Four Key Events to Monitor in the Week Ahead

• The week begins with Donald Trump’s inauguration.
• UK labor market data may challenge expectations of a BoE rate cut.
• Global PMI figures could underscore differences in global growth trends.
• The Bank of Japan is poised to raise interest rates, with subsequent actions likely to impact the Yen.

Last week brought significant economic developments that could shape market trends in Q1. Key among them was a batch of data indicating a return of disinflation in the US and UK. While one month of data doesn’t confirm a trend, sustained disinflation would signal easing price pressures, reassuring central banks. Markets responded positively to progress toward inflation targets. Another notable event was a drop in global bond yields. Following turmoil in the UK bond market earlier this month, UK 10-year yields declined by over 22bps, while US 10-year Treasury yields fell by 15bps.

Markets witnessed a rush to price in interest rate cuts last week. For the UK, expectations now reflect more than 2.5 rate cuts in 2024, with a 90% probability of a Bank of England rate cut in February. In the US, the likelihood of a June rate cut increased to 44%, up from 40% a week earlier. However, this strong market reaction to a single data release raises concerns, particularly given that the timing of the UK’s December inflation survey might have skewed its inflation reading. Meanwhile, the US economy is projected to have grown by 3% in Q4, per the Atlanta Fed GDP Now forecast, suggesting potential overheating and renewed inflation risks in the future.

Despite these concerns, markets rallied globally, reflecting investor relief. The Eurostoxx 50 climbed 3.4%, the FTSE 100 reached a record high with a 3.1% gain, and US indices like the S&P 500 and Nasdaq rose 2.9% and 2.4%, respectively. Mid-cap stocks outperformed, with the FTSE 250 up more than 4% and the Russell 2000 just under 4%. However, Germany’s MDax underperformed the Dax, possibly reflecting ongoing challenges in German economic growth.

In Japan, speculation of an interest rate hike by the Bank of Japan (BOJ) gained traction, with an 83% probability of a 20bps hike this month and expectations of another hike later. This marks a slow but steady normalization of Japanese interest rates, which is unlikely to disrupt global capital flows significantly due to Japan’s high public debt. The yen responded strongly, becoming the top-performing G10 currency last week and reversing its underperformance in 2024.

In FX markets, the British pound’s performance this week warrants attention. Despite the recovery in UK bonds, the pound lagged and was among the weakest G10 currencies. This may indicate skepticism over the sustainability of the bond market rally, sensitivity to rising rate cut expectations, or a delayed reaction that could lead to a rebound. All three factors likely weigh on the pound’s recovery, making its movements this week particularly notable.

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Here are four key factors driving markets this week

Trump 2.0

The week begins with the inauguration of President-elect Donald Trump, marking the start of what is being termed “Trump 2.0.” His return has already significantly influenced global financial markets and the economy. The so-called “Trump trade” drove U.S. stocks and the dollar higher late last year, although some of these gains have recently reversed. His policy initiatives, such as tariff threats, continue to make waves. Over the weekend, UK officials reportedly expressed confidence that tariffs will not be imposed on the UK. However, tariffs remain a concern for other regions, including China and the Eurozone, potentially ushering in a new era of trade disputes. This dynamic has notably impacted the currency market, with the dollar strengthening since the November election against most major currencies, particularly the Mexican peso and Canadian dollar, as the new administration is expected to adopt a tough trade stance with these neighboring nations.

Beyond tariffs, the UK has postponed implementing new capital rules for its banks by a year, pending the Trump administration’s approach to the Basel regulations in the U.S. This decision has buoyed UK bank shares and raises the prospect of more permanent regulatory easing, aligning UK banking standards closer to those in the U.S., while European banks have already implemented parts of the Basel framework. This divergence could further support UK bank stocks.

Immigration reforms and large-scale deportations are also key aspects of Trump’s agenda. The potential removal of illegal migrants could reshape the U.S. labor market, driving wage growth and inflation later this year. Markets are also responding to the prospect of 100 executive orders being signed in Trump’s early days in office. This has led to a contrarian stance in the Federal Reserve’s outlook, with a 25% chance now priced in for a rate hike instead of a cut. Although the consensus still favors a rate cut, such policy shifts could inject volatility into the interest rate futures market and disrupt prevailing economic trends.

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UK Employment Figures

The UK’s labor market data for November and December will be released on Tuesday, offering the first official jobs report since October’s budget. Analysts anticipate a decline of 15,000 in payrolls, potentially linked to the announced increase in employer national insurance contributions. Although these changes will only take effect in April, they may already be influencing hiring trends.

Wage growth is expected to continue its upward trajectory, with average weekly earnings forecasted to rise to 5.6% year-on-year from 5.2% in October, and earnings including bonuses projected to reach 5.5%. Strong wage data could temper expectations for a Bank of England rate cut, which surged last week. However, this is unlikely to significantly boost the pound, as it might partially reverse the recent bond market rally. The FTSE 100, less sensitive to domestic economic conditions and BOE forecasts, is expected to remain relatively unaffected.

Overall, January has seen rising UK bond yields, with 10-year gilt yields up by nearly 10 basis points despite last week’s recovery. Coupled with low inflation and stagnant growth, this has reshaped the UK’s economic outlook for Q1.

January PMI Data

Provisional global PMI data for January is due later this week. The UK’s composite PMI is expected to dip to 50, just above the contraction threshold. The Eurozone’s PMI is forecasted to remain in contraction territory, while U.S. manufacturing activity is projected to improve, with robust growth anticipated in the service sector.

In December, U.S. PMI data highlighted its growing economic lead over Europe and the UK, with accelerating growth. These diverging trends are shaping monetary policy expectations for 2025, with the resilient U.S. economy limiting the market’s pricing of Federal Reserve rate cuts to one next year. Should January PMI data confirm widening U.S. outperformance, this trend may continue, benefiting U.S. and European blue-chip indices.

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Bank of Japan Rate Hike Expected

This week is pivotal for Japan, as markets anticipate a 25-basis-point rate hike from the Bank of Japan (BOJ). Both the BOJ governor and deputy have signaled this possibility unless significant market turmoil or sharp yen movements occur following Trump’s inauguration. December’s national CPI is expected to show headline inflation rising to 3.4% from 2.9%, with core inflation steady at 2.4%.

While most global central banks are cutting rates amidst moderating inflation, Japan is bucking the trend. A rate hike is seen as a measure to stabilize the yen, which remains weak historically, contributing to rising import-driven inflation. Although USD/JPY remains above 155.00, the yen has been the strongest G10 currency this year, with room for further recovery. If the BOJ proceeds with the hike, additional hawkish messaging may be required to strengthen the yen further, though this would be uncharacteristic for the BOJ. As such, continued dollar strength is plausible, especially as the Trump administration’s policies take center stage.