the November elections,the lack of a sharp bond market reaction upon learning the actual election outcome suggests that other forces are likely to have been at play as well.One possible explanation is the cooling and reheating pattern we have seen in the labor market and inflation data,coupled with the recent NIPA revision to personal income.Yet another explanation is a short-term overreaction to noisy information.We judge that there has been some overreaction,but near-term rate dynamics will largely depend on how markets assess the impact of President-elect Trumps second-term agenda.To briefly summarize our assumptions about the first two years of the second Trump Administration:we expect moderately wider fiscal deficits due to lower tax revenues that stimulate the economy,while higher tariffs undo some of the stimulus.This relatively benign outlook means that we do not anticipate large shifts in long-run neutral policy rate.As a result,we continue to project long-term Treasury yields to moderate.Chart 11 shows the recent dynamics of consumer sentiment in the economy.While the Conference Board metric has generally moved sideways,the University of Michigan Consumer Sentiment index took a large dive in 2022 amid high inflation.Since then,the index has been on an upward trajectory with a few setbacks.Both indices remain far below pre-pandemic levels.It remains unclear whether and how the apparent disconnect between the levels of confidence and growth of consumer spending will be resolved.8 Chart 12 shows the Institute for Supply Managements(ISMs)Purchasing Manager diffusion Indices for manufacturing and services.The services index jumped to 56.0 in October,propped up by the new orders and employment sub-indices,suggesting strong service sector momentum to start the fourth quarter.The manufacturing sector continues to struggle,with the ISM index indicating contraction in all but one of the past 24 months.We are hopeful that this manufacturing downturn will end soon.Most manufacturing outlook surveys conducted by regional Federal Reserve banks show a marked improvement in 6-month ahead expectations.Stagnant light vehicle sales are one reason behind the weakness in manufacturing.The seasonally adjusted annualized pace of light vehicle sales topped 16 million units for the second time this year in October,but the average for this year so far stands at a disappointing 15.6 million.Poor affordability due to high vehicle finance interest rates is likely holding back vehicle sales.Chart 14 shows light truck and car transaction prices relative to average monthly wages on the left axis.Both the maize and blue lines are at or below their 2019 levels.The green and red dashed lines(displayed on the right axis)show hypothetical monthly 9 payments as a share of the monthly average wage for a new car or truck purchased at the respective average transaction price and financed over 48 months at the new vehicle finance interest rate reported by the Wall Street Journal.Both metrics show that affordability has deteriorated noticeably since 2021,to levels more in line with 201415 levels for cars and 2012 for trucks,respectively.The good news is that vehicle loan delinquency rates may peak soon,which could bring about lower risk spreads for vehicle finance and improving affordability.With 30-year fixed mortgage rates pushing up toward the 7.0 percent mark again,the housing market is likely to get another swing of the seesaw.Chart 15 shows the National Association of Home Builders(NAHBs)Housing Market Index alongside the Mortgage Bankers Associations(MBAs)volume index of loan applications for purchases.The NAHBs index,which measures builders sentiment on concurrent and six-month forward single-family sales as well as the traffic of prospective buyers,has barely begun to improve this fall after its summer slump.With mortgage rates shooting up again,we do not expect much optimism from homebuilders.The number of new mortgage applications also appear destined to scrape along the bottom of their historical volumes over the near term.Overall,the state of the economy remains challenging to interpret.We believe that the dynamics of the labor market support continued solid consumption expenditure growth in the current quarter.High interest rates and post-election policy uncertainty could weigh on some sectors.Although we forecast the labor market to continue gradually cooling off through the first half of next year,we believe that the Feds pivot to looser near-term monetary policy will filter through the economy over time,helping to sustain the ongoing business expansion over the next two years.Next,we detail several key policy and economic assumptions underlying the forecast.10 Key Policy Implications of the Federal Elections Donald Trump has won the presidency once more,and the Republican Party has won control of both houses of Congress for 202526.The House majority will remain very narrow,but party discipline could become easier to enforce with a Republican President and Senate.Still,the slim seat margin will likely limit the size and scope of policies Congress can implement,with most legislative action likely centered on tax policy.We now expect an extension of most expiring provisions of the Tax Cuts and Jobs Act of 2017(TCJA),reinstatement of 100-percent bonus depreciation,and a reduction of the corporate income tax rate for domestic manufacturing to 15 percent.We think that a full exemption of tips,overtime pay,and Social Security benefit payment from income taxation is unlikely,but a partial exemption is likely.We also expect the cap on the state and local tax(SALT)deductions to be relaxed,fulfilling a campaign commitment.A large portion of Inflation Reduction Act(IRA)funds devoted to renewable energy has gone to Republican districts,so we do not expect a wholesale early phase-out of green energy provisions.However,the highly visible consumer incentives for purchases of electric vehicles(EVs)are likely to get zapped.It also seems very likely that tariffs on imports from China will rise sharply.We project average tariff rates on Chinese imports to grow to eventually be triple the size of those implemented during the first Trump Administration.We project the new tariffs to come into effect early in 2026 and ramp up over the following year as rounds of mutual retaliation follow.We expect about a 0.2 percent permanent increase in consumer prices due to the new China tariffs.On the other hand,and contrary to many observers,we do not project the lasting imposition of broad tariffs on imports from the rest of the world over the next two years.We instead expect the threat of such tariffs(or a short-lived imposition)to be used as a bargaining chip in negotiations with our trade partners.The path of future population growth is highly uncertain,but it is very relevant for our outlook.We think poor economic conditions in several Central American countries will continue to be the key driving force behind the flow of migrants across the U.S.southern border.Tighter border controls and enforcement under the second Trump Administration will deter some and slow the pace of new arrivals.We have lowered our projections for population growth considerably compared to our recent outlooks,11 which relied on Congressional Budget Office projections released in January 2024.2 The campaign promise of mass deportations of unauthorized immigrants is a major wildcard.The removal of a significant portion of the working-age population could push interest rates and inflation higher,while also slowing the economy.A large-scale deportation program has not been attempted since the Eisenhower Administration in 1953.While it is likely that a deportation program will be put in place,we are skeptical that it will ultimately result in the permanent removal a significant portion of unauthorized immigrants.Monetary Policy The Federal Open Market Committee(FOMC)remains committed to its dual mandate of bringing inflation down to its 2.0 percent objective while maintaining full employment.The FOMC has cut the federal funds rate at each of the last two meetings,by 50 basis points in September and by 25 bps in November,bringing it to the 4.54.75 percent range.Committee members have noted that they are strongly committed to supporting maximum employment and that labor market conditions have generally eased in their recent statements,signaling that they are open to further rate cuts if the labor market shows further signs of weakening.On the other hand,Federal Reserve Chair Jerome Powell stated on November 14,The economy is not sending any signals that we need to be in a hurry to lower rates.The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully.We project another 25 bps cut in the Committees December meeting before the pace of cuts moderates next year absent a rapid deterioration of labor market conditions.The median economic projection for the federal funds rate among September FOMC meeting participants envisioned one additional cut in 2024 from the current range and four more in 2025.The Committee maintained its belief that inflation would continue to normalize toward the Feds 2.0 percent target.The median projection foresaw the unemployment rate rising to 4.4 percent in 2024Q4 and staying there in 2025Q4.The actual unemployment rate entered the fourth quarter at 4.1 percent in October,likely allowing the Fed to move gradually toward a more neutral monetary policy.2 Congressional Budget Offices report,The Demographic Outlook:2024 to 2054,Jan 18,2024:https:/www.cbo.gov/publication/59697.12 Core PCE inflation,a key metric for forecasting future inflation,stood at 2.7 percent year over year in September.This metric has been slowing consistently since the September 2022 reading of 5.6 percent,but progress has slowed in 2024.The 3-month average(annualized)rate spiked to 4.4 percent in March and declined to 1.9 percent as of July,but it has since rebounded to 2.3 percent in September.Another hot Core CPI print in October likely means another incoming above-trend PCE Core inflation print.The decline in inflation in the middle of this year cleared the way for the Fed to begin cutting rates,but the recent reacceleration adds credence to a slower path down.Core non-housing services,also known as the supercore(roughly half of private consumption),was one of the final sectors to experience disinflation.As shown on Chart 16,it was a significant driver of the recent spike,the subsequent decline,and the recent firming-up.Its year-over-year level remains stubbornly high as well.The Feds statutory dual mandate requires a balanced approach to promoting maximum employment alongside price stability.The labor market is still near full employment,but it is showing definite signs of further cooling.The topline payroll job gains reading of 12,000 in October came in below expectations,adding to fears that the labor market slowdown has accelerated.While the monthly reading was likely impacted by inclement weather and strikes,the average over the three months before October was 148,000,a meaningful step down from the 2024Q1 monthly average of 267,000(or 196,000 after adjusting for the preliminary estimate of the benchmark revision).The continued slowdown in the labor market alongside close-to-target inflation gives the Fed room to move rates lower.The Fed has been reducing the size of its balance sheet since May 2022.At that time,the Fed announced a 95 billion dollar-per-month redemption cap for its securities holdings,and it has been shrinking its balance sheet by around 80 billion dollars per month since then.On May 1 of this year,the Fed announced that it would slow the pace of decline by establishing a new redemption cap of 60 billion 13 dollars per month beginning on June 1,a small step towards a more accommodative policy.We expect the pace of balance sheet reduction to slow to 30 billion dollars per month by the end of 2025.We believe that our forecast is consistent with a Fed that is preparing to enter a more patient phase of its ongoing rate-cutting cycle.As noted,we project the Fed to cut the target range for the fed funds rate by 25 basis points at the December FOMC meeting.By that time,we expect the unemployment rate to stand at 4.2 percent and the annualized pace of core PCE inflation to be around 2.4 percent,up from 2.2 percent in the third quarter.With the fed funds rate around 4.6 percent,the implied short-term real interest rate of nearly 2.2 percent will still appear slightly restrictive,especially given the softening labor market.We project PCE inflation to reaccelerate from a 2.1 percent annualized rate in 2025Q3Q4 to 2.3 percent by the end of 2026 as President-elect Trumps proposed tariffs make their way through to domestic prices.Even so,we expect four further 25-basis point cuts in 2025,bringing the fed funds rate range to 3.253.5 percent by the end of 2025,the terminal range for this cycle.The inflation related to the tariffs will likely be temporary as markets adjust to the new normal.In addition,the Fed will probably be attentive to the potential adverse effects on output arising from a possible trade war.The Fed referenced economic uncertaintypartially stemming from tariffs on Chinese goodsas supporting evidence for rate cuts in 2019.Although the Fed was not as concerned with inflation then as it is today,we believe that the potential for a retaliatory trade war will encourage the Fed not to raise rates in 2026 in the face of tariff-induced price pressure.Chart 17 shows our projections for selected key interest rates.The 3-month Treasury bill rate steadily falls from 4.5 percent in 2024Q4 to 3.4 percent in 2025Q4 and 3.3 percent in 2026Q1,before holding around that level throughout the rest of the forecast.The 10-year Treasury rate rises to 4.2 percent in 2024Q4 and then declines gradually to 3.9 percent in 2025Q4 and 3.8 percent by the end 14 of 2026.Measured by the quarterly 10-year-to-2-year spread,the yield curve un-inverts this quarter after two years of negative values.Mortgage rates decline more quickly than longer-term government bond yields as the excess spread between them shrinks in the face of subsiding risks related to the paths of the policy rate and inflation.The 30-year conventional fixed-rate mortgage rate falls from 6.5 percent in 2024Q3Q4 to 6.0 percent in 2025Q4 and 5.7 percent by 2026Q4.Fiscal Policy As many provisions in the TCJA are set to expire by the end of 2025,several observers are calling this year the Super Bowl of Tax.Given that the Republicans won undivided control of the federal government in the November elections,they will be calling most of the plays.With the slim majority in the House,significant spending cuts would be very difficult to push through;hence,we expect the 119th Congress to largely focus on reducing taxes.We expect easy agreement on extending several individual components of the TCJA that are currently set to expire.A permanent doubling of the maximum child tax credit(CTC),for instance,is likely to garner bipartisan support.Similarly,we believe that the reinstatement of the immediate write-off on research expenditures and an extension of the 100-percent bonus depreciation will face minimal opposition.On the other hand,the tax incentives on clean energy and EVs introduced by the Inflation Reduction Act(IRA)of 2022 will probably get unplugged sooner than the current end year of 2032.We were already expecting most personal provisions in the TCJA to survive regardless of the election outcome,so the TCJAs personal income tax cuts are virtually guaranteed to stick around.The fiscal cost of extending these cuts is formidable,however.The Joint Committee on Taxation estimated that an extension of the TCJAs personal income tax rates,combined with CTC provisions,would add a cumulative 3.3 trillion dollars to the primary deficit from 2025 to 2034 on top of an estimated baseline in which they expire of 7.4 trillion dollars.3 3 This estimate is available in the Congressional Budget Offices report,Budgetary Outcomes Under Alternative Assumptions About Spending and Revenues,May 8,2024,https:/www.cbo.gov/publication/60114.15 President-elect Trump has also floated several other tax-cutting proposals which could lead to significant further revenue declines if enacted.The SALT deduction cap,currently set at 10,000 dollars,is anticipated to be under scrutiny because it is disfavored by some Republican representatives in deep blue states in addition to most Democrats.President-elect Trump vowed to eliminate the SALT cap less than two months before the election,but the extent of the adjustment could hinge on the size of the Republicans ultimate majority in the House.According to multiple estimates,the full expiration of the SALT cap would reduce revenue by more than 1.1 trillion dollars over a 10-year budget window.4 The size of the SALT cap could become a key battleground for fiscal hawks if the majority ends up slim.We have currently factored in a relaxation of the cap to 15,000 dollars for single taxpayers and 30,000 dollars for couples.Under this assumption,it comes with a yearly price tag of 50 billion dollars.5 In addition,we anticipate that Congress will follow through on President-elect Trumps promise to cut the corporate tax rate to 15 percent for domestic manufacturers,which will lead to an additional annual revenue loss of 20 billion dollars.6 We expect contentious discussions on ending taxation of Social Security benefits and exempting overtime and tip income from tax.Despite being favored by both presidential candidates,tax exemptions for tip income would be challenging to enact because compensation structures would likely be adjusted to take advantage of this policy.The possibility of ending taxation of Social Security benefits,tips,and overtime income also appears uncertain,because the revenue cost could be 3.6 trillion dollars or more over a 10-year budget window.7 If,as expected,the Republicans hold a thin majority in the House,any pushback from GOP fiscal hardliners could pose a serious challenge to the passage of these proposals.We assume a scaled-down version of these policies will take full effect by 2026,with a revenue loss of about 120 billion dollars per year.4 The Penn Wharton Budget Model estimated a 1.1 trillion-dollar revenue decline if the SALT cap were eliminated starting in 2024:https:/budgetmodel.wharton.upenn.edu/issues/2024/2/8/lifting-the-salt-cap-budget-effect.The Committee for a Responsible Federal Budget(CRFB)estimated a 1.2 trillion-dollar revenue loss from 20262035 if cap were eliminated in 2025:https:/www.crfb.org/blogs/salt-cap-expiration-could-be-costly-mistake.5 We calculated this estimate using the CRFBs build your own tax extensions tool:https:/www.crfb.org/build-your-own-tax-extensions.6 The central-cost estimate for corporate tax rate cut for domestic manufacturers is 200 billion-dollar revenue loss from 20262035:https:/www.crfb.org/papers/fiscal-impact-harris-and-trump-campaign-plans.7 The central-cost estimate for ending taxation of Social Security benefits,tips,and overtime income totals 3.6 trillion dollars from 20262035 by CRFB:https:/www.crfb.org/papers/fiscal-impact-harris-and-trump-campaign-plans.16 On the other hand,import tariffs could offer some relief for federal revenues.Tariff revenue accruals surged by 50 billion dollars from 2017Q4 to 2018Q4 at the start of the trade war with China,marking a 37 percent year-over-year increasethe largest jump in 35 years.Throughout the campaign,President-elect Trump frequently proposed imposing tariffs of 60 percent on all goods imported from China and 10 or 20 percent tariffs on goods imported from the rest of the world.If implemented,these tariffs could bring substantially larger revenue than in 201819,when tariffs were levied on about two-thirds of Chinese imports at an average effective rate of about 19 percent.8 However,given the scale of the proposed new tariffs,the subsequent repercussions could pose a drag on near-term growth,reducing the potential tax revenues.For this forecast,we have penciled in higher tariffs duties on Chinas imports coming on over the course of 2026,which will ultimately rise to a level about three times higher than in 202425.While some tariff threats may be used as bargaining tools against some other countries,we do not anticipate any meaningful non-China tariffs to take effect for any significant amount of time through 2026.As a result,we expect to see the annualized tariff-driven revenue increase to ramp up to 85 billion dollars by the end of 2026.The Fiscal Responsibility Act of 2023 suspended the U.S.debt ceiling through January 1,2025,after which the U.S.Treasury will start using extraordinary measures to keep the government open temporarily.With the fiscal 2025 budget unlikely to be finalized during the lame-duck session,we are reminded again that the nation continues to struggle to come up with a clear plan to address both its short-term and long-term fiscal challenges.For a change,we expect this round of debt ceiling theater to go down largely unnoticed given single-party control of the Congress and Presidency.Table 1 shows the data and our projections for the federal budget on a National Income and Product Accounts(NIPA)basis for fiscal years 2023 to 2026,broken down by receipts and major expenditure categories.The pace of revenue growth is set to pick up to 4.5 percent in fiscal 2025.We assume that the projected tax cuts will be working their way through the economy in fiscal 2026,when 8 The Budget Lab at Yale estimated that a 10 percent universal tariff on goods imports with a 60 percent tariff on Chinese imports would raise at least 2 trillion dollars from 2025 through 2034:https:/budgetlab.yale.edu/research/fiscal-macroeconomic-and-price-estimates-tariffs-under-both-non-retaliation-and-retaliation.The Tax Foundation estimated that the trade war with China resulted in a nearly 80 billion dollar tax increase:https:/taxfoundation.org/research/all/federal/trump-tariffs-biden-tariff.The Peterson Institute for International Economics estimates for average China import tariffs can be found here:https:/ higher import tariffs will also be coming online.However,we judge that the revenue increase from tariffs is unlikely to fully offset the cost of the tax reductions we project.Therefore,revenue growth is expected to slow to a 2.7 percent pace in fiscal 2026.We expect federal expenditures growth to outpace receipts growth over the next two years,averaging a 5.2 percent annual pace throughout our forecast window.We estimate that federal consumption growth accelerated to 6.3 percent in fiscal 2024 and will moderate to 4.5 percent in fiscal 2026 but will remain supported by robust defense spending.Transfer payments account for more than 60 percent of the overall expenditure growth,as Social Security and the federal share of Medicaid spending settle into a steady post-pandemic trajectory,while expanded Affordable Care Act(ACA)credits from the IRA expire as scheduled by the end of 2025.Federal subsidies are on track to retreat to near their pre-pandemic levels before resuming growth in fiscal 2026.Interest payments on the federal debt rose by nearly one-third in fiscal 2023 due to sharply higher interest rates.As the Fed continues its rate-cutting cycle,the growth rate of interest payments decelerates from a 21.3 percent pace in fiscal 2024 to a 5.2 percent pace by fiscal 2026.As revenue growth lags expenditure growth,the federal deficit continues to expand,from 6.1 percent of GDP in fiscal 2024 to 6.8 percent of GDP by fiscal 2026.Federal debt held by private investors increases from 79.9 percent of GDP in fiscal 2024 to 87.4 percent of GDP in fiscal 2026.Even as the Fed tapers the pace of its rundown of Treasury security holdings,a large amount of Treasury debt remains on the Feds balance sheet rather than in the hands of the public.18 The Housing Market Affordability in the housing market improved marginally in the third quarter of the year,as the 30-year conventional fixed mortgage rate declined from 7.0 percent in early June to 6.1 percent in late September.However,mortgage rates reversed course early in October,climbing back to 6.8 percent as of mid-November.With listing prices mostly holding up,this falls improvement in housing affordability may prove fleeting,limiting the prospects for recovery in single-family home sales.Inventory of single-family housing available for sale has continued to accumulate as buyers have stayed on the sidelines hoping for lower rates and prices.Our preferred measure of home prices,the seasonally adjusted S&P CoreLogic Case-Shiller National Home Price Index,has