Weekly markets review | 3 February 2025

By Thomas Hibbert, CFA, Multi-Asset Strategist

Summary

• Deepseek’s new Artificial Intelligence (AI) model sparked sharp volatility in tech stocks, raising concerns about AI supply chain profitability, but markets quickly rebounded
• Global equities remained in a secular bull trend, ending the week just 0.7% lower in sterling terms, with broad sector and regional gains
• The US Federal Reserve (Fed) held rates steady, maintaining a cautiously dovish stance, with markets pricing in two more cuts this year despite signs of US economic resilience
• The European Central Bank (ECB) cut rates to 2.75% amid stagnating eurozone growth, with markets expecting further easing as European yields tracked US treasuries lower.
• Trump imposed sweeping tariffs on Canada, Mexico, and China, heightening trade war fears; Canada’s retaliation underscored the challenges of matching US measures
• The Bank of England (BoE) is widely expected to cut rates to 4.5% this week, while US payrolls and annual benchmarking revisions could significantly reshape recent job growth data.

Market review

DeepSeek sparks volatility

The new R1 AI large language model (‘LLM’) released by Deepseek in China sparked disruption on Monday resulting in a surge of volatility in AI related stocks. The Deepseek model performs in-line with popular models like OpenAI’s ChatGPT but does so using a fraction of the computational power – making it more cost effective.

This has raised scepticism about the supernormal profits generated in the AI supply chain and the assumptions embedded in the valuations of such stocks. While the revelations from Deepseek’s achievements could lead other LLM developers back to the drawing board, the impact on hyperscaler capex (the large-scale investments made by major cloud providers into data centres to support their global operations) is unclear. The volatility was isolated to Monday and very distinctive in nature. The market rebounded well as investors were quick to buy the dip as retail investors bought a near-record level of tech stocks last week and the broader US market ended only 0.7% lower in sterling terms. Equities remain in a secular bull trend with most sectors and regions rising over the week and the global index up 0.35%.

Central banks

The Fed meeting was reassuringly uneventful as the Federal Open Market Committee (FOMC) left rates unchanged. US economic resilience means further cuts are unnecessary for now with policymakers preferring a ‘wait and see’ approach. The Fed has implemented four 0.25% cuts from a peak of 5.5% (upper bound) last year and maintains a cautiously dovish stance, with Jerome Powell – the chair of the Fed - noting that policy remains 'meaningfully restrictive’. The market expects the Fed to be able to cut rates twice more this year with the next cut priced in for the summer. This soft-landing type of scenario should be a positive backdrop for investors. US treasury yields drifted lower over the course of the week with the 10-year closing at 4.54%.

The backdrop in Europe is more troubled as economic growth has stagnated. The German economy shrunk at a -0.2% annualised rate in the fourth quarter and growth flatlined for the eurozone as a whole. This relative economic weakness makes it easier for the ECB to loosen policy and as expected they cut rates again last week.

The cut took the Deposit Facility Rate – the interest rate banks receive when they deposit money with the central bank - to 2.75%. The market expects the ECB to ease policy further with another three cuts priced in for this year, taking the policy rate to below 2%. European yields traded lower over the week mostly in sympathy with US treasuries.

Tariffs

Last week I wrote that tariffs were a certainty with Trump eyeing up February for his first salvo. As expected, on 1 February, Trump announced general tariffs of 25% on Canada and Mexico, as well as 10% on China. These tariffs are estimated to impact close to half of US imports. Trump has also threatened tariffs on Europe, the largest source of US goods imports.?

The US tariffs represent potential inflation, and although they will raise Government revenues, most economist do not believe that this will offset the lost revenue from Trump’s previous tax cuts.

For trading partners tariffs this could have severe consequences forcing nations to reshape trade. Canada has retaliated, though no response can match the scale of US measures. The markets open this morning with some trepidation over a potential trade war.

The week ahead

Thursday: BoE rate decision

Our thoughts: The BoE are almost certain to cut interest rates this Thursday, with a 99% probability priced into swap markets. This will take the target rate to 4.5%. The BoE may revise their inflation forecasts up for 2025 and their growth forecasts down for the next three years.

Friday: US payrolls

Our thoughts: Job growth is expected to have slowed to 170k in January. The Bureau of Labour Statistics will also release its annual benchmarking revisions, which could significantly alter the job growth figures for the past year. This process often highlights data reliability issues, especially given the challenges of low response rates in recent surveys.

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