12/01/2025 Market Analysis

Week Ahead: Inflation & Bond Market

Next week’s focus will center on U.S. inflation data following stronger-than-expected job numbers. This could lead investors to reassess the likelihood of near-term interest rate cuts. The bond market, particularly U.K. government bonds, will be closely watched due to recent yield increases. U.K. inflation data is expected to draw significant attention amid these developments.

In Asia, China’s economic data will reveal if the country met its growth targets last year, a key point for the global market outlook.

The recent robust U.S. employment report bolstered the "American exceptionalism" narrative, pushing the U.S. dollar to new highs against most G10 currencies. Derivatives markets have delayed the next Federal Reserve rate cut to September. By then, the European Central Bank, Bank of England, and Bank of Canada are expected to implement notable rate cuts, while the Bank of Japan is anticipated to increase rates.

Despite initial strength, the U.S. dollar’s momentum waned, suggesting much of the news is already factored in. However, upcoming U.S. economic data, including CPI, PPI, retail sales, and industrial production, are expected to show improvements, potentially sustaining the current market trends. Additionally, the Bank of Japan's potential inflation forecast revision highlights the importance of the upcoming speech by its deputy governor.

Sterling has seen consecutive weekly declines, with only occasional rises since Q3 2024. While year-over-year CPI may stabilize, there is potential for improvement in November GDP and December retail sales data. Meanwhile, China might take steps to alleviate pressure on the yuan by reducing liquidity in Hong Kong through significant bill sales.

United States of America

U.S. Economy Shows Strength Ahead of Inauguration

Recent U.S. data, including exceptional jobs figures for December, indicate continued economic strength leading up to President-elect Donald Trump’s inauguration on January 20. This resilience suggests the U.S. economy remains robust as the political transition approaches.

Fed Rate Cut Expectations Shift to September

Money markets are currently pricing in only one Federal Reserve rate cut this year, expected around September. This follows the Fed’s December decision to lower its rate cut forecasts for 2025, reflecting a cautious approach to monetary policy.

Focus on U.S. Inflation Data

U.S. consumer price inflation (CPI) data for December, due Wednesday, will be under intense scrutiny. Persistent inflation could challenge the Fed’s rate cut plans, especially with expectations that Trump’s policies may fuel inflation. This scenario could adversely impact bonds and further strengthen the dollar.

Producer Price Inflation as a Leading Indicator

Tuesday’s producer price inflation (PPI) data could offer early insights into the inflation trend. These figures will be critical in shaping market expectations ahead of the CPI release.

Economic Activity and Rate Expectations

Upcoming data on retail sales, industrial production, and housing starts for December will be pivotal. Retail sales, supported by auto sales, and industrial output gains may reflect a robust real sector. These indicators could influence rate expectations if they signal continued economic momentum.

Federal Reserve’s Shift in Focus

Following a September rate cut, the Fed refocused on its price stability mandate, as emphasized in its December meeting. The expected December CPI increase will likely keep inflation concerns in the spotlight, hinting at a moderated pace of consumer inflation in early 2025.

Dollar Index Nears Key Levels

The stronger-than-expected U.S. employment data propelled the Dollar Index towards 110.00. A breach of this level could trigger further gains towards 111.00-20, though caution is warranted as momentum indicators signal potential resistance.

Key Points:

• U.S. economy remains strong, bolstered by recent jobs data.
• Fed likely to delay rate cuts until September.
• December CPI and PPI data will be critical in assessing inflation trends.
• Retail sales and industrial production to indicate real sector health.
• Dollar Index nearing significant resistance levels.

Australia

RBA Rate Cut Expectations Under Scrutiny

Australian money markets anticipate a strong likelihood of the Reserve Bank of Australia (RBA) cutting interest rates in February. However, this expectation might be challenged by upcoming data.

Robust Job Market Despite Economic Slowdown

Australia’s job market remains resilient, withstanding elevated interest rates, high migration inflows, and a slowing economy. The unemployment rate dropped to 3.9% in November, marking one of the lowest levels in half a century. December’s employment data, due Thursday, will be pivotal in assessing the need for a rate cut.

Retail Sales Growth as a Key Factor

The RBA will also consider the solid retail sales growth recorded over the last quarter of 2024 during its February policy meeting. This growth could influence the central bank's decision-making process.

Inflation Trends Towards Target Range

Inflation appears to be aligning with the RBA’s target range of 2% to 3%. Confirmation of this trend in the upcoming consumer price index data could pave the way for a rate reduction, the first in the current cycle.

Australian Dollar’s Unexpected Weakness

The Australian dollar fell 10.5% in Q4 2024, a surprising decline that doesn’t align with Australia’s monetary policy or its anticipated trajectory. Futures markets initially predicted significant rate cuts, but expectations have moderated.

Labor Market Resilience Highlighted

The employment report on January 16 will be crucial, showcasing the Australian labor market's strength. In the first 11 months of 2024, job growth averaged nearly 36,000 per month, with the unemployment rate falling back to 3.9% by November.

