The global economic landscape is on the cusp of significant changes. There are signals pointing to the potential end of a period of "U.S. exceptionalism", driven by simultaneous private and public sector credit booms in the U.S. This exceptionalism has sustained faster U.S. growth compared to other economies, but there are signs it may be running out of steam.

One of the primary concerns is the growing U.S. budget deficit, which is straining bond markets and pushing yields higher. Rising yields could tighten borrowing conditions for both the private and public sectors. Additionally, weakening bond markets reduce the value of available collateral in the financial system, potentially limiting leveraged borrowing by financial institutions. This constraint on credit expansion could lead to a notable deceleration in U.S. growth as interest rates climb.

However, policymakers are unlikely to let bond markets weaken without a fight. Recent rallies have been driven by liquidity injections through quantitative easing (QE) and drawdowns of government cash balances. This ongoing dynamic—where market forces push yields higher while policy measures attempt to suppress them—is likely to persist in the coming months, making the timing of a potential turning point uncertain. While the U.S. credit expansion may slow by mid-year, market volatility is expected to remain elevated.

Meanwhile, China's credit-driven growth model is also showing signs of strain, particularly in the housing sector. Although some economic indicators improved in early Q4 2024, the broader environment remains fragile. Savers pulling funds from banks could restrict the financial sector’s ability to support property developers and other industries. If both the U.S. and China experience economic slowdowns simultaneously, global growth prospects may weaken significantly.

What this could mean for portfolios

Investors should be mindful of market positioning risks. U.S. Treasury yields could rise toward 5.5% before policy measures drive them lower again, creating tactical opportunities. The U.S. dollar may face near-term softness before strengthening on capital repatriation, but could weaken later in the year if the U.S. economic momentum slows significantly.

In equities, yield assets that are less widely owned could outperform, similar to the dynamics seen in the 2000 recession. European equities, particularly in competitive industries, may become more attractive if the European Central Bank resumes QE. Overall, investment strategies that account for potential recessionary conditions, avoid crowded trades, and prepare for renewed central bank intervention could prove beneficial.