Fiscal to the Fore

How the budget battles in France, Germany and even South Korea fit with our fiscally focused investment themes for the year ahead.

Industrial policy and its fiscal implications loom large in our Solving for 2025 investment themes, published last week. Four of the five themes assume it will become a more important part of the economic landscape, as monetary policy takes a back seat.

But last week also brought home just how disruptive fiscal debates can be in these fractious times. The government of France was brought down over a cost-cutting budget, while South Korea’s brief and chaotic descent into martial law was ostensibly triggered by a budget stalemate. It’s been barely a month since Germany’s government collapsed due to a fiscal fight.

How do these events—alongside the likely policy trajectory of the incoming U.S. administration—fit with our fiscally focused themes for the year ahead?

Budget Drama

These political battles arguably fulfill one of our themes for 2024: “More fiscal policy dispersion.” A year ago, we argued that near-universal agreement on deficit spending to mitigate the impact of the pandemic would give way to more heated fiscal debates, with different countries taking different paths.

The politics can be messy.

In South Korea, the left-wing parliamentary majority had been trying to cut President Yoon Suk Yeol’s budget, which proposed a 3% rise in spending to help boost a weak economy. If that sounds counterintuitive, it’s because the tussle focused on extra money for agencies that parliamentary leaders argue are being used against them.

In France, a center-right government has been trying to tighten spending in the face of a 6% budget deficit and Greece-level bond yields. When a populist pincer movement from both the hard right and hard left opposed the cuts, the government chose to bypass parliament and trigger a successful vote of no confidence.

With no way of holding fresh elections until next summer, a new prime minister needs to be appointed and a new, less austere, budget tabled to gain majority support; otherwise, the likely outcome is a caretaker government authorized to decree tax and spending measures in line with the 2024 budget, resulting in tighter rather than looser policy, overall.

In Germany’s budget drama, Chancellor Olaf Scholz of the Social Democratic Party, wary of the rising electoral threat of the right-wing populist Alternative for Germany, argued that the country’s economic troubles justified the suspension of its constitutional “debt brake.” His finance minister, from junior coalition partner the Free Democratic Party, disagreed.

Scholz sacked the minister in November, and a vote of confidence in his government on December 16 looks likely to lead to new elections in February. Current polling suggests the outcome will be a grand coalition led by the center-right Christian Democratic Union. It is not at all clear that this would be a recipe for fiscal expansion—but it is notable that Joachim Nagel, the normally hawkish president of the Bundesbank, called for softer application of the debt brake last week.

Populist Wave

In contrast to this political and fiscal disarray, the U.S. will enter 2025 with a unified government, a strong fiscal impulse and a mandate to boost domestic industry. The new administration under President-elect Donald Trump also looks set to be fully staffed and more organized than the one in 2017.

But that doesn’t mean everyone will be pulling in the same direction. While Trump appears primarily focused on trade policy and tariff negotiations, his pick for Treasury secretary, Scott Bessent, reportedly has a “3-3-3” plan to raise U.S. oil production by three million barrels a day, achieve 3% GDP growth and cut the budget deficit to 3%.

Achieving all those goals will be a challenge. Halving the deficit while possibly extending tax cuts will require tough debates about what to cut from the Inflation Reduction Act, the CHIPs and Science Act and other parts of the previous administration’s industrial policy. Agreement is not guaranteed, given the benefits many Republican constituents accrue from these policies, as well as the populist wave that took Trump to the White House.

On balance, we think it is likely that the U.S. fiscal and monetary stance will end 2025 looser than it is now, but we could see competing fiscal factions emerge among Congressional Republicans even before midterm elections complicate things further in 2026.

Investing Themes for 2025

That U.S. tilt toward industrial policy, populism and fiscal largesse informs our two macro themes for 2025: We think the U.S., at least, will achieve above-trend economic growth, and that its new government will strive to reward its voters by boosting the real incomes of smaller companies and the less wealthy.

It is also central to our fixed income theme, where we think investors’ focus will move from the impact of monetary policy to the impact of fiscal policy—initially the impact on growth and later the impact on government debt sustainability. Should that play out, expect the recent volatility at the front end of the yield curve to migrate to longer tenors.

Things get a little more complex with our equity theme, where we continue to anticipate a broadening of both earnings and share price performance beyond U.S. mega-caps.

A loose fiscal stance in pursuit of industrial policy is likely to be positive for smaller, cyclical and value stocks in the U.S. Elsewhere, we see more of an active-management opportunity, as macro and policy disadvantages relative to the U.S. could depress the valuations of fundamentally strong companies. Moreover, for U.S. dollar-based investors, hedging currency exposure could add its own substantial return, given the current divergence of interest rates.

For a broader uplift in non-U.S. markets, however, we think clearer alignment behind industrial policy and a resolution of legislative stalemates may be necessary—Germany suspending its debt brake or China choosing to stimulate rather than merely stabilize its economy, for example. The extent to which we see that could be a key determinant of global market performance in 2025.