Macro
The upside surprise to US payrolls has sent yields higher and counterbalanced the rate cuts. The Nonfarm Payrolls released on Friday came in hot at 256K compared to the consensus range of 150K-160K 165K (91K above 165K expectations). The unemployment rate edged down to 4.1%, and average hourly earnings grew 0.3% month over month, with a lighter annualized increase of 3.9%. The University of Michigan Consumer Sentiment report aligned with expectations.
This robust payroll data confirms the strength of the US economy. It was an important signal, as recent concerns about the US economy have predominantly centred on a potential softening of the labour market. A resilient labour market, strong consumer demand, persistent inflation, and a recent rise in inflation expectations all suggest the Federal Reserve is likely to maintain rates at their current levels. The report, regarded as a “hot spring,” prompted risk markets to respond vigorously. The key question now is how the economy will progress from here.
The data has led to a hawkish shift in rate expectations. Markets now anticipate fewer than 30 basis points of rate cuts for 2025, compared to nearly 50 basis points previously. Bank of America no longer expects any rate cuts in 2025, while Goldman Sachs has revised its forecast to two cuts, with the first anticipated in June. Interestingly, financial conditions have been easing, even as the Federal Reserve continues its tightening cycle. This dynamic has added to the uncertainty surrounding the economic outlook.
Market participants acknowledge that there will be further uncertainty not only from forthcoming economic data but also from how markets will react to potential inflationary pressures arising from the new administration’s policies.
In recent months, overall financial conditions have eased, despite the Federal Reserve’s continuation of its tightening cycle. Financial conditions remain supportive across most sectors, apart from the lower end of the consumer credit market, where there has been an increase in delinquencies. Nonetheless, these delinquencies have yet to have a significant impact on the broader economy.
Economists caution against the risks posed by tariffs and immigration policies, emphasising potential damage to GDP growth and inflationary pressures that could limit the Federal Reserve’s flexibility. Meanwhile, investors remain focused on short-term earnings, with net profit margins anticipated to experience significant expansion.
Rates
The payroll report pushed yields higher across the board. The 20-year yield rose above 5%, the 30-year yield is approaching 5%, and the 10-year yield climbed to 4.75%. This rise in yields has been driven by stronger-than-expected economic data, concerns over debt and deficits, persistent inflation, increased Treasury and corporate bond issuance, and the term premium, which has reached its highest level in a decade.
Multiple factors are contributing to higher rates, including sustained above-target inflation, a stronger-than-expected economy, and proposed changes from the incoming administration that are expected to increase inflationary pressure. Inflation remains sticky but steady. While this does not necessitate raising rates, it delays potential rate cuts further into the future.
The Fed currently has little room to signal rate cuts. Instead, it is focused on determining the economy’s potential growth rate. Meanwhile, the market has recalibrated its expectations for the neutral rate upward. The FED must also consider how the new administration’s policies might impact inflationary pressures. As market participants adjust their rate expectations to account for these policies, inflation expectations risk becoming destabilized, adding pressure on the Fed.
There is a growing instability in supply and demand within the US Treasury market, impacting the yield curve. Recent pricing of the term premium reflects heightened expectations for a higher neutral rate. This shift has also heightened concerns regarding the supply-demand landscape in the Treasury market.
The altered expectations for the Fed’s policy path could impose further pressure on the longer end of the yield curve, rendering Treasuries cheaper (with upward pressure on long-term yields). The market will also be closely watching any fiscal stimulus from the new administration. With a 7% budget deficit relative to GDP, we are experiencing an unprecedented level of stimulus typically seen only during wartime, even as the economy remains robust, as evidenced by strong payroll numbers.
The dollar index rose by 0.7%, marking its sixth consecutive weekly gain and 14th increase in the past 15 weeks. Gold climbed 2.3%, while Bitcoin futures dropped 4%. Meanwhile, WTI crude surged 3.5%, closing the week at its highest level since October 7.
Credit
The credit market remains highly accessible for new companies seeking to raise capital, with issuers offering very tight spreads. U.S. high-yield credit spreads have contracted to a 17-year low, reflecting the subdued volatility in risk assets.
Such narrow spreads indicate a market environment where credit risk premiums are minimal, signalling increasing complacency among investors. This diminishing cushion against defaults or economic downturns suggests that investors may be underestimating potential risks despite the prevailing market euphoria.
