After experiencing turbulent years, the global economy is trying to find a new balance.

In 2025, the global economy is not in a position of high security. A series of interconnected risks are brewing, which could pose a severe challenge to global stability. The possibility of a trade war looms, the ghost of inflation has not yet been completely laid to rest, and coupled with potential fiscal crises, stock market bubbles, and geopolitical tensions, the world economy is at a critical crossroads.

Preparing ahead is the key to winning thousands of miles away. Although predicting the future is not an easy task, identifying potential risks and being prepared to respond is crucial.

Risk 1: Global Trade War

Key trigger factors: Other countries respond strongly to U.S. tariffs.

Currently, many Analysts have assumed that the incoming Trump administration will impose hefty tariffs on U.S. imports, but retaliatory measures from other countries may aim to avoid escalating tensions with the U.S., consistent with the first Trump administration, which means that global trade volume will increase next year (albeit moderately).

The risk is that the tariffs implemented by the Trump administration may exceed the 10% universal tariff assumed in market predictions and the 60% tariff on imports from China.

Most importantly, other countries may respond in a way that prompts the USA to take further protectionist measures. For example, the EU may respond more aggressively to tariffs by targeting American Technology companies. Additionally, these countries allowing their currencies to depreciate against the dollar could be interpreted by Washington as an attempt to 'evade' tariffs, leading to the implementation of additional protectionist measures. This could result in a global trade war, and although this trade war may take various forms, in extreme cases, it could cause a 2-3% decline in global GDP.

Risk 2: Inflation rising again.

Key triggering factors: global tariffs universally increased; Trump implementing restrictions on immigration; expansion of US fiscal policy.

In the core forecast of Caixin Macro, the bank's Analyst assumes that higher tariffs will push US inflation to 3% next year, but this is best interpreted as a 'one-time' increase in price levels.

All else being equal, inflation may continue to decline without raising significant concerns for the Federal Reserve. Inflationary pressures in other major developed economies are expected to continue to ease next year, thanks to the normalization of the labor market, but some upside risks still remain.

The first risk is that other countries may respond to the US's shift towards protectionism by aggressively raising tariffs, thereby driving up global inflation (but this could also be a one-time event, and its impact on inflation should again be temporary).

Another risk is that measures to restrict immigration may lead to labor shortages and price pressures in industries reliant on immigrant labor. Although Caixin Macro expects the overall acceleration of inflation resulting from this may not be significant, only a few percent in developed economies, it is enough to slow down the pace of policy easing by central banks.

Finally, if developed economies postpone plans to tighten fiscal policy, the result could be a larger budget deficit than the market predicts, as well as a higher potential inflation rate.

Risk 3: The Federal Reserve may raise interest rates again.

Key triggering factor: Rising inflation.

Wall Street expressed dissatisfaction with signs that the Federal Reserve's rate cuts next year may be lower than expected, but according to Torsten Slok, Chief Economist at Apollo Global Management, 'Strong economic performance, coupled with potential tax cuts, higher tariffs, and immigration restrictions, increases the risk that the Federal Reserve may raise interest rates in 2025. We believe the probability of a rate hike in 2025 is 40%.'

In fact, the economy is so strong that the Commerce Department upgraded the third quarter's economic growth last week to 3.1%, up from the previous estimate of 2.8%, and higher than the 3% in the second quarter, indicating an acceleration in GDP.

The estimates for the current quarter show no signs of slowing down. The Atlanta Fed's GDPNow forecast indicates that economic growth in the fourth quarter will again reach 3.1%. Slok pointed out that the latest estimates are well above the Congressional Budget Office's long-term growth forecast of 2%.

Meanwhile, President-elect Trump promised during his campaign to cut taxes, raise tariffs, and crack down on illegal immigration, measures that are generally seen as exacerbating inflationary pressures.

Since inflation remains stubbornly above the Federal Reserve's 2% target, these policies may limit the central bank's room for further rate cuts after reducing rates by 100 basis points to 4.25%-4.50% this year.

In their economic forecasts for next year, Federal Reserve officials seem to have taken these actions into account, as they have not made similar adjustments to growth and unemployment rate expectations while significantly raising inflation forecasts.

