The Market Searches for Direction Ahead of Labor Market and Inflation Reports
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Weekly Market Recap for January 10th
This week, the stock market traded higher in a shortened week. The Large size factor marginally outperformed, with the Nasdaq and S&P 500 gaining +1% and +0.8%, respectively, compared to the Russell 2000's +0.3%. There was limited return dispersion across factors and sectors, and S&P 500 Equal Weight, Growth, Value, and Momentum performed in line with the index. Cyclical sectors led the way, with Energy, Industrials, and Materials outperforming and Consumer Staples, Real Estate, and Utilities trading lower. In the bond market, the back end of the Treasury yield curve continued to rise. Corp Investment Grade underperformed Corp High-Yield for its longer duration, and Long Duration Treasuries underperformed Short Duration Treasuries. The Fed's December meeting minutes contributed to the rise in the back end of the Treasury yield curve, with officials noting still-elevated inflation, strong consumer spending, and solid labor market dynamics.
S&P 500 Index (Last 12 Months)
S&P 500 Technical Composite (Last 24 Months)
ISM Manufacturing PMI Rises to 9-Month High
ISM Services PMI Index
US 10-Year Treasury Sits at 12-Month High from April 2024
VIX (US Market Volatility) Continues to Rise
US Market Economic Cycle
Long-Duration Bond Outlook
Our outlook for long-duration bonds has improved because we believe inflation concerns are overstated and economic growth projections are too high. This is a longer-term outlook rather than a 3-month outlook, and there is potential for yields to rise further in the near term. Another factor behind our upgrade is the potential for the yield curve to steepen. Yield curves steepen in two ways: (1) the front end declines as the Fed cuts, or (2) the back end rises as investors price in stronger growth, higher inflation, or fewer rate cuts. The rise in yields and steepening of the curve since the first rate cut in September has primarily been driven by the back end rising rather than the front end falling. We expect the yield curve to steepen in 2025, driven by the front end falling as the Fed cuts. The bar for additional rate hikes is high based on Fedspeak, and as the response to rising unemployment shows, the bar to cut rates is low. The market and Fed both forecast two rate cuts for 2025, but we expect projections to rise at some point in 2025, even if the Fed does not ultimately pursue more than two rate cuts. This limits the potential for another sharp rise in interest rates on the back end of the curve, providing relief to long-duration bonds. The other alternative is that the yield curve re-inverts, and while we view that as low probability, it would also benefit Long Duration. The primary risk is that the back end of the curve continues to rise, although it already prices in a lot after the Q4 yield spike (Trump’s policies, fiscal budget concerns, fewer rate cuts, stronger GDP growth).
Fed Rate-Cutting Outlook
Since the first interest rate cut in September, the S&P 500 has mostly followed the non-recession line in the chart below. It diverged late in 2024 as the market softened, but equity market pricing has more closely followed the non-recession path. November’s rise in permits was a positive sign, but it likely reflects post-hurricane activity in the South rather than broad-based strength. Housing has yet to see benefits from rate cuts, as rising Treasury yields have pushed 30-year mortgage rates up by 1% since September. Consumers and labor markets remain solid despite higher rates. Consumer spending is steady, payroll growth remains positive despite slowing, and jobless claims are low. However, weak loan growth is a concern as higher interest rates, tighter lending standards, and an uncertain economic and political landscape weigh on credit demand. The business side of the economy is sluggish. Nonresidential construction and the manufacturing subindex with industrial production are only slightly above 2007. Core durable goods and orders shipments are growing, but business investment remains sluggish overall. As 2025 unfolds, we’ll be watching for continued consumer strength and signs of recovery in housing and business investment.
Fed Rate-Cutting Cycle Index (January 2025)
Historical S&P 500 Performance Following the 1st Rate Cut
Looking Ahead
Next week will be important for the Fed and the market, with both still trying to determine what’s next. By the time this is published, December’s nonfarm payroll data will be out, giving fresh insight into job growth and unemployment trends. The pace of job growth and unemployment change will be the primary focus points. The big data releases next week are the Consumer Price Index (CPI) and Producer Price Index (PPI), with the market searching for information about the pace of inflation after progress stalled in Q4. The two reports will play a key role in setting the direction of the stock and bond markets for Q1. A stronger labor market report and a higher inflation print would likely push the Fed to slow its pace of rate cuts. If this occurs, it could cause the back end of the yield curve to continue rising, further tightening financial conditions and potentially leading to slower economic growth.
Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.
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