Late cycle dynamics played out during 2024, with positive but diminishing growth expectations amid rising probabilities of a future recession absent any significant fiscal and monetary stimulus by major governments. In our House view central-case scenario we expect global economies to continue to show growth albeit small with different speeds within regions. We anticipate only a modest rebound in Europe compared to higher growth momentum in the US, with select emerging markets outperforming while inflation remains contained.
Despite elevated rate volatility, predominantly in 2H24, on the back of frequently changing market expectations of Fed rate cuts, both the implied and realised equity volatility in 2024 has been significantly lower across DMs than in 2023, largely as a result of the rise of call overwriting strategies and zero-day options trading, which serves a broader structural dampening effect on overall volatility, as positive dealer gamma levels minimise price moves.
Although we expect the structural downward pressures on volatility to persist, several factors point to broadly higher volatility levels and more frequent bouts in 2025. We believe uncertainty around the US fiscal strategy and the effect Trump’s tariffs will have both on the broader effort to contain inflation and their effects on major economies to be the main source of volatility going forward especially in the first half of 2025. The new administration’s efforts to streamline the government and manage the excessive rise in the deficit, in tandem with the normalisation of previous month Job data revisions to make it increasingly harder to gauge the health of the underlying economy and will likely be a significant source of volatility.
Current signs of euphoric trading and large concentration in tech stocks amid overstretched valuation pose increased drawdown risks, and elevated contagon risks to other regions due to the growing relative size of the US market. Periods of elevated interest rates also tend to be followed by volatility spikes while we believe the extremely tight credit spreads aren’t reflecting the rise in loan delinquency rates over the last year. In addition, resurging sings of stress in funding markets have started to appear as market liquidity has been decreasing.
We expect the political uncertainty in major European countries to persist in 2025 and continue to be a source of volatility in the region and although Trumps anti-war stance would suggest lower geopolitical risks ahead, escalation of the Russo Ukrainian war, broadening of the Middle Easter tensions, and expectations of renewed oil sanctions on Iran suggest otherwise.
Relative volatility in Europe should remain elevated vs the US, especially in the first half of 2025 due to the ongoing political instability, proximity to the ongoing conflicts in Ukraine and the Middle East and more susceptibility to US tariffs. Given our downgrade of Germany to underweight, we propose DAX June25 19000/18500 put spreads costing 0.3% of underlying. Should the price tick through our price target, the strategy would return 7x on net premium employed.