decelerated on a year-over-year basis,from above 6.0 percent in JanuaryApril to 4.2 percent in August.Although we expect mortgage rates to resume their decline over the next two years,there is substantial uncertainty around their path stemming from large projected deficits,likely increases in tariffs,the resulting pressure on inflation,and potential changes to the mortgage finance system such as the possible reprivatization of Fannie Mae and Freddie Mac.We project housing affordability to improve gradually over the next two years.The extent of the improvement is projected to be underwhelming,however,due to elevated uncertainty and the lock-in effect of the previous surge in mortgage rates preventing many potential sellers from listing their homes for sale.Measures of housing-related sentiment have been mixed recently.Homebuilders sentiment has improved,likely due to expectations that lower financing costs will return in earnest going forward.In the NAHB housing market index,the component for single family sales in the next six months showed consecutive above-50 readings in September and October,with more builders expecting sales conditions to be good than poor.Still,most builders were pessimistic about the present situation and traffic of prospective buyers.On the homebuyers side,the University of Michigan Survey of Consumers sentiment index of home buying conditions inched lower in November after ticking up slightly in October.It remains near a historic low.19 Existing single-family home sales fell below the 3.5-million-unit pace in August and September,possibly related to expectations of further declines in mortgage rates heading into the Federal Reserves easing cycle.The seasonally adjusted months supply of existing single-family homes climbed to 4.1 in September,compared with an average of 3.6 in the second quarter and 3.2 a year ago.Rising months supply is usually a signal of slower home price appreciation ahead.Chart 18 plots our preferred measure of affordability,the ratio between a mortgage payment on a newly bought home and the average wage income per worker.9 We estimate that this ratio decreased to 43.0 percent in the third quarter of 2024 as mortgage rates fell,the lowest since the first quarter of 2023.Looking ahead,we project the affordability ratio to stay flat in 2024Q4 and then to ease gradually to 40.8 percent in the second half of 2025 and 39.9 percent by the end of 2026.Although this improvement in affordability will bring some relief to prospective homebuyers,housing will remain much less affordable than during the years prior to the pandemic,when our affordability metric generally moved within the range of 2030 percent.Annualized sales of new single-family homes rebounded to 724,000 in the third quarter,up from 693,000 in the second quarter.With somewhat cheaper mortgages ahead and still-rising existing home prices,we expect a slow pick-up in new home sales to continue in the near term.Single-family housing starts saw a large dip in July,potentially due in part to Hurricane Beryl,but recovered to an annualized pace of 1,000,000 units in August.Months supply of new single-family homes for sale moderated to 7.6 in September from 8.7 in February,but still suggests an excess in inventory compared with a balanced market featuring under 6 months worth of supply.Single-family residential construction remains restrained as the market works through the supply overhang that has developed since 2022,but we are 9 The mortgage payment is computed assuming no down payment using the contemporaneous average conventional mortgage rate.As a proxy for mortgage size,we index the median home price in 2012 to cumulative house price growth since that time as measured by the Case-Shiller Home Prices Index.Average wage is computed by dividing total wage income by employment level in the BLS household survey.20 cautiously optimistic about this market in the long term given that it should benefit from the expected decline in mortgage rates.Multi-family housing starts recovered slightly to 363,000 in the third quarter compared with an average pace of 340,700 units in the first half of the year,but the multi-family market remained loose as previously started projects were completed,boosting inventory.However,easing financial conditions in the near term and extra demand from recent immigrants as they ramp up their labor force participation should help sustain demand for multi-family units in 202526.Chart 19 shows the historical and forecast paths of year-over-year and quarterly annualized rates of home price growth,measured by the seasonally adjusted Case-Shiller Home Price Index.The latest release in August showed a continued deceleration of home price appreciation to 4.2 percent year over year.We expect the year-over-year pace of price appreciation to dip below 4.0 percent through 2025Q2 before stabilizing at a 4.0 percent level over the remainder of our forecast period.Energy Markets The price of West Texas Intermediate(WTI)crude oil hovered around 7075 dollars per barrel during the first couple weeks of October,as tensions in the Middle East remained high.On October 26,Israel conducted targeted strikes on military sites in Iran.Its decision to spare oil production facilities alleviated emerging energy market concerns about supply.The price of WTI fell below 70 dollars per barrel shortly after the attack but rebounded to 72 dollars in early November as energy markets shifted focus to the U.S.presidential election and another FOMC meeting,in addition to the ongoing tensions in the Middle East.21 Another major risk to our energy outlook is Chinas demand for oil.Chinese demand has slowed significantly in recent quarters,even contracting in mid-2024.In its October Short-Term Energy Outlook,the Energy Information Administration(EIA)forecasts that Chinas liquid fuel consumption will increase by only 0.1 million barrels per day(bpd)in 2024 and 0.3 million bpd in 2025.These modest increases represent just 10 and 20 percent of the projected global growth in consumptiona significant slowdown from the pre-pandemic pace in 2018 and 2019,when China accounted for 40 and 50 percent of the worlds increase in consumption.The Organization of the Petroleum Exporting Countries and its allies(OPEC )once again decided to delay their planned oil production increase to early next year,citing concerns about weak oil demand and increasing supply from outside of the group.The EIA,however,expects OPEC to ramp up production in mid-2025,though output will likely remain below target for the year.Without a substantial increase in supply from OPEC countries in the near term though,global inventories will likely continue to draw down until production growth ramps up to meet global demand.The EIA estimates that increased production in the United States,Guyana,Brazil,and Canada,along with output from OPEC ,will be sufficient to exceed global demand in the second half of 2025,allowing global inventories to rebuild.Chart 20 shows our forecast for WTI and Brent crude prices in maize and blue as well as the Producer Price Index(PPI)for natural gas fuels in green.We expect the price of WTI to tick down from 78 dollars in mid-2024 to a little under 72 dollars by the end of 2026,as tensions in the Middle East keep oil prices from falling much further.We forecast the BrentWTI spread to remain relatively stable at 4.0 dollars per barrel through 2026,as the inclusion of U.S.WTI-Midland crude in the Brent index appears to have reduced the spreads volatility.Natural gas prices,as measured by the PPI for natural gas fuels,rose by 1.4 percent in the third quarter of 2024.However,prices remain 15.5 percent below year-ago levels due to record U.S.natural 22 gas production in 2023 and a mild winter that reduced demand for space heating.High production and low prices led to inventories being restocked to nearly 40 percent above the five-year average(20192023)by March 2024.As production declined moderately over the year in response to lower prices,inventories were drawn down to just 5 percent above the five-year average by September 2024.Over the next few years,we anticipate heating seasons in our forecast to be slightly warmer than the previous 10-year average,with production remaining flat but at record-high levels.At the same time,we expect domestic consumption to stay relatively stable,placing minimal upward pressure on prices.International demand paints a different picture.We anticipate that liquefied natural gas(LNG)exports will increase due to strong international demand,driving up domestic prices.As a result,we forecast natural gas prices to increase by 11.8 percent from 2023 to 2026,outpacing the cumulative projected CPI inflation of 8.0 percent over the same period.23 The Forecast for 20252026 The recent comprehensive NIPA revision has resolved the apparent disconnect between real GDP and real Gross Domestic Income growth rates over recent years.With a significant upward revision to past personal income,and the still-healthy labor market producing meaningful real wage gains,the average consumers budget appears consistent with continued healthy spending growth.Long-term interest rates have risen meaningfully in recent months,however,limiting potential consumption growth.Recent immigrants will likely continue ramping up their labor force participation,assuming that the anticipated deportation policy is limited in scale.As a result,working-age population and,hence,potential GDP growth will likely remain above trend.By 2026,we project the key policies of President-elect Trumps agenda to take shape.We expect about 200 billion dollars in tax cuts in 2026,split between persons and corporations,to be partly counteracted by about 85 billion dollars in new tariff revenue.We project that the stimulative effects of the tax cuts will dominate the drag from the tariffs over the next two years,as domestic importers and foreign producers share some of the tariff incidence with U.S.consumers.As a result,we project GDP growth to accelerate in 2026,but at the cost of a wider federal fiscal deficit.At 6.8 percent of GDP for fiscal 2026,the level of the federal deficit would be unprecedented outside of wars,the recent pandemic,and severe recessions.We project that real GDP growth will slow from its 2.8 percent annualized pace in 2024Q3 to 2.3 percent in 2024Q4 and 1.8 percent in 2025H1.Consumptions contribution lags in 2025Q1,as the campaign-and election-related boost in 2024H2 wanes.Looser monetary policy filters through the economy over the next few quarters,stabilizing the labor market by 2025H2.Strong labor force growth nudges real GDP growth up.The pace of growth ramps up above 2.4 percent by mid-2026,as personal income tax cuts kick in,overpowering the negative growth impacts of deportations and the new China tariffs that take effect early in 2026.Calendar year GDP growth registers 2.8 percent in 2024,then moderates to 2.1 percent in 2025,and ticks up to 2.2 percent in 2026.After the near-term slowdown,consumption expenditures contribution to growth hovers in the 1.41.7 percentage point range from mid-2025 through 2026,as real earnings growth decelerates in a slightly looser labor market.The forecast growth contribution of nonresidential fixed investment is largely driven by spending on equipment and intellectual property,as nonresidential construction flatlines following a spike driven by the early stages of construction at new microchip factories.Residential investment does not start adding to growth until 2025H2,as mortgage rates remain high and housing affordability improves only marginally.Government purchases contribution to growth drops from its unusually high 2024Q3 level,averaging about 0.3 percentage points over 2024Q426Q4.Net exports are a drag on growth in 2025,as businesses attempt to front-run forthcoming tariffs.In 2026,tariffs and retaliation affect both imports and exports,with no change to their net growth contribution.24 The labor market is staying afloat for now.The headline unemployment rate hovered at 4.1 percent over the past two months after edging down from the recent high of 4.3 percent in July.The decline de-triggered a well-known recession indicatorthe so-called Sahm rule.The labor force participation rate has held relatively steady between 62.5 and 62.8 percent since February 2023,with the October reading at 62.6 percent.We expect it to slip marginally from this level during our forecast window,as the baby boom generation continues to retire while the share of recent immigrants working and seeking employment edges up.As interest rates remain relatively high,the cumulative effects of previous monetary tightening continue to work their way through the labor market.The unemployment rate rises modestly to 4.4 percent in 2025Q2 before sliding back to 4.2 percent in 2026Q4 as monetary policy becomes more accommodative.Hurricanes and strike activity had a significant negative impact on Octobers payroll employment gains of only 12,000.Private job gains were reduced by 38,000 due to Boeings machinists strike.However,the pace of government hiring remains steady.Nevertheless,the trend pace of job gains is clearly decelerating.Despite an upbeat report in September,the three-month average pace of gains registered 148,000 prior to Octobers report,weaker than the 166,000 annual average pace in 2019.Private sector job gains continue to decelerate through 2025Q3.Several years of a tight labor market are likely to spur faster productivity growth over the next two years.We expect job growth to pick up again in 2026.The government sector adds jobs throughout the forecast,albeit at a much slower pace compared to 2023,as local government employment tops its pre-pandemic count.All-items CPI inflation decelerated to 2.6 percent year over year in 2024Q3,as energy prices continued to decline.Core CPI inflation dipped to 3.2 percent with slower price increases in shelter and other services but ticked up to 3.3 percent in October.Core CPI inflation slightly outpaces the headline rate throughout 2024 and 2025,as gasoline price increases remain largely subdued and food inflation slows.Year-over-year core CPI inflation slows to 3.1 percent in 2024Q4,eases further to 2.5 percent in 2025Q4,and then rebounds to 2.7 percent in 2026Q4.We expect inflation in the PCE price index,the Feds preferred measure,to pick up briefly to 2.4 percent year over year in 2024Q4 as energy price decreases slow.PCE inflation then resumes its downward trend toward 2.1 percent in 2025Q4.We expect year-over-year PCE inflation to accelerate to 2.3 percent by 2026Q4 as the projected tariffs work their way through domestic prices.25 With plenty of supply for sale,new single-family home construction remains soft,hovering around an annualized pace of 1,000,000 units in 2024 and early 2025,before picking up gradually to 1,081,000 units by 2026Q4.Multi-family starts edged up to an annualized pace of 363,000 units in 2024Q3 following lower prints earlier in the year.We expect multi-family starts to remain soft in 2025H1 due to elevated inventories and completions,but to climb to a pace of 449,000 by 2026Q4 with cheaper financing options.The annualized pace of total housing starts stands at 1,350,000 in 2024Q4 and recovers to the pre-pandemic level by 2025Q4,reaching 1,529,000 in 2026Q4.We remain optimistic about new construction,despite a delayed rebound due to near-term uncertainty related to mortgage rates and home prices.Housing starts should benefit from lower mortgage rates ahead and the recent influx in new immigrants,assuming no blanket mass deportations.Growth in real investment in equipment accelerated to 5.4 percent year over year in 2024Q3,reflecting a continued ramp-up in information processing equipment investment and a spike in aircraft deliveries.We expect its growth to hold roughly steady through 2025Q1,then decelerate to about 2.4 percent year over year by 2026Q4.Intellectual property investment expanded by 3.5 percent year over year in 2024Q3.We project that robust growth in intellectual property will persist throughout our forecast window,with the year-over-year pace accelerating to 6.6 percent by 2026Q4.Year-over-year growth in nonresidential structure investment slowed from 10.6 percent in 2023Q3 to 2.1 percent in 2024Q3,as the microchip factory construction boom appears to have crested.Even with a potential uptick in mining construction,overall investment in nonresidential structures will likely flatline over the next two years.The annualized pace of light vehicle sales posted a solid 16.0 million units in October,the fastest since April.We also expect interest rates on auto loans to decline amid the Feds cutting cycle and the CPI for new light vehicles to extend its recent declines.Auto sales are expected to continue rising gradually as vehicle purchases become more affordable relative to incomes.The light vehicle sales pace softens from Octobers rate to 15.9 million units in 2024Q4 and climbs slowly to 16.3 million by 2026Q4.The sales gains are mainly in the light truck category,which includes pickups,SUVs,and crossovers.We generally expect robust auto production and sales in the medium term,but uncertainty related to EVs is a substantial risk.We expect the current EV tax credit to be slashed,but with little hit to total light vehicle sales as consumers substitute to vehicles with other drivetrains.26 To forecast demand for U.S.exports,we construct a trade-weighted index of real GDP for five of our major export markets:Canada,Mexico,Japan,the United Kingdom,and the euro area.We also track Chinas economy,but we show it separately because it tends to grow more quickly.Despite recent policy stimulus,Chinas economic growth is projected to slow from 5.5 percent last year to 4.6 percent in 2024,due to geopolitical pressures,challenges in its real estate market,and low consumer confidence.In 202526,we expect further deceleration,as new tariffs on Chinas exports kick in.The five-economy composite calendar-year growth rate is projected to slow to just 0.8 percent in 2024,largely due to weak growth in Japan and Mexico.In 202526,growth accelerates meaningfully in Japan and Canada,pushing the two-year average growth of the five-country aggregate GDP to 1.3 percent.The current account deficit declined from its pandemic-era high point of 4.5 percent to about 3.2 percent of GDP in 2023Q4,as consumption of goods moderated.Strong growth of imports in 2024H2 pushed the current account deficit back up to 4.1 percent of GDP.We project it to dip to 3.8 percent of GDP in 2024Q4.We expect new tariffs on imports from China to take effect starting in 2026,with several rounds of retaliation to follow.During 2025,we expect elevated levels of both imports and exports in anticipation of new tariffs,with the current account deficit holding largely flat relative to nominal GDP.The current account deficit is projected to widen despite new tariffs in 2026,thanks to a large domestic tax cut that is expected to fuel extra demand for goods.In nominal terms,the current account deficit registers an annualized pace of about 1.1 trillion dollars in 2024Q4,then widens by about 50 billion dollars more through 2025Q4 and a further 130 billion dollars through 2026Q4.Risks to the Forecast Economic uncertainty is highly elevated.The outcome of Novembers federal elections,delivering a Republican trifecta,has brought to the forefront many previously low-probability scenarios to the forefront.We will broadly group the risks we see by time horizon:those affecting near-term outcomes and those likely to influence our medium-run outlook.There are also large risks to the longer-run economic outlook,but we will not discuss them in detail here.The most prominent near-term risks comprise noisy data leading to deviations of monetary policy from our assumed path,sudden changes in key economic trends,global commodity price volatility,and 27 the paths of the wars ongoing abroad.Hurricane Helene likely led to a drop in job gains in October,but the magnitude of the drop is currently uncertain.With the initial establishment survey response rate lower than 50 percent for the month,sizeable subsequent revisions are likely.Given the elevated core month-on-month inflation prints over the past three months,a strong November jobs report that brings large revisions to prior data would likely place further fed funds rate cuts on hold at least temporarily.With year-over-year core CPI inflation having held stubbornly flat since June,any further acceleration of inflation trends would likely derail the Feds rate-cutting plans absent a further cooldown in the labor market,sending policy rate expectations and longer-term Treasury yields higher.Consumption expenditure growth,the largest driver of economic growth,has remained resilient in the face of low consumer confidence readings and high interest rates.A sudden deceleration in the face of rising delinquencies and financial strain,however,cannot be ruled out.On the other hand,if wage growth persists at higher levels for longer than we anticipate,consumption growth could lift real GDP growth higher than we project.With the incoming Trump Administrations attitudes towards the wars in Ukraine and the Middle East likely to stand in stark contrast to those of the Biden Administration,the conflicts have a high risk of significant near-term developments with potential implications at least for global commodity prices and near-term U.S.defense spending.A ceasefire and the start of political negotiations in either conflict would likely lower escalation premiums embedded in market prices for global commodities produced around the affected region such as oil,natural gas,grains,metals,etc.,but also reopen the currently curtailed shipping and travel routes.Such developments would help lower global inflation further and likely lift real incomes.Further escalation would likely lead to additional disruption to global commodity markets,spurring further increases in U.S.defense expenditures.The net effects on the U.S.economy would likely be ambiguous,however.The list of medium-term risks is a lot longer.We can group them broadly into several,non-mutually exclusive,categories:those affecting the productive capacity of the economy,fiscal trajectory risks,factors affecting the neutral monetary policy rate,and foreign policy issues.28 Two first-order drivers of the economys productive capacity are the working-age population and total factor productivity(TFP).Population growth could change quite dramatically over the coming years.With immigration accounting for a substantial portion of U.S.population growth,border policies and their enforcement could have a disproportionate impact on GDP growth over the medium term.The range of plausible scenarios for immigration is wide.On one end is the prospect of large-scale deportations of unauthorized immigrants already in the country,coupled with significant curbs to inflows of new immigrants.On the other end is the prospect of policy actions that are largely for show but that do not have a large practical effect;in that scenario,we could even see an acceleration of new immigration due to economic and political disruptions in other parts of the world.The range of possible economic outcomes is equally wide,with several key sectors of the U.S.economy(such as construction and agriculture)currently relying on the labor of unauthorized immigrants most at risk.TFP is hard to measure and even harder to shift via policy.However,another key goal of the incoming Trump Administration,rebuilding the U.S.industrial base through a combination of tax incentives,tariffs,and federal spending,has the potential to alter medium-run TFP.Unfortunately,the TFP effects could go either way,depending on the policys implementation.A reinvigorated industrial base could result in faster productivity growth going forward,while a failed policy would still see massive shifts of capital and labor away from a more efficient allocation,lowering TFP.We project that the federal deficit is set to grow from an already high level over the first two years of the second Trump Administration.The set of fiscal policies we project is largely derived from campaign promises.The narrow House majority and other political calculations may limit their scope and delay their timing.In such an event,deficits would likely be slightly narrower,with a bit slower economic growth over the next two years.On the other hand,with no re-election concerns hanging over him,President Trump may choose to pursue a larger set of fiscal issues,such as attempting once more to repeal the ACA,reforming the immigration system,privatizing