After quite a brutal end to 2024 for risk assets, strong US data has prompted a significant repricing in the timing and depth of rate cuts by the Federal Reserve (the Fed). Recent Payrolls were very strong and University of Michigan inflation expectations were high, so forecasts for the next expected quarter point cut in rates has moved from March to June, and potentially even further out. The US thirty-year Treasury bond is heading for 5% (the twenty-year is already there) and the US dollar continues to strengthen as their economy maintains significant momentum.

All polls, commentators and most betting odds were completely wrong about the US election as incoming President Trump gained a clear majority and a clean sweep, handing him a license to do pretty much what he feels like. His subsequent cabinet appointments show that he has lost none of his ability to surprise, although the appointment of Bessent as Treasury secretary is seen as pro-growth. The ‘Tariff man’ also lost no time in announcing potential levies on US imports, starting at 10%, 60% on China and up to 100% (?) on neighbouring Mexico. This offers the prospect of a much bigger global trade war than his last effort and can only weigh on global growth prospects. All this before he takes office, helping to keep forecasts for where markets go in 2025 as tricky as ever.

As Trump gets nearer to taking office the shape of his government and extent of his policies becomes clearer. These look to extend far beyond just tariffs and include taxation, the dollar, government spending and the Fed, as well as reform of the Federal government system. The idea is that all these policies together combine to drive the US economy ahead from its already firm footing. In practise these policies are likely to stoke inflation.

The recent Fed meeting produced a ‘hawkish’ quarter point cut in their base rate but the Fed indicated that the pace of rate cuts is slowing, ruling out a January cut and rates markets are discounting only two more moves for 2025. The Fed (a bunch of ‘boneheads’ according to Trump) and its Chairman fought back against speculation that he would be sacked, saying he would not step down if asked and it is ‘not permitted under the law’ for the White House to force him to do so. However, Vice Chairman for bank supervision, Michael Barr, has already announced he is stepping down; politicisation of the institution looks inevitable. Trump has already stated that he should have influence and a say in setting rates and monetary policy. His efficiency czar has also taken aim at the Fed saying it is ‘grossly overstaffed’.

The European economy continues to drift with weak growth and political and fiscal uncertainty in its two biggest economies, France and Germany, both now subject to foreign interference, which appears to favour the far right. Continuing weakness in business surveys contributed to fears of recession. German manufacturing continues to decline and their automotive sector is experiencing some seismic shifts.

France remains in political limbo and their bonds have reflected this, the yield gap between French and German bonds is at its widest since the eurozone debt crisis. The ECB delivered a ‘dovish’ quarter point cut in rates and looks to be prepared to keep on going, forecasts have consecutive cuts until June, bringing their policy rate down to 2%. Assuming both France and Germany can form coherent coalition governments these rate cuts should start to lead to stability and growth. The weakness of the Euro (currently heading towards parity against the US$) should help exports but potentially might invite even more tariffs.

The dismal start by our new UK government continues, as they lurch from one difficult situation to another. Recent GDP numbers showed no growth in the third quarter since they took office and a contraction post budget of -0.1%; you talk down your own economy at your peril. The Bank of England (the Bank) kept rates on hold in the face of inflation rising above target again to 2.6% (although three MPC members voted for a cut). The long-awaited budget was predictably unpleasant, especially for employers (Tesco’s bill being estimated at £1bn), but falls far short of funding Labours fiscal plans so the Gilt market will have to bear more of the burden. The funding plans for 2024/25 are now close to £300bn and a fair chunk will be borrowed at the longer-dated end, yields have been rising steadily since the Budget, making the Bank’s job even harder.

Subsequently, Gilts have endured a significant move, especially at the long end, as term premium has increased for UK sovereign risk. Yields have largely followed moves in US Treasuries but as the UK has its own set of problems (not least potential for that ugly word, stagflation) the yield premium between the two sovereign curves has widened. Thirty-year Gilts printed yields not seen since the 90’s (reaching 5.45%) prompting commentators to rush to compare the situation to late 2022. However, this is not a liquidity crisis or as a result of forced selling by institutions, more a function of the sheer volume of fund-raising needed to come from Gilts to fund deficits. So far there is no lack of demand for UK Sovereign risk and a recent five-year Gilt auction was three times covered. There is however precious little more confidence for Starmer/Reeves than there was in Truss/Kwarteng and sterling has weakened as foreign investors hold fast, (sterling has passed its crown as the strongest G10 currency in 2024 to the dollar).

European bond sales set a new annual record at over €1.7trn in 2024, sterling corporate bond sales were a healthy £45bn with more than £70bn forecast for 2025 (partly influenced by a clutch of redemptions), fairly evenly split between financials and corporates. The outperformance of credit versus government bonds has been stark. Sterling credit, in particular, has been strong, underpinned by high demand and limited supply. The start of this year has been busy in the primary market despite the rates volatility and corporate bond sales in the first week broke records in $ and €.

The full Quarterly Review is available here. 

January 2025

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