A welcome boost

Stocks rallied this week on the back of strong earnings results for the fourth quarter and mixed inflation data. The core Consumer Price Index, which strips out food and energy, rose 3.2% year-on-year (y/y) in December, down slightly from its annual rate of 3.3% in November, according to data released on Wednesday. 

It was a nuanced picture, however, with headline inflation rising in line with market expectations to 2.9%, up from 2.7% in November, marking its third consecutive increase since September. 

A number of Wall Street’s biggest banks posted surprisingly robust fourth quarter earnings this week, with the likes of JP Morgan, Goldman Sachs and Wells Fargo exceeding expectations. US stocks rallied in response midweek.

The data comes amidst an uncertain period for markets, with president-elect Donald Trump’s inauguration set to take place on Monday. Investors appear cautious as they weigh the potential implications of the former president’s return to office. 

The inflation print has provided some relief to markets, easing concerns over future rate hikes, as Damian McIntyre, Portfolio Manager at Federated Hermes, explains. “Core inflation was softer than expected, despite rumours of goods orders increasing ahead of potential Trump tariffs. Shelter inflation, while high, also continued to creep lower.” 

“We expect to see inflation continue to fall on a year-over-year basis in the first few months of 2025. Additionally, we believe that this decreasing inflation, mixed with a robust economy and healthy jobs markets, could create the perfect recipe for a strong year for risky assets,” McIntyre adds.

The US financial sector navigated a year filled with challenges and turning points. Volatile markets in the summer and the US Federal Reserve’s decision to cut interest rates for the first time in over four years significantly impacted the landscape. However, as fourth-quarter earnings trickle in, the outlook for US banks appears brighter, explains Filippo Maria-Alloatti, Head of Financials for Credit at Federated Hermes Limited. 

“This is driven by resilient net interest income, strong fee income from capital markets, a recovery in loan growth, and potentially lower credit costs. Although rate cuts initially squeeze banks' net interest margins, US banks can mitigate this by lowering deposit rates and reinvesting funds from matured low-yielding securities into higher-yielding assets,” Alloatti says. 

The resilience of major US banks has shone through in the face of economic uncertainty, as key revenue streams show strength as 2025 begins: “Investment banking and asset management fee income remain strong, with large US banks benefiting from significant fee income and reduced loan-loss provisioning. The revival in dealmaking and capital markets has exceeded expectations, with no seasonal December slowdown.” 

“Key points to watch include whether Wells Fargo can exit its asset cap/consent order in the first quarter of 2025 and any comments on credit quality amid higher rates. For major banks, a steeper yield curve is favourable for net interest income. Lower short-term rates should reduce deposit costs, while higher long-term rates support the repricing of fixed assets. Additionally, lower short-term rates make bank revolving credit lines more competitive compared to term loans, potentially boosting loan growth,” adds Alloatti. 

Elsewhere…

UK inflation fell unexpectedly in December, the first decline in three months, with prices rising to 2.5% y/y. The dip has strengthened expectations that the Bank of England (BoE) will cut rates at next month’s meeting. The inflation data arrives off the back of a turbulent week for UK bond markets; last Wednesday thirty-year gilts reached their highest point at any time since 1998, and 10-year borrowing costs rose to their highest level since 2008.

“Weaker than expected UK growth and inflation this week have given some much-needed support to gilts, post last week’s sell off. The miss on inflation, particularly given that it was centred on the service side, allowed markets to increase expectations for a cut at the February Monetary Policy Committee meeting to above 90% probability and saw gilts gain back some of the recent underperformance,” explains Orla Garvey, Senior Portfolio Manager at Federated Hermes Limited.

“While this was very welcome, the UK does remain open to similar issues in the future with the weak growth outlook impacting fiscal headroom as is the case with many other sovereigns. However, given the extent of tightening in financial conditions and growth outlook, even with the recent increase in expectations for BoE cuts, the UK front-end still looks compelling on a relative basis, with the European Central Bank pricing a further 94 basis points of cuts and the BoE pricing 58 basis points,” Garvey adds.