Markets Rattled Amid Policy Uncertainty
Following the strong US ISM services survey print, coupled with the upbeat JOLTS jobs data, US Treasury yields soared, sending ripples through global markets. The resurgence of the risk premium amid fiscal policy and interest rate concerns, rose to levels last seen in 2014 according to the New York Fed’s estimates, and the 2s30s spread widened to 65bps.
Although there appears to have been some reprieve this morning, market anxiety is being fuelled by a number of factors, including, but not limited to, longer-term inflation expectations, this week’s huge USD 22bn 30-year UST bond auction, and tariff and tax cut speculation.
We have also witnessed a surge in corporate bond offerings this week, as firms rushed to secure funding before potential rises in Treasury yields. The market momentum is expected to continue, with ~USD65bn in issuance expected this week and potentially USD200bn for the month, building on a strong 2024 that saw USD1.52tn in investment-grade issuance. Companies are taking advantage of favourable credit spreads, which remain close to record tight levels, while also moving quickly to secure funding before facing potential uncertainties from the incoming administration's policies.
Market makers could be further “tarrified” given reports that Trump's team is considering declaring a national economic emergency to implement tariffs, potentially using the International Economic Emergency Powers Act (IEEPA) which grants the President authority to manage imports during emergencies. So, clearly a lot for markets to digest.
Although outdated, the FOMC minutes noted a shift toward a more cautious approach to rate cuts during the December meeting. The Fed cut the benchmark lending rate by a quarter-point to 4.25%-4.5%, completing a full percentage point reduction since September, but many officials expressed concern about elevated inflation risks. The minutes revealed that participants believed they were "at or near the point" where slowing the pace of policy easing would be appropriate, with many suggesting various factors called for a careful approach in coming quarters.
Chair Powell characterised the December cut as a "closer call" than previous reductions, marking rare instances of dissent under his leadership. The Fed's staff also incorporated preliminary assumptions about potential policy changes under the incoming Trump administration, resulting in slightly slower growth forecasts while maintaining firm inflation expectations. The minutes notably emphasised that "almost all participants judged that upside risks to the inflation outlook had increased," with the Fed acknowledging they would need to navigate new policies on tariffs, immigration, and taxes from the incoming administration that could impact their forecasts.
Interestingly, earlier this week the Fed’s Waller backed further interest rate cuts in 2025, citing confidence in inflation's continued decline towards the central bank's 2% target. He highlighted encouraging factors including recent inflation trends and November price data, whilst acknowledging some policymakers' preference for a more cautious approach. Despite varied views among Fed officials and no anticipated cuts at January's meeting, Waller remains optimistic about the US economy's outlook, pointing to stable unemployment at 4.2% and healthy job growth forecasts.
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