by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is reacting to the latest jobs data. In sports news, Real Madrid triumphed over Mallorca to advance to the final of the Spanish Super Cup. Today’s Comment will delve into the recent rise in UK gilt yields, explore the potential factors behind a prolonged conflict in Ukraine, and discuss other relevant market developments. As always, the report will include a summary of key international and domestic economic data releases.

Another Truss Moment? UK long-term bond yields soared to multi-decade peaks on Thursday, driven by escalating concerns about the nation’s ability to manage its burgeoning debt. The 10-year gilt yield reached 4.82%, its highest level since 2008, while the 30-year gilt yield climbed to 5.38%, its most elevated point since 1998. This surge in interest rates exerted downward pressure on the pound sterling (GBP), causing it to depreciate by 0.6% on the day.

• The cause of the market sell-off remains uncertain, but a potential contributing factor could be the growing tensions between London and Washington. It has been reported that Elon Musk, a prominent figure within the Trump administration, is rumored to be trying to oust UK Prime Minister Keir Starmer before the next election.
• Despite President-elect Donald Trump not having expressed any specific criticism of the UK, concerns linger regarding potential tariffs that could impede the nation’s economic growth. This anxiety emerges at a critical moment when the UK government depends on a strong economy to stave off the severe budget cuts needed to tackle the growing national debt.

• Since the United Kingdom voted to leave the European Union in 2016, it has had six prime ministers and has seen its general government debt surpass the total of GDP for the first time in at least 50 years. Hence, the rise in yields may be driven by the possibility of growing political instability and an increase in the government deficit.
• While the recent rise in yields is concerning, its moderate pace is unlikely to trigger a market rout similar to the one that occurred in 2022 following the release of the controversial mini budget under UK PM Liz Truss. However, the increase in borrowing costs could weigh on the economic growth of the country.

Another Lifeline? President-elect Donald Trump has extended the timeline for ending the conflict in Ukraine from 24 hours after taking office to six months. This shift in strategy appears to stem from concerns within the administration that a hasty resolution could be perceived as a rushed or poorly executed decision, potentially impacting the president’s public image.

• The reported U-turn also appears to be an olive branch to Europe, aimed at persuading the administration to sustain its support for Ukraine. Although the president campaigned on ending US funding for the war, he has been notably quieter on the issue since winning the election.
• In fact, just days after winning the election, Trump reportedly warned Russian President Vladimir Putin against escalating the war and reminded the Russian leader that the US “has weapons, too.”
• Despite President-elect Trump’s initial reluctance to end the war, discussions between the US and Russia appear to be taking shape. Trump is reportedly open to a peace deal that would allow Russia to retain control over several captured regions. However, Russian delegates have expressed dissatisfaction with the initial proposal.

• Although the end of the conflict is a positive development, investors should remain mindful that Russia remains a strong competitor to the US in the global energy market. A key takeaway from the conflict is that sanctions on Russia created new opportunities for US energy producers to capture market share in Europe. The administration’s desire for Europe to increase its reliance on US energy will likely lead to heightened scrutiny by the US administration regarding any resurgence of Russian energy exports.

Japan Inflation Optimism: There are growing signs that the country may have finally escaped its deflationary spiral. The Bank of Japan is expected to upwardly revise its inflation outlook. While the recent revisions have been attributed to an increase in rice prices and the depreciation of the currency, there are also increasing signs that wages have started to pick up.

• The central bank’s decision to raise its inflation forecast signals a stronger commitment to tightening monetary policy to counteract persistent price pressures and safeguard economic stability. This is likely to result in higher Japanese bond yields and a stronger yen (JPY). However, given the prevailing economic slowdown, the impact on equities may be mixed.

China’s Troubles Deepen: The People’s Bank of China has halted purchases of government bonds, a move widely interpreted as an attempt to dampen speculation about the country’s economic growth prospects. This action could further fuel fears of a deflationary spiral in the world’s second-largest economy.

• At the same time, the MSCI China Index seems poised to enter a bear market in the next few days as investors brace for escalating trade tensions between China and the US. On Friday, the index dropped by as much as 1.1%, bringing its total decline closer to 20% since its peak on October 7, 2024.
• Earlier this week, it was reported that outgoing President Joe Biden plans to announce new restrictions on AI chips as the US seeks to maintain its competitive edge over China in the sector.