Other individuals on Wall Street also believe that the Federal Reserve will adopt a tougher stance next year. Market veteran Ed Yardeni noted in a report that it is more likely there will be only one interest rate cut next year, or possibly no cuts at all.

The so-called 'neutral interest rate' (the level that neither accelerates nor slows economic growth) remains uncertain, and Analysts are evaluating whether the economy can now withstand tighter monetary policy than before.

Yardeni's research report states, 'We believe economic growth will far exceed the Federal Reserve's expectations, therefore the neutral interest rate is above 3.0%, possibly close to 4.5%-5.0%. If real GDP growth exceeds the Federal Reserve's expectations, as we anticipate, then the FOMC may pause interest rate cuts for some time.'

Risk 4: Fiscal Error in the USA.

Key trigger factor: Trump attempts to promote additional deficit financing tax cuts in the USA; it is widely believed that the fiscal defenses of developed economies are weakening.

In this regard, the fiscal situation of several developed economies that will be confronted with next year will test the patience of the bond market to its limits.

Although markets assume that these developed economies will not over-leverage, thereby triggering a fiscal crisis, this may be a mistake. The fiscal situation in France is clearly concerning; merely forming a government capable of passing a budget next year seems to be a challenge. However, in terms of fiscal sustainability, ideas and policies are equally important.

Therefore, whether a fiscal error occurs may largely depend on what the government says rather than what they do. If the current government gives the impression that their commitment to long-term fiscal discipline is weakening, or that they are determined to push through additional deficit financing tax cuts or increase spending, then the bond market's reaction could be swift and severe.

A key risk in this regard is the incoming Trump administration pushing for additional tax cuts financed through higher borrowing, without regard for market concerns about medium-term fiscal sustainability. This will threaten a sharp rise in bond yields and an accompanying tightening of financial conditions.

If the government concedes to market pressure, it may be temporary. However, if market volatility is severe, it could still expose hidden vulnerabilities in the financial system. If a crisis triggered by fiscal issues leads to a breakdown in something within the financial system, the macro consequences will be even more serious.

Risk 5: Global recession.

Key trigger factors: "Breakdown" of global supply chains; US fiscal missteps; unexpected interest rate hikes by the Federal Reserve.

Economists will naturally focus on the downside risks to growth, but Capital Economics predicts that 2025 could be a year where economic growth stars align.

While tariffs may push up inflation rates in the USA next year, inflation rates in other major economies may fall back to the 2% target. This will ease pressure on households' real incomes. Meanwhile, bank lending, which has been notably weak over the past year, may recover after interest rates decline.

Since most economies are at or near full employment, any positive unexpected growth would require supply-side improvements in the world's major economies, which are difficult to predict but not impossible.

In developed economies, this requires the acceleration of productivity growth experienced in the USA in the first half of 2024 to be sustained and spill over into other major developed economies.

Capital Economics has raised its forecast for Global GDP growth in 2025 from around 3% to nearly 4%. This requires many things to go smoothly, and any downside risks mentioned above must not materialize. However, the possibility of improved growth in 2025 is a useful rebuttal to the pessimism that has emerged among some commentators in recent months.

Risk 6: Stock market bubble burst.

Key trigger factors: disappointing performance from large Technology companies; slowdown in AI promotion.

Capital Economics' view is that 2025 will be another good year for US Stocks.$S&P 500 Index (.SPX.US)$It is expected to reach 7,000 points, but this depends on the idea that while AI will ultimately bring significant macroeconomic dividends, the bubble around Technology stocks is still inflating as investors try to capture the benefits before AI technology bears fruit in the real economy.

Capital Economics judges that there is still room for further expansion of the current US stock bubble, but it may burst earlier than we expect. The bursting of this bubble will be a striking event, but its macroeconomic consequences could be surprisingly limited. Through the wealth effect, Consumer spending will be impacted, but this may be relatively small. Business investment will be affected, but this is not the main driver of economic growth in the USA. GDP may stagnate for several quarters, but the recession that many might expect as a result is not inevitable. This will be frustrating for stock investors. However, if the stock market bubble bursts in 2025, it will become the most notable market event of that year, but perhaps not a macroeconomic event.

Risk 7: Energy surplus.

Key triggering factors: OPEC+ increasing production and rising output from other non-OPEC+ countries.

