Markets experienced a volatile December, to say the least. Jerome Powell and the Fed effectively pulled the punchbowl on the Red Wave party at the December meeting by forecasting only 0.5% of rate cuts in 2025, down from a forecasted 1% just weeks earlier.

At the same time, long-end Treasuries (10+ years) have seen a significant increase in yields. Interestingly, this increase is entirely due to a rise in the "real rate" (the yield on the 10-year minus the market's expectations for inflation over the same period) and not due to heightened inflation expectations. This suggests that the market anticipates significant productivity gains in the U.S. economy, fiscal challenges, or a combination of both and is looking beyond the inflationary pressures of potential tariffs. I believe it will likely be a combination of productivity gains and fiscal challenges, although some of the fiscal problems might be mitigated by Musk, Vivek, and the Department of Government Efficiency. Time will tell.

I had hoped that the December sell-off in stocks was due to thin trading volume and year-end profit-taking, but the market seems to be struggling to start 2025 on the right foot. Stocks haven't responded well to higher rates in recent years, and this appears to be another period similar to October 2023 or April 2024, when stocks sold off following significant moves higher in 10-year Treasury yields. The market certainly didn’t welcome the blowout jobs report on Friday, January 10th, which showed 100,000 more jobs than expected, with unemployment dropping to 4.1% compared to the 4.3% estimate.

Usually, a robust job market is a positive sign! However, in this case, the market believes the jobs report was too strong, potentially reducing the Fed’s ability to cut interest rates further without risking higher inflation. The Consumer Price Index (CPI) released this morning, January 15th, came in slightly less than expected, and markets are responding positively. A strong economy and decelerating inflation is ideal because it means the Fed is fulfilling its dual mandate of price stability and full employment, even if it means the Fed can’t cut as much as the market was once hoping for.

I never recommend changing investment strategies or asset allocations based on short-term market movements. That said, I remain optimistic about the first round of legislation to be passed by Trump and the Republican Congress, as I believe it will be market-friendly by design, and could be especially supportive of US stocks, small cap stocks, and the dollar.

Stocks have enjoyed a strong run in 2023 and 2024, so some pullback is both healthy and expected, especially to shake out investors who are just chasing returns rather than investing for the long term.

As always, feel free to schedule a meeting to discuss your portfolio, the markets, or anything else on your mind.

Wishing you a happy, healthy, and prosperous 2025!