• As noted in our previous reports, China is likely to face challenges stemming from the five Ds: weak consumer demand, overcapacity coupled with high debt, unfavorable demographics, economic disincentives due to the Communist Party’s market interventions, and the impact of Western decoupling in trade, technology, and capital flows.

DOGE’s Setback: Tesla CEO Elon Musk acknowledged on Wednesday that his newly formed Department of Government Efficiency may fall short of its ambitious goal of reducing the federal deficit by $2 trillion, potentially achieving only half of that target.

• While this news is disappointing amid the market’s strong preference for fiscal restraint, investor skepticism about the feasibility of Musk’s ambitious deficit reduction target was evident from the start.
• That said, we still believe that efforts to reduce government spending are likely to be bullish for bond prices.

Labor Talks: US dockworkers have reached a tentative agreement with their employers, averting a potential shutdown of East and Gulf Coast ports next week. This new deal includes provisions for a framework to address the impact of automation on the workforce, aiming to protect workers’ jobs as technology advances. If ratified, this agreement will have a six-year term.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Note: The Confluence offices will be closed tomorrow, January 9, for the Day of Mourning, and we will not publish a Daily Comment.

Good morning! Concerns about the deficit and inflation continue to weigh on investor sentiment. In sports news, New Orleans Pelicans forward Zion Williamson scored 22 points in a loss to the Timberwolves in his first game back from injury. Today’s Comment will cover our perspective on the rise in 10-year Treasury yields, tensions between the US and its allies, and several other key developments. As always, the report concludes with a summary of international and domestic data releases.

Long-Term Yields Rise: Equity prices plummeted after 10-year Treasury yields rose to their highest level since October 2023. A disappointing bond sale and broader concerns about a return of inflation drove the rise in interest rates. As a result, the S&P 500 fell 1.1% on the day, while the tech-heavy NASDAQ composite closed down 1.9%.

• On Tuesday, $39 billion of Treasury securities were auctioned at a concerningly high yield of 4.68%. This yield, marginally above the initial indicated level, signaled weak investor demand. While the 10-year Treasury rates reached 5% in 2023, the auction marked the highest yield for newly issued securities in over 16 years, raising concerns about the state of the Treasury market.
• Fears of a resurgence in inflationary pressures and tightening labor market conditions may have influenced the auction’s relatively weak performance. The December ISM PMI Services Index registered at 54.1, surpassing expectations of 53.3, with its sub-component prices index exceeding 60 for the first time since January 2024. Concurrently, the BLS Job Openings and Labor Turnover Survey (JOLTS) revealed a significant increase in job listings in November, rising from 7.839 million to 8.098 million.

• The weak auction and stronger-than-expected economic data will likely heighten market focus on the upcoming jobs report. The unemployment rate will be particularly scrutinized, as last year’s rise from 3.7% to 4.2% significantly influenced the Fed’s decision to cut rates by 100 basis points in 2024. A decline in the unemployment rate could jeopardize projected cuts unless inflation demonstrates a substantial decrease.
• The CME FedWatch Tool currently suggests only a 25-basis-point rate cut by the central bank for 2025. While this scenario seems plausible, we believe the possibility of rates remaining unchanged throughout the year remains significant, especially if inflation fails to demonstrate substantial progress, and the labor market remains tight in the coming months.

Rifts Emerge Within the Western Alliance: President-elect Donald Trump has proposed annexing Canada and Greenland, as well as renaming the Gulf of Mexico to the Gulf of America, signaling a dramatic shift in US policy. In a news conference, Trump declined to rule out the use of military or economic measures to achieve these ambitions, further raising tensions.

• Western allies have unsurprisingly dismissed Trump’s attempts to acquire additional territory, warning of potential retaliation if aggression occurs. French Minister Jean-Noël Barrot stated that the EU is ready to defend the sovereignty of its members against any use of force. Similarly, Canadian PM Justin Trudeau firmly rejected the idea of being annexed by the US and implied that force would not be beneficial to either side.
• The move coincides with the incoming administration’s shift away from the US’s traditional role as a benevolent hegemon. This administration appears poised to adopt a more assertive, potentially even adversarial, foreign policy. Consequently, they are likely to prioritize transactional agreements that maximize national self-interest.