Currently, most of the market's attention is focused on the downside risks to global oil supply: the potential for Israel to attack Iranian facilities; the prospect of the USA imposing stricter sanctions on Iran; and the threat of further disruptions to Middle Eastern shipping routes. However, a greater risk may lie in the opposite direction: global oil supply could increase significantly next year.

In recent years, OPEC+ has been limiting supply in an attempt to support prices, but this strategy has not achieved the expected results. Brent crude oil prices have fallen from around $85 per barrel at the end of the first quarter to about $73 per barrel. This is far below the levels needed for major OPEC+ members to balance their budgets and current account positions. Saudi Arabia's budget balance is currently around $90 per barrel. This increases the likelihood that Saudi Arabia and other influential OPEC+ member countries may shift their strategy from trying to support prices to competing for market share from high-cost producers.

In other words, 2025 could be a year of increased production for OPEC+. If this group increases output, oil prices could plummet. The impact on the rest of the world will be reflected in energy prices and inflation. If oil prices fall to $60 per barrel, inflation in developed economies could decrease by 0.2 percentage points. If oil prices drop to $40 per barrel—which sounds extreme but is not impossible—then inflation rates in developed economies could fall by about 0.4 percentage points. This would support real household income, especially in major energy-importing countries like Europe.

Risk 8: Global conflicts persist.

As the Russia-Ukraine conflict approaches its fourth year, the likelihood of Ukraine achieving military victory over Russia is decreasing, and there is an increasing willingness to resolve the conflict through diplomatic means. The incoming Trump administration has promised to facilitate a ceasefire between Russia and Ukraine, raising hopes that the conflict may end by 2025, although Ukrainians are cautious about the potentially high political costs.

However, facilitating and enforcing any lasting ceasefire will be extremely challenging. The Kremlin's initial objectives remain unchanged.

However, a ceasefire in Ukraine will not lead to meaningful and lasting improvements in relations between Moscow and the West.

For the Middle East, it is noteworthy that a core element of the Trump administration's Middle East strategy is the belief that Iran is the primary source of instability in the region.

Former officials of the Trump administration argue that if their successors continue, their 'maximum pressure' campaign will succeed. They claim that the Biden administration's attempt to revive the nuclear agreement, restore Iran's oil exports, and ease economic pressure on the government has led Iran to support Hamas attacks on Israel and Houthi disruptions to shipping in the Red Sea.

Increasing pressure on Iran will be a top priority of Trump's foreign policy. The challenge for Americans and Iranians is to understand the goals of this pressure and the conditions for lifting it. A potential goal is regime change, achieved through imposing substantial economic pressure to the point of government collapse.

Another goal may be negotiation, placing Iran in a vulnerable position so that it abandons its nuclear program and support for regional proxies. Each goal is ambitious.

In this process, Iran will likely attempt to remind the USA and the world that it has the ability to cause destruction and suffering. For 45 years, Iran has invested in developing asymmetric tools to counter stronger nations. Unable to match the military capabilities of the USA and its allies, Iran has developed proxies. Nuclear deterrence is another potential avenue for creating a level playing field against stronger opponents. The downfall of the Assad regime in Syria weakened Iran's power but also provided Iran with opportunities for constructive engagement with the West.

Although newly elected Iranian President Pezeshkian expressed interest in resuming negotiations with the USA, he does not control the security apparatus. Even so, it remains unclear whether he will support mediation at all costs. Trump will seek measures similar to Iranian capitulation. Even if he ultimately succeeds, with increased pressure, Iran may retaliate in some manner.

Additionally, although Trump may not provide more help to Israel than Biden, the pressure he applies will be lesser. This is particularly true for the long-term outcomes of humanitarian aid, reconstruction, and governance in Gaza. Netanyahu appears to prefer a longer-term occupation rather than withdrawal, which the USA is unlikely to strongly oppose.

However, given Netanyahu's recent successful gamble, Trump's presidency may make him feel empowered to take dramatic actions. Iran is likely to be the most probable target, but not the only one. An already seemingly extensive regional war may escalate further. Although Trump's aversion to war makes it less likely he would initiate such efforts, US support for Israel may make the USA a target and draw it into conflict.

Risk 9: Is the dominance of the dollar being lost?

