Muzinich Weekly Market Comment: Relief rally

January 20, 2025

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In our latest roundup of the key developments in financial markets and economies, we look back at a better week for investors after recent turbulence.

After a difficult start to the year, there was respite for financial markets last week. Economic and geopolitical developments were supportive of asset prices; government bond yields declined, corporate credit spreads tightened, and commodity and equity prices increased.

The first positive development came from inflation data in key G7 markets. In the UK, headline consumer price inflation fell to 2.5% in December from 2.6%, below the consensus estimate of 2.6%.^[1] The primary driver was weaker services inflation — a key metric for the Bank of England (BoE) — which dropped to 4.4% from 5%, well below the consensus forecast of 4.8% and the BoE’s projection of 4.7%. A decline in airfares and accommodation services prices were the main factors behind the drop.

The UK disinflation trend could be short-lived, however, as another rise in household energy bills is expected in the spring, which could push inflation closer to 3%, well above the BoE’s 2% target.

Nevertheless, this may not alter the Bank’s plans to cut rates given growing concerns about the UK economy. Last week also saw the release of monthly GDP,^[2] industrial production^[3] and retail sales data^[4] - all of which fell short of expectations and strengthen the case for a 25-basis points rate cut by the BoE in February (see Chart of the Week).

US disinflation back on track?

Meanwhile, US headline inflation rose by 0.4% in December — the fastest monthly increase since March 2024 — pushing annual headline inflation up to 2.9%. Energy costs were the primary cause, with gasoline prices up 4.4% (seasonally adjusted) and natural gas prices up 2.4%.^[5]

However, headline numbers can be deceiving. With energy prices largely beyond the Federal Reserve's control, investors focused instead on unexpectedly muted core inflation. Core prices rose by just 0.2% in December after four consecutive months of 0.3% increases, marking the first step down in six months. On an annual basis, core prices eased to 2.9%. Cheaper hotel stays, a smaller rise in medical services and stable rent increases were contributory factors.

The Fed will welcome signs that disinflation seems to be back on track after stalling in H2, although will remain cautious about potential headwinds, including higher energy prices, the impact of wildfires in Los Angeles on shelter costs and tariff-induced price shocks. However, investors were encouraged by the price data and increased expectations for two policy rate cuts in 2025, with the next cut now pencilled in for June.^[6]

Could US tariffs derail China recovery?

In China, growth has been the primary concern lately. As such, the government will be relieved that its policy pivot since September helped the economy expand by 5.4% in the fourth quarter, the fastest pace in six quarters.^[7] This allowed the government to meet its 2024 target of 5% growth.

Estimates suggest that around 60% of the rebound resulted from policies aimed at boosting consumption and manufacturing investment, with the remainder driven by advanced export shipments.^[8] However, China bears are focusing on the front-loading of export orders, warning momentum may fade in the coming months due to the looming impact of US tariffs.

On that note, it appears US President-elect Donald Trump has authorised his incoming economic team to use tariffs as a tool to negotiate favourable trade deals. However, the new administration faces a challenging balancing act between imposing tariffs and mitigating their impact - particularly to living costs.

Current reports suggest a preference for implementing universal tariffs gradually, with increases of 2% to 5% per month under the International Emergency Economic Powers Act.^[9] The rationale behind this approach is that it will increase the administration’s negotiating leverage while avoiding sudden price spikes for consumers.

Peace sign

Finally, there was encouraging news from the Middle East, as Israeli Prime Minister Benjamin Netanyahu announced that an agreement has been finalised with Hamas to pause the conflict in Gaza.

Outgoing US President Biden emphasised his desire for the truce to permanently end hostilities, stating such a resolution would help stabilise the broader Middle East and foster stronger diplomatic ties between Israel and Arab states, including Saudi Arabia.^[10]

Chart of the week: Will BoE cut in February?

Forecasts mentioned are not a reliable indicator of future results.

Source: Bloomberg, ‘Market implied policy rates,’ as of January 17, 2025. For illustrative purposes only.

Past performance is not a reliable indicator of current or future results.

References

[1] Office for National Statistics, ‘Consumer price inflation, UK,’ January 15, 2025
[2] Office for National Statistics, ‘GDP monthly estimate, UK: November 2024,’ January 16, 2025
[3] Office for National Statistics, ‘Index of Production, UK: November 2024,’ January 16, 2025
[4] Office for National Statistics, ‘Retail sales, Great Britain: December 2024,’ January 17, 2025
[5] US Bureau of Labor Statistics, ‘CPI for all items rises 0.4% in December; gasoline and shelter up,’ January 15, 2025
[6] Bloomberg, ‘Market implied policy rates,’ as of January 17, 2025
[7] National Bureau of Statistics of China, January 16, 2025
[8] Bloomberg, ‘China hits 5% GDP target, but US tariffs threaten further growth,’ January 16, 2025
[9] Bloomberg, ‘Trump’s economic team considers ramping up universal tariff,’ January 14, 2025
[10] US Embassy in Israel, ‘Statement from President Joe Biden,’ January 15, 2025

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific companies are for illustrative purposes only and does not reflect the holdings of any specific past or current portfolio or account. The opinions expressed by Muzinich & Co. are as of January 20, 2025, and may change without notice. All data figures are from Bloomberg, as of January 17, 2025, unless otherwise stated.

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