Three things to watch in the week ahead

US stocks turned negative for the year at the end of last week, after a monster payrolls report triggered a surge in the dollar and in payrolls, and led to fears about a rolling back of Fed interest rate cuts. There is currently just over 1 cut priced in by the Federal Funds market for the whole of 2025. The S&P 500 is down nearly 1% YTD, the Nasdaq is lower by 0.77%. However, small caps and mid cap US stocks that are more leveraged to the US economy have been hit harder by the January sell off, and the Russell 2000 is down more than 1.8% YTD.

Interestingly, The FTSE 100 and the Eurostoxx index have outperformed US stocks, even though they also sold off sharply on Friday. This does not mean that the market believes that European stocks are necessarily more resilient to persistent inflation and a relentless rise in bond yields, instead it could be a sign that investors are ditching US stocks with high valuations that may not be compatible with current market conditions. The dollar has also surged, and the pound has taken another hit on Monday morning. GBP/USD is hovering around $1.2150, inching closer to the key $1.20 level.

The key theme of 2025 is the bond market sell off. This is not a new phenomenon, the 10-year Treasury yield has jumped by 65bps in the last 3 months, the UK yield is higher by 62bps. However, the speed of the bond market sell off has picked up pace in the opening days of the new year. For example, the 10-year Treasury yield is higher by 19bps, the 10-year Gilt yield is up 27bps and the French, German and Italian yields are higher by 23bps, 22bps and 24bps, respectively. The sell off is global, and it appears to be about more than just inflation. The increase in bond yields is due to multiple factors: inflation fears, public sector deficits and economic policy uncertainty, which are all driving yields higher and draining risk sentiment from financial markets.

Recent economic data suggests that these issues will not go away. Inflation is expected to rise, the latest payrolls report is evidence that the US economy remains on a strong footing, and this suggests that the Fed cannot ride to the market’s rescue if the stock market sell off gathers pace. The Fed do not even have room to talk about rate cuts right now, which could aggravate risk aversion even more.

Is 5% the new normal for yields?

2025 has seen a re-set higher for borrowing costs around the world, but with a particularly focus on the UK. 5% could be the new normal for the price of money for the long term. The question is, what does this mean for economic growth, credit quality and inflation?

The relationship between US stocks and Treasury bond yields is not pretty. Stocks have tended to sell off when Treasury yields reach this key psychological threshold. The 30-year US Treasury yield is 4.95%, in the UK, long term yields have already breached this threshold and are at 5.4%, more than 100 bps higher than Italian 30-year yields. 10-year yields are quickly approaching this level. In the UK, the 10-year yield is 4.83%, in the US it is 4.75%. The rise in yields now threatens a fiscal event in one of the world’s major economies. If that happens then that could weigh on stock markets in the coming months.

Public sector spending cuts could be demanded by the bond market

The problem for the UK is the size of the government deficit. It is worth noting that the pace of increase in UK government bond yields slowed at the end of last week, but only after the Treasury promised to cut disability benefits. We expect to hear more details of this in the coming days, however, this is the tip of the iceberg. The bond vigilantes have their eyes on public sector balance sheets, yet governments do not seem to have the appetite to slash their deficits. The bond market is attempting to intimidate Chancellor Rachel Reeves into forcing the UK to live within its means. We think the bond market will get its way. The Labor government may well get the UK on a secure fiscal footing, but it may not do it in the way it had wished for when it came to power last year. In 2025, public sector spending is out, Rachel Reeves needs to acknowledge this before the bond market will calm down.

FX market follows the bond market  

The new phase of the bond market sell off includes the FX market. FX traders have rapidly lost interest in sterling, and the pound is the weakest performer in the G10 so far this year, after being the second-best performer in 2024. This is a sign that bond market weakness is seeping into the FX market, which is another red flag for traders. GBP/USD is down by 1.4% so far this year, and has taken another lurch lower at the start of the new week. The pound is not alone, the dollar is the top performer in the G10 FX space, and it is expected to stay there while this period of risk aversion grips financial markets.

