Good news for the US economy, bad news for markets

13 January 2025

AT A GLANCE

Last week was negative for most asset classes, with gold, the ultimate safe haven, the exception
Data confirmed a strong year-end for the US economy, hurting further expectations for rate cuts
The rise of long-dated Treasury yields in a bear-steepening is an opportunity for us

Last week confirmed that US growth and employment ended 2024 on a strong note, with an impressive monthly jobs report. Expectations for a Fed cut moved further to a distant future, while US Treasuries rose in a bear-steepening pattern that lifted the 2,5 and 10-year to respectively almost 4.4%, 4.6% and 4.8%. This pressured equities and real estate. Oil prices rose to renewed US sanctions on Russia’s energy ecosystem, adding to inflationary concerns. Meanwhile, all UK assets sold off as market participants question the government ability to fund their policies.

No doubt, Q4 was strong in the US. The Fed has no reason to help an economy which doesn’t need it and carries some inflationary risk. Still, a strong Q4 is not bad news, as the corporate earnings season is about to start. This is also not a total surprise. Finally, regardless of markets’ current projections, the future state of the economy is not a given, especially with political changes at work. The new US administration may be cautious on the most inflationary items of their agenda, while finding more reasons to address fiscal deficits. Inflation risk is real, and interest rates volatility is not pleasant, but the levels are, with some margin of safety in real terms, as well as diversifying power and upside potential in case the US economy would not obey the bullish consensus and slow down.

We are fully invested, pretty neutral everywhere except for an overweight on government bonds with 7-10-year duration, funded by an underweight in hedge funds.

The week ahead will provide CPI reports for the US, UK and Eurozone, activity data for the US and China, and see the start of the earnings season with US banks.

Preparing for the winds of change of 2025

Cross-asset Update

We cut to the chase. We hold the view that the recent events in the UK represent the first instance of a fledgling sovereign debt crisis in the West, and that it is possibly the start of an unravelling process driven by excessive debt levels coupled with counterproductive public choices. The benign scenario is that the authorities tackle debt burdens with credible plans, unlikely to happen in our view unless forced to by market events. We advocate for holding gold, the only store of value against currency debasement. And while many investors believe that some alternative assets like cryptocurrencies could also diversify portfolios, bitcoin’s reaction to the gilt rout is proof of the contrary. That is, bitcoin is an energy-consuming, pro-cyclical asset, and as such can offer little comfort in times of widespread market stress.

Last week gave us a foretaste of what can happen when a capital flight occurs in a developed country. The pound fell by 1.7% even as longer-dated gilt yields skyrocketed to multi-decade highs. Usually, a country’s currency appreciates when rates rise, unless market participants have decided to offload its assets altogether. Gilt yields even surpassed the highs recorded during the so-called Liz Truss crisis in 2022, when investors rejected the PM’s mini budget and forced her resignation in only 45 historical days. Chancellor of the Exchequer Rachel Reeve’s 2024 autumn budget, also now heavily questioned by investors, has become the epicenter of a renewed crisis, actually a continuation of the previous one, still marked by unsustainable debt and wrong policies that compound the issue. The UK is facing the prospect of stagflation, that is muted growth and high price pressures, and this is to an extent government self-inflicted pain. Labour’s autumn budget planned onerous tax hikes and minimum wage increases, and at the same time large public investments deemed to eventually boost growth. But the end result was the killing of animal spirits, as businesses went on a hiring strike, as well as the increasing of price pressures. Far from promoting growth, Labor’s public choices hampered it, killing the prospect of reducing the debt-to-GDP ratio. Now, any proposed remedy will carry some downside. It is either austerity, and stocks will fall, or a mix of policies aimed at suppressing yields and the cost of debt, and inflation will not be tamed, negative for gilts.

Gold reacted promptly, rising by almost 2% for the week, while bitcoin lost over 4%. We think the yellow metal is the ultimate hedge against the loss of value of fiat currencies, whereas bitcoin rather behaves like a pro-cyclical asset, though with some utilitarian value, hence is less able to diversify portfolios. Investors are advised to allocate to gold in the appropriate weight, as we suspect that the UK events may serve as a template for what may happen next in other DM countries burdened by high debt levels.

