Macro
The December Federal Open Market Committee (FOMC) meeting was the week’s key event. Contrary to analysts’ strong expectations of a 25 basis point rate cut and signals of a potential pause in future cuts, the meeting was perceived as more hawkish than anticipated. The official statement included a minor but significant adjustment, indicating that the committee is preparing to assess the “extent and timing” of any further policy changes.
During his press conference, FED Chair Jerome Powell delivered a balanced message but emphasized that the committee remains concerned about inflation risks and uncertainties, advocating for a more cautious approach moving forward. Future FED actions will largely depend on evolving economic conditions.
The recently released Summary of Economic Projections (SEP) revealed that the median forecast for rate reductions in 2025 was halved to 50 basis points from 100 basis points in September. Additionally, projections for near-term economic growth and inflation were revised upward. During his press conference, FED Chair Jerome Powell delivered a balanced message but emphasized that the committee remains concerned about inflation risks and uncertainties, advocating for a more cautious approach moving forward. Market analysts have generally recognized the meeting’s hawkish tone, resulting in lower expectations for rate cuts in 2025. However, there remains an understanding that future FED actions will largely depend on evolving economic conditions.
November retail sales exceeded expectations, bolstered by strong vehicle sales, while control-group sales met forecasts despite an uncertain economic environment. Both headline and core Personal Consumption Expenditures (PCE) came in below consensus and declined month-over-month, although personal spending and income also fell short of projections. The longer it takes for the FED to reach the 2% inflation target, the greater the risk that inflation expectations become unanchored.
The U.S. economy is growing at its potential, supported by constructive fiscal policies that promote capital formation and growth. Anticipated deregulation from the new administration, potential additional fiscal stimulus, and continued low unemployment further enhance economic prospects. Consequently, monetary easing appears unnecessary and may be phased out in the near future.
However, the United States continues to grapple with significant fiscal deficits and a burgeoning national debt, exacerbated by sustained government spending in areas such as healthcare, defense, and social services. In a higher interest rate environment, interest payments on the national debt are projected to consume a larger share of government revenues in the coming years. Additionally, political stalemate in Congress over budget allocations highlights the difficulty in achieving consensus on spending priorities, with issues like the expiration of tax cuts, ongoing spending debates, and the debt ceiling contributing to fiscal uncertainty.
The U.S. faces ongoing fiscal challenges, including the expiration of tax cuts, spending issues, and debates over the debt ceiling. Political stalemate in Congress regarding budget allocations makes it difficult to achieve consensus on spending priorities. Recently, negotiations have intensified, with some Republicans showing flexibility to avert a government shutdown. Congress must find a compromise quickly to prevent economic disruptions, considering short-term funding extensions as interim solutions while negotiating longer-term agreements. Former President Trump is advocating for the complete abolition of the debt ceiling or at least its suspension for another two years, as the current suspension is about to expire.
The aging population, particularly baby boomers, holds substantial wealth, with an estimated $76 trillion in nest eggs expected to be spent or inherited. As of Q1 2024, total U.S. wealth stood at $152 trillion, with 50% held by high-net-worth households (those with a net worth over $10 million, representing 2% of the population). Currently, the U.S. collects only 1% of taxes on wealth passed through inheritance each year. This means that 80% of inherited wealth is expected to transfer to the next generation over the next 25 years, up from 50% a decade ago. This surge in inherited wealth is likely to exacerbate current economic conditions, where inheritance constitutes the largest portion of household assets in recent history.
Next week is expected to be relatively quiet due to a shortened trading day on December 24th and the market closure for Christmas Day. Key economic releases will include December consumer confidence on Monday and November new home sales alongside preliminary durable goods orders on Tuesday.
Rates
The Federal Reserve (FED) cut interest rates by 25 basis points this week and signaled the possibility of additional reductions. This move has heightened inflation expectations and driven yields higher. It continues the trend observed in September, when the FED implemented a substantial 50 basis point cut despite strong market opposition. At that time, the 10-year Treasury yield stood at 3.6%. The Fed’s next move is likely to be either maintaining the current rates or implementing a hike, which could position the Fed in opposition to the current administration’s policies.
Mary Daly, President of the San Francisco Fed, stated that the period of recalibrating rates is over. She emphasized the need for the FED to continue monitoring economic data and adopt a gradualist monetary approach—slowly adjusting the policy rate in response to changes in its targets. This gradualism is intended to prevent shocking the bond market and suggests that fewer rate cuts should be expected next year.
Beth Hammack, President of the Cleveland Fed, believes that monetary policy is approaching a neutral stance. She expects policy to remain steady, allowing more evidence of declining inflation before considering further rate cuts.
Market participants labeled the December rate cut as a “hawkish cut” because the FED effectively justified not lowering rates initially before eventually doing so. Since August, the U.S. Treasury yield curve has steepened more than at any other point this year, aligning with the current economic environment.
Treasury bonds weakened as the yield curve steepened. The 10-year yield rose by 42 basis points over nine sessions leading up to Thursday. On Friday, yields saw a slight decline after an extended period of increase. The recent FED meeting pushed the 10-year Treasury yield back above 4.5%, marking an increase of 16.8% from the beginning of the year.
