2025 year-ahead US outlook: Macro, equities, RMBS, CMBS, and CLO insights

1. Post-2024 US election markets broadly followed the 2016 playbook with equities outperforming Treasuries and yield curves steepening due to fiscal policy expectations. Rising federal debt and servicing costs may limit fiscal flexibility.
2. Strong fundamentals and earnings growth are supporting US equities, but high valuations and narrowing equity risk premiums present risks. Small-cap earnings growth is expected to outperform in 2025. Growth broadens to the S&P 493 as Mag-7 dominance declines.
3. The housing market is recovering slowly, supported by Fed rate cuts, though challenges like tight supply, affordability and potential volatility from the new administration’s policies and GSE reforms.
4. Optimism in the CRE market and CMBS issuance continues, driven by Fed easing and improved sentiment, despite elevated office distress and maturity risk. CLOs had a strong 2024, with ongoing demand in 2025 supported by floating-rate investments, though risks remain tied to broader economic conditions and evolving monetary and fiscal policies.

The yield curve began disinverting and steepening in early-2024, as the Fed pivoted towards easing policy. Rapid growth in the U.S. Treasury market since 2016 may help explain why the yield curve has steepened, and the 10-year term premium has increased in 2024.

Substantial increases in the stock of U.S. Federal debt, and higher rates, have combined to deliver a rapid increase in U.S. debt service costs and begun to transform government finance. Debt service costs are close to $1 trillion per annum – one of the largest items in current expenditure on the Federal budget. U.S. fiscal deficits may serve as a constraint on the scale of the tax cuts proposed by President-elect Trump in the election campaign, and future infrastructure spending.

Despite higher rates, U.S. equities are supported by a constructive backdrop, driven by strong fundamentals, expanding profit margins, and broader earnings contributions from the 'S&P 493' in 2025. However, this optimism is tempered by elevated valuation levels, a narrowing equity risk premium, a potential 'higher for longer' rate environment, and uncertainty around tariffs. The rest of the world trades at a substantial discount to U.S. equities, with valuations near an all-time high and the narrowest equity-to-bond yield spread in nearly two decades.

The 2025 outlook for S&P 500 earnings and revenue growth is promising, with earnings expected to grow by 14.1% and revenue by 5.6%, marking the third-best year in over a decade. Analyst estimates forecast that small-caps will outperform large-caps, with Russell 2000 earnings expected to grow by 43.7%.

Along with a strong earnings outlook, we also see a case for companies being able to effectively manage profit margins in an uncertain economic environment, supported by positive operating leverage and sales growth exceeding input costs. In anticipation of upcoming tariffs, we calculate that approximately 60.8% of S&P 500 revenues are generated domestically, while 39.2% come from international sources. Since 2020, Industrials has seen the largest number of transcripts mentioning 'supply chain' or 'reshoring,' followed by Information Technology, Consumer Staples, and Consumer Discretionary.

Attempts to determine a straightforward relationship between US government policy prescriptions, and the fund asset classes and sector they impact, fail. For example, alternative energy investments have done well under the previous Trump administration, and have bombed under Biden. The reverse was the case with traditional, oil and gas-laden energy funds. Drawing on the wealth of LSEG Lipper fund data, it’s clear that the relationship between policy and returns has been at best contingent over the past three administrations, argues Lipper Research, and there is no strong reason to believe that this time will be different.

Residential Mortgage-Backed Securities (RMBS) suggests a gradual recovery in the housing market, with modest increases in issuance and a slow improvement in inventory, alongside with existing home sales. Prepayment speeds are expected to pick up slightly, driven by the Fed rate cuts and the resulting media effect. While challenges such as tight housing supply and affordability issues will persist, the overall market is expected to show incremental improvement in 2025.

At the same time, we also expect to factor in the uncertain environment for the housing market, which may impact issuance, mortgage rates and existing home sales, stemming from the new administration's economic policies. These policies, including potential changes to tariffs, inflation, and the easing of construction regulations, could create additional challenges and volatility in the market. Additionally, the potential GSE reforms could introduce further market unpredictability, affecting prepayment speeds and issuance trends for both conventional and GNMA securities.

Commercial Mortgage-Backed Securities (CMBS) saw a dramatic rebound of private label CMBS issuance in 2024 and massive tightening of spreads on the back of sustained cooling of inflation and the kickoff of Fed easing cycle. CRE market sentiment improved significantly despite elevated distress in maturity refinance and office fundamental. We are bullish on CRE and CMBS market for 2025 as the Fed continues the easing cycle and the soft landing remains the base case for the economy but would be cautious on the risk of sticky inflation, new administration policies, and hotter than expected jobs data, which may cause disruption and turbulence for CRE fundamentals and financing conditions.

Collateralized Loan Obligations (CLO) had a banner year in 2024, and we see a lot of market optimism for CLOs. While the strength of the market is poised to carry over to 2025, the new year will ultimately be shaped by the economic trajectory and evolving monetary and fiscal policies. We expect credit condition to be steady or improve under the baseline scenario, which would be supportive to continued growth in CLO issuance and spread tightening. On the other hand, the stress scenario may sour investor sentiment and pressure corporate profit margin and interest coverage ratio. However, the higher-for-longer rate environment could benefit CLO demand as floating rate investments retain their appeal, mitigating the downside risk.