Prepare for unadulterated data dependence. We still see signs that policy rates are restrictive and expect the Fed to cut rates in 2025. But the pace will slow as the Fed searches for the ever-elusive neutral rate. Our baseline scenario expects rate cuts to 3.50%/3.75% (3.25%/3.5% in our prior base case) and  the 10-year U.S. Treasury yield ending the year at 4.45% (4.35% prior).

We anticipate a substantial increase in tariffs on Chinese imports, from 20% to 50%, which prompts us to raise our U.S. core inflation outlook by 0.2% for 2025 and 2026. Tariffs and industrial subsidies provide short-term barriers to further global supply chain integration and a long-term tailwind for building industrial capacity domestically (and/or with U.S. allies).

After an outstanding two-year run, we expect total returns to moderate in 2025. We are cautiously optimistic relative to consensus. Consider adding market beta on pullbacks, and in the meantime focus on thematic (AI, global security) and sector alpha (industrials, utilities, financials and tech) opportunities. We continue to favor U.S. investments over the rest of the world.

High volatility in fixed income markets will likely continue, with core bonds offering sub-optimal diversification from stocks. To enhance income and strengthen portfolio resilience, consider municipal bonds, go-anywhere fixed income funds, and alternative income sources such as infrastructure and real estate.