• Currently, financial markets seem to be discounting the risk of a significant rift between the US and its allies. Investor attention remains largely fixated on domestic concerns like inflation and the growing national debt. However, escalating tensions between the US and its allies could inject renewed uncertainty into global markets. This increased volatility could bolster demand for traditional safe-haven assets like gold and silver.
• As US global influence wanes, we anticipate a rise in demand for alternatives to the dollar. Gold and silver are likely to emerge as contenders. The current gold-to-silver ratio exceeds 80, significantly higher than the 30-year average of 67, suggesting gold’s relative expensiveness compared to silver. However, this elevated ratio may now be the norm, given its consistent range between 80 and 90 over the past four years.

Virginia Election Races: The first political test following Donald Trump’s victory brought no surprises in Virginia. Democrats retained two State House seats in left-leaning Loudoun County, while Republicans held onto their State Senate seat. The closely watched contest was seen as an early indicator of the state’s political direction for when Republican Governor Glenn Youngkin’s term ends next year.

Immigration Bill: The new Congress has passed its first bill of the year, the Laken Riley Act, which mandates the detention of undocumented immigrants for non-violent offenses such as theft. This legislation is likely the first in a series of measures aimed at restricting immigration. Financial markets will closely monitor the potential impact of this crackdown on the labor market, as it could exacerbate labor shortages and push up wages for businesses.

China’s Woes Continue: The country’s currency fell to a 16-year low due to fears that the Trump tariffs are likely to complicate the country’s growth efforts. Prior to this escalation, the country had been grappling with sluggish growth and deflation, exacerbated by waning investor and consumer confidence.

• The negative sentiment has also spread into the country’s bond market with the yield on 30-year government debt falling below the psychological level of 2%, placing it below the current level in Japan.

• A weakening Chinese economy poses a significant risk to global growth, as subdued consumption in the world’s second-largest economy will inevitably impact global demand. While the US remains an attractive destination for equity investments, we believe that compelling opportunities exist in international markets, particularly when analyzed on a sector-specific or individual stock basis.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with new US moves to constrain the Chinese economy and military buildup. We next review several other international and US developments with the potential to affect the financial markets today, including some notes on yesterday’s resignation of Canadian Prime Minister Trudeau and a positive new outlook for artificial-intelligence darling Nvidia.

United States-China: The Department of Defense yesterday put a slew of additional high-profile Chinese companies on its list of firms that support the People’s Liberation Army. Firms added to the list include social media giant Tencent, electric-vehicle battery maker CATL, and shipping firm COSCO. Companies on the list aren’t automatically sanctioned, but Western firms and investors typically become skittish about doing business with them or investing in them.

• The action appears to mark yet another of the Biden administration’s parting shots at Beijing and its military.
• Biden’s outgoing China hawks may fear that President-elect Trump will be convinced by the Chinese and/or the internationalist business interests in his administration to go soft on Beijing. Indeed, Trump’s recent moves on immigration and tariffs suggest he will favor his corporate supporters over the populist nationalists in his coalition.
• As we outlined in our recent Outlook 2025 report, “Technology Sector Supporters” are a key part of Trump’s coalition. This constituency includes many tech leaders who hadn’t been close to Trump in the past but are investing heavily to curry favor with him to protect their business interests both domestically and internationally.
• In the latest example of this today, Meta CEO Mark Zuckerberg said Facebook and Instagram will stop fact-checking and end speech restrictions, aligning the platforms with Trump and his incoming administration.

North Atlantic Treaty Organization: In an interview with the Financial Times today, the chief of the NATO’s military committee said Western rating agencies, banks, and investors are being “stupid” for not investing more in defense companies. Consistent with our own analysis here at Confluence, Adm. Rob Bauer pointed to the huge amounts of new money European governments are pouring into defense rebuilding. We continue to believe that European and Asian defense stocks are especially well positioned to benefit from this new spending.

