2025 Bond Market Snapshot: A Challenging Start

Tuesday 14th January 2025

The bond market enters 2025 in an environment that is, if anything, even more complex than the prior year, with a multitude of risk factors to navigate. Needless to say, the geopolitical situation remains a major source of concern: the war in Ukraine, multiple conflicts in the Middle East, and the emergence of new global tensions create a context of high uncertainty and increased volatility.

Beyond geopolitical tensions, several domestic political developments are directly or potentially influencing the bond market. In France, there is anticipation for more details about the next steps—especially regarding the budget—of the government under recently appointed Prime Minister Bayrou. In Germany, after the collapse of the cabinet led by Chancellor Scholz—primarily over budget disagreements—snap elections are scheduled for February 23.?

In the United States, there is significant interest in observing the actions of the new president, Donald Trump, particularly regarding his proposed tariffs on foreign products. On both sides of the Atlantic, the economic debate focuses on public finances and the real economy, albeit with opposing strategies and in different contexts. In the Eurozone, despite the opposition of some populist forces to strict fiscal discipline, the EU advocates a return to pre-pandemic austerity. Conversely, the new U.S. administration is expected to pursue economic plans centred on deficit spending.

The macroeconomic scenarios also differ markedly. In the Eurozone, manufacturing and service sectors continue to struggle, as highlighted by recent PMI data, particularly in Germany, the region's largest economy. In contrast, the U.S. economy shows signs of improvement, with strong employment data pointing to a recovery.

This divergence is also evident in price dynamics. In the Eurozone, inflation -2.2% in December- has not yet reached the European Central Bank's target level. The ECB is closely monitoring key components like energy costs and negotiated wages, with particular attention to the cost of services. Recent price increases in the Eurozone are attributed largely to seasonal factors, and the region is believed to be on a steady disinflationary path. On the other hand, with the U.S. economy in full recovery, inflationary pressures are more pronounced. Consequently, upcoming data on price trends will be scrutinised closely by both markets and policymakers.

Central banks remain pivotal in this environment. The Federal Reserve will meet on January 28-29, followed by the European Central Bank on January 30. Given the differing economic conditions and price dynamics, their responses are likely to diverge. While many analysts expect the ECB to implement at least two rate cuts in the coming months, the outlook for the Federal Reserve is less clear.

As 2025 begins, bond yields are generally on the rise. This reflects market expectations for inflation and macroeconomic trends, as well as factors specific to bond issuance. In the Eurozone, despite expectations of a supportive ECB, markets are factoring in the significant volume of new bond issuances, estimated at approximately €1.8 trillion. The ECB’s decision to halt reinvestments of maturing bonds at the end of 2024, and the further normalisation of its balance sheet, is also influencing the market.

The divergence between U.S. and Eurozone bond markets is highlighted by the evolution of the "transatlantic spread," which measures the difference between 10-year benchmark yields. With U.S. Treasury yields approaching 5.00%—currently at 4.80%, the highest level since November 2024—and German Bunds at around 2.60%, the spread has widened to 220 basis points, an increase of 70 basis points over the past three months.

Outside the Eurozone’s core markets, political tensions are weighing on French OATs, which are trading around 4.45%, similar to Greek bonds. Italian bonds are following the broader European trend, but the BTP-Bund spread has widened slightly in recent months and now stands at around 120 basis points

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