Kicking Off 2025: Rates, Trade Tensions, and Tech Investments Ep.4

Welcome back to our fourth episode of Long/Short Lens, which is the first one this new year 2025. Today we will start with US interest rates and treasuries.

U.S. Interest Rates and Treasury Yields in Focus

In 2024, inflation showed a cooling trend, but it remained sticky enough to prevent sharp Federal Reserve rate cuts. This led to U.S. Treasury yields ending the year above 4.50% as markets adjusted their expectations. The Federal Reserve's pivot from an easing cycle to a recalibration of rates created significant market volatility. Despite the cooling inflation, the persistent budget deficits and geopolitical fragmentation contributed to the higher-for-longer rate view. This environment of heightened market volatility and shifting narratives provided numerous investment opportunities.

Bear Steepening: A Shift in the Yield Curve

Current rate cut expectations present a completely different picture compared to what we observed following the US election and the November rate cut.

Currently, there is a clear Bear Steepening occurring the yield curve, as demonstrated by the chart below comparing current yield curve to the 7th of November curve with the 10-year rate standing at 4.69% today.

So, what does the bear-steepener means?

A bear steepening of the yield curve occurs when longer-term bond yields rise faster than shorter-term yields, resulting in a steeper curve. This often suggests that investors expect stronger economic growth, which can lead to higher inflation and thus higher long-term interest rates. For borrowers—such as governments or corporations—this can mean increased costs to finance long-term projects. At the same time, shorter-term borrowing costs might not rise as quickly, providing some relief to businesses needing near-term financing. Overall, bear steepening can signal a shift in market sentiment toward more robust economic activity, while also raising concerns about the potential for rising inflation and financing costs over time.

Sticky Inflation: ISM Services Data Adds Pressure

Talking about inflation, the latest ISM Services PMI release on the 7th of January, especially Prices Paid Index suggests the inflation proves to be stickier than market participants initially thought.

The Prices Index registered 64.4 percent vs 57.5 percent expected during the month of December, with Real Estate, Rental & Leasing and Finance & Insurance leading the prices surge.

With interest rates expected to remain elevated for an extended period and data suggesting continued challenges in reducing inflation, we are looking at long opportunities in the Financials sector as we expect it to outperform the index benchmark.

Labor Market Strength Adds to Yield Pressure

The latest NFP and Unemployment data paints a strong picture overall. If one were inclined to nitpick, they might point to the slight downside surprise in year-over-year earnings growth. However, the headline payrolls beat and the significant drop in the unemployment rate were much more impactful. The 4.1% unemployment rate was solid thanks to a notable 478k increase in household employment.

This development puts additional upward pressure on yields and is likely to act as a curve-flattener. Demand for the back end of the curve could rise as 30-year yields approach 5%, particularly given that long positioning appears more concentrated at the short end.

As for equities, we’re at valuation levels where changes in interest rates hold considerable sway. With yields climbing further, it was not a surprising to see the stock market react negatively to this data.

Positioning: Staying Agile

Our Long/Short portfolio is positioned slightly bearish, but we are constantly monitoring the economic releases as we do not expect a full-on bear market from here, only a slight correction lower.

Trump Targets Trade Deficits: Mexico and Canada on the Hot Seat

Donald Trump’s recent rhetoric toward Mexico and Canada reflects a recurring theme in his trade policies. By portraying these nations as economic offenders, Trump reinforces his belief that trade operates as a zero-sum game. While this perspective clashes with the prevailing consensus among economists, it remains a cornerstone of his approach to trade.

Trump highlights the U.S. trade deficits of $170 billion with Mexico and $60 billion with Canada, second only to China’s $300 billion. His focus intensifies due to their worsening trade balances with the U.S. since 2020—Mexico by $59 billion and Canada by $46.6 billion.

Threatened tariffs on day one of his term have rattled markets, potentially weakening the Canadian dollar (CAD) and Mexican peso (MXN). Trump’s broader skepticism of globalization leaves the markets and neighboring economies on edge. Whether these tactics benefit the U.S. economy remains uncertain.

Balancing Innovation and Policy

Microsoft is set to invest $80 billion in data centers this fiscal year, with more than half of the spending focused in the U.S. This underscores the massive infrastructure demands required to support AI innovation. For context, Microsoft spent over $50 billion last year, largely on server farms driven by the growing demand for AI services.

I believe it's crucial for the incoming Trump administration to avoid overly restrictive AI regulations. Policies should enable the private sector to thrive while maintaining a balanced approach to export controls. Strong security protections for AI components are essential, but it's equally important to enable U.S. companies to scale efficiently and maintain a reliable supply chain for allied nations.