Key triggering factor: The USA has repeatedly 'weaponized' the dollar for financial sanctions.

As Trump returns to lead the world's largest economy, he threatens to punish countries that diverge from the dollar.

Trump's threat to impose a 100% tariff on countries that no longer use the dollar seems to be a significant deterrent. However, currently, few countries rely 100% on the dollar for international payments, so it remains unclear what 'abandoning the dollar' actually means.

Furthermore, major players do not intend to completely abandon the dollar. Instead, some countries are seeking to establish alternatives to the dollar, primarily motivated by concerns over the weaponization of the dollar through sanctions and tariffs. A key question is whether the threat of imposing further sanctions or tariffs on countries already affected by such policies will have an effective deterrent effect.

An important milestone is whether Trump facilitates a lasting ceasefire between Russia and Ukraine. If this includes lifting some financial sanctions against Russia, Moscow may deprioritize its de-dollarization efforts. As trade disruptions diminish, some domestic participants in Russia might resume using Western currencies. However, this would not alter the Kremlin's long-term strategic goal of developing alternatives to what it considers outdated, Western-dominated global governance, which is based on mitigating the impact of potential sanctions in the future.

India also has its own agenda aimed at promoting the rupee's increased usage in cross-border trade and finance. Some Analysts believe that New Delhi may neither advance nor scale back its direct settlement initiatives with the UAE or the local currency trade mechanism with Russia, including purchasing Russian oil with UAE dirhams. Aside from pushing for the rupee against the dirham, the Indian central bank is also revisiting expanding local currency trade with Russia, but there are concerns about US retaliation.

Risk 10: Turmoil in great power politics.

After the ruling coalition of the Liberal Democratic Party and Komeito lost their majority in the House of Representatives in the October elections, Japan's domestic politics will begin 2025 with an unstable balance. The current Prime Minister Shigeru Ishiba will lead a minority government with the informal support of the People's Democratic Party, which will demand policy concessions to help pass the fiscal year 2025 budget and other legislation.

The Liberal Democratic Party may seek to replace Shigeru Ishiba before the July Senate elections. If the ruling coalition loses its majority in the Senate, Japan may face a legislative stalemate similar to the 'twisted Diet' of 2007-2009 and 2010-2012. However, if the fortunes of the Liberal Democratic Party improve, a double election may be held to restore the majority in both houses of the Diet.

There is also uncertainty in foreign policy. Tokyo will be encouraged by Trump’s recent positive comments about Japan, as the US-Japan alliance is stronger in military cooperation than ever before. However, potential pitfalls loom, including the impact of Trump's plan to impose tariffs on Japanese Auto Manufacturers and the possibility of demanding higher payments from host countries before the current agreement expires in 2027. Compared to former Prime Minister Shinzo Abe, Shigeru Ishiba lacks diplomatic experience, and his close relationship with Trump exacerbates this issue.

In South Korea, Yoon Suk-yeol's declaration of a state of emergency in December has triggered an impeachment process, potentially leading to an unscheduled presidential election in 2025, while profound political polarization will continue to cause friction regarding the budget and other legislation. Trump's tariff threats pose a risk to exporters of South Korean Autos, electronic products, and other advanced commodities, and past precedents suggest that Trump may demand a significant increase in host nation payments to maintain the current US security commitments. The weakening of the US-South Korea alliance in 2025 may prompt Seoul to reconsider establishing its own independent nuclear deterrent.

In Germany, after the infamous internal strife of Olaf Scholz's 'traffic light' coalition collapsed, German voters will face early elections. The voting will be seven months earlier than the usual September date, but from a political perspective, the campaign has already been delayed by three years.

The balance between structural reforms and domestic investment, and between transatlantic relations and strengthening European military cooperation, has been evident since 2021, and these issues will ultimately become focal points in Germany's 2025 elections. Polls have long predicted that Friedrich Merz and his center-right Christian Democratic Union will win, but the severity of the challenges Germany has faced over the past three years may still impact the final stages of the campaign.

Regardless of who the Chancellor and the coalition government may be, the policy outcome in Germany has been made clear, and despite expectations of a revival of right-wing politics, Germany will continue to abandon its traditionally prudent fiscal policies to promote domestic investment while taking on greater responsibilities in Europe.

Editor/Rocky