Muzinich Weekly Market Comment: Hype and seek
Insight
February 3, 2025
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In our latest roundup of the key developments in financial markets and economies, we consider a big week for central banks and a potentially seismic development in artificial intelligence.
Financial markets entered 2025 with significant uncertainty, yet also a sense of optimism about what could be achieved under a new US administration. As it transpired, January, historically a positive month for corporate credit and equity markets, exceeded even the most optimistic of forecasts.
Cash was the notable underperformer, despite money market funds attracting an additional US$168 billion of assets.[1] German equities outperformed, despite the economy contracting by 0.2% in the fourth quarter,[2] weighed down by ongoing manufacturing struggles, domestic political strife, and concerns over US tariffs.
Government bonds remained surprisingly range-bound given how volatile the asset class was in 2024. US Treasury yields edged slightly lower from the start of January, while European government bond yields closed the month marginally higher.
Surprise, surprise
Last week saw the release of Q4 and full-year 2024 growth data for the eurozone and US. The eurozone economy expanded 0.7% in 2024, an improvement from 0.4% in 2023.[3] Meanwhile, US real GDP increased 2.8% in 2024, slightly down on the 2.9% reported in 2023.[4] In nominal terms (before adjusting for inflation), US growth outpaced China for the third consecutive year, with US nominal GDP rising 5.3% compared to China’s 4.2%[5] (see Chart of the week).
Although Q4 growth fell short of expectations in the US and Eurozone, January data suggests conditions are improving. European industrial output is showing signs of recovery, as reflected in manufacturing PMI returning to expansionary territory,[6] while a robust US labour market is boosting domestic consumption, which continues to power the economy. Economic surprise indices are positive,[7] indicating aggregate economic data released in January exceeded forecasts.
Great expectations
The second key driver of stable government bond yields has been the ability of central banks to meet market expectations. Following an uneventful Bank of Japan meeting, the European Central Bank (ECB) and the Federal Reserve took centre stage last week.
The ECB reduced borrowing costs for the fifth time since June 2024, cutting the deposit rate by 25bps to 2.75%.[8] “We know the direction of travel,” ECB President Christine Lagarde stated, reinforcing expectations for additional rate cuts.
In contrast, the Fed unanimously voted to keep the policy rate steady at 4.25%–4.50%.[9] Fed Chair Jerome Powell emphasized the US central bank is in no rush to cut rates further, opting to wait for the new administration's economic policies to take shape.[10] The committee also made small but notable adjustments to its policy statement, acknowledging inflation remains elevated by removing prior references to progress on disinflation.
The overnight interest rate swap (OIS) market is fully pricing in 75 basis points (bps) of cuts to ECB policy rates this year, with an 81% probability assigned to 100bps of cuts. In the US, the market is currently pricing in 1 rate cut of 25bps and a 90% probability of 2 cuts.[11]
Range-bound government bond yields, a positive start to Q4 earnings season, decent economic data and a shortage of new issuance combined to make January a good month for corporate credit. High yield outperformed its investment-grade peers, with both US and emerging-market high yield delivering total returns above 1%.[12]
Seek and destroy?
While sentiment toward corporate bonds was positive, in equities, FOMO (the fear of missing out) seemed to be the prevailing theme. The Bloomberg World Large & Mid Cap Price Return Index climbed 3.5% in January. European equities outperformed, with the German and Swiss Large & Mid Cap Indexes rising nearly 9%, and Polish equities soaring over 12%, leading gains in Eastern Europe.
In the US, equity investors eagerly awaited earnings reports from 4 of the so-called ‘Magnificent Seven’ – Apple, Meta, Microsoft and Tesla. However, their earnings were completely overshadowed by news of an artificial intelligence breakthrough by Chinese startup DeepSeek.
Reports that DeepSeek has been able to build its large language model at a fraction of the cost of US platforms has raised concerns about AI hyperbole and one company in particular. On January 27, Nvidia plunged 16.97%, wiping out almost US$600 billion of its market capitalization. To put this in context, it was the biggest single day fall in history for a US company and larger than the total value of ExxonMobil.
If DeepSeek’s announcement proves accurate, it could represent a positive supply shock to AI technology, implying hardware barriers to entry and scalability are less critical. This should enable AI technology to spread more rapidly and on a larger scale across the global economy, driving faster productivity, higher growth, and lower inflation — a favourable outcome for equity and bond markets.
It could also reduce the world’s reliance on US technologies. Nvidia and other US tech firms are likely to face increased competition, even as sales increase in line with lower barriers to entry. The US must realise China is not far behind on AI development. Recent history in the tech sector highlights that being a first mover doesn’t always guarantee lasting success. Blackberry, anyone?
Chart of the week: US outpaces China for 3rd successive year
Source: Bureau of Economic Analysis, ‘Annual gross domestic product, unadjusted for price changes,’ as of January 31, 2025. For illustrative purposes only.
Past performance is not a reliable indicator of current or future results.
References
[1] Standard Chartered, ‘Flow dynamics – walking on thin ice,’ January 31, 2025
[2] Statistiches Bundesampt, ‘GDP in the 4th quarter down 0.2%,’ January 30, 2025
[3] European Commission, ‘GDP stable in the euro area and up by 0.1% in the EU,’ January 30, 2025
[4] Bureau of Economic Analysis, GDP data, January 30, 2025
[5] National Bureau of Statistics of China, ‘2024 Yearbook,’ January 17, 2025
[6] S&P Global, ‘HCOB Flash Eurozone PMI,’ January 24, 2025
[7] Citi, ‘Economic Surprise Indices,’ as of January 31, 2024
[8] European Central Bank, ‘Monetary policy decisions,’ January 30, 2025
[9] Federal Reserve, ‘Federal Reserve issues FOMC statement,’ January 29, 2025
[10] Federal Reserve, ‘Transcript of Chair Powell’s press conference, January 29, 2025
[11] Bloomberg, ‘Market implied policy rates,’ as of January31, 2025
[12] ICE Data Platform, as of January 31, 2025
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