government-sponsored enterprises such as Fannie Mae and Freddie Mac,or significantly ramping up defense spending relative to GDP.While some of these policies may raise some revenue,the overall outcome is likely to produce considerably wider deficits,raising the probability of an adverse bond market reaction.29 Many of the potential scenarios outlined above would also have implications for equilibrium medium-run real interest rates,and,hence,for the neutral monetary policy rate.As the neutral rate shifts due to policy action,the real-time effective monetary policy stance may evolve even without explicit action from the Fed.In the event that the neutral policy rate shifts substantially,it will take time for the Fed to observe enough data to correct course,raising the possibility of persistent deviations from its dual mandate over the medium term.Finally,foreign policy is likely to stay in the headlines throughout our forecast window.We have projected a significant jump in import tariffs on Chinese goods during 2026,but no broad tariffs on imports from the rest of the world.We think the latter will likely be used as a threat in negotiations with our other key trading partners but will not actually be implemented.However,these assumptions are tentative,and a broad-based tariff on imports is certainly plausible.Such broad tariffs would probably trigger a significant retaliatory response,leading to a reshuffling of trade flows and realignment of exchange rates.The economic ramifications would likely be orders of magnitude larger than those of tariffs targeting only China.Beyond tariffs,a further escalation of current wars and the breakout of new conflicts is certainly possible given the current state and the trajectory of the geopolitical affairs.Overall,we consider the most prominent risks to the 202526 U.S.economic outlook to be fairly balanced,but the range of potential outcomes to be quite wide,primarily because the Federal Reserve may not be able to react quickly enough to shocks that shift the medium-term neutral policy rate.A list of predominantly downside tail risks,which we do not describe here,also appears larger than usual.Appendix 1:Brief Review of the Previous Years Forecast In line with our longstanding tradition,Table 3 shows RSQEs forecast record for real GDP/GNP growth.10 The final row illustrates the evolution of our real GDP growth forecast for calendar year 2024.Our November 2023 forecast had anticipated a pullback in consumer spending in the first half of 2024,leading us to underestimate the strength of the economy this year.10 Our real GNP level forecast record spanning 1953 to 1990 is available on our webpage.30 Table 3 Review of Past Real GNP/GDP Forecasts(Figures represent%change over the preceding year in real GNP from 1971 through 1991 and in real GDP beginning with 1992.)RSQE Forecast Preceding November February/March August/September Observed*1971 3.3 3.8 2.9 3.3 1972 5.7 5.4 6.3 5.3 1973 7.1 7.2 6.2 5.9 1974 2.3 0.5 1.1 0.4 1975 1.1 2.3 3.5 0.4 1976 5.9 6.7 6.2 5.5 1977 4.3 4.9 5.2 4.7 1978 3.6 4.1 3.5 5.5 1979 2.0 2.8 1.5 3.5 1980 0.3 0.3 1.4 0.3 1981 1.4 1.6 1.8 2.4 1982 1.1 0.1 1.3 1.7 1983 3.4 3.2 3.2 4.5 1984 6.5 6.2 7.2 7.1 1985 3.8 4.6 2.5 3.8 1986 2.9 3.3 2.4 3.2 1987 3.3 3.2 2.5 3.4 1988 2.9 2.3 3.8 4.2 1989 2.9 2.5 2.6 3.7 1990 2.7 2.5 1.1 2.0 1991 1.5 0.4 0.1 0.2 1992 2.2 1.6 1.7 3.5 1993 2.7 3.2 2.3 2.8 1994 2.4 3.9 3.5 4.0 1995 2.4 3.3 3.0 2.7 1996 2.6 1.7 2.2 3.8 1997 2.4 3.2 3.3 4.4 1998 2.6 2.9 3.1 4.5 1999 1.5 3.5 3.7 4.8 2000 3.1 4.1 5.1 4.1 2001 3.6 1.6 1.6 1.0 2002 0.4 2.5 2.2 1.7 2003 2.5 2.4 2.4 2.8 2004 5.1 4.7 4.3 3.8 2005 3.5 3.5 3.7 3.5 2006 3.4 3.6 3.3 2.8 2007 2.4 2.4 1.8 2.0 2008 2.4 1.0 1.4 0.1 2009 1.0 3.7 2.5 2.6 2010 2.3 2.9 2.6 2.7 2011 2.1 3.1 1.6 1.6 2012 2.4 2.2 2.2 2.3 2013 2.0 1.9 1.6 2.1 2014 2.7 2.6 2.1 2.5 2015 3.1 2.9 2.6 2.9 2016 2.6 2.3 1.5 1.8 2017 2.3 2.1 2.2 2.5 2018 2.5 2.6 2.9 3.0 2019 2.7 2.4 2.3 2.6 2020 1.7 2.1 4.9 2.2 2021 4.2 4.8 5.8 6.1 2022 4.0 4.1 1.5 2.5 2023 0.5 1.2 2.1 2.9 2024 1.7 2.5 2.6 2.8*Observed refers to the chained real growth rates as currently published.Forecasts published in June 1976 and April 1980.*Estimated by RSQE as of November 2024.31 Despite uneven progress in controlling inflation in the first quarter and rising signs of weaknesses in the labor market,we judged that broader economic momentum had remained solid,prompting us to raise our forecast in February and again slightly in August.Currently,we have cautiously nudged up our growth projection relative to our August estimate,as the labor market has not deteriorated further while the Fed has recalibrated its policy.The 2.8 percent real GDP growth we now expect for 2024 translates into an absolute forecast error of 1.1 percentage points compared 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The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile Prepared for CTIA 22 January 2025 Project Team Dr.Hector Lopez Julien Martin The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile Contents NERA Contents Executive Summary.i 1.The importance of the wireless industry to the American economy.1 2.The unique role of licensed mid-band spectrum.5 3.The economic impact of allocating mid-band spectrum to mobile.8 3.1.Continued improvements to mobile service to millions of Americans.9 3.2.Improving broadband with FWA.12 3.3.Supporting industries that rely on mobile connectivity.17 3.4.Supporting industries that serve the wireless industry.24 4.Allocating additional spectrum to Mobile vs Wi-Fi.28 5.Conclusion.32 The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile Executive Summary NERA i Executive Summary The wireless industry has become a cornerstone of the American economy,influencing nearly every aspect of daily life and business operations.As technology continues to advance,the demand for wireless communication continues to surge,with Americans consuming an astounding 100 billion gigabytes of data in the past year alone.This growing reliance on wireless networks underscores their role as critical infrastructure,essential for facilitating economic transactions,maintaining personal connections,and maintaining national security.The industrys significant contributions to economic output and job creation further highlight its importance.Wireless enables vast swathes of economic activity,both directly through investments in communication infrastructure and indirectly by enabling new services and improving worker productivity.Over the past decade,wireless has contributed over$5 trillion of GDP and 3 million jobs to the U.S.economy.Approximately 1.1 GHz of licensed spectrum below 6 GHz has supported this economic growth and employment.However,the wireless industry is rapidly approaching a spectrum deficit that will result in network congestion,thereby hindering the continued growth fueled by the wireless industry.Projections indicate that wireless operators will need at least 400 MHz of additional spectrum by 2027 to meet the needs of the U.S.economy,a deficit that will continue to grow to over 1400 MHz by 2032.Additional wireless spectrum is fundamental to so many aspects of the U.S.economy.In particular,this study focuses on the economic activity and consumer benefits generated by:continued improvements to mobile service to millions of Americans;improved fixed broadband coverage and penetration via fixed wireless access(FWA);support for industries that rely on mobile connectivity,such as video streaming and cutting-edge VR/AR;and support for industries that serve the wireless industry,such as construction and electronic maintenance.All this economic activity and wireless industry investment enabled by additional licensed spectrum will contribute significantly to the American economy.We estimate that each additional 100 MHz of mid-band spectrum to mobile will generate$264 billion of GDP,about 1.5 million new jobs,and about$388 billion in consumer surplus.The impact of 400 MHz of mid-band spectrum would be$1.1 trillion of GDP,6.18 million new jobs,and about$1.5 trillion in consumer surplus.Beneficial effects would continue to accumulate beyond 400 MHz,and we estimate that by 2028 even 400 MHz of new 5G spectrum will not be enough to keep up with consumer demand.The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile Executive Summary NERA ii Table 1:Summary of the economic impact of allocating each additional 100 MHz of mid-band spectrum to mobile GDP($B)Employment(M)Consumer Surplus($B)Continued improvements to mobile service to millions of Americans 385 Improving broadband with FWA 40 0.30 3 Supporting industries that rely on mobile connectivity 188 0.93 Supporting industries that serve the wireless industry 36 0.32 Total 264 1.55 388 Note:Effect of each 100 MHz up to 400 MHz The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The importance of the wireless industry to the American economy NERA 1 1.The importance of the wireless industry to the American economy The wireless industry is an integral part of the U.S.economy,with wireless communications deeply integrated into how we live and work.Americans consumed 100 billion GBs of data last year,and data traffic continues to grow.1 From enabling economic transactions to connecting families and defending the nation,wireless networks are not just a convenience,but critical infrastructure.By providing fast,efficient communication,the wireless industry enables vast swaths of economic activity.The core wireless industry,which includes mobile and wholesale network operators,contributes significantly to the American economy.Figure 1 shows the consistent investments wireless providers make in the U.S.s communications infrastructure.Since the launch of the first commercial cellular networks,wireless operators have invested over$700 billion in capital expenditures to build and deploy networks throughout the nation.2 In 2023 alone,the wireless industry invested$30 billion;and this decade,the industry has been the second-largest source of direct investment in the United States.3 These significant capital investments in infrastructure have allowed wireless providers to expand network coverage,improve service quality,and introduce advanced technologies such as 5G,all of which have translated into substantial economic output.Over the last decade,the core wireless industry generated$270 billion in gross output and$133 billion in GDP annually.4 Figure 1:Cumulative wireless industry capital expenditure in the United States,2011-2024 Source:CTIA Annual Wireless Industry Surveys 1 Timothy Tardiff,“Wireless Investment and Economic Benefits,”AACG(Apr.2024),available at https:/www.ctia.org/news/wireless-investment-and-economic-benefits 2 Ibid.3 Ibid.4 Compass Lexecon,2022,The Importance of Licensed Spectrum and Wireless Telecommunications to the American Economy,available at:https:/api.ctia.org/wp-content/uploads/2022/12/Compass-Lexecon-Licensed-Spectrum-Report.pdf The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The importance of the wireless industry to the American economy NERA 2 Beyond its direct economic contribution to output and GDP,the wireless industry also generates significant indirect benefits through its infrastructure deployment and wider supply chain,as it purchases goods and services like network equipment and software from other industries.And as the wireless industrys workers spend their incomes,they generate additional induced economic effects,multiplying the industrys impact across the economy.Once indirect and induced effects are taken into account,the core wireless industry is estimated to have driven$650 billion in gross output and$376 billion in GDP a year over the last decade.5 Figure 2 shows that the GDP contribution of the core wireless industry has been steadily growing at a compound annual growth rate of about 5%.By any account,the wireless industry has been a critical driver of the American economy.Figure 2:GDP contribution of the core wireless industry in the United States,2011-2020 Source:Adapted from Compass Lexecon Report Note:The core wireless industry includes network operators and MVNOs and does not include other downstream or upstream industries.The wireless industrys impact across the economy extends further still.As a general-purpose technology,wireless communication networks fuel the broader economy by enabling innovation and economic activity in other,downstream industries that rely and build upon the services they provide.For example,a recent study by Accenture estimates that 5G networks will contribute an additional$159 billion to the American manufacturing industrys GDP over a 5-year period.6 Compass Lexecon,meanwhile,find that in 2020 alone the wireless industry broadly contributed$825 billion in GDP;including the effects of the core mobile industry and the broad mobile ecosystem which includes social networking sites,mobile gaming,smartphone apps,search engines and digital advertising.7 Through network expansion and new services,most notably mobile Fixed Wireless Access(FWA),the wireless industry also expands broadband connectivity in under-served areas,creates new competition 5 Ibid.6 Accenture,available at https:/ 7 Compass Lexecon,2022 The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The importance of the wireless industry to the American economy NERA 3 to wired broadband,and promotes inclusive access to the economy.FWA has been pivotal in closing the digital divide and bringing Americans online.In 2022,90%of new home broadband connections were 5G FWA,and many of these connections were in areas that are underserved by fixed networks such as cable.8 Numerous studies have established the economic benefits associated with increasing broadband penetration.For example,The World Bank estimates that in developed economies,a 10-percentage point increase in broadband penetration boosts GDP growth by 1.2%.9 Other studies have found effects of similar magnitudes for developed economies,with concomitant benefits on wages and employment.By employing workers and enabling up and downstream economic activity,the wireless industry is also a significant driver of employment in the United States.Directly,wireless providers enable a large number of high-quality jobs,employing engineers,technicians,customer service representatives and administrative staff to run their operations.The ongoing expansion of 5G networks is expected to continue to create jobs well into the decade.Indirectly,the wireless industry also supports jobs upstream,as it fuels demand for goods and services in other sectors like manufacturing and software development.Over the last decade,the core wireless industry is estimated to have enabled nearly 2 million jobs per year.10 In the first half of this decade,meanwhile,5G is projected to create or transform up to 16 million jobs.11 Importantly,the wireless industry also plays a crucial role in closing the digital divide.Studies in the U.S.have found that improving the quality of broadband has a disproportionately positive impact on reducing unemployment in rural areas.According to one study by Lobo et al.(2020),unemployment rates are about 0.26 percentage points lower in counties with access to high quality broadband than in counties with lower quality services.12 This highlights the vital role that the wireless industry plays in levelling the playing field and promoting economic opportunity and inclusive access to the economy.In addition to its direct contribution to the economy,the wireless industry also generates substantial consumer welfare by connecting Americans and offering ever-improving services at lower costs.Today,Americans pay$0.006 per MB of data.13 This represents a 93crease from a decade ago.14 At the same time,the services offered to consumers are hugely improved.Average mobile broadband 8 CTIA,2024,CTIA Response to FCC Communications Market Report 2024,available at:https:/api.ctia.org/wp-content/uploads/2024/06/240606-FINAL-CTIA-Comments-for-2024-Communications-Marketplace-Report.pdf 9 https:/documents1.worldbank.org/curated/zh/178701467988875888/pdf/102955-WP-Box394845B-PUBLIC-WDR16-BP-Exploring-the-Relationship-between-Broadband-and-Economic-Growth-Minges.pdf 10 CTIA,2024,Annual Survey Highlights,available at:https:/api.ctia.org/wp-content/uploads/2024/09/2024-Annual-Survey-Highlights.pdf 11 Accenture,2021,The Impact of 5G on the United States Economy,available at:https:/ 12 Lobo,Alam and Whitacre,2020,Broadband speed and unemployment rates:Data and measurement issues,available at:https:/ 13 Cable.co.uk,2024,The cost of 1GB of mobile data in 237 countries,available at:https:/www.cable.co.uk/mobiles/worldwide-data-pricing/14 Nielsen,2011,Average U.S.Smartphone Data Usage Up 89%as Cost per MB Goes Down 46%,available at:https:/ Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The importance of the wireless industry to the American economy NERA 4 speeds in the U.S.are now over 100 Mbps a thirty-fold increase relative to the North American average of 3 Mbps at the start of the decade.15 And these benefits are widespread too:some 95%of U.S.adults say they use the internet and 15cess the internet solely via their smartphone.16 In 2015,the 645 MHz of spectrum licensed for wireless broadband networks was estimated to generate between$5 trillion and$10 trillion in savings for consumers.17 Given the improvements in service quality and declines in prices,savings should be higher today.Again,this underscores the critical role that the wireless industry plays in supporting Americas society and its economy.15 Cisco,2011,Cisco Global Cloud Index:Forecast and Methodology,20102015,available at:https:/ 16 Pew Research,2024,Internet,Broadband Fact Sheet,available at:https:/www.pewresearch.org/internet/fact-sheet/internet-broadband/17 The Brattle Group,2015,Mobile Broadband Spectrum:A Vital Resource for the U.S.Economy,available at:https:/ The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The unique role of licensed mid-band spectrum NERA 5 2.The unique role of licensed mid-band spectrum Radio frequency spectrum has been described as one of the“Nations most important national resources”,owing to its role supporting the wireless industry.18 The large sums invested by wireless operators on acquiring spectrum licenses demonstrates their vital importance to their networks.Figure 3 shows the cumulative revenues raised for the Treasury by wireless operators from spectrum licenses acquired in FCC auctions since 2014.Figure 3:Cumulative revenues raised for the Treasury in licensed spectrum by wireless operators since 199419 Source:FCC Different frequencies within the usable range of wireless spectrum have different characteristics and use cases:Low-band frequencies below 1 GHz are ideal for providing wide-area coverage owing to their long-range propagation,and also penetrating deep indoors,but they are in limited supply so cannot support significant capacity;Lower mid-band spectrum lies between 1.0 and 3.0 GHz.This set of frequencies comprises core mobile frequencies like the PCS and AWS bands,which have been an integral part of 18 https:/www.whitehouse.gov/briefing-room/presidential-actions/2023/11/13/memorandum-on-modernizing-united-states-spectrum-policy-and-establishing-a-national-spectrum-strategy/19 FCC,2022,Fiscal Year 2023 Budget Estimates to Congress,available at:https:/docs.fcc.gov/public/attachments/DOC-381693A1.pdf.Values for 2023 and 2024 are the same as 2022 as there have not been any auctions in those years.$54$95$95$114$114$117$129$210$233$233$233 20142015201620172018201920202021202220232024H-BlockAWS-3600 MHz28 GHz24 GHz3.5 GHzmmWave3.7 GHz2.5 GHz3.45 GHzThe Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The unique role of licensed mid-band spectrum NERA 6 wireless operators networks for a long time.These bands offer superior capacity to low-band frequencies;Mid-band spectrum,which comprises frequencies between 3.0 and 8.5 GHz,holds a unique position in wireless providers spectrum portfolios,offering a combination of high bandwidth for capacity and good propagation;and High-band spectrum above 10 GHz offers exceptionally large capacity,but signals only travel for short distances,making it best suited for use in dense urban areas and venues like stadiums.The C-Band,with frequencies around 3500 MHz,has emerged as the key 5G band worldwide.The outsized share of U.S network traffic now carried over this spectrum evidences its importance.For instance,Verizon,which invested heavily into acquiring C-Band licenses,reports that half of its network traffic is now carried by C-Band spectrum,and it expects this share will grow further.20 Mid-band spectrums critical importance is also reflected in its wide-spread deployment.Ericsson estimates that 85%of the population in North America is covered by mid-band spectrum only 5low the reported coverage of low-band spectrum.21 To maximize the economic benefits that flow from this high capacity and speed,it is essential that sufficient spectrum is available so that wireless network capacity can keep up with the growing demand for data and provide for new innovative services.Currently,380 MHz of mid-band is licensed for mobile in the U.S.22 While this bandwidth may currently be sufficient to meet data demand,recent studies estimate that the U.S.will need between 400 MHz and 2 GHz of additional spectrum to support future traffic growth.For example,Brattle estimates that the U.S.will need an additional 400 MHz by 2027 and 1.4 GHz by 2032.23 Similarly,the GSMA estimates that densely populated American cities,such as New York,will require between 1 and 2 GHz of additional mid-band spectrum by the end of the decade.24 Releasing additional mid-band spectrum suitable to power mobile connectivity is crucial if the U.S.is to retain its status as the global leader in wireless connectivity.Yet,the U.S.is at risk of falling behind,as other countries continue to award spectrum for mobile.China,for example,has already allocated 20 Verizon Communications Inc,2024,Q2 2024 Earnings Call,available at:https:/ 21 Ericsson,2023,5G Network Coverage Outlook,available at:https:/ does provide a definition for mid-band in this document 22 FCC,2022,2022 Communications Marketplace Report,available at:https:/docs.fcc.gov/public/attachments/FCC-22-103A1.pdf 23 Brattle 2023,How much licensed spectrum is needed to meet future demand for network capacity?24 Coleago,2021,Estimating the mid-band spectrum needs in the 2025-2030 time frame,available at:https:/ The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The unique role of licensed mid-band spectrum NERA 7 700 MHz of spectrum in the 6 GHz band to meet the demand for mobile data.25 As a result,China now leads the way in terms of spectrum allocations for mobile,and by 2027,is expected to have released up to1560 MHz of exclusive-use,high-power mid-band spectrum to commercial wireless operators.26 Meanwhile,the U.S.is expected to lag four of the G7 member countries by 2027 if no additional mobile mid-band spectrum is released.Figure 4:Mid-band spectrum allocated to mobile in different countries by 2027 Source:Adapted from Analysys Mason,2022,Comparison of total mobile spectrum in different markets.Notes:We have removed any spectrum that is not available on an exclusive use,full-power basis.25 CTIA,2023,China Commits to 5G Mid-Band Spectrum with 6 GHz Allocation:U.S.Needs Clear Response,available at:https:/www.ctia.org/news/china-commits-to-5g-mid-band-spectrum-with-6-ghz-allocation-u-s-needs-clear-response#:text=The 6 GHz band China,5G technology in the band 26 Analysys Mason,2022,Comparison of total mobile spectrum in different markets,available at:https:/api.ctia.org/wp-content/uploads/2022/09/Comparison-of-total-mobile-spectrum-28-09-22.pdf 1,560 800 600 450 390 390 380 326 300 ChinaJapanS.KoreaCanadaUKFranceUSItalyGermany1,180 MHzdeficit vs ChinaThe Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 8 3.The economic impact of allocating mid-band spectrum to mobile Allocating additional mid-band spectrum to mobile in the form of full-power flexible-use licenses will create value throughout the economy.Although our analysis may not capture all of the benefits over time,in this paper we focus on the impact on mobile consumers,FWA consumers,industries that rely on mobile connectivity,and industries that support the wireless industry:Continued improvements to mobile service to millions of Americans.FWA consumers will benefit from additional coverage,increased penetration,higher speeds,higher additional data consumption,and lower prices.Industries that rely on mobile connectivity,such as video streaming,mobile games,and cutting-edge virtual reality and AI,will enjoy