Market Commentary: week to 14 January 2025

The UK economy faced significant headwinds in 2024, marked by stagnation and subdued growth. December’s Purchasing Managers’ Index (“PMI”) data revealed the weakest private sector performance since October 2023, with composite PMI at 50.4 and a sharp decline in new orders. Rising payroll costs and declining demand drove the steepest fall in employment since January 2021, while business confidence fell to a two-year low following tax increases in the Autumn Budget. Although KPMG raised its 2025 Gross Domestic Product (“GDP”) forecast to 1.7% due to expansionary fiscal policy, 2024 growth remained modest at 0.7%, with inflation averaging persistently high levels. Despite signals of gradual rate cuts from the Bank of England, bond market volatility added uncertainty to the outlook.

The UK fiscal outlook has become increasingly challenging, as rising gilt yields threatened fiscal headroom and forced difficult policy decisions. Chancellor Rachel Reeves faces a ￡6.4 billion increase in borrowing costs, reducing her fiscal buffer from ￡9.9 billion to just ￡3.5 billion by 2030, according to Oxford Economics. Concerns over fiscal sustainability may necessitate additional tax hikes or spending cuts, with economists suggesting Reeves is close to breaching her fiscal rules. Reeves has urged her cabinet to propose alternative growth strategies, though inflationary pressures and weak economic activity pose further obstacles. Public sentiment reflects scepticism, with 72% believing the economy is heading in the wrong direction.

UK markets faced heightened volatility last week as rising borrowing costs and fiscal concerns weighed on sentiment. Gilt yields surged, with the 30-year yield reaching 5.4%, the highest since 1998, exacerbating fiscal challenges and sparking fears reminiscent of past crises. Sterling hit a year low, while the FTSE 250 declined amid concerns over the Labour government’s ability to manage escalating deficits. Meanwhile, UK equity funds saw ￡221 million of net outflows in December, reflecting cautious investor sentiment.?

US markets too ended the week lower, with the S&P 500, Nasdaq and Russell 2000 all declining amid rising yields and a strengthening dollar. The 2-year and 10-year Treasury yields reached their highest levels since October 2023, following robust economic data, including December payrolls surpassing expectations at 256,000 and a decline in the unemployment rate to 4.1%. Megacap tech stocks, including NVIDIA and Tesla, faced pressure from valuation concerns and dollar strength, which also raised revenue headwinds ahead of fourth quarter earnings. Hawkish commentary from the Federal Reserve (“Fed”) and market expectations for fewer rate cuts in 2025 added to the week's cautious sentiment.

The UK housing market showed signs of cooling in December, with the Halifax house price index dipping 0.2% month-on-month, the first decline after five months of gains. Year-on-year growth slowed to 3.3%, underperforming consensus and contrasting with Nationwide's more optimistic reading. Elevated borrowing costs and subdued consumer confidence weighed on residential activity, which contracted for the third consecutive month according to S&P Global's construction PMI, which fell to 53.3. Meanwhile, inflation expectations among UK households continued to rise, with 12-month expectations at 3.7%, up from 3.3% in October, reflecting persistent concerns about cost-of-living pressures.

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