January 27, 2025
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In our latest roundup of the key developments in financial markets and economies, we consider the implications of a softer tone on US tariffs.
It was a short week in the US, with Monday marking Donald Trump’s presidential inauguration and Martin Luther King Jr. Day, a federal holiday. The Federal Open Market Committee (FOMC) entered its blackout period ahead of its January 28-29 policy meeting, leaving investors without fresh signals on monetary policy.
Meanwhile, many world leaders were out of office, attending the World Economic Forum's Annual Meeting in Davos, and the economic calendar, typically light during the third week of the month, saw the few notable events concentrated on Friday. As a result, investors had little to focus on beyond news headlines, which were largely focused on the new US administration.
Top Trumps
If the immediate price action in financial markets was a reliable indicator of success and approval for policy announcements, solutions or considerations, investors seemed to give a resounding thumbs up as markets largely delivered solid returns.
US Treasury yields remained stable, slightly outperforming European government bonds, where yields edged higher after the release of Euro Area Purchasing Managers Index data.[1] The PMI report improved for the second consecutive month, with the overall index returning to expansionary territory.
The headline reading rose to 50.2 in January from 49.6 in December, surpassing the median forecast of 49.7. The improvement was broad-based across the Eurozone, with Germany's manufacturing PMI increasing to 50.1 from 48.0 and France's rising to 48.3 from 47.5. This data is encouraging, signalling that the Eurozone economy may be on a recovery path in the first quarter. Additionally, any impact from US tariff threats has been muted.
Despite positive economic data, the European Central Bank (ECB) is expected to loosen policy by 25 basis points at its next meeting, scheduled for January 30. This reflects its belief that inflationary pressures are contained. Speaking at Davos, ECB President Christine Lagarde expressed “strong confidence that inflation will continue to slow”.[2]
Take a hike
The main event for bond markets last week was the Bank of Japan’s (BOJ) monetary policy meeting. Investors widely anticipated further tightening, especially after Deputy Governor Ryozo Himino’s speech earlier this month,[3] which prepared markets for such a move and avoided a repeat of last year’s communication challenges.
As expected, the BOJ raised its rate target by 25 basis points to 0.50%, a level last seen in 2008.[4] Notably, the BOJ’s policy statement omitted references to uncertainties surrounding the US economy and global markets. The statement also included upward revisions to its projections for core CPI inflation for all three fiscal years in its forecast horizon (see Chart of the Week).
However, speaking to local media, BOJ Governor Kazuo Ueda set a cautious tone, refraining from providing explicit hints about the timing of future rate hikes. The overnight interest rate swap market is currently pricing in one additional 25-basis-point hike in the fourth quarter,[5] with investor sentiment leaning toward the possibility of an extra 25 basis points cut, which would push the policy rate to 1% by year-end.
Credit market recovery continues
Corporate credit had another positive week, with high yield continuing to outperform. US high-yield bonds led the pack, delivering over 1% returns year-to-date, followed closely by emerging market high yield. European high yield trailed but still outpaced its investment-grade counterpart.
A common theme across global high-yield markets is the lack of supply. In the US, for instance, the average weekly supply of new securities typically ranges between US$6–8 billion. However, total new issuance for January currently stands at just over US$10 billion with one week remaining in the month.[6]
Meanwhile, fund managers continue to report inflows, driven primarily by institutional investors, including insurers and pension schemes, who are allocating more to credit broadly and high yield specifically.[7] Last week also saw US$1.3 billion in bond calls and US$0.4 billion in coupon payments, returning capital to managers and reinforcing high yield’s positive momentum.[8]
Much ado about nothing?
The prevailing concern for 2025 is tariffs, which have shaped the consensus outlook for a strong US dollar, US rates remaining higher for longer, and a steepening of global government bond curves. However, a potential flaw in this reasoning lies in the inherent conflict between tariffs and the administration’s pro-growth, pro-business objectives. These goals favour low interest rates, reduced taxes, and policies that support rising market valuations.
What if the consensus is wrong? Since his inauguration, President Trump has been notably less enthusiastic about tariffs. Perhaps most telling was his interview on Fox News, where he remarked: “I’d rather not have to use it. But it’s a tremendous power over China.”[9] This would seem to underscore a preference for alternative strategies.
Meanwhile, Maroš Šefčovič, the EU's Trade and Economic Security Commissioner, suggested the European Union and US should explore lowering tariffs on each other’s goods as part of a broader solution.
Previously, President Trump has criticized the disparity in tariffs, noting that the EU imposes higher tariffs on US exports than vice versa. Šefčovič highlighted this imbalance at the World Economic Forum in Davos, Switzerland, pointing out that the EU tends to levy higher tariffs on passenger vehicles, while the US imposes steeper tariffs on light trucks.[10]
Equities embraced the news enthusiastically, rallying across the globe. The Bloomberg World Large & Mid Cap Price Return Index climbed over 2% for the week, while US equity indexes surged more than 3%. Year-to-date, the standout performer, however, has been the German DAX, which is up over 7% to hit an all-time high.
Industrial commodities and oil saw price declines, while the US dollar weakened significantly. Emerging market currencies had a strong week, particularly Latin America currencies, which appreciated more than 2.5% against the US dollar. However, it was noteworthy that US Treasuries outperformed, and the money market priced in an additional 5 basis points of policy easing for 2025.[11]
If consensus shifts to a 180-degree reversal on tariffs, investors may consider shorting the US dollar, going long on US duration, covering underweights in emerging markets and possibly Europe, and maintaining a long position in risk assets.
Chart of the week: Bank of Japan prepares investors for further tightening
Forecasts mentioned are not a reliable indicator of future results.
Source: Bank of Japan, ‘Outlook for economic activity and prices,’ as of January 24, 2025. For illustrative purposes only.
Past performance is not a reliable indicator of current or future results.
References
[1] S&P Global, ‘HCOB Flash Eurozone PMI,’ January 24, 2025
[2] CNBC, ‘ECB’s Lagarde: Not overly concerned by the export of inflation to Europe,’ January 22, 2025
[3] Bank of Japan, ‘Speech: Japan's Economy and Monetary Policy,’ January 14, 2025
[4] Bank of Japan, ‘Decision at the January 2025 Monetary Policy Meeting,’ January 24, 2025
[5] Bloomberg, ‘Market implied policy rates,’ as of January 24, 2025
[6] Bank of America, ‘High yield strategy,’ January 24, 2025
[7] Morningstar, ‘Fund flows data,’ January 21, 2025
[8] Bank of America, ‘High yield strategy,’ January 24, 2025
[9] Fox News, ‘President Donald Trump says he will bring America back,’ January 22, 2025
[10] Politico, ‘EU trade chief to Trump: Let’s deal,’ January 22, 2025
[11] Bloomberg, ‘Market implied policy rates,’ as of January 24, 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 27, 2025, and may change without notice. All data figures are from Bloomberg, as of January 20, 2025, unless otherwise stated.
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