Preparing for the winds of change of 2025

Fixed Income Update

The bear steepening gained pace last week on firm labour data and hawkish Fedspeak garnered from the FOMC meeting minutes. The US 10-year yield has crossed the lower threshold of the overnight Fed Rate indicating an inflation/growth scare. The 10-year breakeven has increased by 18bps since the start of December 2023. While the net change in the nominal 10-year yield has gone up 35bps since then, meaning that the real yield is increasing. This happens when investors get convinced that the growth will strengthen even under the restrictive rate maintained by the Fed. Complicating the picture are surging commodity prices, led by oil climbing to a four-month high, that is reigniting concerns about persistent price pressures. The growth/inflation scare regime means yields should remain elevated until we see evidence of material cooldown. But at current yields we maintain our long duration view.

This is a heavy macro week with NY Fed 1-year inflation expectations due today. US PPI is due tomorrow, and most importantly the CPI data out on 15th Jan Wednesday. On the same day we get the Empire Manufacturing. We have the key Retail Sales on the following day. We also have a host of Fed speakers on Tuesday and Wednesday. Overall, the yields would be highly volatile depending on the CPI numbers and Retail Sales.

Investment Grade Issuance for the year has already crossed $75bn, while the Bloomberg Global Agg Credit Index spreads have remained around 82bps. Similarly, $3.3bn HY bonds have been issued so far. S&P expects the HY default rate to fall to 3.5% through September 2025, from 4% as of September 2024. This forecast incorporates declining default rates in the U.S. and Europe, alongside a slight rise in Asia-Pacific. Interest rates are expected to decline in the U.S. and Europe, although at a slower pace than they've increased, while APAC could experience more case-specific drivers than any macro-credit influenced trend.

Last week we saw a wave of bond issuances in the GCC led by significant volume from KSA. KSA has issued multi-tranche bonds worth $12bn out of a total of $14.6bn sold by GCC borrowers. This trend is expected to continue into this week with multiple mandate GCC announcements such as AT1 sukuk from Al Rajhi Bank, senior sukuk from Banque Saudi Fransi and BAPCO Energies. BAPCO Energies has issued a mandate announcement of 7-, and 10- year senior unsecured Sukuks.

Preparing for the winds of change of 2025

Equity Update

Neutral DM: OW US/Japan, Neutral UK, UW Eurozone

Neutral EM: OW India/UAE, Neutral China

The first 10 days of the year saw global equities down a percent – not extreme, but adding to Decembers 2% fall, however maintaining two years of strong performance. UAE equities along with some tech behemoths are among the few with YTD gains. We have seen extreme daily swings (3 to 5%) in Nvidia share price, which was briefly the most valuable company in 2025, before handing back the crown to Apple.

US equities fell last week (almost 2%) amidst an unexpected decline in the US unemployment rate in December and expectations of none or few rate cuts in 2025. A rapid increase in yields following the strong labor market print put pressure on the US equity market. Stay invested in quality equities, as companies with stronger balance sheets or less leverage are likely to remain less rate sensitive.

The equity trajectory in January will be determined by S&P 500 earnings and the impact of higher Treasury yields. This week, starting with banks, S&P 500 companies commence the Q4 reporting season with consensus forecast of 11.7% y/y EPS growth, revenue at 4.7% y/y. Focus will be on guidance from companies with a new administration starting 20th Jan, potential tariffs, the outlook for sales growth against a backdrop of slowing nominal GDP growth and a strengthening US dollar. Will mega-cap tech stocks' superior earnings growth and returns relative to the rest of the index continue? Our 2025 S&P 500 EPS growth forecast is +12% ($271). We expect the S&P 500 to gain 10% through year-end to our target of 6450. Earnings growth will be the primary driver of S&P 500 gains. The Q4 US earnings season is a crucial test of the post-election optimism. The earnings season will reveal if there are signs of increased post-election consumer spending, corporate capex and corporate inventory building ahead of potential tariffs under the new administration.

US and UAE banks should continue to outperform: The interest rate environment was generally a positive in Q4, given the steepening of the yield curve. The US bank earnings season starts on Wednesday. Trends will be mixed - NIMs, loan and deposit growth should be positives, while noninterest income and the effects of higher long rates on the consumer may be negatives. Guidance on earnings calls is likely to be leaning bullish with lower rate cuts on the horizon, a steeper yield curve, and a more favorable regulatory environment expected than has existed in several years. The strong loan growth momentum of UAE banks, execution of government projects, residency reforms are aiding consumption and wealth creation. UAE bank dividends will be watched closely as EPS growth moderates. The median 2024e yield for the sector is about 5.5%, which remains attractive.

Preparing for the winds of change of 2025

Written by:

Maurice Gravier Chief Investment Officer , [email protected]
Anita Gupta Head of Equity Strategy , [email protected]
Satyajit Singh Fixed Income Analyst , [email protected]
Giorgio Borelli Head of Asset Allocation , [email protected]

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