a more robust platform to deliver their services.Industries that support the wireless industry will benefit from the additional capital expenditure(capex)required to deploy the spectrum and the additional operational expense(opex)required to maintain the network.We measure the economic impact of allocating each additional 100 MHz to mobile by estimating its impact on three metrics:gross domestic product(GDP),employment,and consumer surplus.GDP is a measure of value added to the economy,that is,the value of the gross output of an industry minus the value of the intermediate inputs required to produce the output.The additional GDP produced by the spectrum allocation is a measure of the value of the additional goods and services that can be consumed by final demand.Employment represents the number of additional one-year jobs.Consumer surplus is a measure of consumer benefit and is the difference between what consumers would be willing to pay and what they actually pay.For all metrics,we estimate the impact of allocating mid-band spectrum by comparing a situation with additional spectrum against a counterfactual in which the spectrum is not allocated.Table 2 shows the metrics estimated for each channel affected by the spectrum allocation and deployment.The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 9 Table 2:The sources of the economic value of allocating mid-band spectrum to mobile Channel GDP Employment Consumer Surplus Better mobile service at no additional cost *Improving broadband with FWA*Supporting industries that rely on mobile connectivity*Supporting industries that serve the wireless industry*We estimate the effect of each additional 100 MHz by first estimating the impact of 400 MHz and then dividing by four.Therefore,throughout the paper,we report the marginal impact of adding 400 MHz of spectrum and the average effect of 100 MHz(up to 400 MHz).Conceptually,we would expect the first 100 MHz to have a larger effect than the last 100 MHz,but we do not estimate the impact of 100 MHz blocks individually.However,the sum of the first four 100 MHz blocks would equal the effects reported in this paper.Beneficial effects would continue to accumulate beyond 400 MHz,and we estimate that by 2028 even 400 MHz of new 5G spectrum will not be enough to keep up with consumer demand.However,estimating the economic benefits beyond 400 MHz is outside this papers scope.3.1.Continued improvements to mobile service to millions of Americans Mobile consumers will be the prime beneficiaries of the additional spectrum.Wireless operators will deploy and operate the spectrum to meet future growth in mobile data consumption.Figure 5 presents historical data on mobile data consumption from 2010 to 2023,measured in GB per month.The graph reveals significant growth in mobile data usage,reaching an average of 24 GB per month in the United States in 2023.The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 10 Figure 5:Historical mobile data traffic per capita in the U.S.Source:TeleGeography.Note:Includes FWA.For example,15 years ago,data-intensive applications such as video streaming and video calls on mobile were not commonplace,whereas nowadays,they represent a typical consumer experience.For the most part,consumers have not had to pay additional dollars for the ever-increasing capabilities of mobile networks.One way of estimating the value to consumers of the increased data consumption possible with the additional mid-band spectrum is to estimate the consumer surplus produced by the spectrum.The consumer surplus is the difference between the value consumers would be willing to pay and what they actually pay.Without additional spectrum,networks would eventually become congested.Plans tiered by consumption would likely come back,and those consumers wishing to add additional data would pay more.This difference,what consumers would be willing to pay without additional spectrum and what they pay with spectrum,is the consumer surplus produced by the spectrum.To estimate the impact of the spectrum on consumer surplus,we use previous research that links the price of the spectrum and consumer surplus.Conceptually,the price is inherently linked to the consumer surplus because both are based on comparing a future with and without additional spectrum.Table 3 shows the results of previous research linking spectrum prices and consumer surplus.Specifically,these papers show that the spectrum produces between 0.9 and 1.35 annual dollars of consumer surplus for every dollar of auction price.Table 3:Consumer surplus to price multipliers Paper Consumer Surplus to Price Multiplier Hazlett&Munoz 2004a 0.9 Hazlett&Munoz 2009b 1 Rosston 2003c 1.35 Source:(a)Hazlett and Munoz,2004,A Welfare Analysis of Spectrum Allocation Policies,Joint Center:AEI-Brookings Joint Center for Regulatory Studies.(b)Hazlett and Munoz,2009,A welfare analysis of spectrum allocation policies.RAND Journal of Economics Vol.40 No.3:424-454.05101520253020102011201220132014201520162017201820192020202120222023GB/monthThe Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 11(c)Rosston,2003,The long and winding road:the FCC paves the path with good intentions.Telecommunications Policy 27:501515.We use the two most recent auctions to estimate the price of 400 MHz of mid-band spectrum:the C-Band(3.7 GHz)and the 3.45 GHz auctions.The C-Band achieved a total price of$94 billion for 280 MHz,and the 3.45 GHz achieved a total price of$22 billion for 100 MHz.27 Table 4 shows the prices paid at the time of the auctions.The prices paid are not directly comparable because the volume of MHz available varied,and the C-Band prices are based on the 2010 census population and the 3.45 GHz on the 2020 census population.To address this,we calculate the price per MHz pop in 2025 US dollars by(a)using inflation to adjust the prices paid to 2025 prices28;and(b)applying a 2025 population projection to obtain 2025 prices per MHz-Pop.29 Table 4:Recent mid-band spectrum prices Total price paid MHz Price paid$MHz-Pop 2025 Price$MHz-Pop C-Band 94.17 280 1.10 1.17 3.45 GHz 22.51 100 0.68 0.79 MHz-Pop Weighted Average 1.07 Source:NERA Economic Consulting Combining the consumer multipliers and the average price for the mid-band spectrum,we obtain an implied annual consumer surplus of between$128 billion and$192 billion.We use three different discount rates typically used to discount spectrum consumer surplus to calculate the cumulative impact of allocating the spectrum.30 Table 5 shows the present value for discount rates of 5%,7.5%,and 10%using the multipliers identified in the three research papers on this subject.27 The C-band price includes gross proceeds,accelerated relocation payments to satellite companies,and relocation payments.28 IMF Data Portal,Inflation rate,average consumer prices(Annual percent change),last retrieved November,2024,available at:https:/data.imf.org/?sk=4FFB52B2-3653-409A-B471-D47B46D904B5&sId=1485878855236 29 The 2025 sticker price per MHz-Pop is weighted based on each Partial Economic Area(PEA)population.To estimate the population for each PEA in 2025,we first calculated the population for each county in 2025 using data from the U.S.Census Bureau,available here:https:/www.census.gov/data/tables/time-series/demo/popest/2020s-counties-total.html.We then aggregated the county populations to determine the total population for each PEA.30 See,for example,Bazelon and McHenry,2015,Mobile Broadband Spectrum:A Vital Resource for the U.S.Economy.Available at:https:/api.ctia.org/docs/default-source/default-document-library/brattle_spectrum_051115.pdf The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 12 Table 5:Present value of the consumer surplus Surplus to price multiplier Implied annual consumer surplus($B)PV 5%($B)PV 7.5%($B)PV 10%($B)Hazlet&Munoz 2004a 0.9 128 2,561 1,707 1,280 Hazlet&Munoz 2009b 1 142 2,845 1,897 1,423 Rosston 2003c 1.35 192 3,841 2,561 1,920 Source:Ibid and NERA Economic Consulting Given the high uncertainty in future spectrum prices in this band,we use the 10%discount rate to be conservative in our estimation.The future mid-band spectrum may be allocated at lower prices than the C-Band or 3.45 GHz since 400 MHz would more than double the stock of the mid-band spectrum.However,the alternative could be true,and the new spectrum could be as valuable,or even more valuable,given mounting capacity pressures and operators desire to expand FWA and other services.We use the most recent auction data as we do not estimate future spectrum prices in this paper.Table 6 shows our selected consumer surplus.We show the marginal impact of adding 400 MHz and the average effect for each piece of 100 MHz.Table 6:Consumer surplus associated with a better mobile service at no additional cost 400 MHz 100 MHz Concept Consumer Surplus($B)Consumer Surplus($B)Hazlet&Munoz 2004a 1,280 320 Hazlet&Munoz 2009b 1,423 356 Rosston 2003c 1,920 480 Average 1,541 385 Source:Ibid.3.2.Improving broadband with FWA 5G Fixed Wireless Access(FWA)is the fastest-growing terrestrial broadband technology.31 In 2024,FWA accounted for nearly all of the net broadband additions and one of the largest terrestrial footprints.32 Figure 6 shows the FWA adoption in the U.S.Starting around the fourth quarter of 2020,5G FWA has accounted for the large majority of net adds in the fixed broadband market.This 31 Singer and Urschel,2023,Competitive Effects of Fixed Wireless Access on Wireline Broadband Technologies.Available at:CTIA-Competitive Effects of Fixed Wireless Access on Wireline Broadband Technologies 32 Opensignal,5G Fixed Wireless Access(FWA)Success in the US:A Roadmap for Broadband Success Elsewhere?,Available at:5G Fixed Wireless Access(FWA)Success in the US:A Roadmap for Broadband Success Elsewhere?|Opensignal The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 13 tremendous growth has been achieved despite the capacity limitations faced by network operators.For example,T-Mobile reports a waiting list of over 1 million to become fixed wireless customers.33 Figure 6:FWA adoption growth in the U.S.Source:Opensignal34 This expansion has generated great consumer benefits through lower prices and additional broadband coverage.35 Additional mid-band spectrum for mobile will further improve FWAs capacity and economics.In particular,adding 400 MHz of mid-band to the existing 380 MHz of licensed spectrum will essentially double the mid-band capacity available for FWA.The additional capacity will increase the benefits of competition and penetration.In terms of competition,Singer and Urschel estimate that the consumer benefits associated with more choice and price competition in the fixed market owing to the availability of mobile FWA are around$6 billion annually.Table 7 shows the breakdown of benefits by market type and benefit channel.At current prices,some consumers switch from cable or fiber to FWA,whereas others choose to stay with their existing technologies.The switchers benefit from an improved match between the service they need and the price they pay.Those who decide to stay benefit from the lower prices offered by cable and fiber providers in response to the FWA providers offerings.33 Fierce Network,2024.The 1 million people on T-Mobiles fixed wireless waiting list will get a little help from fiber,Available at:https:/www.fierce- 34 Opensignal,5G Fixed Wireless Access(FWA)Success in the US:A Roadmap for Broadband Success Elsewhere?,Available at:5G Fixed Wireless Access(FWA)Success in the US:A Roadmap for Broadband Success Elsewhere?|Opensignal 35 https:/www.ctia.org/news/fcc-shows-how-wireless-is-delivering-much-needed-home-broadband-competition-closing-the-digital-divide The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 14 Table 7:Yearly consumer benefits of FWA in markets with existing service Market type Benefits from switching per annum($M)Price savings owing to competition($M)Total($M)Cable 369 5,735 6,104 Cable/Fiber 27 219 246 Total 396 5,954 6,350 Source:Singer and Urschel(2023)A critical assumption in Singer and Urschels research is that FWA providers obtain all the spectrum they need to compete effectively with other terrestrial technologies.They do not estimate the spectrum requirements to materialize the benefits they estimate.However,they mention that GSMA estimates that an additional 2 GHz of mid-band spectrum is needed to sustain FWA delivering a download data rate of 100 Mbps in rural communities in the longer term.36 Based on these estimations,we attribute 20%of the total benefits to the additional 400 MHz in consideration in this paper.In addition,we estimate the preset value of these benefits based on a discount rate between 5%and 10%.Our calculations are presented in Table 8.Table 8:Present value of the consumer benefits associated with 400 MHz of additional mid-band spectrum Market type Total($M)Benefit of 400 MHz($M)PV 5%($M)PV 7.5%($M)PV 10%($M)Cable 6,104 1,221 24,416 16,277 12,208 Cable/Fiber 246 49 982 655 491 Total 6,350 1,270 25,398 16,932 12,699 Source:NERA Economic Consulting We estimate the benefits of additional penetration in three steps.First,we identify the impact of the additional spectrum on broadband coverage.Second,we estimate the impact of the marginal coverage on national broadband penetration.Finally,we use previous research to identify the impact of increases in penetration on GDP and employment.According to the latest national broadband map released by the FCC,96.2%of the country is covered by terrestrial technologies.37 Terrestrial technologies include cable,fiber,FWA,and others.Figure 7 shows terrestrial coverage by county density decile.We ordered all counties by residential unit density and created buckets containing 10%of the countrys total residential units.We show the coverage of 36 Singer and Urschel,2023,Competitive Effects of Fixed Wireless Access on Wireline Broadband Technologies.Available at:CTIA-Competitive Effects of Fixed Wireless Access on Wireline Broadband Technologies 37 https:/broadbandmap.fcc.gov/data-download.November 13 2024.The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 15 terrestrial technologies for each bucket.The data shows that more densely populated counties have greater coverage.Figure 7:Terrestrial broadband penetration by density decile Source:NERA analysis of FCC data Note:Each column represents 10%of the residential locations in the U.S.The first column represents the least-dense 10%,and the last column the most-dense 10%.We first focus on the impact of the spectrum on coverage.In our estimation,we consider a location covered by FWA if the base stations that can serve the location have enough capacity to provide the service.Therefore,additional spectrum increases coverage by expanding the capacity of existing base stations and increasing the profitability of new ones.We use county unit density to estimate the impact of additional spectrum on additional coverage.In particular,we assume that with an additional 400 MHz of mid-band spectrum,FWA coverage in a given country would be similar to todays coverage of a county with 2.05 times its density an increase proportional to the spectrum holdings.Previous research by the GSMA has found that the number of units that can be served from a single base station is proportional to the spectrum holding.In particular,a base station can support 90 users with 400 MHz,315 with 1.4 GHz,and 540 with 2.4 GHz.38 We estimate that adding 400 MHz of mid-band spectrum will increase the total number of residential units covered by 1.1 million,or 0.7%of the total residential units.Figure 8 shows the increase by county decile.Based on our estimation,the increase will be more pronounced in the sparser counties where terrestrial deployment with other technologies is more expensive.Our calculation also assumes a modest increase in coverage in some of the top 10%more densely populated counties.While these counties enjoy a relatively high terrestrial coverage,FWA providers still have the potential to increase coverage if they can secure the capacity needed to serve their customers.38 GSMA and Coleago Consulting,2021.Estimating the mid-band spectrum needs in the 2025-2030 time frame(Global Outlook),available at:Estimating-Mid-Band-Spectrum-Needs.pdf.The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 16 Figure 8:Increase in coverage associated with an additional 400 MHz of mid-band spectrum Source:NERA Economic Consulting To estimate the impact on penetration,we assume that other terrestrial technologies eventually would cover the same residential units by 2035.That is,the additional spectrum would create an initial increase in penetration but gradually fade out when compared to a counterfactual in which other terrestrial technologies would eventually reach the same coverage and penetration.We assume that the additional penetration caused by the spectrum would reach a peak of 50%of the newly covered residential units and slowly fade out by 2035.Figure 9 shows the increased broadband penetration caused by the additional spectrum.Figure 9:Increase in penetration associated with an additional 400 MHz of mid-band spectrum Source:NERA Economic Consulting Finally,we use employment and GDP forecasts and results from the literature to estimate the impact of the increased penetration on GDP and employment.The Bureau of Economic Analysis estimated that GDP was 27.36 trillion in 2023.39 We use a constant 2%annual growth rate to project GDP until 39 Source:Bureau of Economic Analysis,2024,Gross Domestic Product(Second Estimate),available at:https:/www.bea.gov/sites/default/files/2024-11/gdp3q24-2nd.pdf The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 17 2035.Regarding jobs,the Bureau of Labor Statistics projects that total jobs will grow from 169.9 million in 2023 to 176.6 million in 2033.40 We complement these forecasts with literature estimations.In particular,the ITU has estimated that a 1%increase in penetration increases GDP by 0.1856%.41 Similarly,Crandall et al.2007 estimated that a 1%increase in penetration increases jobs by between 0.2%and 0.3%.42 Our estimated economic impact is shown in Table 9.Table 9:Economic impact of increased FWA penetration associated with 400 MHz 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 GDP($B)12.1 24.3 24.3 21.7 19.0 16.3 13.6 10.9 8.2 5.5 2.7 Employment(000)96.3 190.0 187.2 164.1 141.5 119.6 98.2 77.4 57.3 37.6 18.5 Source:NERA Economic Consulting 3.3.Supporting industries that rely on mobile connectivity The wireless industry provides essential services that support a wide range of other industries and economic activity.Originally,the wireless industry supported basic communications via text messaging and voice calls.Today,it enables much richer forms of interaction,allowing people to share not only messages and voice calls,but also photos,videos,and other forms of content through social media platforms.This has given rise to companies like Meta and Snapchat,which collectively generated$139 billion in output in the U.S.in 2024 and account for 35%of total mobile network traffic.Likewise,the motion picture and sound recording industry has been transformed by allowing people to consume content on their mobile devices,wherever they are.Video and audio streaming generated 32%of network traffic in 2024 and services like Netflix and Spotify generated$70 billion in output in the U.S.While social media and content streaming account for the majority of mobile network traffic and generate billions in output,the impact of the wireless industry is far broader.Search engines like Google and Bing have seen significant increases in usage owing to the availability of wireless services.Google estimates that 63%of its organic search traffic in 2023 originated from mobile devices,highlighting the key role that wireless networks play in enabling access to information and e-commerce.Today,over three-quarters of U.S.adults report buying things online using a smartphone.43 40 Source:Bureau of Labor Statistics,2024,EMPLOYMENT PROJECTIONS 20232033,available at:https:/www.bls.gov/news.release/pdf/ecopro.pdf 41 Source:ITU,2021,The economic impact of broadband and digitalization through the COVID-19 pandemic,available at:https:/www.itu.int/dms_pub/itu-d/opb/pref/D-PREF-EF.COV_ECO_IMPACT_B-2021-PDF-E.pdf 42 Crandall et al.,2007,The Effects of Broadband Deployment on Output and Employment:A Cross-sectional Analysis of U.S.Data,Issues in Economic Policy,The Brookings Institution.43 Pew Research Center,2022,For shopping,phones are common and influencers have become a factor,available at:https:/www.pewresearch.org/short-reads/2022/11/21/for-shopping-phones-are-common-and-influencers-have-become-a-factor-especially-for-young-adults/The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 18 The mobile gaming industry,too,generates vast amounts of output and leverages the fast connection speeds and low latencies available on modern wireless networks to allow users to play games on their mobile devices.The file-sharing industry,meanwhile,has taken advantage of wireless networks to allow secure,mobile access to files that would traditionally only have been accessible on a home or office fixed network.In doing so,the file sharing industry accounts for 7%of mobile network traffic.In Table 10 below,we outline the output and mobile network traffic generated by the five key uses for mobile networks discussed above.We focus on these use cases as they account for most of mobile network traffic today and significantly contribute to the American economy.However,we note that these use cases do not account for all network traffic nor all of the economic activity attributable to wireless networks.Nor can they account for new uses of the network that could develop when innovators are assured of the capacities necessary to support those uses.Additionally,5G and future wireless technologies are increasingly serving as the foundation for enterprise connectivity innovations,and the economic benefits of those should expand over time assuming sufficient spectrum is made available to account for those use cases.Therefore,the figures in this section should be interpreted as a conservative estimate of the total impact on downstream industries that an additional mobile allocation of 400 MHz of mid-band spectrum would have on the American economy.Table 10:Output and network traffic generated by selected use cases for wireless connectivity Social media Video and audio streaming Device and cloud gaming General web apps File sharing Share of total mobile network traffic 352%7%5%7%Output generated in 2024($B)139.0 73.0 55.4 287.5 7.3 Share of traffic taking place on mobile 18%8%7%8%Industry output attributable to mobile($B)24.6 5.9 5.4 21.5 0.6 Output CAGR 16.7%6.1%3.4.4%0.4%Source:Network usage data from Sandvine Global Internet Phenomena Report 202444;industry output data from IbisWorld Market Research Reports45.Output attributable to mobile is equal to the produce of industry output share of traffic taking place on mobile networks.The output for general web apps is assumed to be from search only.This economic activity generates an ever-increasing demand for data as it flows through wireless networks.However,the demand for data is not evenly distributed throughout the day,with peak usage generally occurring in the evening,when people consume the most data as they stream content,engage with social media,or browse the internet.Figure 10 displays the amount of video 44 Sandvine,2024,The Global Internet Phenomena Report,available at:https:/ 45 IbisWorld,2024,Market Research Reports,available at:https:/ Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 19 streaming traffic taking place over mobile networks by hour.Peak usage occurs between 5 and 6 p.m.,whereas usage is significantly lower between 1 and 5 a.m.,when most people are sleeping.Data traffic demand during the busiest hours places wireless networks under significant strain,reducing customer service quality.The reduction in speeds,higher latencies,or interrupted connectivity affects wireless subscribers and hampers the ability of industries that rely on this connectivity to drive their businesses.For example,if a consumer is unable to watch a streaming video owing to buffering as a result of network strain,they will inevitably churn away from the streaming platform to do something else.Consequently,the streaming platform loses out on ad revenue that it would have otherwise obtained had the network enabled the user to stream content smoothly.Figure 10:Video streaming usage on mobile networks by hour Source:Adapted from Sandvine Mobile Internet Phenomena Report 2021 Today,network congestion only affects a