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Data over the last month continues to paint a picture of strong US growth and weakness almost everywhere else. The incoming US administration will likely add further pressure to already weak European and Chinese economies via trade uncertainty, whilst inflation remains stuck at levels that are above central bank targets, notwithstanding some modestly good news on that front in the US. This has combined to further reduce market rate cut expectations whilst simultaneously pushing inflation expectations higher and straining global bond markets. This will further pressure government deficits, which are already too high.

US

We saw another strong payroll report. Job openings also rose. The ISM surveys continued to move higher. The prices paid component of the ISM Services survey rose to the highest level since early 2023. Small business optimism has bounced to levels last seen in 2019. Housing starts bounced significantly after several months of weakness.

Inflation data was slightly better than expected, although core inflation is still running at 3.2% year over year and many inflation indicators suggest inflation may well begin drifting higher from here, not lower. Medium term consumer inflation expectations, as measured by the University of Michigan, rose to their highest level since the late 1990’s barring a single month in 2008 when the oil price was $140. The FOMC did cut rates in December, as expected, but gave strong hints that a long pause might be on the cards. Markets are now fully pricing the next rate cut in July, with just a 50% chance of one additional rate cut after that, sometime in Q4, and a terminal rate of about 4%.

The fiscal deficit at more than 6% of GDP remains large. The pro-growth policies of the incoming administration are likely to see deficits increase at least in the short term, adding to funding requirements of a US Treasury that needs to refinance almost $10tln (more than 1/3 of US GDP) this year before any federal deficit is considered.

Europe

The challenging mix for Europe continues, with headwinds stemming from weakness in China, tight monetary policy, political uncertainty, trade uncertainty, declining productivity, rising gas prices, and pressure on governments to reduce large fiscal deficits. Political gridlock in Germany and France will face a solid Trump administration.

Despite all of the above, the market has reduced further its expectation for further rate cuts from the ECB, and while another full percentage point of cuts is priced over the year, this would still leave the terminal rate at about 2%, while the end of PEPP reinvestments will see the ECB balance sheet continue to shrink.

China

The raft of policy announcements over the last few months all adds up to a significant change and should draw a line under the weakness of the last few years, but the outlook remains murky in the short term until we get clarity on the intentions of the new US administration, despite reports of a positive call between President Trump and Chairman Xi. Although GDP data did rebound in Q4, much of this was export-led, and it remains to be seen if this was simply front-running ahead of potential tariffs.