Eurozone: The December consumer price index was up 2.4% from the same month one year earlier, accelerating from a rise of 2.2% in the year to November and 2.0% in the year to October. Eurozone price inflation has now accelerated for three straight months and remains above the European Central Bank’s target of 2.0%. Because of the eurozone’s sluggish economic growth, the ECB is still expected to cut interest rates at its January 30 policy meeting, but sticky inflation will complicate the outlook for further rate cuts.

Canada: Prime Minister Trudeau announced his resignation yesterday, finally bowing to his many critics both within his Liberal Party and outside of it. The deeply unpopular Trudeau said he will stay on as prime minister until the party picks his successor, which could take several months. To forestall a no-confidence vote in the meantime, he also suspended parliament.

• Trudeau is the latest of the world’s progressive national leaders to lose power over issues such as weak economic growth, high price inflation, burgeoning debt, burdensome new climate regulations, and rising immigration.
• Going forward, Trudeau’s resignation leaves Pierre Poilievre and his right-wing Conservative Party in pole position to win Canada’s next parliamentary election. If Poilievre were to become prime minister, he would likely push pro-growth policies such as tax cuts and deregulation.

US Monetary Policy: Fed Vice Chair for Supervision Michael Barr yesterday said he will resign his regulatory role in February but will remain on the central bank’s board of governors. Barr has pushed for tough bank regulations, raising the prospect of conflicts with the incoming Trump administration and its plan to push for deregulation. Now, that prospect of conflict is much reduced, as Trump will be able to nominate his own vice chair from the other remaining Fed governors.

US International Trade Policy: Yesterday, President-elect Trump denied the Washington Post’s early morning report that his proposed big import tariffs would be limited to critical goods. True to character, he described the report as “fake news.” In response, the US dollar regained much of the value it had lost early in the day, with the US Dollar Index closing down only slightly.

US Economy: According to S&P Global, at least 686 companies in the US filed for bankruptcy in 2024, up about 8% from 2023 and the most since 2010, when filings associated with the Great Financial Crisis peaked at 828 filings. The report is a reminder that despite the US economy’s continued strong growth and moderating price inflation, it still has pockets of weakness. High interest rates have probably been one key reason for the rise in business failures.

US Technology Sector: Nvidia CEO Jensen Huang yesterday laid out a future vision for the firm that encompasses not only more growth in its current business of producing chips for developing artificial-intelligence systems, but also “trillions of dollars” of opportunities in areas such as robotics and self-driving vehicles. Given that Nvidia has been such a key driver of the US stock market over the last couple of years, a credible outlook for continued strong growth that can keep the stock’s price moving upward is important to the overall US market.

US Financial Services Industry: According to the Financial Times, the US private-equity industry is preparing to lobby the incoming Trump administration to broaden the types of investors that can invest in its funds. For example, one deregulation goal would be to allow defined contribution retirement plans, such as 401(k)s, to invest in private-equity funds.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our first Comment of the New Year opens with the same old geopolitical tensions in Asia, this time with reports touching China, Taiwan, and Japan. We next review several other international and US developments with the potential to affect the financial markets today, including the new French government’s decision to ease its deficit-cutting target and news that President-elect Trump will try to pass all of his major policy initiatives in a single bill once the new Congress is in place.

China-Taiwan: Beijing has reportedly launched a new program under which Taiwanese visiting the mainland are being urged to sign up for local resident cards, bank accounts, and mobile-phone numbers, which in total allow them to apply for the identity cards used by Chinese citizens. The program appears to be another effort by Beijing to undermine Taipei’s jurisdiction over Taiwan. In a worst-case scenario, it could also be used as an excuse for Beijing to intervene in the island’s domestic affairs or even to invade.

Japan: New reports say Tokyo will release its first-ever arms export plan sometime this year. Developed with Japanese industrial firms, the plan will lay out medium- and long-term targets for defense equipment exports. Its goal will be to strengthen Japan’s arms makers so they can better support the country’s defense buildup ahead of a potential conflict with China. Development of the plan illustrates how defense is becoming a growth industry worldwide, but especially in Asia and Europe.