relatively low proportion of total network traffic and only constrains economic activity at the busiest hours.However,the demand for data continues to grow as the quality of content streamed over the internet improves,online games require more bandwidth and more commerce takes place over the internet.As use cases continue to demand more data,the strain placed on networks will intensify,not just at the busiest hour but starting to affect more hours throughout the day.Without additional spectrum,mobile networks will become more congested across wider swathes of the day,a problem that may only be partially alleviated by expensive investments in densifying networks.This lost traffic will directly translate into lost sales and foregone revenue across the many industries that depend on reliable wireless communications.To estimate the economic impact that an additional allocation of 400 MHz of spectrum to mobile would have,we estimate the value of the output that would be foregone between 2025 and 2040 if no additional spectrum was allocated to mobile.Volume of mobile traffic that would be foregone without an additional 400 MHz of spectrum The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 20 We begin by projecting mobile data traffic from 2023 to 2040 by applying a 16GR to the current mobile traffic volume.This is the rate at which Ericsson forecasts mobile data traffic will grow until the end of the decade.46 We then forecast the unconstrained,desired network usage for each hour of the day using the estimated share of traffic occurring at each hour from Sandvine hourly network usage estimates.Next,we estimate the volume of traffic that could be served at each hour under two spectrum allocation scenarios:no additional spectrum is allocated to mobile;and an additional 400 MHz of spectrum is allocated to mobile.Under the first scenario,we assume that without additional spectrum,mobile data network capacity at a given hour cannot exceed present-day traffic at the busiest hour to forecast the volume of traffic that can be served in each hour given spectrum constraints.For the second scenario,we assume that the maximum hourly traffic capacity that can be carried is proportional to the quantity of spectrum that is allocated to mobile.An additional 400 MHz of spectrum would therefore increase the capacity of the network at the busy hour by 36%relative to the first scenario.47 We assume that the pace of network densification is identical in each of the two scenarios.In reality,network operators are likely to build cell sites and densify their networks at a faster rate under the first scenario to minimally compensate for a shortage of spectrum.However,the rate in data growth exceeds the pace at which operators densify their networks to such a large degree that this simplifying assumption has little impact on results.Between 2013 and 2023,the number of cell sites deployed in the U.S.grew at an average of 3.6%a year.48 Over that same period,wireless data grew at a rate of 42%per year,from 3 trillion MB in 2013 to over 100 trillion MB in 2023.49 The difference in traffic between these two scenarios allows us to identify the volume of traffic that would be foregone were no additional spectrum to be allocated to mobile.We note that because our model examines the difference between the two traffic-constrained scenarios,our estimated economic impact is robust to the baseline level of the total unconstrained traffic used and the growth rates assumed over the projected period.To see this,observe that in Figure 11,the rapid growth in the unconstrained traffic(in yellow)does not lead to unbound growth in traffic differences between the two constrained traffic scenarios(in blue and purple).Moreover,the more aggressive the traffic growth assumption,the smaller the estimated economic impact of an additional 400 MHz allocation because network congestion becomes severe early on,and the marginal spectrum alleviates a 46 Ericsson,Mobile data traffic outlook,available at:https:/ 47 There is currently 1123 MHz of spectrum allocated to mobile in the U.S.An additional 400 MHz of spectrum represents an increase in the allocation of 36%.48 CTIA,2022,Summary of CTIAs Annual Wireless Industry Survey,available at:https:/api.ctia.org/wp-content/uploads/2022/09/Summary-of-CTIAs-Wireless-Industry-Survey-2022.pdf;and CTIA,2024,2024 Annual Survey Highlights,available at:https:/www.ctia.org/news/2024-annual-survey-highlights#:text=By the end of 2023,reforms were enacted in 2018.49 Ibid.The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 21 relatively small proportion of the lost traffic.This counsels for a pipeline of additional spectrum with longer foresight,accounting for spectrum needs beyond these initial 400 MHz benefits.Figure 11:Mobile data traffic with and without additional 400 MHz of spectrum Source:NERA analysis based on Ericsson Mobility Visualizer traffic data for North America Traffic associated with mobile network use cases To attribute total mobile traffic across the five use cases identified in Table 10 we multiply total network traffic forecasts by the share of mobile traffic accounted for by each application.We assume that the relative proportion of mobile traffic generated by each application remains constant through to 2040.Output associated with mobile network use cases We forecast the output of each of the five use cases listed in Table 10 until 2040 using CAGRs obtained from IbisWorld Market Research Reports.We then estimate the share of this output that is attributable to mobile under the assumption that output is proportional to traffic.We multiply total output by the share of traffic associated with that application that takes place over mobile.For many applications,output is closely related to the volume of traffic.For example,the advertising revenue of a social media platform is closely linked to the traffic that platform serves.Value of additional traffic served with additional 400 MHz We recognize that an applications output will not necessarily have a linear relationship with the traffic it generates.For instance,some of the additional bandwidth consumed by say,Instagram,will be associated with serving higher quality video content rather than being generated by new users.And while higher definition content will attract more users and improve user retention,this effect will likely The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 22 exhibit diminishing marginal returns.To account for this,we estimate each applications marginal output that is generated with each additional exabyte(EB)of data per year.This means for social media applications,for example,each additional EB of data generates about 30%less revenue in 2030 than it does in 2025.We then obtain the marginal output that would be generated by each application with an additional 400 MHz allocation to mobile by multiplying the extra traffic generated by that application with additional spectrum by the marginal output generated by each incremental EB of data.Obtaining estimated GDP and employment impacts We use input-output multipliers to estimate the total impact of the additional direct output generated by each application on GDP and employment.We use type II multipliers to account for the direct,indirect,and induced effects of the additional direct output.We identify the input-output multipliers for each application based on previous research by Compass Lexecon as described in the table below.50 We use the latest data from the Compass Lexecon report,which examines the period 2011-2020.To obtain the GDP multiplier we divide total GDP generated by the application by its direct output.We benchmark the implied GDP multipliers against those in the Regional Input-Output Modeling System(RIMS)dataset produced by the Bureau of Economic Analysis(BEA).We observe that the multipliers in Table 11 are slightly higher than the RIMS multipliers for industries in the Information sector.However,we note that this is to be expected given these industries deep integration within the economy and substantial spillover effects,which are not captured in RIMS multipliers owing to their regional nature.To obtain the employment multiplier we divide total jobs enabled by the application by its direct output.We benchmark the implied employment multipliers against those in the RIMS dataset as well as employment multipliers produced by the Economic Policy Institute.We observe that the multipliers in Table 11 for device and cloud gaming,general web apps and file sharing are consistent with the multipliers published by BEA and the Economic Policy Institute.However,the employment multiplier we obtain from the Compass Lexecon paper for social media is 18.7.The figure is higher than expected,and we therefore use a more conservative multiplier of 9.3 from the Economic Policy Institute.51 50 Compass Lexecon,2022 51 Economic Policy Institute,2019,Updated employment multipliers for the U.S.economy,available at:https:/www.epi.org/publication/updated-employment-multipliers-for-the-u-s-economy/.The value of 9.3 is the total employment multiplier associated with the software publishers industry.The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 23 Table 11:Input-output multipliers associated with each application Application GDP multiplier Employment multiplier Social media 1.82 9.3 Video and audio streaming 1.82 9.3 Device and cloud gaming 0.51 8.5 General web apps 2.00 8.2 File sharing 2.00 8.2 Source:Compass Lexecon(2022)and Economic Policy Institute(2019).For video and audio streaming,we use the same multipliers as for the social media industry.For general web apps and file sharing,we use the same multipliers as for search engines.The employment multiplier is scaled to produce jobs per$1M in direct output.Economic impact Table 12 shows the total impact on U.S.GDP and employment of an additional 400 MHz by selected applications between 2025 and 2040.Over this period,we estimate that the social media,video and audio streaming,mobile gaming,general web apps and file sharing industries will generate around 750 billion dollars in GDP.At the same time,these industries will generate close to 4 million jobs.The allocation of additional mid-band spectrum for mobile may give rise to new applications and business models that are not feasible today owing to network constraints.In our calculation,we only estimate the impact of network constraints on foregone revenue from existing applications and businesses.With more bandwidth and faster speeds,new applications like VR gaming or improved telehealth services may emerge,driving the creation of further output,GDP,and jobs.In particular,AI is expected to greatly accelerate data growth.AI mobile data is expected to grow at a 55GR between 2023 and 2033,increasing the need and value of the spectrum.AI traffic is expected to be bursty and unpredictable,require low latency,and increase the demand for the uplink(for applications using cloud computing).52 Table 12:Total economic impact generated by an additional 400 MHz for selected applications,2025-2040 Application GDP($B)Employment(M)Social media 342 1.7 Video and audio streaming 74 0.4 Device and cloud gaming 18 0.3 General web apps*311 1.3 File sharing 8 0.0*Total 753 3.7 Source:NERA Economic Consulting.*General web apps includes 5%traffic share plus residual traffic share of 14%*0.031 52 Harri Holma,The AI revolution:Preparing for a surge in 5G uplink traffic The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 24 3.4.Supporting industries that serve the wireless industry The wireless industry will spend billions of dollars deploying and operating 400 MHz of additional mid-band spectrum increasing the demand for equipment,construction,power,and other industries that serve the wireless industry.To estimate the economic impact of the additional capex and opex associated with the deployment and operation of the spectrum,we follow two steps:1.We estimate the additional capex and opex required to deploy and operate 400 MHz of mid-band spectrum nationwide.2.We use an input-output model and data from the Bureau of Economic Analysis to estimate the economic impact of the marginal capex and opex on GDP and employment.Capex and opex required to deploy and operate 400 MHz of mid-band We estimate that the capex required to deploy 400 MHz of mid-band spectrum is approximately$35 billion over seven years.The capex will be used to install new equipment and infrastructure,requiring additional expenses to operate and maintain.We estimate the associated additional operating expenses will be around$9 billion annually.We estimate the required capex to deploy 400 MHz of mid-band spectrum based on the capex spent deploying 280 MHz of C-Band spectrum(3.7 GHz).We estimate the relevant opex based on previous studies establishing that wireless operators typically spend 25%of the capex as yearly opex.53 Based on previous studies,we project that deployment would take about seven years and that equipment would be operated for ten years.54 55 Based on company filings,we estimate that deploying 280 MHz of C-band required about$20 billion between 2021 and 2024.AT&T has reported spending$7 billion in deploying C-Band and Verizon has reported$10 billion.56 57 Based on these figures,we estimate that the total capital expenditure required to deploy 280 MHz of C-Band was about$20 billion.Table 13 shows the MHz-Pop weighted holdings for each operator and its associated capex.53 GSMA and Coleago Consulting,2021.Estimating the mid-band spectrum needs in the 2025-2030 time frame(Global Outlook),available at:Estimating-Mid-Band-Spectrum-Needs.pdf 54 Prieger,2020.An Economic Analysis of 5G Wireless Deployment:Impact on the U.S.And Local Economies,available at:Microsoft Word-ACT Report-An Economic Analysis of 5G(Feb 2020).docx 55 Sosa and Rafert,2019.The Economic Impacts of Reallocating Mid-Band Spectrum to 5G in the United States,available at:The Economic Impacts of Reallocating Mid-Band Spectrum to 5G in the United States 56 T,2021,AT&T to spend less than Verizon on C-band 5G rollout,available at:https:/ 57 T,2023.Verizon confirms climb-down from C-band capex peak,available at:Verizon confirms climb-down from C-band capex peak The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 25 Table 13:Implied capex associated with deploying 280 MHz of C-Band Operator MHz Disclosed Capex($B)Average Capex per 100 MHz Implied CAPEX AT&T 79.8 7 8.77 7.00 T-Mobile 27.4 1.94 UScellular 4.9 0.35 VZW 160.7 10 6.22 10.00 Other 7.1 0.50 Total 280 7.07 19.79 Source:NERA Economic Consulting based on public filings Based on the C-Band capital expenditures and previous studies that have established the timeline and capex,we estimate the marginal opex and capex associated with deploying the spectrum.Table 14 shows the deployment schedule.For purposes of our analysis,we have assumed that spectrum becomes available in four tranches of 100 MHz and that total deployment will take seven years.We believe this is a reasonable assumption given past trends,but different bands have different timelines,and buildout would vary depending on how much spectrum is made available at what time.We assume ten years of opex are triggered any time capex is spent.We adjust the 2021 C-Band reference numbers by inflation with respect to their initial deployment years but make no additional adjustments on projected capex or opex.Table 14:Estimated capex and opex associated with four tranches of 100 MHz of mid-band spectrum Year of initial deployment Total capex($B)Yearly opex($B)2025 8.57 2.142 2026 8.73 2.182 2027 8.91 2.228 2028 9.10 2.275 Total 35.31 8.83 Source:NERA Economic Consulting There is uncertainty regarding the quantity and availability dates for mid-band spectrum,and the scenario presented here is a hypothetical.If quantities change,our calculations will scale down proportionally for blocks of 100 MHz up to 400 MHz.Spectrum capex and opex depend more on the number of carriers than the bandwidth.In mid-band spectrum,the maximum current carrier is 100 MHz which means that our calculations are proportional in blocks of 100 MHz but would not be proportional for smaller increments.If dates change,inflation-adjusted figures will change in proportion to the delay or acceleration with respect to the base schedule.However,inflation has a The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 26 minor impact on these calculations,provided that projected inflation for the relevant period is about 2.1%per year.58 I-O GDP and employment multipliers We use input-output multipliers to estimate the impact of the marginal capex and opex on industries that serve the wireless industry.First,we identify the industries where the marginal capex and opex are spent.Second,we distribute the total annual expenditure to each industry.Finally,we identify the multipliers associated with those industries to compute the effect of the marginal expenditure.We identify the industries and their corresponding weights based on previous research.For capex,we use the industries and weights identified by Sosa and Rafert(2019).59 For opex,we obtained the weights from an Analysis Mason paper identifying the destination of opex,and we matched their categories with NAICS industries.60 We obtained the multipliers for each industry from the Bureau of Economic Analysis.61 We use type II multipliers to account for the direct,indirect,and induced effects of the expenditures on GDP and employment.Table 15 shows the industries affected by the marginal capex and opex,their GDP and employment multipliers,and their weight in each category.Table 15:Multipliers associated with the additional capex and opex Industry Gross Domestic Product1 Employment1 CAPEX weight2 Opex weight3 334210 Telephone apparatus manufacturing 1.03 7.1 1534220 Broadcast and wireless communications equipment 1.11 7.4 4735920 Communication and energy wire and cable manufacturing 0.80 6.3 10#3240 Power and communication structures 1.17 9.8 29D1100 Electric power generation,transmission,and distribution 1.02 4.7 81200 Electronic and precision equipment repair and maintenance 1.31 14.9 38%Total Capex 1.10 8.03 Total Opex 1.21 11.12 58 IMF,2024,World Economic Outlook,October 2024 59 Sosa and Rafert,2019.The Economic Impacts of Reallocating Mid-Band Spectrum to 5G in the United States,available at:The Economic Impacts of Reallocating Mid-Band Spectrum to 5G in the United States 60 Anil Rao,2020.Network automation is key to delivering significant opex reduction and increasing agility in the 5G era 61 RIMS II multipliers,Bureau of Economic Analysis(BEA),see:RIMS II multipliers|U.S.Bureau of Economic Analysis(BEA)The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile The economic impact of allocating mid-band spectrum to mobile NERA 27 Source:(1)RIMS II multipliers,Bureau of Economic Analysis(BEA)(2)Sosa and Rafert,2019.The Economic Impacts of Reallocating Mid-Band Spectrum to 5G in the United States (3)Anil Rao,2020.Network automation is key to delivering significant opex reduction and increasing agility in the 5G era Economic impact We use the total capex over seven years and the total opex over ten years to estimate the total effect on the economy on GDP and employment.Table 16 shows the total capex and opex we estimate are needed to deploy 400 MHz of mid-band spectrum.The table also shows the total years we are considering in our economic impact.Our opex estimation is likely conservative as operators may maintain the equipment longer than 10 years.Table 16:Incremental capex and opex required to deploy and operate 400 MHz of mid-band spectrum Total($B)Annualized($B)Years Capex 35.3 5.0 7 Opex 88.3 8.8 10 Total 123.6 13.9 Source:NERA Economic Consulting Table 17 shows our economic impact estimation in terms of GDP and jobs.As with other estimations in this paper,we report the marginal impact of 400 MHz,and the average impact of each 100 MHz.Table 17:Economic impact of deploying and maintaining 400 MHz of mid-band spectrum 400 MHz 100 MHz GDP(B)New Jobs GDP(B)New Jobs Capex 38.8 283,626 9.7 70,906 Opex 106.5 981,520 26.6 245,380 Total 145.3 1,265,146 36.3 316,287 Annualized Capex 5.5 40,518 1.4 10,129 Opex 5.3 49,076 1.3 12,269 Total Annualized 10.9 89,594 2.7 22,399 Source:NERA Economic Consulting The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile Allocating additional spectrum to Mobile vs Wi-Fi NERA 28 4.Allocating additional spectrum to Mobile vs Wi-Fi Spectrum is a scarce natural resource with many competing uses.Two key conflicting uses for spectrum are mobile telecommunications,which benefits most from high-power exclusive-use licenses,and unlicensed use,which includes Wi-Fi,where users share spectrum.To ensure the U.S.remains a leader in wireless telecommunications,and for spectrum to deliver maximum economic value,both use cases require access to sufficient spectrum bandwidths.Figure 12 shows that while the U.S.has ensured Wi-Fis spectrum needs are met by allocating more mid-band frequencies to unlicensed use than any other country,its spectrum policy has not delivered the mid-band spectrum mobile operators need.As a result,the U.S.has fallen behind the likes of China,Japan,and the UK,all of which have allocated more mid-band spectrum to commercial wireless use than the U.S.Of course,wireless operators can,to a degree,substitute between spectrum bands to compensate for a shortfall of a particular type of spectrum.However,even when looking at total spectrum allocations across all bands,the U.S.,which has allocated 1,123 MHz of spectrum below 6 GHz to mobile62,still lags well behind China,which has allocated over 1,800 MHz to mobile.63 Spectrum requirements As Wi-Fi technology and applications evolved,so too have their bandwidth requirements.In 2020,the FCC addressed this by opening 1200 MHz of spectrum in the 6 GHz band for Wi-Fi and other unlicensed applications.This allocation was in addition to the spectrum already allocated in the 2.4 and 5 GHz bands.In a white paper published by Intel,Akhmetov et al.estimate that Wi-Fi 7,the latest iteration beginning deployment in the U.S.,would need three non-overlapping channels of 320 MHz to ensure optimal long-term Wi-Fi performance for bandwidth-demanding future applications.64 Even ignoring the constraints on allocations imposed in the context of competing uses for spectrum,Wi-Fis spectrum needs appear to be met.Moreover,the U.S.already leads its peers in terms of unlicensed spectrum allocations,as shown in Figure 12.American wireless operators,meanwhile,currently only have access to 380 MHz of full-power mid-band spectrum five times less than that allocated to Wi-Fi.And while the U.S.may lead in terms of unlicensed allocations,it has already fallen behind several of its peers,both in terms of mid-band and total spectrum allocations for commercial wireless use.The last auctions of spectrum for commercial wireless use in the U.S.took place in 2022,when 100 MHz of spectrum in the 3.45 GHz band was assigned,followed by an auction for 2.5 GHz overlay licenses which amounted to approximately 68 MHz of spectrum nationwide.Since then,wireless operators have had to cope with the exponential 62 FCC,2024,2024 Communications Marketplace Report,Fig.II.B.11,available at:https:/docs.fcc.gov/public/attachments/FCC-24-136A1.pdf 63 Analysys Mason,2022,Comparison of total mobile spectrum in different markets,available at:https:/api.ctia.org/wp-content/uploads/2022/09/Comparison-of-total-mobile-spectrum-28-09-22.pdf.To compute the current holdings for China,we sum the 682 MHz of spectrum below 3.0 GHz,the 460 MHz of mid-band spectrum already released,and the 700 MHz of spectrum in the 6 GHz band that was allocated after the Analysys Mason report was published.The total is 1842 MHz.64 Akhmet et al.,2022,6 GHz Spectrum Needs for Wi-Fi 7,available at:https:/ The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile Allocating additional spectrum to Mobile vs Wi-Fi NERA 29 rise in demand for data using their existing spectrum allocations.Of greater concern,however,is the absence of a clear pipeline of future spectrum allocations for commercial wireless use in the U.S.