Macro
This year’s World Economic Forum in Davos, themed “Collaboration for the Intelligent Age,” convened amid rising geopolitical tensions and a rapid push to lead in artificial intelligence. Participants highlighted AI’s immense promise to benefit society as a whole but also warned that weak oversight could deepen existing inequalities. Calls for responsible innovation and inclusive frameworks resonated throughout the event, yet much of the spotlight fell on President Trump’s video speech. He reiterated plans for potential tariffs, criticized European regulations, and urged companies to relocate to the United States under a low-tax regime. Ultimately, the Forum ended on a subdued note, reflecting both the urgency of global cooperation and the challenges posed by divergent national agendas.
The Federal Reserve is expected to keep interest rates at 4.25%–4.50% during its January 2025 meeting, holding firm despite renewed calls for cuts from President Trump – echoing similar pressure from his first term. A range of policy measures contributes to this uncertain backdrop: tariffs threatened against Mexico and Canada could reach 25% if negotiations fail by February 1, while China has so far been spared from harsh penalties. In parallel, Republican leaders are exploring a debt-and-funding deal with Democrats, and there is talk of bundling key White House initiatives into a single legislative package.
These moves complicate the Fed’s efforts to gauge longer-term economic effects, even as proposals for deregulation could help keep inflation in check. Balancing the myriad impacts of trade policy, fiscal negotiations, and deregulation leaves the Fed navigating a particularly complex policy landscape.
The macro calendar was relatively quiet this week. Weekly jobless claims exceeded forecasts, and continuing claims also ticked higher. The S&P US manufacturing PMI returned to expansion territory for the first time since June, although the services PMI fell to its lowest reading since April. The Bank of Japan raised rates by 25 basis points as anticipated. Consumer sentiment slipped, reflecting higher long-run inflation expectations, while December existing home sales topped estimates. Notably, US core CPI has now remained above 3% for 44 consecutive months, marking the longest stretch of elevated inflation since the early 1990s.
Credit
This week, the European and U.S. credit markets were highly active. Record orders, strong investor demand, and evolving risk-reward dynamics reshape issuance. Despite tight spreads, robust inflows continue, as strong economic fundamentals and low volatility support the market.
Issuance in Europe remained exceptionally strong this week, with markets in the United Kingdom, France, and Spain witnessing a surge in new deals and surpassing previous records for indicated order volumes.
Credit spreads continue to be a key focus in the U.S. Investment-grade (IG) credits recorded spreads of 78 basis points, while High-Yield (HY) credits traded at 256 basis points. Despite these tight spreads, robust economic growth and stable employment have ensured that credit yields remain attractive enough to drive steady inflows.
The narrowing gap between high-quality bonds and those lower in the credit spectrum suggests that the premium for taking additional credit risk is becoming marginal. As a result, many market participants favour higher-quality credits for their more attractive risk-adjusted profiles.
Moreover, 30-day volatility for credit spreads reached its lowest level since mid-2022, reflecting market confidence and a relative calm amid tight pricing conditions. However, this low volatility also underscores the need for active management. As the margin for risk compensation narrows, a deeper, more granular analysis of underlying collateral and credit fundamentals becomes increasingly critical for portfolio construction.
Investors are also finding value in segments that have traditionally received less attention. Asset-backed securities (ABS) and Commercial Mortgage-Backed Securities (CMBS) offer yields in the 40th to 70th percentile relative to their peers, presenting compelling opportunities in a yield-starved environment. Additionally, while delinquencies in the U.S. office sector have averaged around 10%, the risks are highly localized—varying significantly by region and even by individual property—warranting careful, case–by–case analysis.
Furthermore, AAA–rated collateralized loan obligations (CLOs) have emerged as an attractive trade. With credit quality at the forefront of investor considerations and yields offering a modest premium, these CLOs present a balanced risk-return proposition for those looking to capitalize on current market dynamics.
Rates
The rates market was very steady this week. The 10-year yield finished above 4.6%, marking its quietest week since September 2024. Earlier in the week, market participants had priced in significant bond moves driven by tariff rhetoric. However, as that rhetoric was scaled back, prices stabilized, leaving no changes ahead of next week’s FOMC meeting.
A noteworthy event was the 10-year Treasury Inflation-Protected Securities (TIPS) sale. The deal attracted significant attention for its pricing, with yields awarded at 2.243%—the highest since the post–GFC period – and a strong bid-to-cover ratio of 2.48. This performance underscored investors’ appetite for inflation-hedged instruments that still offer competitive yields.
