Author: Jamie McGeever
ORLANDO, Fla. (Reuters) – U.S. financial markets were more sensitive than usual to economic surprises last year, and as Donald Trump prepares to begin his second term as U.S. president, investors should brace themselves more in 2025.
Especially in state treasuries.
The sensitivity of 10-year yields to inflation and activity data surprises last year was the highest in more than 20 years, according to Goldman Sachs. Although inflation has fallen, growth concerns have subsided and the Federal Reserve has begun to cut interest rates, this sensitivity remains.
Again, especially in Treasuries.
While the sensitivity of stocks to inflation surprises has declined as price pressures have cooled, it remains high by historical standards. And stocks' sensitivity to growth surprises, while still modest, has begun to decline to near-pandemic levels.
What does this mean for the coming year? While benchmark measures of implied volatility in stocks and bonds are muted, markets are in a weaker position than a year ago. By many measures such as prices, sentiment and valuations, they are extremely tight.
U.S. stocks have never been higher or represented a larger share of global market capitalization, and the Fed's 100 basis point rate cut since September was met with a counterintuitive 100 basis point increase in .
Does this mean America's core markets are set for a correction? Maybe. But what's easier to say with certainty is that we'll see wider intraday trading ranges and short-term reversals as investors grapple with the biggest wild card of all: the Trump agenda.
'VOLATILITY MAN'
History shows that there is a “tight” relationship between macroeconomic and market volatility, as Citi's Stuart Kaiser points out. And with the world still in the dark about how Trump's trade and tariff policies will play out and how the Fed will respond, macro uncertainty is still alive and well.
The top two “end risks” to global markets cited in the latest Bank of America fund manager survey were “global trade war triggers recession” and “inflation causes Fed hike.” Both received 37% of respondents' votes, significantly more than the 10% received by “geopolitical conflict”, the third most cited risk.
“With numerous major policy shifts on the horizon, markets should brace for much more volatility,” Deutsche Bank (ETR:) George Saravelos said Monday.
It's true that the first year of Trump's first term, 2017, turned out to be a good one for Wall Street, rising 19% despite Trump's unpredictable moves. But that was a period of low inflation, low interest rates and solid growth. This low macro volatility is unlikely to be repeated this time around. And given the stretched nature of today's markets, even modest economic surprises could trigger big moves.
Just look at the sharp swings in US stocks and the dollar on Monday in response to a media report – later dismissed by Trump – suggesting that his proposed tariff regime would be less severe than expected.
But even if macro “volume” picks up, will it be enough to disrupt the generally bullish market consensus for 2025? Maybe not, suggests Phil Suttle, a Washington-based economist. “(Markets) will be quite volatile, but without a clear clear direction as the perceived odds of these different (tariff) scenarios oscillate,” Suttle wrote in a note titled “Volatility Man” on Monday.
It's also possible that investors will increasingly ignore Trump's social media posts about the markets, economic policy or the Fed, as they ultimately did in his first term, especially if real-world economic indicators remain steady. But it's still too early for that.
Given the combination of tight markets and an unpredictable commander-in-chief, the markets in 2025 will contain a lot of sound and fury. It could be a bumpy ride.
(The views expressed here are those of the author, a columnist for Reuters.)
(By Jamie McGeever; Editing by Paul Simao)