(and even the authority for the FCC to auction that spectrum),especially in light of the continuing increase in demand for wireless data.Figure 12 shows that by 2027,the U.S.s mid-band spectrum allocation will fall behind all but one of its G7 peers.By then,it is estimated that the U.S.could face a mobile spectrum deficit of 400 MHz,which could more than triple to over 1400 MHz by 2032.65 Given the long lead times required before spectrum that has been designated for study for a particular use can be deployed,it is imperative that federal policymakers prioritize identifying additional spectrum for commercial wireless services.The discrepancy in mid-band spectrum allocations to unlicensed use and commercial wireless use does not align with how these technologies use the spectrum.Wi-Fi and other unlicensed users operate at low power in localized environments,like homes and offices,where spectrum is readily available for re-use,even in close proximity.With Wi-Fi,a relatively small amount of bandwidth is capable of serving high volumes of traffic in a given geographic area.In contrast,mobile networks must serve users spread across wide geographic areas,travelling at differing speeds,and often outdoors.The wide coverage areas that need to be served mean that wireless operators need access to full-power,dedicated spectrum licenses to avoid interference and maintain network quality.Therefore,the scope for frequency re-use is far more limited than with unlicensed use,leading to wireless operators needing much more spectrum per GB of traffic served than unlicensed users.65 The Brattle Group,2023,How Much Licensed Spectrum is Needed to Meet Future Demands for Network Capacity?,available at:https:/api.ctia.org/wp-content/uploads/2023/04/Network-Capacity-Constraints-and-the-Need-for-Spectrum-Brattle.pdf The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile Allocating additional spectrum to Mobile vs Wi-Fi NERA 30 Figure 12:Mid-band spectrum allocations for unlicensed use and commercial wireless use in selected countries by 2027 Source:Adapted from Analysys Mason,2022,Comparison of total mobile spectrum in different markets.Notes:We have removed any spectrum that is not available on an exclusive use,full-power basis.Economic impact In assessing how to allocate spectrum,policymakers should consider the economic impact of allocations alongside the technical needs of different use cases.In 2024,the WiFiForward coalition commissioned a paper to establish the economic benefits of Wi-Fi and an additional allocation of 125 MHz of mid-band spectrum for unlicensed use.66 This study identified eight sources of GDP and consumer benefit that would derive from an additional 125 MHz of spectrum in the 7 GHz band.In Table 18,we summarize the economic value generated by source.Although Wi-Fi as a whole generates tremendous value,the results in Table 18 suggest that given how much spectrum Wi-Fi already has,an additional 125 MHz allocation would produce relatively little incremental economic value.66 Telecom Advisory Services,2024,Assessing the economic value of Wi-Fi in the United States,available at:https:/wififorward.org/wp-content/uploads/2024/09/Assessing-the-Economic-Value-of-Wi-Fi.pdf The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile Allocating additional spectrum to Mobile vs Wi-Fi NERA 31 Table 18:Economic value of an additional 125 MHz allocation to Wi-Fi Source Metric 2025 2026 2027 Benefit to consumers of free Wi-Fi traffic offered in public sites GDP($B)0.36 Deployment of free Wi-Fi in public sites CS($B)0.35 Benefit to consumers of faster free Wi-Fi under Wi-Fi 6E&above CS($B)0.01 0.01 0.01 Closing the digital divide:use of Wi-Fi to increase coverage in rural&isolated areas GDP($B)0.36 0.84 1.72 Wide deployment of IoT GDP($B)2.05 4.90 11.20 Capex&Opex savings Cellular offloading PS($B)0.08 0.17 0.31 Revenues of service providers offering paid Wi-Fi access in public places GDP($B)0.02 0.04 0.05 Aggregated revenues of WISPs GDP($B)0.01 0.02 0.04 Source:Telecom Advisory Services,2024,Assessing the economic value of Wi-Fi in the United States Note:CS:consumer surplus,PS:producer surplus In contrast to unlicensed users,commercial wireless operators face a looming spectrum shortage.As we highlight in Table 19,the impact on GDP,employment and consumer surplus of allocating additional spectrum to mobile is substantial.Direct comparisons between the two studies are challenging owing to the Wi-Fi studys limited forecast horizon to 2027.However,we note that Wi-Fi has already been allocated an additional 1200 MHz in the 6 GHz band,which is only just recently seeing equipment for.There is a less immediate need for additional unlicensed spectrum than commercial wireless users,who only have access to 380 MHz of full-power mid-band spectrum.Furthermore,some use cases can be equally or better served by mobile than Wi-Fi,for example,the wide deployment of IoT.Consequently,the economic impact of adding 100 MHz to a base of 380 MHz for mobile can reasonably be expected to have a larger impact than adding 100 MHz to a base of 1900 MHz already allocated for unlicensed use.Table 19:Summary of the economic impact of allocating each additional 100 MHz of mid-band spectrum to mobile GDP($B)Employment(M)Consumer Surplus($B)Better mobile service at no additional cost 385 Improving broadband with FWA 40 0.30 3 Supporting industries that rely on mobile connectivity 188 0.93 Supporting industries that serve the wireless industry 36 0.32 Total 264 1.55 388 Note:Effect of each 100 MHz up to 400 MHz The Economic Impact of Each Additional 100 MHz of Mid-band Spectrum for Mobile Conclusion NERA 32 5.Conclusion The wireless industry serves as a vital pillar of the American economy,significantly contributing to innovation,economic growth,and job creation.Its extensive investments in infrastructure and technology not only enhance communication capabilities but also support a wide range of industries that rely on wireless connectivity for their operations.As the demand for data continues to escalate,additional mid-band spectrum will be more needed than ever to continuing fueling the American economy.NERA 2112 Pennsylvania Avenue NW 4th Floor Washington,DC 20037 QUALIFICATIONS,ASSUMPTIONS,AND LIMITING CONDITIONS This report is for the exclusive use of the NERA client named herein.This report is not intended for general circulation or publication,nor is it to be reproduced,quoted,or distributed for any purpose without the prior written permission of NERA.There are no thirdparty beneficiaries with respect to this report,and NERA does not accept any liability to any third party.Information furnished by others,upon which all or portions of this report are based,is believed to be reliable but has not been independently verified,unless otherwise expressly indicated.Public information and industry and statistical data are from sources we deem to be reliable;however,we make no representation as to the accuracy or completeness of such information.The findings contained in this report may contain predictions based on current data and historical trends.Any such predictions are subject to inherent risks and uncertainties.NERA accepts no responsibility for actual results or future events.The opinions expressed in this report are valid only for the purpose stated herein and as of the date of this report.No obligation is assumed to revise this report to reflect changes,events,or conditions,which occur subsequent to the date hereof.All decisions in connection with the implementation or use of advice or recommendations contained in this report are the sole responsibility of the client.This report does not represent investment advice nor does it provide an opinion regarding the fairness of any transaction to any and all parties.In addition,this report does not represent legal,medical,accounting,safety,or other specialized advice.For any such advice,NERA recommends seeking and obtaining advice from a qualified professional.CONFIDENTIALITY Our clients industries are extremely competitive,and the maintenance of confidentiality with respect to our clients plans and data is critical.NERA rigorously applies internal confidentiality practices to protect the confidentiality of all client information.Similarly,our industry is very competitive.We view our approaches and insights as proprietary and therefore look to our clients to protect our interests in our proposals,presentations,methodologies,and analytical techniques.Under no circumstances should this material be shared with any third party without the prior written consent of NERA.NERA
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H1 20253Introduction and Key Findings5Perspectives on The Innovation Economy7Macro12VC Fundraising 17VC Investment25VC-Backed Tech Benchmarks30ExitsSTATE OF THE MARKETS H1 20252Nearly every investor we speak to sees AI as a platform shift analogous to the steam engine,the internet or the rise of mobile.Pick your parallel.Even conceding the potentially inflated expectations and valuations this sentiment will drive investment.”STATE OF THE MARKETS H1 20253Marc CadieuxPresident SVB Commercial B Mark GallagherHead of Investor CoverageSVB Commercial B Venture investment is booming,companies are raising colossal rounds and valuations are flexing to all-time highs.That is,if youre an AI company.For the rest of the innovation economy,the times are slower.Deal activity is stagnant,valuations are low and exits are limited.AI is the explosive,albeit unproven,fuel of the innovation economy.The positive is that new technologies spur recoveries.In 2009,mobile a vertical turned horizontal spurred the global financial crisis(GFC)recovery that took under three years to return to peak levels and fueled durable growth.Nearly every investor we speak to sees AI as a platform shift analogous to the steam engine,the internet or the rise of mobile.Pick your parallel.Even conceding the potentially inflated expectations and valuations this sentiment will drive investment.At the company level,the innovation economy is recovering in a healthy way.Efficiency reigns supreme.Companies that successfully raised capital in 2024 managed their burn,and companies across life stages are closer to profitability.With the focus on efficiency,revenue growth has been slow to improve.Growth rates reached a floor in 2024 and are no longer falling,but they arent improving either.Lower interest rates may be the accelerant that kick-starts growth.Both the market and Federal Open Market Committee(FOMC)members expect the federal funds rate(FFR)to fall below 4%by year-end,which could help spur additional spending on new technologies from public companies and lead to higher growth rates.But the strong December jobs report and continued wage growth at 4%may put the breaks on future cuts,and if inflationary policies such as tariffs are implemented,the rate-cutting cycle could end.If a low interest rate outcome prevails,it may provide the last push to crack the exit window,and provide the much-needed liquidity to end the three-year exit drought.A handful of notable companies like Chime,xAI,Stripe and others are well positioned to go public in 2025.Furthermore,a less aggressive anti-trust policy at the Federal Trade Commission(FTC)may send big tech on a shopping spree especially for AI companies with talent and tech that can scale in-house offerings.Most facets of the innovation economy found market bottom in 2024 and are transitioning to growth in the year ahead.While hype cycles come and go,advances in one sector spur innovation in ways we cannot yet anticipate.What we know for sure is that investment and innovations today scaffold the foundation of future growth.STATE OF THE MARKETS H1 20254AI drives the next wave of growth in venture investment.Jump to PageDemand for venture outpaces the supply,throwing prices on ice.Jump to PageCompanies raising VC have controlled their burn,leading to low growth.Jump to PageLarge funds dominate fundraising,changing long-term venture dynamics.Jump to PageSTATE OF THE MARKETS H1 20254VC fund life cycles extend,changing GP and LP1 expectations.Jump to PageMost unicorns are stuck in the stable without metrics to go to the IPO race track.Jump to PageA growing number of VC-backed companies are running out of runway.Jump to PageM&A remains scarce and increasingly reserved for the most troubled companies.Jump to PageNotes:1)General Partner(GP).Limited Partner(LP).5“Many VCs went all-in for crypto in 2020.Unfortunately,by 2022 plans for decentralized financial systems were shaken when the crypto industry collapsed,crushing many startups and the funds that backed them.AI use cases are clearer and less speculative,but likely will play out very differently than VCs expect today.The crypto boom and bust is training data that every investor should include in their AI projection models.”Eric Paley General PartnerSource:SVB Interviews.STATE OF THE MARKETS H1 2025 RETURN TO TABLE OF CONTENTS“Conversations have picked up with companies looking to go public.Overall Fed policy is positive.People like the clarity of the new administration.But you have a high bar in the tech market.To IPO,companies need high ARR(more than$300M-$400M)and a good Rule of 40.But more than that,you need to be able to predict the next 12 months of revenue.”“As hiring remains competitive,weve seen public companies leverage liquidity to attract and retain top talent.Private companies increasingly want to tap into the same benefits.As a result,private companies are approaching Forge to better understand how they can adopt liquidity programs on a similar scale.”Jordan SaxeSr.ManagingDirector,Listings:AmericasEric ThomassianHead of Private Company RelationsSTATE OF THE MARKETS H1 20256Marc CadieuxPresidentSVB Commercial BankSilicon Valley BMark Gallagher Head of Investor CoverageSVB Commercial BankSilicon Valley BMarc Cadieux is president of Silicon Valley Banks commercial banking business where he focuses on the needs of innovation companies at all stages of development,including the investors who back them.Mark Gallagher is the co-head of the investor coverage practice.He and his team provide tailored services,industry insights and strategic guidance to top investors in the innovation economy.Eli OftedalSenior Analytics ResearcherSVB Market InsightsSilicon Valley BJosh PherigoSenior Analytics ResearcherSVB Market InsightsSilicon Valley BAndrew Pardo,CFASenior Analytics ResearcherSVB Market InsightsSilicon Valley BThe SVB Market Insights team leverages SVBs proprietary data,deep bench of subject-matter experts and relationships with world-class investors and founders to develop a holistic view of the innovation economy for our State of the Markets Report.We partnered with lead authors Marc Cadieux and Mark Gallagher,who bring over a half century of industry knowledge and experience working with many of the top companies and investors across the innovation economy.Together,were proud to present this 29th edition of SVBs State of the Markets Report.To learn more about the lead authors see page 37.Jake Ledbetter,CFASenior Analytics ResearcherSVB Market InsightsSilicon Valley B 7STATE OF THE MARKETS H1 2025 RETURN TO TABLE OF CONTENTSSTATE OF THE MARKETS H1 20258US VC Fundraising1Notes:1)For funds headquartered in the US by date closed.2)For funds that have a reported focus.Only half of funds have a reported focus.3)Limited partner(LP).4)Tech defined broadly as VC excluding healthcare.5)Late-stage defined by PitchBook Data,Inc.as Series C or a round that occurs more than five years after a company is founded.6)Nasdaq and New York Stock Exchange(NYSE).Source:Preqin,PitchBook Data,Inc.,S&P Capital IQ and SVB analysis.2025 OutlookUS venture funds outperformed our 2024 outlook to the tune of$16B fueled by large funds and AI.The top 10%of funds accounted for 64%of venture fundraising in 2024,and half of funds closed reported a focus in AI.2 With the same trends likely to persist in 2025 fueled by a continued lower rate environment and potential distributions to LPs3 we anticipate a growth in fundraising this year.US Series A Tech Deals42025 OutlookSeries A tech deals underperformed our expectation,hitting the lowest level since 2012.But the backlog of seed companies looking to raise a Series A remains,thus we expect moderate growth in Series A tech deal activity to reach 1,450 deals.While this would represent an inflection point toward growth,activity levels are still lower than they were a decade ago.US Late-Stage Tech Valuations4,52025 OutlookLate-stage valuations rebounded quickly,and we expect continued expansion.But the absolute increase obfuscates the reality.AI deals are the primary driver of this jump.For example,AI has a 100%valuation premium to non-AI at Series C.Secondly,late-stage deals are often structured through instruments like liquidation preferences and ratchets.That said,strong valuations reflect improving sentiment.US VC-Backed Tech IPOs on Major US Exchanges62025 OutlookWe jumped the gun on our 2024 IPO outlook;anticipated exits did not materialize.We expect the IPO window may tentatively open for a select group of top companies that are profitable or have a clear path to profitability.Several tech companies such as Chime,xAI and Stripe are all positioned to go public after ServiceTitans strong performance in Q4.$66B$50B$80B2025 OutlookActual2024 Outlook1,500 1,450 1,370 Actual2024 Outlook2025 Outlook$83M$80M$95MActual2024 Outlook2025 Outlook15710Actual2024 Outlook2025 Outlook$0B$10B$20B$30B$40B$50B$60B$70B$80B$90B$100BQ1 16Q3 16Q1 17Q3 17Q1 18Q3 18Q1 19Q3 19Q1 20Q3 20Q1 21Q3 21Q1 22Q3 22Q1 23Q3 23Q1 24Q3 245.50%4.50%lllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllll2025 Year End2026 Year End2027Year EndLonger run0%2%4%6%8%Jan.20Jul.20Jan.21Jul.21Jan.22Jul.22Jan.23Jul.23Jan.24Jul.24The Federal Reserve has made great progress in its fight against inflation,but VC continues to reel from the consequences of high interest rates.Inflation settled around 2.5%-3.0%at the end of 2024,and consumer survey respondents reckon 2025 will show similar readings.The downward trend in expectations will be especially reassuring to Fed officials who have stressed the importance of anchoring inflation expectations.With this progress has come a normalizing of rates,with 100 basis points of rate cuts in the back half of 2024.In his December speech,however,Chair Jerome Powell downplayed potential future rate cuts.Indeed,the dot plot suggests rates just under 4%for the remainder of 2025 and slightly below that for 2026.Markets tend to agree,at least through year end.Of course,expectations are just that:predictions about an uncertain future.Shocks like economic downturns or tariff policies could lead to a reversal in interest rate policy.Lower interest rates are a potential tailwind for VC.Over the past several years,VC investment has been highly correlated to interest rates.As rates decrease,VC activity may be expected to get a boost.But this is not a return to the market peak seen during the zero interest rate policy(ZIRP)period.In a moderate interest rate environment,rates will likely play a smaller role in determining VC levels,similar to the 2017-2019 period.Notes:1)Dot plot based on the December 17-18 FOMC meeting.Market-implied rates as of January 9,2025;each observation represents one FOMC meeting through 2026.2)Upper end of target range.3)Count of articles in major news sources by year,indexed to 100 at 2019 levels.Source:University of Michigan Surveys of Consumers,Bureau of Labor Statistics,FOMC,Bloomberg,PitchBook Data,Inc.,Federal Reserve Economic Data,St.Louis Fed,Factiva and SVB analysis.STATE OF THE MARKETS H1 20259Median75th Percentile25th PercentileActual RateExpectation,MedianExpectation,RangeFOMC ExpectationsMarket ExpectationQuarterly Deal Value AnnualizedFed Funds Rate2Current Level4.54.03.53.02.52.0llllllllllMost FOMC members believe the FFR will be between 3.75%and 4.00%at the end of 2025.0100200300400500600192021222324Inflation and VCInterest Rates and VCIn 2024,there were still 3x the number of articles on inflation and VC as in 2019.lThe Fed is in a balancing act.While inflation has stabilized,it is at a level above the Feds target.The cost:A weakening labor market.“If you have a job,youre doing very well,”noted Jerome Powell in his December 18 press conference.“If you are looking for a job,though,the hiring rate is low.”The headline unemployment number has remained stable around the 4seline,but other metrics show signs of softening,such as the 23-percentage-point drop in the share of workers saying that jobs are plentiful.The tech job market was perhaps the tip of the spear in terms of white collar job weakening,as venture dollars dried up.Since then,job growth in professional services,IT and finance have underperformed other industries.Similarly,there is a bifurcation in consumer spending.From 2018 through 2021,consumer spending increased similarly for both upper-and lower-income consumers.Starting mid-2021,however,there has been a bifurcation.Those whove kept their high-earning jobs continue to spend more.Lower-income earners,meanwhile,are increasing their spending far less,with the bulk of the spending increase going to combat inflation.Flat spending delivered another blow to a challenged consumer sector.Revenue growth rates among VC-backed consumer companies fell 40-percentage points since 2021 on top of a 60cline in VC investment.1Notes:1)Decline in revenue growth rates at the median for US VC-backed companies.2)Current employment statistics industry code 50(“Information”)includes tech.Source:Bloomberg,Bureau of Labor Statistics,Federal Reserve and SVB analysis.STATE OF THE MARKETS H1 2025101.5%2.0%2.5%3.0%3.5%Q1 18Q3 18Q1 19Q3 19Q1 20Q3 20Q1 21Q3 21Q1 22Q3 22Q1 23Q3 23Q1 24Q3 24Credit CardsConsumer LoansUnemployment RatePercentage Reporting Jobs Are PlentifulAll IndustriesFinanceProfessional and Business ServicesInformation/Tech2-4%-2%0%2%4%6%8%Jan.22Apr.22Jul.22Oct.22Jan.23Apr.23Jul.23Oct.23Jan.24Apr.24Jul.24Oct.24In 2022,information/tech sector jobs grew more than other industriesin 2024,they grew less.2018201920202021202220232024-15%-10%-5%0%5%High IncomeLow IncomeMid Income0 0P%0%3%6%9%Jan.18Jun.18Nov.18Apr.19Sep.19Feb.20Jul.20Dec.20May.21Oct.21Mar.22Aug.22Jan.23Jun.23Nov.23Apr.24Sep.24Job Plentiful PercentageUnemployment RateUS tech layoffs have slowed as most of the companies that could shed jobs to save money have already done so.For those in the job market,there are fewer positions to choose from.Tech hiring has stagnated for the last two years.Tech companies are hiring at half the pace they were in the 2022 peak,the weakest level since at least 2016,according to LinkedIn data.US tech salaries are showing signs of weakening due to lower demand and pressure from lower-cost and growing talent pools overseas.Emerging markets in Asia,Africa and Latin America are adding millions of coders every year,quickly closing the software skills gap to the US.Startups are taking note.About 60%of companies already outsource app development.India is expected to overtake the US in number of developers by 2030.AI is having a greater impact on programming work in the US,though it doesnt appear to be replacing human developers(yet).According to an annual survey from Stack Overflow,63%of developers now use AI in their work,up from 44%last year.Most use it to directly write code,find answers or debug.Complex coding tasks are still best left to the humans,a sentiment reflected in lukewarm responses gauging developers trust in the accuracy of results.This may explain why only 12%of developers said they view AI as a threat to their job.Notes:1)Hiring rate is the percentage of LinkedIn members in the technology,information and media industry who added a new employer to their profile in the same month the new job began.The hiring rate is indexed to the average rate in 2016.Layoffs in thousands.2)Annual survey most recently conducted in May 2024 with 65,000 respondents.3)Among countries with at least 1M developers.4)Based on global HackerRank scores,last updated in 2016.Source:LinkedIn Workforce Report,Stack Overflow Developer Survey,GitHub Octoverse Report and SVB analysis.STATE OF THE MARKETS H1 2025110K30K60K90K120K150K180K4050607080901002021202220232024US tech hiring has slowed to half its peak pace in 2022.26()0222369Ac%MexicoTurkeyArgentinaBrazilJapanIndonesiaPhilippinesVietnamIndiaNigeriaSingaporePakistanBangladesh42wDCrc 24Currently Using AI in Development:Favorable Opinion of AI Tools for Development:Top Uses for AI:1.Writing Code 82%2.Finding Answers 68%3.Debugging/Testing 57%4.Documenting Code 40%5.Generating Content 35%Trusts the Accuracy of AI Outputs:Developers15M22MYoY Growth33!