Macro
January typically does not benefit much from seasonal adjustments, but we should see some cooling in inflation in the following months. This expected easing is due to a softening job market, stabilizing shelter costs, and cooling auto insurance prices, which have previously distorted the CPI. Investors anticipate that the December U.S. payroll report will reflect a change in payrolls while other parameters remain steady.
While inflation pressures may ease, underlying concerns in the labor market persist. JOLTS data show that hires have been declining since 2021, while layoffs are increasing. Concurrently, the duration of unemployment is rising, with the median now over 9 weeks and the mean over 23 weeks. Unless these trends reverse, meeting the Fed’s 2025 target unemployment rate of 4.3% will be challenging. The unemployment rate has already risen by 80 basis points from its cycle low of 3.4% to about 4.2%. The job-finding rate, a key leading indicator of labor market health, has declined, implying that unemployed individuals are increasingly struggling to secure work.
Credit card and auto loan delinquency rates are also climbing—now at their highest since 2011, a period marked by weak job markets and high unemployment. High inflation, coupled with stagnant wage growth, has reduced disposable income, making it harder for households to meet debt obligations. Factors such as an uneven labour market recovery, rising interest rates, and high household debt contribute to this growing financial pressure.
On a more positive note, there are signs of easing services inflation, and it is likely that core PCE will continue to track below the Fed’s 2025 forecast of 2.5%. The median FOMC participant anticipates a 50 basis point rate cut in 2025, lowering the federal funds target range to 3.75% – 4.00%. This expectation is driven by core PCE inflation falling well below the Fed’s 2.5% forecast and unemployment slightly exceeding projections. Given these conditions, even more than 50 basis points of easing seem likely.
Rates
Over the last three months, the rates market has recalibrated significantly, now pricing in only a 38 basis point drop in rates. Although the market currently expects just two rate cuts—one in June and another in September 2025—the exact trajectory will likely change as it remains fully dependent on upcoming economic data.
There are two key relative risks to consider. The first relates to cash during periods of yield curve steepening, when extending exposure towards longer durations becomes more attractive. The second is potential repricing based on the terminal rate. Currently, the terminal rate is expected to settle around 4% in the medium to long term—an arguably high level given potential risks to the labour market. Entering the year without any bond bulls, the market is gradually accepting that the Fed may be overcorrecting. This sentiment is reflected in longer-term yields rising due to inflation fears, which leads to a steeper yield curve. For instance, the 10-year Treasury yield finished the week at 4.62%, marking a 100 basis point increase from the 3.62% level observed in September before the first 50 basis point rate cut.
The 2Y/10Y spread is currently about 32 basis points, its highest in over two years. This widening spread suggests increasing demand for term premiums, driven by fiscal concerns and investor risk aversion. The 10-year yield is approaching the 4.6% level again, a significant technical resistance zone observed over the past several months. As the market expects a slower pace of cuts, the front end of the curve has dropped substantially, while the long end has risen by over 30 basis points in just two months. Only the very front of the curve, up to a 1-year maturity, is inverted, while the rest of the curve has normalised.
This normalisation is evident in real yields, which now stand at just over 1.5% for one year, around 2% for the belly, and 2.25% at the long end. There has also been a resurgence in the term premium for the 10-year, signalling that the market is concerned about inflation and duration risks. As uncertainty about the future path of the economy and Fed policy increases, volatility is likely to rise. The uncertainty surrounding future economic data directly influences monetary policy, creating an environment where data dependence and market expectations are in constant flux.
Credit
Credit growth is surging, with private credit capturing the largest share of this expansion. The U.S. credit market maintains higher quality than in many past periods; however, elevated overall interest rates are pressuring corporates with increased debt servicing costs.
Private credit, in particular, is benefiting from the higher-rate environment. Its future growth will largely depend on the dynamics of interest rate volatility. As we move into 2025, more dispersion is anticipated due to very tight valuations. This suggests that potential market stress will likely be issuer- or sector-specific rather than systemic.
Meanwhile, public markets have become highly concentrated, with liquidity drying up quickly during times of distress. In the leveraged credit arena, borrowers have demonstrated significant pricing power throughout the recent inflationary cycle. Expectations of increased mergers and acquisitions activity could spur additional credit issuance volume, attracting investor interest.
Looking ahead to 2025, however, narrow valuations are expected to limit the outperformance of corporate bonds. Although historical gross leverage remains low and rating upgrades outpace downgrades—factors that should help keep spreads tight absent a recession—the potential for excess returns is likely to remain unchanged and constrained.
Equities
The U.S. equity market closed 2024 on an exceptionally high note, with the S&P 500 advancing over 23% (nearly 25% including dividends), outpacing other major asset classes. This surge was driven by strong earnings growth—particularly in technology, media, and telecommunications—and a period of subdued volatility, which together pushed investor sentiment to record bullish highs even as valuation metrics stretched further.
Despite a robust year in equities driven largely by multiple expansion, some key indicators suggest caution. U.S. stocks are currently trading at 21.6 times forward earnings, a valuation that is over a quarter higher than when Trump was first elected. Tight credit spreads and elevated price-to-earnings ratios hint at potential complacency, leading analysts to debate whether the market can sustain another year of double-digit growth amid high expectations.
In 2024, the market did not experience the traditional “Santa Claus rally”—the seasonal surge often seen in the last five trading days of the year through the first two days of the following year. Since WWII “Santa Claus rally” happens 77% of the time (positive returns) and is associated with an average gain of 1.3%. This holiday season is characterized by lower trading volumes, general enthusiasm, and a celebratory atmosphere that helps to boost the impact of positive market news. The expectation of a Santa Claus rally can become a self-fulfilling prophecy, where investors buy stocks in anticipation of a rally, thus driving prices up. However, this year, we already had a massive rally after the election, and it looks like that momentum has been exhausted before the year’s end.
International interest in the U.S. market remains strong. Despite a recently strong dollar, robust economic growth and ongoing innovation continue to attract global investors. The “America First” narrative has bolstered expectations of increased domestic investments and strategic trade negotiations, which could further enhance the U.S. economy’s competitiveness. Such optimism fuels capital inflows that support the market, even as valuations reach pricey levels.
However, the market remains narrow, and investors are eagerly seeking signs of breadth expansion. Particular attention is on consumer goods—potential beneficiaries of rising inflation in that sector—and transportation, which has lagged over the past two years. Yet, without a clear catalyst, these sectors are likely to experience relative weakness in the short run, despite their relatively attractive valuations.
As we step into 2025, market watchers are closely monitoring the cyclical nature of tech earnings and the broader valuation environment, weighing the odds between a continued bull run and the possibility of a correction. There’s a timeless adage in investing: if everyone expects something from the market in the future, it will not happen. This serves as a reminder that caution and skepticism are essential even during bullish periods, as market dynamics can shift rapidly when expectations become too homogenised.