Monthly House View - February 2025 - Download here 

The financial market adage, “buy the rumour, sell the news,” underscores the market’s tendency to stay one step ahead. It consistently anticipates future events, though with varying degrees of accuracy. Since the Federal Reserve (Fed) began lowering its key interest rates last September, US 10-year Treasury yields have actually risen by one point, from 3.6% to 4.6%. This reflects the market’s initial expectation of monetary easing, which has now shifted towards anticipating higher future inflation, an increased risk premium on long-term bonds tied to future growth, the implementation of tariffs and the debt burden. This shift is part of a broader adjustment in yields. One notable exception is China, which is experiencing structural economic slowdown and struggling to generate price increases.

 The main concern for investors is inflation. Although it has decreased globally, from over 10% at the end of 2022 to 4.4% today, it remains difficult to bring it down to the 2% target desired by the major central banks. It is quite complicated to predict how the wind will blow in the United States, considering the opposing effects expected from the implementation of inflationary tariffs and the increase in oil production, which, conversely, should lead to lower prices. 

One thing is certain: public debt is on the rise! Governments, faced with ageing societies, increased defence spending, and the energy transition, must also contend with populist resistance to spending cuts. This climate has forced Justin Trudeau, the Canadian Prime Minister, to resign and has also caused governmental instability in France. In the United States, a budget battle looms, with a new president advocating for tax cuts, despite an already high deficit of around 7% of GDP. 

The debt-to-GDP ratio of major wealthy economies is approaching 100%, a threshold where a one-point increase in bond yields could cost 1% of GDP annually. This represents more than half of current European defence budgets. Growth is therefore necessary in the debt reduction equation, but at what cost? It is a fact that US productivity has increased by 10% in five years, fuelling American growth. Developments in artificial intelligence (AI) could further boost it. However, as fires in California rage at the time of writing, a turning point in history is being reached. In January, bills aimed at reducing water and electricity consumption for data centres and AI were proposed in California. Until now, agriculture has been the main target of these restrictions, but in the future, AI will increasingly be in the spotlight due to its high-water consumption. The United States currently hosts over 5’000 data centres that require significant amounts of water for cooling as much of the energy they consume turns into heat. California alone has nearly 300 data centres (in comparison, the entire country of China has about 450) that consume several million cubic metres of water annually. Even if no longer driven by political conviction, the realisation that the fires in California could cost the United States up to one point of GDP means that the energy transition is still partly in motion for economic reasons. 

In an environment where all countries exporting to the United States could potentially be affected by tariff increases, and with Donald Trump’s possible rise to 25% on imports from Canada and Mexico potentially adding up to one point of inflation in 2025, this edition takes a contrarian view to the prevailing pessimism about Europe. We offer an analysis of the catalysts that could reignite the Old Continent.

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_{Monthly House View, 24.01.2025. - Excerpt of the Editorial}