%Median Salary$21K$130KTalent Rank431st28thLinkedIn Tech Hiring IndexNumber of Tech Job Layoffs AnnouncedAsiaAfricaLatin AmericaEurope$100K$120K$140K$160K$180K$200K$220KDeveloper:QAData AnalystDeveloper:DesktopDeveloper:Front-EndDeveloper:GraphicsDeveloper:Emb.AppsDeveloper:Full StackDevOps SpecialistEngineer:DataData ScientistDeveloper:Back-EndEngineer:Cloud Infr.Engineer:Site ReliabilityEngineer:ManagerSalaries for full-stack developers are down 7.1%since 22.23 Median24 Median(Decrease)24 Median(Increase)202312STATE OF THE MARKETS H1 2025 RETURN TO TABLE OF CONTENTSNotes:1)Assessed over the trailing 24 months to smooth data given significant swings caused by large top-end outliers.Source:Preqin,PitchBook Data,Inc.and SVB analysis.Rank20202021 202320241Tiger GlobalGeneral Catalyst2Andreessen HorowitzNew Enterprise Associates3LightspeedAndreessen Horowitz4AccelKhosla Ventures5New Enterprise AssociatesARCH Venture Partners 6Flagship PioneeringNorwest Venture Partners7ARCH Venture Partners Flagship Pioneering8Khosla VenturesTiger Global9Norwest Venture PartnersGreenoaks Capital10General CatalystOrbiMedIf Bernie Sanders were a venture economist,he would undoubtedly draw attention to the growing inequality in venture fundraising.The bottom 90%of venture firms have raised as much capital as the top 2%,highlighting a significant skew towards the largest funds.Since 2020,the VC industry has been increasingly dominated by large firms,with the top 10 firms alone capturing 22%of all fundraising.This concentration of capital is leading to entrenchment,with the elite group of top 10 VC fundraisers changing little from year to year.This dominance of large funds is marginalizing mid-sized funds.There is a clear bifurcation in the market,where the biggest funds focus on making large investments and,in some cases,nearly“index”the venture market.On the other hand,small funds carve out niches,targeting specific sectors or stages.This leaves mid-sized funds in a precarious position.Their role is less clear.Most are neither giants able to compete in mega-deals nor niche funds in hyper-specialized markets.This could lead to consolidation and a less competitive market,with capital and talent increasingly concentrated among a few top firms.STATE OF THE MARKETS H1 202513$0B$20B$40B$60B$80B$100B$120B$140B$160B$180B$200B$220B$240B$260B$280B0%5 %05EPUep 00200120022003200420052006200720082009201020112012201320142015201620172018201920202021202220232024US Venture Capital Fundraising:Trailing Twelve Months Share of Venture Capital Fundraising Going to$500M Fund1$500M funds consistently capture 35-45%of venture fundraising The top 10 firms capture 22%of all fundraisingTop 10%of Firms:$258BBottom 90%of Firms:$148BColors illustrate change in rankingDeal Size,Top 20 VCsDeal Size,All VCsSeries ASeries BSeries C$0M$10M$20M$30M201920202021202220232024$0M$20M$40M$60M201920202021202220232024$0M$30M$60M$90M201920202021202220232024$0M$25M$50M$75M$100M201920202021202220232024$0M$75M$150M$225M$300M201920202021202220232024$0M$125M$250M$375M$500M201920202021202220232024Series ASeries BSeries CValuation,Top 20 VCsValuation,All VCsBased on the data,lessons from past downturns have not been fully absorbed.Namely,scaling is hard!There is only so much capital that can be effectively deployed in each company without driving inefficient burn.For VCs investing in early stages,fund sizes are difficult to scale.Larger funds will naturally have big portfolios of small bets that begin to mirror the market,limiting outperformance potential.This venture pitfall persists.The largest VCs are deploying more capital per deal and paying more per deal compared to the median VC fund.Overpaying can lead to underperformance,which is particularly evident in the top quartile of large funds.Concentration of capital and power can drive up prices unnecessarily,leading to outsized valuations during peak times valuations that the industry is still struggling to come to terms with today.This trend poses significant challenges for the industry.Larger funds simply have more capital to deploy,and those that invested early can dominate later-stage deals.Together,this can effectively squeeze out smaller VCs.Nevertheless,the incentives for individual firms to grow remain compelling,making it difficult to reverse course without LP pressure.Should muted returns become the norm,however,fund sizes may decrease and LPs may increasingly opt for other asset classes.STATE OF THE MARKETS H1 202514Notes:1)Top 20 VCs defined as US-based VCs that have raised the most during their life,calculated by the funds aggregate VC fund size.2)Internal rate of Return(IRR);For each vintage,large and small funds are those that have fund sizes above or below the median,respectively.3)Big funds are those$750M ,small are less than$250M.Analysis assumes the top quartile return of each group for vintage years 2010-2019.Carry net of an 8%hurdle rate.Source:Preqin,PitchBook Data,Inc.and SVB analysis.Management Fees Carried Interest$50M$150M$336M$389M0 0%SmallBigFund SizeMiddle 50%of Small FundsMiddle 50%of Large FundsMedian Small FundsMedian Large Funds-10%0 0 002005201020152020VintageAfter 2014 over half of returns are unrealized.The old rule of an 8-to 12-year fund life cycle is not a reality for most funds.Top quartile funds dont actually return capital for 16-20 years.To reflect this new reality,some funds are changing the language in their limited partner agreements(LPAs)to reflect longer fund life cycles but cut off the fee period.With large funds investing at the latest stages,companies are able to stay private longer,and the trend toward large funds is only likely to continue.As a result,the average age of a US VC-backed unicorn is now 10.3 years,just four months less than the average age of tech IPOs.The vast majority of those unicorns do not have the metrics to make a compelling IPO(see pg.32).Despite longer time frames,LPs are still investing in venture.During peak times,we saw record-low time between funds.While it is increasing,it is still historically low;however,this time will likely continue to grow as fewer funds have come back to market since 2022 and investment rates remain below peak levels.What this data misses is the VCs that may not raise capital again after investing their first fund at the peak of the market and having marginal returns to show for it.But a venture firm doesnt disappear overnight unless they sell their portfolio in a secondary.It takes 16-20 years to liquidate their investments and close their doors.STATE OF THE MARKETS H1 2025150P00 0%000500E0P0 05 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024Median DistributionsMedian Residual Value of Investment(Unliquidated/Unreturned)1Fund BreakevenVintage Yr.Fund Age2019171615141312111098765432118100%An 8-12 yr.fund cycle is not realistic:Most of the fund is not distributed.Majority is distributed to LPs with limited residual value:True fund life cycle is 16-20 yrs.Notes:1)For top quartile multiple on invested capital(MOIC)funds.Distributions are Distributions to paid in capital(DPI)and Residual Value is the residual value of paid in capital(RVPI)both expressed as a percent of capital paid in.Source:Preqin and SVB analysis.413226282729322930242324231515107912244952364241464745483634322929312324202934586664787064716169625045474444404034434120052006200720082009201020112012201320142015201620172018201920202021202220232024Middle 50%of FundsMedianFunds More Than Double the PaceDeployment rate slows and the time between funds increases amid venture contraction.Consistent,Predictable Fundraising CyclesStartup launch programs have become the front door for the venture ecosystem,welcoming in thousands of startups each year that might otherwise be overlooked or go unfounded.Deals from incubators and accelerators are typically small dollar values relative to seed deals,but they comprise a significant share of overall VC activity,accounting for a quarter of all deals in 2024.1 Incubators are a stabilizing force in early-stage formations.Not only do they act as a quality screen for investors,theyre also less fickle in downturns.When VCs apply the brakes during market lulls,incubators tend to continue churning out new cohorts at a steady rate.The era of startup programs took root during the Global Financial Crisis when programs such as Y Combinator,Plug and Play and Techstars helped launch iconic companies like Stripe,AirBnB and DoorDash.More than 13,000 companies from these programs across the country have raised over$200B in VC over the last 15 years.As the model has spread nationwide,the impact from startup launch programs has been more pronounced in non-tech hubs,where supportive local governments,corporations and universities give these programs a concentrating effect,attracting as much as 40%of all VC deals in some states.Here,incubators fill the market gap by finding and supporting founders outside of the main innovation hubs.Notes:1)Incubator and accelerator deals are presented here as a share of overall VC deals to show their scale,however,we exclude these deals in our analysis of VC activity elsewhere in the report.2)Includes companies that received an incubator or accelerator deal,as classified by PitchBook.Premium as compared to companies with no incubator/accelerator deal.Source:PitchBook Data,Inc.and SVB analysis.STATE OF THE MARKETS H1 20251643%0%5 %0 052006200720082009201020112012201320142015201620172018201920202021202220232024Accelerators and Incubators accounted for 24%of US VC deals in 24.$0B$50B$100B$150B$200B2005200720092011201320152017201920212023In VC Raised by AlumsNotable Alum:Companies IncubatedSince 05Founded:2005Founded:200625w%SeedEarly StageLate StageCompanies from incubators have a valuation premium at every stage.23%C)1$A )8%STATE OF THE MARKETS H1 202517 RETURN TO TABLE OF CONTENTSSimple supply and demand models go a long way in describing the current state of the innovation economy.We assessed demand by looking at the number of companies that need to raise in the next six months and how much those companies would need to finance operations at current burn rates.The supply of capital is simply a function of US VC fundraising and investment.As company fundraising boomed in 2020 and 2021,the demand for capital fell because fewer companies needed to raise at any given time.At the same time,supply increased,pushing prices for companies higher as measured by revenue multiples.Fast-forward to 2022 and the trend flipped.Demand began to rise and supply began to fall,pushing multiples down.Not only are valuations lower,but the speed of valuation growth is slower.It now takes the typical Series A company over two years to increase its valuation as much as companies in 2021 did in a single year.While this is partially attributable to the supply and demand in venture,it is important to note that growth rates for VC-backed companies have also slowed substantially(see pg.26).This slower growth further drives down multiples as high growth is one of the main reasons for investing in a company with a high multiple.STATE OF THE MARKETS H1 202518Median Series C Revenue Multiple(Trailing 4 Quarters)Spread Between Supply and Demand Indexes for US VC1 0 0000%Series ASeries BSeries CSeries D201920202021202220232024Notes:1)Demand for venture is a function of the number of companies that need funding in the next six months and the amount those companies are burning.Supply is a function of fundraising and investment(equal weighted index of the two).A baseline for the index was established between 2017-2019;the percentage point variance is expressed in relation to that baseline.2)Calculated at the valuation increase between rounds divided by the years between rounds for the given year a company closed a deal.Source:SVB proprietary data,PitchBook Data,Inc.and SVB analysis.Middle 50%of DealsMedianQ1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q42018201920202021202220232024-100pp-50pp0pp50pp100pp150pp200pp250pp5x10 x15x20 x25xDemand:Company Funding Needs Next 6 Months Supply:Venture Fundraising and Investment Supply significantly outpaces demand.Demand outpaces supply.Multiples Contracts as Oversupply Ends0 x10 x20 x30 x40 x50 x60 x70 x80 x90 x100 xQ1Q3Q1Q3Q1Q3Q1Q3Q1Q3Q1Q3202320242023202420232024Series ASeries BSeries CAnd just like that,VC is back.US VC investment totaled$204B in 2024,a 30%year-over-year increase and the third-highest annual total on record.The recovery marks an about-face for the venture ecosystem.This year started at a low-point,after eight straight quarterly declines in annual VC investment,and ended on a hot streak with three quarterly increases.What happens next depends on the prospects for the one technology most responsible for the turnaround:generative AI(GenAI).Exclude AI investment and the story changes.There is no meaningful investment uptick for companies not leveraging AI.Investment for this group is essentially flat for the last year.AI has gobbled up VC market share in the last two years.At the peak of the last cycle,only one in four companies getting VC deals had AI as a vertical.Now,its half of all companies.And a handful of these are controlling a huge portion of the VC dollars.For the first time,more mega-deal dollars went to AI companies($73B)than to non-AI companies($47B).This inflection marks a turning point like we havent seen since the rise of mobile technology after the GFC.The emergence of the iPhone and the App Store kicked off a wave of innovation that at first was confined to a core group of mobile-focused companies.VC flowed disproportionately to this group for the first few years,sparking a general VC recovery as mobile spread to all companies.Could we see a similar trend with AI?Notes:1)What-if projections simulate investment levels if AI company investment follows the same path as the mobile tech vertical post-GFC,indexed to the investment peak prior to the decline.Our forecast picks up when mobile VC returned to its pre-GFC peak,which is where we are with AI now.Source:PitchBook Data,Inc.and SVB analysis.STATE OF THE MARKETS H1 202519Non-AI VC InvestmentHorizontal PlatformsAI grows 50%-60%in 2025 before leveling off.All other investment grows 20%in 2025.02550751001251501752002021202220232024202520262027$13B$17B$25B$61B$34B$39B$73B$65B$66B$79B$203B$111B$73B$47B201820192020202120222023202461%Of VC mega-deals went to AI companies.$0B$100B$200B$300B$400B200720082009201020112012201320142015201620172018201920202021202220232024202520262027AI/ML:Vertical AppsAI Chips and Machines48%of VC went to AI-leveraged companies in 2024.What if AI investment follows the trajectory of mobile investment after the GFC?161100105Other VCGFC RecoveryCore AI VCNon-AI VCCore AI VCNon-AI VCCombinedIts hard to comprehend the advancements in computing that have led us to GenAI.In 1969,the Apollo Guidance Computer calculated 14,000 math operations per second to deliver astronauts to the moon.Today,we measure compute in quadrillions of operations per second(called a PetaFLOP).ChatGPT 1 took a full day of PetaFLOP computing to train its 100-million parameter model.But even PetaFLOP-days arent cutting it anymore.Metas latest model,Llama 3.1,required a staggering 1,200 PetaFLOP-years to train on over a trillion words.All of that compute doesnt come cheap.Every new large language model(LLM)costs hundreds of millions of dollars to develop,and foundational AI companies are churning these out several times per year,releasing multiple versions that are optimized for developers to build upon.The metric that may best capture this activity is NVIDIAs revenue.The AI chipmaker has cornered the market on semiconductors needed to train new models,and its sales are rising in proportion to public adoption of AI.Corporations are increasingly investing in AI products and tooling.Research by the VC firm Menlo Ventures shows that US companies spent at least$16B on AI products in 2024,a 7x increase from 2023.1 Thats only expected to grow as the costs come down and apps get better.STATE OF THE MARKETS H1 202520Notes:1)According to Menlo Ventures analysis of dollars spent on foundation models,model training and deployment,AI-specific data infrastructure and new GenAI applications from startups and established corporations.2)This is an illustrative example with model capability and inference costs approximated based on estimated data such as the number of parameters to train models and subjective factors like iterative improvements in models.Source:SEC filings,Google trends,company websites and SVB analysis.0255075100$0B$5B$10B$15B$20B$25B$30B$35B$40B201720182019202020212022202320241101001,00010,000100,0001,000,0002018201920202021202220232024PetaFLOP-DaysGPT-1Llama 3.1BERTXLNetGPT-2GPT-3LLaMA 2OPTPaLMNemotron-4(NVIDIA)OtherGPT-4Inference CostModel CapabilityGPT-3(2020-22)GPT-4(2023-?)OpenAI-o1(2024-?)GPT-4o MiniGPT-3 AdaGPT-3 DavinciGPT-4 TurboGPT-3 BabbageGPT-4oo1-PreviewModel CapabilityInference CostFull-Scale,LegacyLightweight,UtilitiesOptimized,General UseFull-Scale,PremiumPhase 1:Most-capable,highest-cost model is released.Phase 2:Less-powerful model with more efficient inference costs.Phase 3:Further optimized for specific tasks or faster use.Phase 4:Full-scale models,obsolete by new architecture.Ex)GPT-3 series(now)Ex)GPT-4 TurboLife Cycle of LLM Model DevelopmentEx)GPT-4oEx)GPT-4o minio1-MiniWith AI driving nearly all of the growth in VC investment,its not surprising that the sectors benefiting most are those where the AI hype is peaking:enterprise software(LLMs)and frontier tech(autonomous machines).Attention on these sectors is at an all-time high and so is investment.Companies at the core of GenAI,such as xAI,Databricks and OpenAI,are generating massive VC deals,pushing enterprise software investment up 47%from 2023.Much of the capital for these deals is consumed by the high cost of training models.A single new LLM released to market takes hundreds of millions of dollars in compute to train,and the pace of new releases is only growing.Then there are the machines.Autonomous vehicles are driving a large share of the investment in frontier tech,which has jumped from the fourth-most heavily invested sector in 2022 to the second-most favored sector in 2024.Defense technology is also emerging as a growth area for frontier tech investors,with notable deals for several defense tech unicorns such as Anduril among the largest deals of the year.Consumer tech is still struggling to find its footing in the era of AI.Only 25%of consumer companies have AI as a key vertical,yet those that are building AI products have a much higher valuation over those that dont(4x premium for later-stage companies and 2x for early-stage).STATE OF THE MARKETS H1 202521Notes:1)Based on SVBs proprietary taxonomy of PitchBook deals.2)xAI closed two$6B deals in 2024.3)Anthropic closed three deals for$9.2B raised in 2024.At least$3B of this was convertible debt.They closed another$1B in January 2025 and are in-progress to close$2B more,according to PitchBook.Source:PitchBook Data,Inc.and SVB analysis.20192020202120222023202412345Enterprise SoftwareFrontier TechFintechConsumer InternetClimate Tech47P%-41%YoY Change in US VC-25%-12%-7%-23I0%-65i61 614%ClimateTechEnterpriseSoftwareFintechFrontierTechConsumerInternetThe valuation premium for companies with an AI vertical is greatest at the later stage.SeedEarly StageLater Stage0 0Pp 1620172018201920202021202220232024Enterprise SoftwareFrontier Tech FintechConsumer InternetClimate TechCompanyVC in 24SectorFocusxAI2$12.1BEnterpriseFoundational AIDatabricks$10.0BEnterpriseAI InfrastructureAnthropic3$9.2BEnterpriseFoundational AIOpenAI$6.6BEnterpriseFoundational AIWaymo$5.6BFrontier TechAutonomous VehiclesAnduril$1.5BFrontier TechAerospace and DefenseCoreweave$1.1BEnterpriseAI InfrastructureMistral AI$1.1BEnterpriseFoundational AIWayve$1.0BFrontier TechAutonomous VehiclesScale AI$1.0BFrontier TechAerospace and DefenseDefense tech is emerging from the shadows to claim a more prominent role in the venture ecosystem.The wars in Ukraine and Israel have drawn stark awareness to the impact that technologies such as drones have on the modern battlefield.VC investment in US defense technology has ticked higher as a result,jumping 2x in 2023 and staying at that level in 2024.The largest deals are dominating with the top 10 deals accounting for about 80%of VC dollars in the last two years,a 20-percentage-point jump from 2022.At least seven defense tech unicorns received later-stage deals in 2024,positioning the cohort well for potential exits in the year ahead.More VCs are mentioning defense tech as a specific focus area than ever before.General Catalyst named defense a key strategy for their recent$8B fund(though it wasnt clear how much of that was earmarked for defense).Follow-on investors could further increase the demand for what is still a niche segment of the venture ecosystem.Defense tech companies have steeper capital requirements than other sectors.Later-stage deal sizes were 4x higher for defense tech than other technologies.Machines are expensive(and complicated)to build,which can be a deterrent for investors.However,the companies that do find product market fit,tend to achieve exit velocity,given the large government contracts that tend to be lucrative and dependable.STATE OF THE MARKETS H1 202522Notes:1)Terms include“defense,”“instability,”“war,”and exclude“financial instability.”2)Defense tech includes all of PitchBooks analyst curated vertical:“Aerospace and Defense”as well as an SVB-curated list of VC-backed defense contractors.3)Post-money valuations for all disclosed deals.Source:CB Insights,PitchBook Data,Inc.and SVB analysis.5010015020025030020202021202220232024US corporate attention on defense and security is up 2x from what it was in 2020.$1.6B$2.1B$3.5B$5.4B$2.5B$5.2B$5.0B59EcQdy 18201920202021202220232024Total VCTop 10 Largest Deals$21.4M$29.5M$6.5M$7.5MEarly StageLater StageDefense TechOther VC$0B$2B$4B$6B$8B$10B$12B$14B2015201620172018201920202021202220232024Exited UnicornsActive UnicornsThe 15 active US defense tech unicorns are valued at$50B.Seed extensions are capturing the highest percentage of seed deals and capital ever witnessed.Starting with the 2015 seed cohort,extension rates(i.e.,the share of seed companies that raised an additional seed round)ticked up year by year,peaking for those that raised a seed in 2021.Graduation rates moved similarly to extension rates up until the 2021 cohort.Following the 2021 class,graduation and extension rates started to tick down.On a relative basis,graduation rates fell faster than extension rates.This shift occurred for a number of reasons.First,seed cohorts from 2020-2021 raised in a growth-at-all-costs environment,whereas more recent seed cohorts were forced to be capital efficient from day one.Second,the venture landscape recalibrated as investors pulled back,pushing graduation rates down and leading companies to depend on extension rounds.Third,the cohorts that raised in 2020-2021 need more time to reach the higher Series A benchmarks expected of them.Lastly,seed companies are using extensions to kick the can down the road in hopes of raising a Series A at a better valuation.As a result of these trends,seed extension deal sizes and valuations continue to climb.Until those older cohorts work through the system,expect graduation and extension rates to drudge along.STATE OF THE MARKETS H1 202523Notes:1)Seed extension defined as any seed round after the first seed for the specific startup.Source:PitchBook Data,Inc.and SVB analysis.20202021202220232024MonthsMonths2019Cumulative Seed Extension Rates 2015-2024Cumulative Graduation Rates 2015-20242015-20180 0Pp0 152016201720182019202020212022202320240 0Pp0 152016201720182019202020212022202320241st Seed2nd Seed3rd SeedDeal CountCapital Invested$0.0M$0.5M$1.0M$1.5M$2.0M$2.5M$3.0M$3.5M$4.0M2015201620172018201920202021202220232024$0M$2M$4M$6M$8M$10M$12M$14M$16M$18M2015201620172018201920202021202220232024Median Deal SizeMedian Pre-Money Val.1st Seed2nd Seed3rd Seed0%5 %0691215182124273033360%5 %069121518212427303336Extension rates increase from 2015-2021 before declining.2015-2020 graduation rates moved in lock step with extension rates.2021 marked a divergence in that trend despite extension rates being above graduation rates on a relative basis.