The UK is not alone. Japan also has a huge government debt. Usually, its government bond yields barely move due to yield curve control, however, even Japanese 10-year yields are higher by 11bps this year, and over the last 3 months they have risen by 24bps. At the same time, the yen is the second weakest performer in the G10 in the past 12 months. If the Japanese authorities want to stem the yen’s decline, then they may need to consider a faster pace of rate hikes, right now, the market is pricing in a 57% chance of a rate hike in January.

As you can see, traders have much to digest at the start of a volatile year. There are also some key events this week that could determine the trajectory of markets.

Bank earnings

It is the start of Q4’s earnings season, and the market will be focussed on US banks, who will report earnings this week. This includes JP Morgan, Citi, Goldman Sachs, and Wells Fargo. JP morgan will be the highlight. It reports Q4 earnings on Wednesday. The market is expecting a bumper earrings report, driven by a pickup in deal making activity and vibrant capital markets in the final months of last year. Share buybacks are also expected to increase. The market expects JPM to report a 1.9% YoY increase in revenues to $41.9bn, net income is expected to rise 20% YoY, to $11.6bn. Earnings per share is also expected to rise by more than 23% to $4.1. The US’s largest bank is expected to report stellar earnings growth for Q4 and for 2024 as a whole; but will it be enough to boost the broader banking sector? Its 2025 outlook is important. Will it flag the relentless rise in bond yields as a threat to dealmaking in the coming months, or will it see the recent wobbles in financial markets as temporary setbacks that are unlikely to impact its pipeline of business? JP Morgan’s share price dropped more than 1% on Friday and is lower year to date. The KBW banking index is also close to its lowest level since last May, and if the current trend continues then it may approach the 38.2% retracement level of the entire 2024 rally, at 120.00. The question is, can this week’s banking results stem the decline?

Goldman Sachs is also expected to report a strong earnings report on Wednesday. Analysts have revised up their expectations and they expect revenues to rise to $12.3bn, with net income expected to rise to $2.69bn for Q4.

UK and US inflation

The bond market sell off may be about more than just inflation, but this week’s CPI reports from both the US and the UK have the power to roil financial markets. The US will report CPI on Wednesday afternoon, and headline CPI is expected to tick higher to 2.9% from 2.7%. The core rate is expected to remain steady at 3.3%. Combined with a strong NFP reading for December, higher inflation could knock expectations of rate cuts from the Fed. There is a chance that a stronger than expected CPI reading could see all rate cuts for 2025 get priced out. This may be an overreaction, but traders should be braced for another leg lower in stocks and risk assets if there is a nasty upside surprise to US prices.

In the UK, CPI data is also released on Wednesday. Before that there is no data scheduled for release, so all eyes are likely to be on the UK’s CPI. The December reading is expected to see a hefty monthly increase of 0.4%, however the annual headline figure is expected to remain steady at 3.6%. The core rate is expected to tick lower to 3.4% from 3.5% and service price inflation is also expected to moderate to 4.8% from 5%. Service price inflation has been a sticking point for UK price data; however, anecdotal reports suggest that the UK consumer is weakening/ scaling back and this could take the edge off inflation this month. Lower price pressures would be welcomed, but we don’t think this will be enough to reduce pressure on the UK bond market, especially if it adds to fears about UK economic growth. A recovery in the bond market lies with the UK government and its ability to build confidence in a plan to make public sector sustainable. Also, there are upward pressures building for inflation, for example, brent crude is higher by 6.8% so far this year and there have also been gains for corn, coffee, and meat prices so far in 2025.  

China’s data

There are some key economic releases out of China this week, including trade data, new home prices and GDP. GDP is expected to have jumped to 5% on an annualised basis in Q4, up from 4.6% in Q3. If this is true, then it would suggest that recent China stimulus measures have helped the real economy to reach Beijing’s growth target for 2024. Beijing has promised more support to boost consumption, this weekend. However, this has not boosted sentiment to Asian shares on Monday. The Hang Seng is down 1.2% and the CSI 300 is lower by 0.6%. External risks, including Donald Trump’s presidency, are bigger drivers of Asian share prices right now compared to domestic policy.