Technical Indicators for the Australian Dollar

Technically, the Australian dollar has shown bearish signs, with recent support levels around $0.6100 and potentially lower. To stabilize, it may need to surpass $0.6200-$0.6220. The currency’s six-week decline marks its longest losing streak in a decade.

Key Points:

• RBA’s February rate cut expectations are under review.
• Australia’s job market remains strong despite economic challenges.
• Retail sales growth could influence the RBA’s decisions.
• Inflation trends are moving towards the RBA’s target range.
• The Australian dollar’s unexpected weakness reflects broader economic pressures.

China

Yuan's Stability Amid Managed Exchange Rate

The Chinese yuan is not highly sensitive to macroeconomic data due to active management aimed at maintaining stability, especially against the dollar. Despite facing tariffs and sanctions, China may report a record trade surplus in December, exceeding $100 billion. Chinese companies are increasingly offshoring production, similar to the practices of the US and Japan after the Plaza Agreement.

Trade Surplus Amid Stimulus Measures

China's trade surplus figures, while politically sensitive, are expected to reflect the impact of recent stimulative measures. Growth in Q4 2024 might rival the best performance in two years, potentially reaching 5% year-over-year. Retail sales are projected to rise by 3.5% in December, a noteworthy figure given the perception of weak domestic consumption.

Beijing's Response to Dollar Strength

The strong dollar is causing concerns in Beijing, leading the People's Bank of China (PBOC) to take measures like selling bills in Hong Kong and pausing bond purchases. Although these actions moderate the yuan's depreciation, they do not entirely prevent it. The dollar's value could rise to CNY7.50 if the broad uptrend continues.

Economic Growth Target in Focus

A critical week lies ahead for China as markets assess whether Beijing met its 2024 growth target of around 5%. December trade figures, expected on Monday, will show if exports recovered from the prior month's slowdown. Rising trade protectionism adds significance to China's export performance.

Anticipation of Trade and Interest Rate Data

Economists anticipate a 7.4% year-over-year increase in December exports, driven partly by front-loading ahead of US tariffs. Imports are expected to decline, leading to an estimated $99.75 billion trade surplus. On Wednesday, the PBOC's interest rate announcement will be closely monitored amid ongoing monetary easing efforts.

Impact of Beijing's Stimulus Measures

Friday will bring a series of data releases, including GDP growth likely boosted to 5.1% in Q4 2024 due to stimulus efforts. Stabilizing consumption, investment, and industrial output are anticipated, indicating the effectiveness of Beijing’s stimulus measures. Retail sales and fixed-asset investment are also expected to show moderate growth.

Real Estate Market and Yuan Support

Attention will also turn to housing price and property investment data for signs of recovery in the real estate sector. Efforts to support the yuan amid trade risks and dollar strength remain crucial, alongside monitoring Chinese government bond yields following the central bank's suspension of bond purchases.

Key Points:

• The yuan's exchange rate is managed for stability, with a record trade surplus expected.
• China's Q4 2024 growth could reach 5%, supported by recent stimulus measures.
• The PBOC is actively moderating the yuan's depreciation against the dollar.
• Upcoming trade and GDP data will reveal if China met its economic targets.
• Retail sales, industrial output, and fixed-asset investment are projected to show steady growth.
• Real estate data will be analyzed for signs of market stabilization.

Europe

ECB Meeting Accounts Awaited for Rate Cut Signals

The European Central Bank (ECB) will release the accounts from its December meeting on Thursday, drawing attention to any indications of a potential rate cut at the upcoming meeting this month.

Inflation Concerns Rise Among Policymakers

Eurozone policymakers are likely growing cautious about inflation prospects. Preliminary data showed annual inflation climbed to 2.4% in December, with services inflation rising to 4.0% from 3.9%.

Impact of Final Inflation Figures on ECB Decisions

If the final inflation figures confirm these trends, it could support gradual ECB rate cuts. Analysts note that persistent price pressures in the services sector bolster the stance of hawkish policymakers within the ECB.

Upcoming Inflation and Industrial Output Data

Inflation data from France and Germany are due mid-week, while eurozone industrial output figures for November will be released Wednesday, adding to the economic data points for policymakers to consider.

Government Bond Auctions Across Europe

The week will see bond auctions from Italy, the Netherlands, Greece, and Spain, with Germany set to launch a new federal note and Bunds. Issuances through syndication are anticipated from several countries, including Ireland and Austria.

Fed and ECB Rate Cut Dynamics

While a Fed rate cut this month seems unlikely, the ECB is widely expected to proceed with a rate cut, despite rising inflation in December. Eurozone growth is projected to be modest, with consumption showing resilience amid declining fixed capital formation.

Eurozone Trade Surplus and Historical Comparison

The eurozone’s trade surplus stood at over 159 billion euros through November, significantly higher than in 2023, but still below the pre-pandemic level of 217 billion euros from the January-November 2019 period.

Euro's Recent Performance Against the Dollar

The euro recently dipped to a marginal new low of $1.0215, responding to US economic reports. If it breaks below $1.02, it could remove the last significant technical support before parity.

