The first full week of 2025 is now in the bag, and what a nervy week it was! It felt fragile all week, but investors in both stocks and bonds completely capitulated on Friday morning following the release of an unexpectedly strong US jobs report for December (here). US yields marched higher (again) and stock futures sold off before the open, as investors increasingly recognise that inflation will remain problematic and the Fed will likely stand down as far as any near-term monetary policy easing. Higher US yields splattered government bonds in other countries, sending their yields higher, but the collateral damage is perhaps most concerning in the UK which is also dealing with slower-than-expected growth and stubborn inflation.
I am a firm believer that the bond market always shows us the path forward more accurately than the stock market, the latter of which is prone to being pushed around minute-by-minute by technical trading factors and fast-money momentum investors. As “the grown up in the room”, fixed income investors are sending definitive messages in both the US and the UK.
In the US, the increase in bond yields could on one hand reflect President-elect Trump’s pro-growth policies, or – on the other hand – could reflect his deficit-increasing fiscal plans which are likely to cause inflation to remain elevated. The Federal Reserve is well aware of the risk of inflation remaining above target, perhaps less because of the rhetoric coming from the incoming president and more about hard economic data, which continues to point to a resilient US economy that is making the “last mile” of the inflation battle very difficult. The Fed is clearly concerned about persistent inflation as was revealed in the minutes from the December FOMC meeting, released mid-week. In addition, the updated December Economic Projections (here) prepared by the Fed only include two 25bps reductions in the Fed Funds rate 2025. The more currency CME FedWatch Tool (here) is now suggesting that the Fed will only reduce the Fed Funds rate one time in 2025, by 25bps.
The UK has worked its way into a fiscal bind. Unlike the US – in which there are no guardrails to control deficits – bond investors will hold the UK accountable for its missteps. Chancellor of the Exchequer Rachel Reeves presented a budget in October that she and her Labour Party felt would restore growth and integrity to the public finances. However, she gave herself very little headroom to manuevre, and also stated that Labour’s commitment to their new budget was “iron clad”. With only £10 billion or so of headroom, higher Gilt yields will certainly cut into this cushion, which could be compounded by any negative variances in tax revenues or public expenditures as growth slows to a crawl.
The result of the wobble in UK finances and the reality that the Federal Reserve will likely keep interest rates above the desired target for longer than expected has sent the US Dollar higher, and the Pound (and Euro) lower. It is also clobbering fixed income investors that invest in duration, who probably thought things couldn’t get worse after last year, but suddenly find their portfolio of intermediate- and longer-duration bonds heading south again. It’s too early in the year for me to have to digest this!
If I sound nervous, it is because I am. I reckon buy-the-dip investors will support risk assets like stocks and cryptocurrencies for a while, until they gap down too much, at which time market forces could deflate the bubble (if you want to call it that) that many believe characterises US stocks and other risk assets like cryptocurrencies.
From a portfolio perspective, I am taking care of my cash, writing short-dated covered calls (for income) on some of my positions, and am hoping things settle down soon as I do not intend to directly lighten on equities. Recall that I also have S&P 500 (SPY) puts expiring in March, April and May, and I keep rolling these forward as protection should US stocks crack. What I am hoping for as a worst-case scenario is a gentle and orderly decline in US stocks which will keep retail investors from running for cover, creating a doom loop. But given the last two years of exceptional performance, who knows? We might be up 20%+ at the end of this year again although we are certainly not off to a very good start!
RECENT ARTICLE ON AMERICAN EXEPTIONALISM
I wrote and released a rather long article mid-week on American Exceptionalism. One of my readers (Jim S) pointed out something regarding the comparison of deficits across countries. He noted correctly that unlike most developed countries in the world, the US does not have a national healthcare system. If it did, the US deficit – and certainly the total amount of US debt outstanding – would likely be considerably larger than it is. Also, as far as public sector employees, the largest state employer in most countries is the public healthcare system (for example, the NHS in the UK). The fact that the US public sector is smaller as a percent of the total workforce might be mis-leading in that the US does not provide national healthcare to its citizens.
THINGS LAST WEEK THAT MATTERED
Both the JOLTS report (here) and the December jobs report for the US were released last week, and both were market moving.
As an aside, two audio podcasts that I listed to last week iwhich were interesting included:
Prof Jeremy Siegel, Wharton emeritus professor of finance, interview on Wharton Business Daily radio show on SiriusXM recorded in December, 16 minutes. You can find both audio podcast link and YouTube video link on the “Knowledge at Wharton” website.
The “Unhedged” audio podcast, sponsored by FT and Pushkin Industries, features several of the best FTcommentators, including one of their best and most interesting journalists (including daily commentary via email each morning for FT subscribers) of “Unhedged”, Robert Armstrong. (You can access the podcast for free, but to access written “Unhedged”, you need to be an FT subscriber.)
WHAT’S AHEAD
There is a lot of global inflation data next week, including PPI (Dec) in the US on Tuesday, and CPI (Dec) for the US and the UK on Wednesday and the Eurozone (second reading) on Thursday; retail sales for the US on Thursday, and for the UK and China on Friday, and 4Q2024 GDP for China on Friday.
Upcoming central bank meetings:
Bank of Japan: Jan 23-24
FOMC: Jan 28-29
ECB: Jan 29-30
Bank of England: Feb 6
MARKET DATA
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