However with equities highly priced and following two consecutive years of spectacular returns, some investors may turn to credit markets to diversify their risk. With equities highly priced and following two consecutive years of spectacular returns, some investors may turn to credit markets to diversify their risk. While yields are higher, surprisingly strong growth data continues to create conditions for credit spreads to tighten further. While yields are higher, surprisingly strong growth data continues to create conditions for very tight spreads.
Global credit issuance is surging, with January already matching last year’s total issuance. In the U.S., investment-grade (IG) issuance this week reached $60 billion. Additionally, the issuance of 3-year, 10-year, and 30-year bonds saw the 10-year and 30-year achieve the highest yields at auction since 2007, at 4.68% and 4.913%, respectively.
From an opportunity perspective, European credit seems highly attractive, particularly for U.S. investors who can capitalise on the current strength of the dollar. Moreover, private markets offer greater value than public ones. The illiquidity premium in the private credit market lies between 50 and 200 basis points. Additionally, structured credit solutions may provide a premium of 100 to 140 basis points over similarly rated corporate credit. Meanwhile, corporate credit appears increasingly attractive in comparison to equities.
Equities
U.S. equities declined this week, with the S&P 500 and Nasdaq recording their second consecutive weekly losses. The S&P posted losses in four of the past five weeks, and the Russell 2000 reversed two weeks of gains, returning to pre-election levels. AI-related developments offered limited upside despite updates from TSM and Microsoft on AI initiatives. At CES 2025, NVIDIA CEO Jensen Huang delivered a 90-minute keynote highlighting advancements in artificial intelligence, gaming, and autonomous technologies. Analysts had mixed reactions, and NVIDIA’s stock declined 6.2% (-5.9% for the week) following the presentation due to the lack of updates on the anticipated next-generation GPU platform, Rubin.
Other Mag-7 stocks also continued to underperform the broader S&P 500 since Christmas, as the technology sector has weakened. Weakness spanned sectors like media, fund managers, Chinese technology, and semiconductors. Resilience was seen in airlines, drug stores, energy, metals miners, agricultural chemicals, and discount retailers.
This week featured notable M&A activity, including CEG’s +20.9% acquisition of Calpine and SYK’s +1.2% purchase of NARI. Earnings season saw DAL surge +13.5% and WBA rise +23.8% on strong results, while STZ dropped -18.1% on weaker guidance. Energy (+0.90%) and Healthcare (+0.52%) led sector performance, while Real Estate (-4.10%), Technology (-3.10%), and Financials (-2.71%) lagged.
Despite recent declines, overall U.S. equities remain buoyant as investors bet on Trump 2.0 economic policies boosting corporate earnings, despite economists’ concerns about potential economic headwinds. Analysts forecast a 10% rise for the S&P 500 this year, driven by expected earnings growth of 15%, the strongest in a decade. However, some caution that profit margins, currently above historical norms, could shrink and dampen future earnings.
Over the past 12 months, the S&P has risen 24% and is just 3% below its all-time high (ATH) of 6,090 points. Similarly, the technology sector, which has contributed more than half of these gains, is also 3% away from its ATH. However, breadth is narrowing, with the index’s performance increasingly reliant on fewer stocks. This week, volatile sectors such as Materials, Banks, and Energy are down double digits for the year.
The tech-heavy “Magnificent 7” stocks are projected to grow earnings by 21%, a decrease from the exceptional 33% growth observed in 2024. Meanwhile, the broader S&P 500, excluding these stocks, anticipates a rebound to 13% growth, up from last year’s 4%. Trump’s deregulatory stance may further bolster sectors beyond technology, encouraging corporate investment.
High growth expectations have pushed U.S. equities to their highest relative valuation against government bonds in over two decades, raising concerns about stretched prices, especially in mega-cap tech companies. The S&P 500’s forward earnings yield has dropped to 3.95%, well below the 10-year yield of 4.75%. Alternative valuation metrics that account for inflation-adjusted yields and projected future cash flows suggest valuations, while elevated, remain within acceptable ranges. However, risks related to market concentration in a few tech giants and sensitivity to rising bond yields persist.
Rising yields weighed on megacap tech stocks due to valuation concerns, while strategists highlighted the strength of the dollar as a growing headwind for earnings and revenues ahead of Q4 results. Bullish themes this week included improved positioning and sentiment, as the AAII bull-bear spread reached a new 52-week low. M&A activity further supported market optimism, alongside media speculation regarding a potential resurgence of IPOs.
Looking ahead, earnings season will gain momentum next week, with major banks reporting results. On Wednesday, January 15, C, GS, JPM, and WFC will announce earnings, followed by BAC and MS on Thursday, January 16.