Economic data released in December and early January show continuing above trend economic growth in the in the US, touch firmer economic indicators in China, Europe languishing and Australia showing signs of a lift in household spending. The fall in inflation through much of 2024 is showing signs of faltering, notably in the US, and that is driving up government bond yields even as most central banks continue to lower official interest rates.
2025 is starting with the US economy out-performing but uncertainty abounds about whether this will continue because of doubt about what will win out in incoming President Trump’s policy agenda, pro-growth deregulation, freer rein for productivity enhancing information technology companies and lower taxes or growth-reducing factors such as support for old-style manufacturing, higher tariffs on imports and tighter controls on immigration.
The stickiness of inflation in the US and growing doubts about what lies ahead in the US took a toll on financial markets in December and in the early days of 2025. Longer-term government bond yields have lifted, and risk assets have mostly turned weaker, albeit after very strong improvement through much of 2024.
Taking government bond markets first, the US 2-year bond yield rose by 9 basis points (bps) in December to 4.24% and that rise in yield came even though the Federal Reserve cut the Funds Rate by 25bps to 4.50% at the mid-December policy meeting. Longer-term US bond yields rose much more than the 2-year bond yield in December with the 10-year yield up by 40bps to 4.57% and the 30-year yield up 42bps to 4.78%. In the first 10 days of 2025 US bond yields rose further with the 2-year yield up 14bps to 4.38%, the 10-year yield up 19bps to 4.76% and the 30-year yield up 17bps to 4.95%.
The substantial sell-off in the US bond market over the past few weeks has been driven mostly by US economic reports showing that growth is continuing strongly enough to prevent inflation from falling further and introducing the risk that it may rekindle.
Turning to a brief summary of some of the key US economic reports, household spending growth remains strong in the US with retail sales up 0.7% m-o-m in November. The US labour market remains tight with non-farm payrolls up 256,000 in December, the unemployment rate edging down one notch to 4.1% and average hourly earnings up 0.3% m-o-m, 3.9% y-o-y. GDP grew at 2.8% annualised pace in Q3 2024 and the Atlanta Fed’s GDP now tracker is placing growth at 2.7% in Q4. Strong US demand is starting to make inflation sticky with headline CPI inflation lifting to 2.7% y-o-y in November from 2.6% in October while core inflation has been stuck at 3.3% y-o-y each of the three months through to November.
This firm US growth picture influences our view the Fed has little scope to reduce further the Funds rate while the threat remains that inflation cannot fall much further and may rekindle. Longer-term US bond yields look set for a prolonged stay in mid-4% to mid-5% yield territory.
In Australia too, longer-term bond yields have risen in December and eary-2025, but not as much as in the US. Unlike the US Federal Reserve Australia’s RBA has some scope to cut the official cash rate largely because economic growth is weaker in Australia. Q3 2024 GDP was up only 0.3% q-o-q, 0.8% y-o-y. Relatively weak Australian growth has reduced inflation (on the latest monthly CPI report for November 2.3% y-o-y with trimmed mean, or underlying, inflation at 3.2% y-o-y) but progress has been slower than might otherwise be expected because of a tight labour market (unemployment rate down to 3.9% in November) combined with poor productivity (Q3GDP per hour worked fell 0.5% q-o-q, -0.8% y-o-y). Now there are signs that previously weak household spending is improving with retail sales up 0.8% m-o-m, 3.0% y-o-y in November.
What scope there is to cut the cash rate seems limited and the first cut may still be delayed until mid-year. In December the 2-year Australian bond yield fell 10bps to 3.85% but it has risen since by 6bps to 3.91%. The 10-year Australian bond yield rose by 2bps in December to 4.36% but has risen another 18bps since to 4.54%. We see a slim chance that the RBA may cut the cash rate 25bps to 4.10% in mid-February, but the April or May meetings seem more likely.
Turning to risk assets, major share markets around the world were mixed in December ranging from a 3.4% fall for Australia’s ASX 200 to 2.6% rise for Hong Kong’s Hang Seng. The US S&P 500 fell by 3.4% in December although still out-performing in 2024 with a 24.0% gain compared with own-currency gains of 8.5% for Europe’s Eurostoxx 50 index and 7.0% for Australia’s ASX 200. The outperformance of the US stock market in 2024 led by tech stocks seems less assured in 2025, as likely continuing US economic out-performance increases the likelihood that bond yields stay threateningly high.
Credit markets also weakened a little in December but came after a year in which yield margins on credit narrowed substantially. Default rates for Australian lenders are rising but still at a lesser pace than has been the case during previous periods of weak economic growth. The strong labour market, rising real household disposable income and prospect of a lower cash rate at some point this year are all likely to limit how much defaults rise from here.