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Weekly Update - Bond yields tightening again in a more uncertain political environment

BOND YIELDS TIGHTENING AGAIN IN A MORE UNCERTAIN POLITICAL ENVIRONMENT
The financial markets are starting 2025 on the same trend as they ended 2024: with a rise in long bond yields. This movement appears to run counter to the cut in central bank rates. This could make various parts of the bond market very attractive again but may ultimately weigh on the outlook for activity and the equity markets.
 
A sharp rise in long-term yields. 
Sovereign 10-year yields have risen sharply since early December, with a broad-based increase of around 50 basis points. Rates are now back to their mid-2024 highs, at more than 4.7% in the United States, above 3.4% in France and 2.5% in Germany. The trend is slightly more pronounced in the UK, where it is up 60 basis points to above 4.8%. This trend goes in an opposite way to the cuts in key interest rates by the main central banks, which began in the second half of 2024. The Federal Reserve (Fed) and the European Central Bank (ECB) have already cut rates by 100 basis points, while the Bank of England (BoE) has cut rates by 50 basis points
 
First and foremost, a more uncertain political environment. 
There are several factors behind this renewed pressure on rates. Firstly, the markets have once again revised their expectations of central bank rate cuts. They now expect only a single 25-basis point cut for the Fed and the BoE between now and June 2025, and three cuts for the ECB.
 
Indeed, the still favourable indicators for US economic activity are raising fears of continued inflationary pressures (such as the employment report, see events of the week thereafter). The markets also seem to start considering that the economic policies of the new Trump administration (such as the increase in tariffs) could lead to permanently higher inflation.
  
The markets may finally be adjusting to an environment of higher rates for longer. Inflation may not fall as much as it did before Covid, forcing central banks to maintain rates at higher levels than in the past (higher equilibrium rate).
 
In the euro area, the latest inflation figures have also contributed to concerns (2.4% year-on-year compared with 2.2% in December, and 2.7% for core inflation).
 
Secondly, flows on the bond markets are contributing to tensions: the start of the year has been marked by large sovereign bond issuances, while central banks continue to reduce their presence (quantitative tightening).
 
Opportunities but also risks. 
Short term, this rise in yields is creating new opportunities on the bond markets, particularly in the euro area. We continue to expect the ECB to cut interest rates further, which should allow long-term interest rates to ease over the coming months. But if bond yieldspressures continue, the global economy will suffer (higher financing costs for companies, banks and governments), with possible repercussions for equity markets
 
Other highlights of the week
 
In the highlights of the week, we chose to talk about the labor market in the United States and the inflation in the euro area :

United States: labour market still awaiting normalisation 
In the United States, the labourmarket is still not back to normal. Non-farm payrolls rose by 256,000 over the month - much more than expected by the consensus. Moreover, the vigourof job creation is widespread across all sectors. Nevertheless, the 3-month moving average remains close to the pre-Covid average at 170,000. The unemployment rate fell by a tenth to 4.10%. The robustness of the labourmarket data added to the tensions already present on bond markets (up to +10bp on US long bond yield just after the publication). The only more encouraging news was the very slight fall in wage growth, to 3.9% year-on-year. Against this backdrop, the fixed-income markets continued to reduce their expectations of rate cuts by the US central bank, and the equity markets fell..
 
Euro area : Inflation rises slightly, with wide regional disparities 
Euro area inflation came out at 2.4% year-on-year in December, up 0.2 percentage points from November, but mainly due to base effects in energy prices. However, this rise was also driven by a slight increase in services prices (+4% year-on-year, after 3.9%). Even so, there were wide disparities between euro area countries, with inflation in France at 1.8% in December and at 2.8% in Germany and Spain. These figures have fueled the upward movement in European bond yields seen in recent weeks (see editorial). Nevertheless, these inflation levels should not thwart the ECB in its pursuit of monetary easing, as economic activity is still lacking dynamism

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