• According to the authoritative Stockholm International Peace Research Institute, the world’s 100 largest defense firms boosted their total domestic and foreign arms revenues to $632 billion in 2023, for an inflation-adjusted increase of 4.2% from 2022.
• The five Japan-based companies in that total — Mitsubishi Heavy Industries, Kawasaki Heavy Industries, Fujitsu, NEC, and Mitsubishi Electric — increased their total defense revenues to $10 billion, up 35% on the year.
• As in many other countries, the Japanese budget for reconnaissance and strike drones is rising especially fast, reflecting both their critical role in the Ukraine war and troop recruiting challenges related to Japan’s low birthrate.

France: The new minority government of Prime Minister Bayrou today said it would only try to cut the budget deficit from an estimated 6.1% of gross domestic product in 2024 to a range of 5.0% to 5.5% in 2025. Ostensibly to help protect economic growth, the target would be a bit easier to achieve than the 5.0% planned by the previous prime minister before he lost power in a no-confidence vote. Since it would also require smaller tax hikes and spending cuts, the new target also has a better chance of being passed by parliament and averting a fiscal crisis.

US International Trade Policy: We noticed a headline on Bloomberg television today saying the enormous tariffs that President-elect Trump has threatened to impose on foreign imports will only apply to “critical” inputs. However, we still have not seen the details behind the report. In any case, the news appears to have pushed the US dollar sharply lower against most major foreign currencies so far today. As of this writing, the US Dollar Index is down 0.9% to 107.95.

US Fiscal and Regulatory Policy: President-elect Trump and House Speaker Johnson have reportedly decided to pursue a single mega-bill encompassing all the Republicans’ major policy priorities once the new Congress is in session later this month, rather than the two-bill strategy considered previously. The single bill would include everything from extending and expanding the 2017 tax cuts and cutting spending to cracking down on immigration and deregulating the energy industry.

• Because of the Republican party’s very narrow majorities in Congress, both the strategies have political risks. A single bill covering such a large number of issues may also take much longer to be passed. Observers currently think such a bill couldn’t be signed into law until at least late April or May.
• In any case, the policies covered by the bill would be in sync with a recent research paper by Steve Miran, the incoming chair of Trump’s Council of Economic Advisors. In his paper, Miran argues that boosting growth would best be achieved by slashing regulation to incentivize more investment related to artificial intelligence and other technologies required for military modernization.

US Monetary Policy: In a speech Friday, Richmond FRB President Barkin said the continued strength in the labor market and waning price pressures mean there are more upside risks than downside risks to economic growth in 2025. However, he warned that such a scenario means there are also more upside than downside risks to inflation. Barkin’s statement is consistent with our view that the Federal Reserve may cut interest rates less than expected this year.

US Critical Minerals Mining Industry: The US Forest Service late Friday granted a permit for Perpetua Resources’ “Stibnite” gold and antimony mine in Idaho. When it starts producing in 2028, the mine is expected to supply some 35% of the nation’s demand for antimony, a rare mineral used in armor-piercing ammunition, solar panels, and other high-technology goods. In response to the news, Perpetua’s stock price surged 9.1% in after-market trading.

• Antimony is not currently produced in the US, and Beijing has recently restricted its exports to retaliate for Washington restricting the sale of advanced semiconductor technology to China. Approval of the mine illustrates how US-China tensions and global fracturing have spurred re-industrialization in the US, especially regarding goods critical to national security and advanced technologies.
• Although US industrial firms are often constrained by stringent environmental and other regulations, we think the US’s new prioritization of defense and economic growth could lead to those rules being watered down. If so, we could see many more examples of new mining and other industrial investments related to defense and technology.
• Indeed, the US defense budget and industrial-development programs could provide much of the funding for these investments. In fact, the $1.3-billion Stibnite project has been partly funded by the US Export-Import Bank and the Defense Department.

US Commercial Real Estate Industry: The Wall Street Journal today has an interesting article on the shortage of space at open-air shopping centers and the resulting strong performance of real estate investment trusts (REITs) focused on retail properties. The article notes that the sector has benefitted from reduced construction after the Great Financial Crisis and work-from-home rules that allow people to shop throughout the week. The article illustrates why investors may not want to avoid REITs entirely, despite the current challenges facing the office sector.

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