Deflated yields

• Developed market equities; US, European & UK indices all advanced between 3.0%-3.4% in sterling terms
• UK government bonds, which were up 1.8%. The UK index-linked index advanced 3.1%

• Japanese equities, which fell -1.4% in local currency terms – although tempered to -0.1% in sterling terms

The annual rate of inflation in the UK fell to 2.5% in December, from 2.6% in November. The move in the Consumer Prices Index (CPI) surprised investors somewhat, with market participants widely expecting there to be no change, or even a rise. Although the latest print remains above the Bank of England’s 2% target, futures markets are now pricing in a cut to interest rates at the Monetary Policy Committee’s next meeting in February, and a further cut by year-end. In addition, UK Retail sales signalled further weakness for the economy, declining by -0.3% in the pivotal month of December, well below forecasts of +0.4%. The print may signal that growth is slowing and therefore strengthen the case for further rate cuts.

After UK borrowing costs had risen to levels not seen since 2008 last week, the yield on the benchmark 10-year Gilt fell markedly from 4.9% to 4.65%, which is likely to come as a relief to Chancellor of the Exchequer, Rachel Reeves. The Chancellor had been somewhat under pressure as markets digest how the policies outlined in her Autumn Budget chime with the implications of a second Trump administration in the US. As if to highlight the situation, the UK economy was reported to have returned to growth for the first time in three months last week, with a 0.1% increase reported for November - while the International Monetary Fund (IMF) upgraded its 2025 growth forecast for the UK - however the rate of economic expansion was less than expected and the IMF’s forecast included notable caveats on the possible impact of Trump’s policy agenda.

Cooler than expected inflation data saw both equities and treasuries rally in the US last week. Although the core Consumer Prices Index (CPI) – which excludes more volatile components including food and energy – only fell to 3.2% from 3.3% in December, it was a notch better than forecast and the monthly data print was just 0.2%, suggesting prices rises could slow nearer to 2.4% in 12 months’ time - close to the US Federal Reserve’s (Fed) target. Producer Prices Inflation (PPI) also slowed and came in below consensus estimates. As CPI and PPI are key inputs to the Fed’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) Index, forecasters’ expectations of further interest rate cuts in 2025 moved from less than 1 to nearer 2 by the end of the week. Accordingly, the US 10-year treasury yield fell from over 4.8% to nearer 4.6%, and US equities advanced notably.

Elsewhere, US retail sales slowed but remained positive in absolute terms, a trend echoed by the release of the Beige Book – the Fed’s commentary on current economic conditions - which suggested spending in December was stronger-than-expected and the US consumer is in decent shape.

Last week kicked-off the highly anticipated fourth quarter 2024 US earnings season, with S&P 500 companies set to report their strongest earnings growth in over three years. Amongst the first to report were Financials, and they did not disappoint.  JPMorgan Chase, Morgan Stanley, Goldman Sachs, Citigroup and Wells Fargo all posted impressive earnings and profits, sending share prices higher. BlackRock, the world’s largest asset manager, saw assets hit a record USD 11.5 trillion, up 15% year-on-year. The MSCI World Financials index, which captures Financials listed across developed markets and is led by the big US banks, jumped over 4.5% last week.

Lower interest rates and post-election market volatility fuelled strong trading and deal-making. US businesses have also grown more optimistic, expecting a more pro-growth environment in 2025 - a clear positive driver for the US banking sector. The year ahead is also expected to be a good year for the US financial sector in general, due to a pickup in merger and acquisition (M&A) activity driven by tech and artificial intelligence (AI) related businesses seeking initial public offerings (IPOs).

The Chinese economy grew at an unexpectedly strong rate of 5.4% in the final quarter of 2024, up from 4.6% in the third quarter. The fourth quarter acceleration helped bring China’s full-year GDP growth to 5.0% - bang in line with the government’s official target - according to the Country’s National Bureau of Statistics. In his annual address to the nation a few weeks ago, Chinese President Xi Jingping stated that the economy was also on course to expand by 5% in 2025. The target was reached in 2024 thanks in no small part to the significant stimulus measures Xi’s government have announced since September.

On Friday, officials also announced industrial output growth rose to an 8-month high, while retails sales emerged from a 3-month low. December export data also came in very strong, reaching its highest level in 3 years. Despite President Xi playing down concerns that the incoming Trump administration in the US would harm the Chinese economy, US importers appear to have rushed in shipments from China ahead of potential tariff hikes after Trump takes office. Some economists warned against calling China’s economic recovery too early, pointing to continual deflation, which has now persisted for a seventh straight quarter.  Nevertheless, the week’s news flow was well received by investors, as both main Chinese equity indices rose after the announcements.