Weekly Markets Review
Summary
- UK gilt (government bonds) yields surged with ten-year yields reaching their highest levels since 2008 and 30-year yields hitting 5.40% – the highest since the late 1990s
- Rising borrowing costs have made headlines, driven by persistent inflationary pressures and a deteriorating growth backdrop and further exacerbated by UK Chancellor Rachel Reeves’ Budget
- Higher borrowing costs are also worsening the fiscal profile, raising concerns that the UK Labour government may break its fiscal rules and increase taxes
- Investment flows in gilts balanced out later in the week, with many investors – including retail investors – taking advantage of high yields to increase positions
- The mid-cap FTSE 250 index declined 4.2% over the week, while the large-cap FTSE 100 index rose 0.3%, supported by a weakening pound
- US equities fell during a shortened week, with small-cap stocks underperforming and value stocks faring better than growth stocks
- US economic data raised inflation concerns, with strong job growth reinforcing the Federal Reserve’s (Fed) cautious stance and pushing treasury yields higher
- European equities rose 3.3%, with investors expecting a rate cut by the European Central Bank (ECB) despite rising inflation, while commodities like oil, copper, and gold performed well
- Inflation is likely to remain in focus this week with December CPI data due in the US and UK.
Market review
UK gilts
Last week I wrote that the bond vigilantes would likely be out in force in 2025, and it hasn’t taken long for that to come to fruition. UK gilt yields accelerated their ascent higher into the new year, with UK ten-year yields reaching levels not seen since 2008. The 30-year gilt yield surpassed an eye-watering 5.40%, the highest since the late 1990s.
This rise in borrowing costs has made front-page headlines, reminiscent of late 2022. Structural forces continue to plague the UK economy, with persistent inflationary pressures and a deteriorating growth backdrop creating a fear of stagflation (high inflation, slow growth, and high unemployment simultaneously), all exacerbated by Chancellor Rachel Reeves’ heavily criticised budget.
Higher borrowing costs are feeding back into a deteriorating fiscal profile and there is a growing sense that the Labour government will break its own fiscal rules and be forced to go back on its promise not to raise taxes further.
Despite some large institutions, including systematic hedge funds, maintaining short positions against gilts, the flow of investments became more balanced later in the week. Many investors, including retail investors who benefit from the tax advantages of gilts, saw the high yields as an opportunity to increase positions and some invested in short-dated gilts extended the maturity of their holdings to lock in higher yields for longer.
The more domestically-focused mid-cap FTSE 250 index declined 4.2%, while the large-cap FTSE 100 ended 0.3% higher supported by a softening pound. The pound fell 1.7% against the US Dollar and 1.1% against the euro.
Global
US equities declined during a shortened week due to the market closure honouring former President Jimmy Carter. The fall in the pound helped offset losses in international equities with the US market declining 1.9% in US Dollar terms but only 0.4% in sterling. Small-cap stocks underperformed and value stocks fared better than growth stocks. Technology was the worst performing sector while defensive and cyclical sectors such as healthcare, energy and materials performed relatively well.
Economic data raised inflation concerns and the Fed’s December meeting minutes highlighted ongoing inflation risks, suggesting a slower pace for rate cuts. The nonfarm payrolls report showed extremely strong job growth, reinforcing the Fed’s cautious stance. Treasury yields surged following the report, with the ten-year yield closing the week at 4.76%, its highest level since October 2023.
European equities ended 3.3% higher, with investors anticipating a rate cut by the ECB despite rising inflation. Eurozone inflation accelerated, driven by higher energy and services costs and accentuated by base effects. Despite this statistical rise, disinflation is on track in the Eurozone and policymakers continue to suggest further moves towards a lower neutral rate.
As inflation concerns returning to the forefront, commodities performed well. Oil rose towards US$80 per barrel with West Texas Intermediate now up almost 8% in 2025. Copper, an economically sensitive commodity rose 2.4% while gold gained 2.4%.
The week ahead
Wednesday: US inflation
Our thoughts: Policymakers are growing more conscious of upside risks to inflation and the December data is expected to corroborate these concerns. Annual inflation is expected to rise to 2.9% while core inflation is expected to remain at 3.3%. The Fed are likely to remain on hold until there is evidence that the disinflationary trend has resumed.
Wednesday: UK inflation
Our thoughts: Inflation is expected to remain at 2.6% while core inflation is anticipated to slow marginally to 3.5%. Fears of stagflation have seen the market pare back interest rate cut expectations from the Bank of England with now less than two cuts priced in for 2025.
Markets for the week
