Weekly market update - 14 January 2025

Persistent fears around inflation and the pace of interest rates changes pushed up government borrowing costs last week, hitting multi decade highs in the UK.

Global bond yields have been rising since September last year, when the US Federal Reserve began cutting interest rates. Since then, inflation has proven more resilient than many expected, while initial hopes for a rapid return to lower interest rates also faded.

As a result, last week 30-year UK gilts saw yields hit heights not seen since 1998, while 10-year gilt yields reached 2008 levels.

According to Hetal Mehta, Head of Economic Research at SJP, while the rise in gilt yields has been primarily driven by global factors, the recent stubbornness of inflation and wage growth in the UK makes it more difficult for the Bank of England (BoE) to cut policy rates aggressively.

Hetal notes: “The domestic upshot is that higher cost of debt will reduce already limited fiscal headroom. For the Chancellor, the options are limited, especially given that the optimistic growth forecasts from the Office for Budget Responsibility (OBR) look increasingly unrealistic. Raising taxes would be politically difficult but cutting spending risks further slowing growth. It's a tough balancing act with no easy solutions. This policy ‘catch-22’ may have exacerbated daily market moves beyond what global factors might imply.”

Unsurprisingly, all this has added pressure on the Labour government. Over the weekend, reports emerged that Prime Minister Keir Starmer will pin at least some of his hopes on artificial intelligence to boost UK growth.

In late March, Chancellor Rachel Reeves is due to present her Spring Statement, which will include updated OBR economic and fiscal forecasts.

Looking at what might help the situation, James Ringer, Fixed Income Portfolio Manager at Schroders, said: “There are two main catalysts for a turnaround in the current market conditions: intervention or lower inflation data. Intervention could originate from the UK Treasury or the BoE. On the Treasury side, verbal intervention is likely the first step. The Chief Secretary to the Treasury recently reiterated the government’s commitment to the fiscal rules, but did not provide further details.”

Despite the gilt issues, the FTSE 100 remained reasonably flat last week, as a weaker pound helped exporters. The headline figure hid a range of differing results, however. Housebuilder companies have come under sustained pressure since the October budget, as buyers grapple with potential higher funding costs and increased job uncertainty.

Equity markets in the US stalled, as strong jobs data released on Friday pushed out expectations of US interest rate cuts to later this year.

This hurt the large US tech companies that dominate the US indices, with the NASDAQ dropping 2.3% and the S&P 500 falling 1.9% over the week. Overall, the S&P 500 has now lost virtually all of the gains it made in the immediate aftermath of the November Presidential election.

Figures released by the Bureau of Labor Statistics on Friday showed 256,000 jobs were added last month, exceeding expectations. Meanwhile unemployment fell to 4.1%.

With a relatively stable job market, the Federal Reserve can afford to be more patient with interest rate cuts this year. With this in mind, economists will be closely watching the inflation data due to be released this week for further hints at what it might mean for the future decision making of the Federal Reserve.

Turning to mainland Europe, the MSCI Europe ex UK rose 1.2% on expectations of an interest rate cut from the European Central Bank later this month.

Finally in Asia, the Nikkei 225 and Shanghai Composite retreated by 0.5% and 0.2% respectively (both local currency). The Nikkei 225 fell on the growing view that the Bank of Japan could soon hike rates. Meanwhile the Shanghai Composite fall reflected persistent deflationary pressures shown in the latest Consumer Price Index and Producer Price Index releases.