Asset prices: vulnerable to correction if/as US growth slows

Asset prices reflect expectations of 2.7% economic growth in the US in the first quarter of 2025, with inflation returning to the 2% target. The strong growth outlook carries risk of asset price falls should actual data print below expectations. Equities price in the strongest growth and most benign inflation outlooks. Treasuries suggest US growth and inflation of above 2%. These market-implied views can help investors, including insurers, to identify potential market correction risks and guide hedging decisions.

Key takeaways

• Our analysis indicates that on aggregate, asset markets price US growth of 2.7% in 1Q 2025, with inflation above 2% target.

• Equity market expectations signal the strongest growth and lowest inflation outcomes one year out.

• Hence, relative to other assets, equity prices face greatest risk if correction if growth slows or inflation surprises to the upside.

• Treasury yields, meanwhile, still price for high inflation. As such,  yields may reprice lower if disinflation continues.

• Analysis of market-implied views can help inform insurers' asset-allocation decisions.

On aggregate, asset prices currently reflect expectations of continued strong economic activity in the US through 2024, with some assets even pricing for reacceleration towards the year-end. This differs from our baseline view in that while we do see still-robust growth in the US through this year, we also anticipate slowdown from current levels. It also highlights prospect of price corrections should growth indeed slow. On the inflation front, meanwhile, most asset prices reflect a return to the 2% target one year ahead. Understanding the growth and inflation outlooks as priced in by financial markets is information insurers can use in asset allocation decision-making. As a starting point, market expectations can be used to inform economic forecasts (or  revisions thereof). Market-based information can also help identify price correction risks and inform insurers' strategic investment or hedging decisions. And further, market expectations can be part of the component inputs for alternative scenario analysis.

Building on a technique developed by some banks, we have used principal component analysis and regression of the resulting data on GDP growth, inflation and 1-year ahead consensus expectations of both. While financial market-based instruments like inflation swaps reflect inflation expectations, there is no market-equivalent tool for GDP growth rates. By extracting the asset-implied growth and inflation rates through the same method, our approach ensures that the asset-implied view of the two variables is coherent and conform to the same assumptions. We compare the different asset-implied outlooks to identify potential mis-pricings in markets. Note that as asset prices are based on more than growth and inflation expectations alone, and also discount information beyond 2024, the approach helps identify big dislocations between asset prices and macro fundamentals only.

Our baseline view of slowing growth is different from that implied by asset market pricing. The analysis we have done here indicates that on average, asset prices on average imply a 3.4% q-o-q annualised GDP growth rate this quarter and 2.7% in 1Q 2025 (see Figure 1). Equities price highest, with implied 4.4% growth in the current quarter, suggesting that equity prices are more vulnerable to a correction than other assets in the short term, if growth falls short of this view. Notably, all assets other than the 2-year Treasury yield imply above-trend growth one year ahead, suggesting that most asset classes would be vulnerable to repricing should growth slow significantly. Traditional valuation measures like cyclically-adjusted price/earnings ratios paint a similar picture: those are elevated at levels above +1 standard deviation. Although below the +2 standard deviation observed in prior bubbles, this further indicates risk of valuation correction should growth slow.

Figure 1: US GDP real growth asset-implied expectations, current and one year ahead

For inflation, the average asset price implied reading suggests an inflation rate of 3.3% in the current quarter and 2.2% one year out (see Figure 2). This is similar to one-year ahead inflation swaps which, at the time of writing, suggest inflation at 2.3% in Q1 2025. Put differently, most asset prices point to inflation returning to the 2% target in one year. Of the different assets, in this case equities reflect the most benign view on inflation, pricing 2.1% currently and 1.8% one year out. US Treasury yields suggest still-above target inflation by 2025. The model hence suggests that Treasuries are better priced for an above-target inflation outcome, were that to happen, than equity markets.

Figure 2: US inflation asset-implied expectations, current and one year ahead 

In sum, we find that most assets seem priced for continued strong economic activity and a return of inflation back to the 2% target by 2025. Among assets, equities reflect the strongest growth and lowest inflation outlook. Meanwhile, Treasury yields seem better prepared to show resilience if inflation stays around current levels. Insurers may wish to consider a similar approach, since the market-implied method enables the direct comparison of market views on growth and inflation in a comparable manner. This can then be used to identify the assets that, relative to other assets, are susceptible to repricing, which aids in identifying potential market correction risks and guiding hedging decisions.