Key Points:

• ECB meeting accounts will provide insights into potential rate cuts.
• Eurozone inflation rose to 2.4%, with services inflation at 4.0%.
• Final inflation data may influence gradual ECB rate cuts.
• France and Germany will release crucial inflation data this week.
• Government bond auctions are scheduled across Europe.
• The ECB is expected to cut rates despite rising inflation, unlike the Fed.
• Eurozone trade surplus has grown but remains below pre-pandemic levels.
• The euro recently fell to $1.0215, approaching parity.

Japan

Focus on Bank of Japan Deputy Governor's Speech

On Tuesday, Bank of Japan (BOJ) Deputy Governor Ryozo Himino is set to meet local leaders in Kanagawa. His speech may offer insights into whether the central bank will raise rates this month.

Market Expectations for a BOJ Rate Hike

Morgan Stanley MUFG Securities holds its base-case projection for a BOJ rate hike in January, citing local media reports and recent comments from BOJ officials as supportive evidence.

Economy Watchers Survey to Provide Economic Insights

Japan’s economy watchers survey for December, due Tuesday, could reveal improved sentiment in sectors like taxi services and hairdressing, driven by increased foreign tourist spending and higher bonuses.

Current Account Balance and Upcoming Data

The November current account balance is expected to show a surplus of 2.692 trillion yen, up from 2.457 trillion yen in October. The BOJ’s consumer sentiment survey will be released on January 17.

Upcoming Government Bond Auctions

The Ministry of Finance will auction five-year sovereign notes on Tuesday and 20-year government bonds on Thursday. These auctions are expected to attract interest from Japanese investors looking for higher yields.

Yen's Correlation with US Interest Rates

The yen remains more correlated with US interest rates than Japanese rates. Over the past 60 days, the correlation with the US two-year note yield was around 0.50, while correlations with the Japanese 10-year bond yield were lower.

Trade Deficit Despite Undervalued Yen

Despite the yen's undervaluation, Japan continues to run a trade deficit. By October, the 2024 deficit was JPY3.97 trillion, though this was an improvement from JPY5.94 trillion during the same period in 2023.

Dollar's Recent Performance Against the Yen

Following the rise in US rates, the dollar hit a six-month high near JPY158.90 but then retreated to around JPY157.20. The JPY160 level is seen as psychologically significant, with markets awaiting the BOJ deputy governor’s speech for further clues.

Key Points:

• BOJ Deputy Governor Himino's speech on Tuesday may hint at a rate hike.
• Analysts expect a BOJ rate hike in January based on recent reports.
• Japan’s economy watchers survey could indicate stronger economic sentiment.
• November’s current account balance is expected to show a surplus.
• Government bond auctions this week may attract investors seeking higher yields.
• The yen is more sensitive to US interest rates than Japanese rates.
• Japan's trade deficit persists despite the yen's undervaluation.
• The dollar recently hit a high against the yen but then pulled back, with markets cautious ahead of the BOJ deputy governor’s speech.

United Kingdom

U.K. Bond Yields Reach Record Levels

U.K. government bonds saw yields surge recently, with the 30-year yield hitting its highest point since 1998. This rise, coupled with sterling's decline, reflects growing concerns about public finances, persistent inflation, and significant government debt issuance.

Impact of Global Yield Increases

The rise in U.K. gilt yields aligns with a broader increase in yields globally, including in the U.S. and eurozone. These movements are driven by inflationary pressures and expectations of tighter monetary policies.

Upcoming U.K. Economic Data Releases

Key economic data will be released in the coming week, including U.K. consumer-price and producer-price inflation for December on Wednesday. These data points will be closely examined for their implications on inflation and monetary policy.

Focus on U.K. CPI Inflation

Nomura economists highlight that the focus will be on U.K. CPI inflation, particularly given the recent bond selloff linked to inflation concerns. Stabilization or changes in inflation could influence market expectations for interest rate adjustments.

Challenges for the U.K. Economy

Data suggesting economic struggles, combined with persistent inflation, could limit the Bank of England's ability to cut interest rates. U.K. money markets currently anticipate fewer rate cuts for 2025.

GDP and Industrial Production Data Release

On Thursday, the estimate for November GDP will be released alongside industrial production data. Previous figures showed a 0.1% contraction in October, raising concerns about a possible quarterly GDP decline.

Retail Sales Data Expectations

December U.K. retail sales data, due Friday, will provide insights into consumer spending trends. After a weak recovery in November, another modest gain is expected.

Sterling's Recent Performance

Sterling faced pressure last week, falling below $1.22 for the first time since November 2023. It briefly stabilized but encountered resistance around $1.2350, with the $1.2255 level and the next psychological threshold at $1.20 being key areas to watch.

Key Points:

• U.K. bond yields have reached their highest levels since 1998.
• Inflation and debt issuance are driving the surge in gilt yields.
• Upcoming inflation and GDP data will be critical for market expectations.
• The U.K. economy faces challenges with inflation limiting rate cut options.
• Retail sales data will offer further insights into consumer behavior.
• Sterling has been under pressure, with key support levels near $1.22 and $1.20.