In Japan, inflation climbed to 3.6% in December, with core inflation at 2.4%, largely driven by robust consumer spending. Although the Bank of Japan expects inflation to remain above 2% for the foreseeable future and anticipates sustained wage gains to support its target rate, the manufacturing sector contracted for the seventh consecutive month even as the services sector expanded. BoJ Governor Kazuo Ueda noted that these mixed signals point to a gradual overall economic recovery.
In a move toward policy normalization, the BoJ raised interest rates by 25 basis points to 0.50%—the highest level in over 17 years, returning to territory last seen in 2007. While Japanese bonds rallied in response, the equity market’s reaction was muted – a stark contrast to the pronounced response observed after the previous rate hike in 2024.
Equities
The US equity market has rebounded from its recent pullback, setting a fresh record on Wednesday by surpassing 6,100 for the first time. This was a second consecutive week of gains, with notable upside in large-cap technology stocks. Netflix led the charge with a 13.9% surge, while Apple lagged, declining 3.1%. The official S&P index outperformed its equal-weighted counterpart, reversing the trend from the previous week. Although sentiment briefly soured on Friday after developments involving DeepSeek, an efficient AI model which could reduce the demand for advanced computing power, potentially impacting the profitability. DeepSeek released its latest AI model, DeepSeek-R1, on January 20, but more analysis on DeepSeek is coming out this weekend, and it might significantly affect the market on Monday.
So far, US equity performance has been driven by cyclical sectors, with Industrials up 7%, Materials at 5.8%, and Financials following at 5.1%. Some sensitive sectors have also performed strongly, with Communication Services rising by 6.1% and Energy gaining 6%. Defensive Utilities have also shown solid performance, increasing by 5% this year. This cyclical strength relative to defensive sectors has persisted since the end of the bear market in 2022.
Investors appear increasingly driven by FOMO, shifting capital out of money-market funds – despite attractive yields – and into equities. Money-market funds saw their largest outflow in nearly a year, dropping to $6.86 trillion, while US large-cap equity ETFs recorded $14 billion in inflows.
Nonetheless, valuations remain historically elevated. The CAPE ratio, which uses a 10-year average of earnings, reached 38.45—a level previously only seen at the peak of the 2021 meme-stock era and during the dot-com bubble. In comparison, the ratio’s long-term average is around 17x.
Beyond these valuation concerns, corporate earnings have delivered robust Q4 results so far. About 16% of S&P 500 companies have reported, showing blended earnings growth nearing 13%, surpassing expectations of around 12%. Roughly 80% have beaten consensus EPS forecasts—above the 77% one-year average—while 62% have exceeded revenue estimates. Although earnings surprises are running higher than usual, revenue surprises remain slightly below their five-year trend, reflecting cautiously optimistic sentiment on corporate fundamentals.
The “Mag-7” mega-cap technology firms continue to lead the US equity market, propelled by solid fundamentals, rapid innovation, and near-monopolistic advantages. Over the past decade, these companies have surged by a factor of 30 (up 2,900%), far exceeding the performance of top stocks during earlier booms. Last year alone, they returned nearly 65%, compared to about 18.5% for the rest of the S&P 500. Despite concerns over steep valuations, investor focus remains on whether tech earnings can maintain this pace and whether other sectors, stalled by earnings stagnation, might catch up.
US tech companies, for their part, continue to invest heavily in AI, motivated more by fear of losing ground than by guaranteed returns. Even executives who initially warned about over-investment, like Mark Zuckerberg, have announced massive spending plans—Meta alone is set to invest up to $65 billion in 2025. Yet this approach is under scrutiny from emerging competitors such as China’s DeepSeek, whose low-cost, open-source model challenges the assumption of America’s unassailable lead in AI. Major chipmakers, notably Nvidia, could be most exposed if the broader AI narrative shifts to favor leaner, more cost-effective solutions. Despite huge outlays, US tech dominance is not guaranteed, illustrating the delicate balance between innovation and market realities.
Donald Trump’s second term begins amid record market valuations, fueling worries about potential risks and diminished long-term returns. While US equities have massively outperformed the rest of the world—now comprising 75% of the MSCI World Index—European stocks are trading at the lowest relative valuations in over three decades. Meanwhile, growth stocks in the US stand at their most expensive levels relative to value since the dot-com peak, highlighting just how concentrated the market has become.