The first full week back from the Christmas and New Year celebrations has certainly been an eventful one as far as investment markets are concerned. From an economic perspective there has been little news from the UK, with only the final purchasing manager indices for the services and manufacturing sectors for December published, indicating that both remain in a state on expansion.

From the US we also saw data which continues to indicate that the service sector remains in an expansionary phase. By far the most important data coming from the US, however, was non-farm payroll data which showed that a further 256,000 jobs were added in December. Whilst there was a downward revision to the number of jobs added in November, this latest figure was significantly above the market consensus of 160,000 jobs to be added. The unemployment rate was therefore slightly less than forecast, at 4.1%.

Whilst wage growth came in slightly below forecast at 3.9% year on year, the above figures indicate that the labour market remains quite buoyant. We had already seen bond yields rise during the course of the week as investors pushed back their expectations as to when we will see the next interest rate cut. This now appears to be September of this year and that the number of cuts may now be down to as low as two. At the time or writing the US 10 year Treasury yield is trading around the 4.75% level, having ended 2024 at 4.57% (source: investing.com). With the 2 year yield trading currently at 4.35%, we are slowly but surely seeing an upward shaping yield curve, although not perhaps in the way investors initially expected.

The rise in government bond yields has also been felt in the UK. The 10 year gilt yield now trades at 4.85%, having also traded around the 4.57% (source: investing.com) at the end of 2024. The correlation between yield moves in the UK and US is often high and this has proven to be the case this time. The rise in UK gilt yields year to date has been a little more aggressive, as the markets reassess the last Budget promises on the basis of higher government bond yields.

Any headroom which the Chancellor thought they would have ha potentially now been eradicated due to the higher yields and increase in borrowing costs, although this has been quashed by the Treasury. So what are the potential implications? If yields stay higher this potentially leads to two outcomes. Either there would need to be an increase in taxation to fund the proposed spending or we see spending cuts. The latterly potentially has ramifications for economic growth which initially could be weaker than previously expected. Ironically, that could actually provide headroom for the Bank of England to cut interest rates further down the line.

For now, the economic concern along with the lower potential for interest rate cuts in the immediate future appears to have weighed on the performance of the mid and small cap area of the UK equity market, with both underperforming their large cap counterparts. In the US meanwhile we are currently seeing a negative reaction in the equity market to the higher than expected jobs print and higher bond yields.

As we wait for further geopolitical events to come to the fore there may yet be further market volatility but with volatility can come opportunity.

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