Some of us have been waiting for the other shoe to drop in financial markets since at least 2022. And yet they keep going higher, while bond prices tick lower. Will 2025 be the year there is a correction — or do high asset prices reflect a growing real economy that is on the verge of a major productivity boom because of AI, corporate tax cuts and a wave of deregulation?
No one knows for sure. But I will be looking at a few indicators in 2025 to tell me where financial markets are going. Most of them relate to the bond market, because it is both a window into the overall economy and an important component of how stocks and other risky assets are valued. Data for equities, commodities and currencies can be noisy. Bonds can give a sense of where everything is headed, including government policy.
The term premium. In my opinion, this is the single best gauge of the direction of the macroeconomy (and, by extension, financial markets): the difference between the yield on long- and short-term bonds. Unlike shorter-term bonds, which are highly influenced by monetary policy, longer-term bonds reflect the economic outlook. What happens to the term premium next year will be a good sign of whether markets are buying President Donald Trump’s growth agenda, or see it being stymied by the threat of tariffs, debt and high inflation. If the term premium increases, the 10-year rate will stay high — and higher for longer really means higher forever, which may cause some problems.
The term premium captures inflation risk and the worry that bond prices will fall further because of rising debt, a smaller population and what happens to the dollar because of possible tariffs. If the term premium continues to rise, it suggests more economic risk and uncertainty, and that the US is truly in a new economic era, marking the end of the halcyon low-rate days of the 2010s.
Because so many borrowers locked in low rates, higher rates have not been too damaging to the economy so far. But that could change fast. There are already cracks in the private credit market, with borrowers missing payments; homeowners are taking out variable-rate mortgages, hoping rates will fall eventually; and the prospect of unfunded tax cuts suggest this could all get worse. If the term premium continues to rise, 2025 may finally see the high-rate reckoning we’ve all been fearing. If it flattens, Trump will have much more space to enact his agenda.
French and German bond spreads. Long-term, the European economy is in trouble. Many eurozone countries are plagued with high debt, an aging population and low productivity. In the near term, however, the bigger challenge comes from the structure of the eurozone economy, which appears to offer an implicit subsidy to the bond market of more profligate European economies such as France, enabling them to punt on issues like pension reform. The Greek debt crisis showed the limits of this kind of promise. Rising spreads suggest markets are getting shaky and may be starting to doubt how much they can count on Germany (with its own problems) to keep things stable.
Argentine bond yields. Argentina is conducting an important economic experiment: whether it is possible to both lower inflation and produce growth by being more fiscally responsible and stabilizing its currency. If it succeeds, it will be a big win for neoliberal economic policies — despite President Javier Milei’s reputation as a populist. The measure of success will be whether the long-beleaguered Argentine bond market continues to inspire enough confidence that foreign investors come back, causing yields to fall. And if the Argentine bond market has a comeback, then maybe neoliberalism will too, and the world will see more trade and fiscal discipline.
Inflation expectations. The best indication about where inflation is going, which may be the most important economic fact of 2025, is what markets and individuals expect it to be. The Federal Reserve pays attention to expectations when it sets policy, of course, and they can also be self-fulfilling: If you expect 3% inflation, that might affect what kind of raise you ask for. Market expectations also can be self-fulfilling, and they have a big influence on bond prices.
Expectations are also a good indicator of whether the Fed has credibility and has truly licked inflation, or a higher rate of inflation is now a permanent feature of our economic lives. When the Fed says, “expectations are anchored,” it is normally referring to expectations from the bond market. And while the bond market does not have a great track record when it comes to predicting inflation, what it thinks might happen is still important. It is also useful to look at household surveys of inflation expectations, both the median and the dispersion, to see how confident people are about inflation risk.
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