Concurrently, the U.S. dollar strengthened against major currencies, particularly the yen, influenced by dovish statements from the Bank of Japan’s recent meeting. The DXY index advanced by 0.7%, marking its 11th rise in the past 12 weeks.
Predicting bond durations this year has been challenging due to significant fluctuations in the 10-year yields. However, the steepening of the yield curve has been more predictable and easier to incorporate into investment portfolios. This week saw a $13 billion sell-off in 20-year Treasury bonds, reaching the highest yield since April.
On December 13th, the yield curve reinverted. Technical analysts view this as a negative indicator, forecasting a significant decline in equities and risk assets with a lag of 6 to 18 months, typically followed by a recession. However, during this lag period, a market rally may continue. It is important to note that the U.S. economy remains fundamentally strong, and many technical signals may have misinterpreted the rates market.
Credit
US high-grade sales experienced a slowdown following the Federal Reserve meeting; however, total December sales still impressively reached $41 billion, nearly doubling the $23 billion recorded in December 2023. This surge made December 2024 the second busiest December since 2017, with the peak being December 2021, which saw US high-grade sales of $61 billion. Looking ahead, banks forecast that investment-grade (IG) issuance for 2025 will range between $1.5 trillion and $1.9 trillion.
In response to these market dynamics, credit investors increasingly turn to alternative methods to enhance returns, starting with the loan market. The credit market now appears divided into two segments, each operating under different conditions. This division has been exacerbated by rising compliance costs and stricter lending standards, which have inadvertently driven some segments toward alternative lending sources.
Within the leveraged loans market, fundamentals remain robust. The creation of Collateralized Loan Obligations (CLOs) has significantly boosted demand this year, making CLOs particularly attractive in the competitive yield environment.
While most corporations continue to demonstrate resilience in their capital structures and free cash flows, investors remain cautious about specific sectors, notably energy and housing. This cautious outlook reflects ongoing uncertainties and sector-specific challenges that could impact future performance.
Equities
US equities declined throughout the week, primarily due to a significant drop on Wednesday, which marked the S&P 500’s second-worst day of the year before notable bounce on Friday. The Dow Jones Industrial Average experienced a ten-session losing streak—the longest since 1974—before recovering some ground on Thursday. Market breadth was a key focus, with the S&P 500 registering more declining stocks than advancing ones for fourteen consecutive sessions.
Several sectors underperformed: energy, homebuilders (affected by rising interest rates), building products, housing-related retail, industrial metals, chemicals, REITs, machinery, packaging, and food. In contrast, sectors such as airlines, payments, aerospace and defence (A&D), apparel and apparel retailers, off-price retail, cruise lines, and high-performance computing (HPC) stood out as relative outperformers. Big technology stocks showed mixed results, and few sectors ended the week firmly in positive territory.
In sector performance, the S&P 500 saw Technology and Utilities leading the gains with increases of 0.73% and 1.62%, respectively. Conversely, Energy (-5.58%), Real Estate (-4.97%), Materials (-4.16%), and Industrials (-2.64%) were the top underperformers. The spot VIX has surged by 75%, marking only the fourth time in history that it has risen more than 60% in a single day. In each of those instances, the market recovered all its losses within a week. Meanwhile, small-cap stocks have come under significant pressure.
Market breadth is narrowing. Over the past two weeks, only seven stocks (AVGO, TSLA, AMZN, AAPL, MSFT, GOOG, META) have posted positive returns, contributing 3.5% to the S&P 500’s growth. In contrast, the remaining 493 stocks combined declined by 2.9%, resulting in a total S&P 500 performance of 0.8%. This narrowing breadth signals the exhaustion of the post-election rally. So far in December, there have been more declining stocks than advancing ones on nearly every trading day.
In corporate news, Lisa Sue appeared on the cover of Time Magazine as CEO of the Year, despite her company experiencing a 40% drawdown. Nevertheless, the company’s fundamentals remain strong, and it maintains revenues growth. AMD has secured significant wins with Oracle, Microsoft, and Meta. Their MI300 chips are designed to meet the escalating demands of high-performance computing (HPC), artificial intelligence (AI), and data-intensive applications. Additionally, the latest version of their CPU, “EPIC” (a series they have been producing for over 30 years), is now in high demand for data centres—a rapidly growing area where AMD is swiftly gaining market share.
While widespread bullish sentiment does not necessarily indicate a bearish market, it does warrant caution. The Assets Under Management (AUM) of leveraged long ETFs have exceeded the AUM of inverse ETFs (short ETFs) by 11 times, the highest ratio on record.
While specific sectors and companies show strength, overall market indicators suggest caution. Valuations remain high and breadth narrow, potentially signalling upcoming. Although certain sectors and companies perform well, overall market indicators warrant caution. Valuations remain high, and market breadth narrows, potentially signalling upcoming volatility or a market correction. Elevated valuations are tempering investors’ expectations for future performance, with projected returns modest at around 5–6% annually. However, if the market continues to rise by 20–30% next year, it could further inflate valuation multiples and potentially lead to an overheated market.