$35BCore-weave$9B$12B$11B$12B$23B$27B$29B$41B$36B$24B$46B1,1161,4291,3941,4191,5391,7391,8152,3392,0891,7001,32105001000150020002500$0B$5B$10B$15B$20B$25B$30B$35B$40B$45B$50B20142015201620172018201920202021202220232024Rising interest rates in 2022-2023 sent ripples through the capital markets,curbing the appetite for debt among public tech companies.Yet in the startup world,venture debt is a key lever,compensating for a slowdown in VC funding and providing critical runway extension.In the past,later-stage venture debt was a complement to equity.When it was a replacement to equity,it was due to the companys strong fundamentals,such as reducing burn.This could become a problem for companies and their lenders if the financing was insufficient to achieve the milestones necessary to raise the next round,or if new investors are unwilling to see their new dollars go to repay debt.Venture-backed companies are also finding new ways of using debt.CoreWeave,for instance,turned to a collateral-backed facility for financing compute.Historically,lenders pulled back during downturns,as those who invested heavily during the peak times realized losses.During this cycle,however,the opposite has occurred.New entrants,such as deep-pocketed private credit funds,are further increasing the competitive pressure,offering sweetheart deals to gain market share.Whats clear is that venture debt is no longer just a stopgap measure.STATE OF THE MARKETS H1 202524Notes:1)Sample includes companies listed on major US exchanges with a primary industry of“information technology.”Calendar years and quarters are shown.Averages use data winsorized at the 5th and 95th percentile.2)Q4 2024 data is extrapolated based on average quarterly data for Q1-Q3.3)The majority of companies in the dataset are later-stage.4)Data for 2024 includes Q1-Q3 only.Source:S&P Capital IQ,PitchBook-NVCA Venture Monitor(Q3 2024),PitchBook Data,Inc.,SVB proprietary data and SVB analysis.Average Median Deal ValueDeal CountDeal Value Linear TrendMedianAverage101111141213Q1 23Q2 23Q3 23Q4 23Q1 24Q2 2420242023202220212020201920182017201620152014$0M$1M$2M$3M$4M$5M$0M$10M$20M$30M$40M$50M20242023202220212020201920182017201620152014Median Deal SizeAverage Deal Size23!%$54275551 192020202120222023Q1 24Q2 24Q3 24Extrapolation Average Driven Up by Large AI DealsSTATE OF THE MARKETS H1 202525 RETURN TO TABLE OF CONTENTSOne of the most common questions we hear from founders is“what are the benchmarks for raising capital?”Unsurprisingly,the answer has changed over time.Revenue growth is no longer as important as it once was.In fact,the typical company raising a Series A is growing at 69%today.This is down from 171%YoY in 2021.Managing burn is of utmost importance today.Among companies that raised capital in 2024,the typical Series B company only increased its burn 8%YoY.This means that companies are growing,but they arent growing their burn.Companies that are raising are increasingly efficient.This is vastly different from companies raising in 2021 and 2022 that rapidly grew burn YoY in an environment where capital was easier to come by.At the Series A we have also seen a significant increase in the median revenue companies have at the time of raise.The median Series A company now has a whopping$2.5M in annual revenue 75%higher than companies had in 2021.This has coincided with more companies raising multiple seed rounds and a bottleneck of seed-stage companies seeking to raise a Series A.There were fewer Series A tech deals done in 2024 than at any point in the last decade those that are being done are the exception.STATE OF THE MARKETS H1 202526Notes:1)YoY growth rate comparing annualized quarterly values;does not include extension rounds.2)The annualized current run rate;does not include extension rounds.Source:SVB proprietary data,PitchBook Data,Inc.and SVB analysis0 00000 1920202021202220232024$1.4M$5.0M$14.2M$2.5M$6.0M$13.8MSeries ASeries BSeries C75 %-3%Series ASeries BSeries C20212024Series ASeries BSeries C-50%0P00 0%00050 18201920202021202220232024Increase in Burn the Year Following the DealIncrease in Burn the Year Leading up to the Deal Starting Point(1 year Before Deal)Year of Venture RoundUnhealthy,Inefficient Increases in Burn Fueled by Too Much CapitalCompany burn stagnates as many companies continue to grow into their burn rates.-286%-171%-105%-71%-45%-21%-12%-3%-450%-400%-350%-300%-250%-200%-150%-100%-50%0%$1.0M$2.5M$5.0M$7.5M$10.0M$20.0M$50.0M$100.0MThe long and winding road that leads to profitability may be shorter today than in 2021.More companies are approaching profitability and doing so sooner in their life cycle.This is not to say early-stage companies are profitable far from it.The median VC-backed tech company with$1M in revenue has a profit margin of negative 286%.But as the YoY increases in burn settle near zero and revenue growth rates continue(albeit slower),companies continue to trend toward profitability.In fact,the median VC-backed tech company with$1M in revenue saw margins improve 119 percentage points since 2021.The trade-off of lower burn and higher profitability is slower growth.When companies burn less,they spend less on marketing and expansion that drive the top-line growth.Therefore,in addition to exogenous factors like a slower economy and lower spending on new tech,growth rates have fallen.Balancing growth and profitability is a tightrope all companies walk,but many have been falling off.The median Rule of 40 fell in 2022 and 2023,as growth rate declines outpaced the improvements in profit margin.But 2024 marked an inflection point;growth rates leveled out and profitability continued to improve,which means companies are generally operating with better Rule of 40 metrics.STATE OF THE MARKETS H1 202527Notes:1)Year over year revenue growth.2)Revenue corresponds to bins:$1M-$2.5M,$2.5M-$5M,$5M-$7.5M,$7.5M-$10M,$10M-$20M,$20M-$50M,$50M-$100M.3)Rule of 40 is equal to revenue growth rate plus profit margin.Source:SVB proprietary data and SVB analysis.201920202021202220232024$1M$2.5M$5M$7.5M$10M$20M$50M$100M$1M$2.5M$5M$7.5M$10M$20M$50M$100M0 0 1920202021202220232024-250%-200%-150%-100%-50%0P%Company RevenueProfitability has improved,but back at 2019-2020 levelsCash has always been king.But right now,most startups cash reserves would be lucky to be a prince.As investment remains subdued,companies are feeling the pinch.Most have cut where and what they can,but without investing in growth or being able to raise another round,startups have started to see their reserves dwindle.Median runway for US tech startups has settled at 12 months in 2024 the lowest level since 2019.Furthermore,61%of startups saw their cash runway decline from the previous year,the second highest share since 2016.For those that have been fortunate enough to raise cash,theyre raising far fewer months of runway compared to previous years.On a median basis,startups are raising nine months less of runway compared to the boom times of 2021.To be sure,some of this is supply driven with late-stage capital fleeing the ecosystem.It may also be demand driven,as startups have realized that all capital is not created equal,and there is such a thing as too much capital.However,there are a mounting number of startups that need to raise in the coming months.Its estimated that half of cash-burning US tech startups will need to raise in the next year similar to 2019 levels.While 2025 has brought more optimism that checkbooks will open,some companies are still likely to be grounded on the runway.STATE OF THE MARKETS H1 202528Notes:1)Data for 2024 based on Q4 data where applicable.If Q4 is not available,then Q3 is used.2)Cash runway raised determined by using current burn rates for companies with 100%increase in cash balance from the previous quarter and the company raised an equity round.Source:PitchBook Data,Inc.,SVB proprietary data and SVB analysis.0%5 %0HMonths of Cash Runway Bucket2019202020212022202320240 Mos.5 Mos.10 Mos.15 Mos.20 Mos.25 Mos.30 Mos.35 Mos.40 Mos.25th50th75th-14 Months-4 Months201920202021202220232024Share of Startups with Decreasing Runway YoYPercentile0 0Pp069121518212427303336201920202021202220232024Months Until Need to Raise55BTcXa%Q419Q420Q421Q422Q423Q424STATE OF THE MARKETS H1 202529Notes:1)Q4 used for each year except 2024 where Q4 is not available for some companies.In those instances,Q3 is used instead.Source:SVB proprietary data and SVB analysis.5776661215141215122333282327292019 2020 2021 2022 2023 20246998771318181514122534342524252019 2020 2021 2022 2023 2024710109971418191614142736372420222019 2020 2021 2022 2023 2024577644101313131082025292218162019 2020 2021 2022 2023 2024577755111414131192125282218162019 2020 2021 2022 2023 2024917131214151834262327293674514568812019 2020 2021 2022 2023 2024688876121617141312243333242424201920202021202220232024Consumer InternetFintechEnterprise SoftwareFrontier Tech$0-$10M$10M-$25M$25M-$50M$50M Median75th Percentile25th PercentileUS VC-Backed Startups711119991320221518212438392431352019 2020 2021 2022 2023 202471086981420181314142538322327262019 2020 2021 2022 2023 2024STATE OF THE MARKETS H1 202530 RETURN TO TABLE OF CONTENTSThe VC slowdown is testing startups resilience,particularly when it comes to managing debt.With less funding available,some companies are finding it harder to stay on track with repayments a trend that evokes parallels to the early pandemic period.Data suggests that at the end of 2023 and into 2024,more startups began having difficulty with debt repayments,a sign of financial trouble for these companies.While this peak has since eased,levels remain elevated,reflecting the ongoing adjustments many companies face in todays funding environment.For startups encountering financial strain,options are more constrained than in previous years.Acquisitions,whether full buyouts or tech-focused deals,have become less frequent.An increasing number of companies are winding down entirely.Bankruptcy filings in Silicon Valley are on the rise,underscoring the harsh realities of operating in a capital-constrained environment.Macro headwinds in the funding environment are creating a critical turning point for many companies.An increasing share of VC-backed startups is showing no growth or profit,forcing many to confront hard choices about their future.As the startup ecosystem contends with this wave of financial fragility,the question remains:How many will sink before the tide turns?STATE OF THE MARKETS H1 202531Notes:1)Two-quarter moving average.2)Data for 2024 includes Q1-Q3 only.“Other”outcomes are excluded,so each year does not sum to 100%.3)Silicon Valley includes San Francisco,San Mateo,Santa Clara and Alameda counties.Data includes bankruptcies across industries.Source:US courts,SVB proprietary data and SVB analysis.Borrower Winds DownBorrower Is AcquiredDistressed Debt ResolutionRefinanceLoan Amortizes FullyBorrower Raises Equity9095100105110115120Q1 22Q2 22Q3 22Q4 22Q1 23Q2 23Q3 23Q4 23Q1 24Q2 24Q3 24IndexLinear Trend Since Q1 220%5 %Q4 2018 Q4 2019 Q4 2020 Q4 2021 Q4 2022 Q4 2023 Q4 2024050100150200250300350400Q1 20Q2 20Q3 20Q4 20Q1 21Q2 21Q3 21Q4 21Q1 22Q2 22Q3 22Q4 22Q1 23Q2 23Q3 23Q4 23Q1 24Q2 24Q3 24Chapter 7(Liquidation)Chapter 11(Reorganization)No Growth and No ProfitNo Growth,No Profit and Less than 12 Months of Runway15#2)#!%9%7%2%4%7%5%7%8%5!$ 2020212022202320242018201920202021202220232024The herd of US VC-backed tech unicorns continues to grow,with few exiting,closing their doors,or taking a down round below$1B post-money.With the growth of the herd,so too comes growing demand for liquidity.Secondary markets and M&A activity may provide some liquidity to unicorns,but IPOs will need to play a key role as well.But the IPO bar is higher today,and few unicorns surpass it.According to Jordan Saxe,who oversees Nasdaqs listings in the Americas,to IPO“companies need high ARR(more than$300M-$400M NTM ARR)and good Rule of 40.”Many US tech unicorns are simply too small to be likely IPO candidates.Thirty percent of US tech unicorns have less than$100M in annual revenue.An even greater percentage are growing too slowly to be a compelling IPO.Nearly half of US VC-backed tech unicorns are growing slower than 15%annually.Profitability is also an important factor.“You need to be profitable or have a clear path to profitability.If not,you will not get a warm reception from investors,”Saxe said.Even if we consider IPO benchmarks to be relatively low:over$100M run rate for revenue,at least 15%YoY growth,and greater than negative 25%margin,only one quarter of the unicorn cohort are IPO hopefuls.But it is hard to know exactly what the benchmarks are today.They are certainly higher than they were in 2021,but few have exited to establish new benchmarks.Notes:1)Unicorn value is the last known valuation.Value of tech IPOs is the value at IPO.Source:SVB proprietary data,PitchBook Data,Inc.and SVB analysis.STATE OF THE MARKETS H1 202532Too Small:Revenue$100MToo Low Growth:Revenue growth 15%AnnuallyIPO HopefulsYears1%2%3%3%5%8%9%9%8%6%5%3%2%2%1%1%33456789 10 11 12 13 14 15 16 17 18 19 2010.3 Yrs.Average Age of UnicornsUnicorns Created in 2021All Other Unicorns10.6 Yrs.Average Age of a Tech IPO$2.4TCurrent Value of All US VC-Backed Tech Unicorns$1.3TValue of US VC-Backed Tech IPOs at Time of IPO Since 201015 yrs.of IPOs released less value than the current value of US VC-backed tech unicorns.75%pAd6Unicorns CreatedUnicorns Exited,Fallen,FailedTotal2015201620172018201920202021202220232024TotalEBITDA-25%Unprofitable:50100150200250300350400450500-900901802703604505406307208109009901080-100%00 0000P0%Down Round IPOsDespite most investors calling for a thawing of the exit market(including us),the IPO window barely cracked open a relative surprise considering US public markets were up 20% in 2024.1 While the 2024 IPO cohort wasnt mighty in numbers,it was mighty in clout.Seemingly forever-private social media platform Reddit finally went public after eyeing an IPO for years.Notable startups like Rubrik,Pony.AI and ServiceTitan also went public.So,what gives?Notably,of the seven US VC-backed tech IPOs in 2024,four of them were down rounds a popular narrative among the investor community of why some startups dont want to exit.While down rounds seem unpleasant,theyre not uncommon.Additionally,it is far from the whole story.Successful companies(such as Block)have taken down round IPOs only to soar past previous private high-water marks.Its also worth noting that with war chests still fairly full,most late-stage startups might not need the capital(even though investors would benefit from the liquidity).Despite this,still look for tech startups to test public waters should markets remain favorable.One additional wrinkle that may pressure startups to go public is IPO ratchet structures,which put startups on the clock to go public to minimize dilution impact should they trade below the hurdle price.Notably,both Block and ServiceTitan(both down round IPOs)had ratchet provisions.STATE OF THE MARKETS H1 202533Notes:1)Based on the S&P 500 price return from 12/31/2023-12/31/2024.2)Company names in order of left to right:Astera Labs,Rubrik,Ibotta,Reddit,Pony.ai,zSpace and Service Titan.Performance data as of 12/31/2024.3)Last private valuation.4)Metric as of 1,080 days post-IPO.Company names in order of appearance:Coupa,Cardlytics and Block.Source:PitchBook Data,inc.,S&P Capital IQ,S-1 filings and SVB analysis.IPO/LPV3Current MV/IPOMedian:Low PeriodMedian:High PeriodMedian OverallAverage OverallShare of Down Round IPOsIPO DayLPV3989x42,695x4738x4-30%-100P 1020112012201320142015201620172018201920202021202220232024Low PeriodHigh PeriodHigh PeriodLow PeriodSTATE OF THE MARKETS H1 202534Notes:1)Revenue growth determined using latest annualized quarterly revenue at time of IPO.If quarterly data is not provided,then the available time frame provided by the company is used.Earnings before interest,taxes,depreciation and amortization(EBITDA)margins determined using latest quarterly data at time of IPO.2)VC-backed determined using SVB analysis of previous equity rounds.3)Tech determined using SVB analysis and taxonomy.4)Revenue size determined using revenue level provided by PItchBook Data,Inc.Source:PitchBook Data,Inc.,S&P Capital IQ,S-1 filings and SVB analysis.201920202022-202320242021Bubbles Scaled to Revenue Size4-100%-50%0P00 0%000500%-150%-125%-100%-75%-50%-25%0%P%Revenue Growth YoYEBITDA MarginUberRobinhoodDoorDashMaplebearLyftAirbnbPalantirToastCompassAppLovinPelotonCoinbaseTuSimpleCompanies are scraping to the bone when it comes to exhausting all options before exploring an acquisition.At least thats what it seems.To start,companies are being acquired closer to the end of their runway.Median cash runway at time of acquisition fell 35%to just below six months,dropping for the first time since 2019.Financials tell a similar story.Pre-pandemic revenue growth hovered around 10%to 20%and EBITDA margins -80%to-100%at time of acquisition.Those figures(on a median basis)have slipped lower the past two years.In fact,revenue growth trends downward leading up to an acquisition.This is in stark contrast compared to the frothier times of 2020-2022.Revenue growth held fairly steady leading up to an acquisition,potentially suggesting that more deals were strategic rather than done out of necessity.In todays climate,more startups are likely forced to look for a new home and subsequently lose revenue sources leading up to that.Another data point that supports this thesis is the share of deals that report a valuation.Out of nearly 900 US VC-backed M&A deals done in 2024,only 18%disclosed a purchase price.1 While data may be backfilled as more information becomes available,its unlikely this number will reach peaks of previous years.In part,this is attributed to the fact startups are getting acquired for much less than what they raised and were valued at.See our previous analysis from last years State of the Markets here.STATE OF THE MARKETS H1 202535Notes:1)VC-backed determined using SVB analysis of previous equity rounds.2)Revenue growth determined by annualizing a companys revenue on its most recent statement.Source:PitchBook Data,Inc.,SVB proprietary data and SVB analysis.82uved%4.1 Mos.4.5 Mos.2.7 Mos.6.1 Mos.7.4 Mos.8.4 Mos.5.5 Mos.2017201820192020202120222023-2024-140%-120%-100%-80%-60%-40%-20%0%0 0 172020202120222023-202420182019Revenue Growth YoYEBITDA MarginRunway at PurchaseShare with Less than 12 Mos.Runway51PF%3371%4 Quarters Prior3 Quarters Prior2 Quarters Prior1 Quarter Prior2018-20192020-20222023-202420192024202220232020202131&06%$0.0T$0.2T$0.4T$0.6T$0.8T$1.0T$1.2T$1.4T200020022004200620082010201220142016201820202022202412s%With the growth of unrealized returns and limited exit activity,GPs,LPs and employees are hungry for liquidity.“Momentum is building within the ecosystem for alternative paths to liquidity,”says Eric Thomassian,Head of Private Company Relations at Forge Global.Enter secondary markets.GPs of venture firms are selling down positions to reduce exposure to bets placed in 2021,and to boost DPI before their next fund.In some instances,smaller GPs are selling off their entire portfolios.GPs at asset managers and hedge funds are using secondaries as an off-ramp for private exposure and reducing growth investing.Some LPs like family offices,pension funds and endowments are selling co-investments and fund interests.While employees are selling options.But the secondary market is challenging,with its limited price transparency,inefficient price discovery,extended settlement cycles,high transaction costs and stock transfer restrictions.That said,it is increasingly more transparent and accessible with the rise of secondary exchanges like Forge Global,Nasdaq Private Markets and others.Furthermore,the growth of VC-specific secondary funds creates more opportunities for transaction.While secondary transaction volumes are elevated,73%of investors have not participated in secondary markets.There is still a lot of opportunity for growth as markets become more liquid and efficiency improves.STATE OF THE MARKETS H1 202536Notes:1)Total unrealized returns in the US innovation economy as of year end;2024 data as of March 2024.2)Data smoothed using trailing six months.3)Pitchbook Data,Inc.survey of global venture investors from 2024.Source:Forge Global,Preqin,PitchBook Data,Inc.and SVB analysis.No,we do not participate in secondaries.Yes,we are buying through secondaries.Yes,we are selling through secondaries.050100150200250Mar.20Jun.20Sep.20Dec.20Mar.21Jun.21Sep.21Dec.21Mar.22Jun.22Sep.22Dec.22Mar.23Jun.23Sep.23Dec.23Mar.24Jun.24Sep.24-70%-60%-50%-40%-30%-20%-10%0 %Jan.21 Jul.21 Jan.22 Jul.22 Jan.23 Jul.23 Jan.24 Jul.2475%of funds since 2015 have a DPI less than 25%.37Marc CadieuxPresidentSVB Commercial BankSilicon Valley BEli OftedalSenior Analytics ResearcherSVB Market InsightsSilicon Valley BMark Gallagher Head of Investor CoverageSVB Commercial BankSilicon Valley BJosh PherigoSenior Analytics ResearcherSVB Market InsightsSilicon Valley BAndrew Pardo,CFASenior Analytics ResearcherSVB Market InsightsSilicon Valley BMarc Cadieux is president of Silicon Valley Banks commercial banking business where he focuses on the needs of innovation companies at all stages of development,including the investors who back them.Marcs career at Silicon Valley Bank,a division of First Citizens Bank,began in 1992.In the three decades since,he has held a variety of top credit and sales roles serving some of the worlds most innovative companies.Most recently,he served as chief credit officer,appointed in 2013,and oversaw credit policy and process,credit underwriting,loan approval and portfolio management activities.He is a strong advocate of bank initiatives to expand opportunities for those who are underrepresented in the innovation economy.He serves as an executive sponsor for the companys employee resource group focused on women employees.Mark Gallagher is the co-head of the investor coverage practice.He and his team provide tailored services,industry insights and strategic guidance to top investors in the innovation economy.Mark has served as a financial partner to venture capital firms and technology and life science companies for the majority of his career.During his 22-year tenure with SVB,he has been involved in a number of strategic projects and initiatives,most recently leading the corporate venture capital practice.Hes held numerous leadership roles including head of the Northeast technology banking practice,head of business development in New England and several years running the Northeast life science practice.A supporter and champion of the New England technology community,Mark serves as a board member for BUILD Boston and was formerly on the board of overseers for The Mass Technology Leadership Council(MTLC).STATE OF THE MARKETS H1 2025Jake Ledbetter,CFASr.Analytics ResearcherSVB Market InsightsSilicon Valley BSilicon Valley Bank(SVB),a division of First Citizens Bank,is the bank of some of the worlds most innovative companies and investors.SVB provides commercial banking to companies in the technology,life science and healthcare,private equity and venture capital industries.SVB operates in centers of innovation throughout the United States,serving the unique needs of its dynamic clients with deep sector expertise,insights and connections.SVBs parent company,First Citizens BancShares,Inc.(NASDAQ:FCNCA),is a top 20 U.S.financial institution with more than$200 billion in assets.First Citizens Bank,Member FDIC.Learn more at .Silicon Valley B See complete disclaimers on following page.2025 First-Citizens Bank&Trust Company.Silicon Valley Bank,a division of First-Citizens Bank&Trust Company.Member FDIC.38STATE OF THE MARKETS H1 202538The views expressed in this report are solely those of the authors and do not necessarily reflect the views of SVB.This material,including without limitation to the statistical information herein,is provided for informational purposes only.The material is based in part on information from third-party sources that we believe to be reliable but which has not been independently verified by us,and,as such,we do not represent the information is accurate or complete.The information should not be viewed as tax,accounting,investment,legal or other advice,nor is it to be relied on in making an investment or other decision.You should obtain relevant and specific professional advice before making any investment decision.Nothing relating to the material should be construed as a solicitation,offer or recommendation to acquire or dispose of any investment,or to engage in any other transaction.All non-SVB named companies listed throughout this document,as represented with the various statistical,thoughts,analysis and insights shared in this document,are independent third parties and are not affiliated with Silicon Valley Bank,division of First-Citizens Bank&Trust Company.Any predictions are based on subjective assessments and assumptions.Accordingly,any predictions,projections or analysis should not be viewed as factual and should not be relied upon as an accurate prediction of future results.Investment Products:Are not insured by the FDIC or any other federal government agencyAre not deposits of or guaranteed by a bankMay lose value2025 First-Citizens Bank&Trust Company.Silicon Valley Bank,a division of First-Citizens Bank&Trust Company.Member FDIC.39STATE OF THE MARKETS H1 202539
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