UK assets in recovery mode

Markets in recovery mode, but UK faces key test

The pound and UK bond yields are getting a reprieve this morning as the dollar falls across the board. GBP/USD is back above $1.22, after dropping to £1.21 on Monday. UK bond yields are also declining and are outperforming their European counterparts across the curve. Stock markets are also in recovery mode, as risk sentiment gets a boost from reports that Donald Trump will implement a gradual programme of tariffs. This has eased inflation fears as we get closer Trump’s inauguration. This has also boosted Asian stocks. The Hang Seng is higher by 1.9%, the CSI 300 is up by more than 2%.

UK bond market in recovery mode, but the length of the recovery could depend on key UK economic data releases

UK bond yields are retreating on Tuesday. Interestingly, US bond yields have calmed down in recent days, which suggests that the UK bond market may play catch up, since UK bonds have moved closely with US bonds in recent months. However, UK asset prices face a tough test this week. Later this morning there is a £1bn sale of 30-year debt, the latest reading of CPI is released on Wednesday, there’s monthly GDP for November on Thursday and further debt sales out to the end of January. The Chancellor is set to speak in the House of Commons on Tuesday, ostensibly about her trip to China, but she will likely be pressed on the selloff in the pound and in UK bonds. So far, the Treasury have been keen to under play the relentless rise in UK bond yields, but the question is can she avoid the tough questions as she comes back to face the music?

The Chancellor’s Budget in October included large spending increases and tax hikes but delayed the release of a public spending review. This review is what the markets wanted: a commitment to responsible public spending that actively brought down the UK’s deficit. Because she did not do that, and because tax rises are threatening growth, the government is back to chasing the markets.

The next 72 hours will be crucial for UK assets. If we get a shock increase in inflation or a sharp decline in November CPI, then bond yields could surge once more. There may be a silver lining to the bond market sell off, it has reduced bond prices, so coverage for the UK debt auctions this week may surprise on the upside.

BP’s share price tanks as strategic review delayed

Elsewhere, BP reported a weak Q4 outlook and delayed its strategy update until February 26^th.  BP is not alone, Shell also reported lower sales and trading earnings from its key energy divisions last quarter. BP reported lower oil and gas production for Q4, which is typically a strong period for the oil market. The company also said that its oil trading revenue would be weak. While this is likely to weigh on the stock price, and on the energy sector as a whole, losses could be limited after a sharp rise in the oil price in recent days. Brent crude is back above $80 per barrel and is higher by more than 7% so far in January. BP’s share price is currently down by 2%.

French budget test to drive yields

European yields have eased this morning, with declines for French and Italian yields, in particular. This comes ahead of the new French Prime Minister’s announcement of his government’s plans for the Budget. France still does not have a Budget for 2025, yet the bond market has gone easy on France so far this year. That may not last if the new PM does not deliver a plan for public spending that is acceptable to the bond market.

Japanese yields are also rising sharply, and the 40-year yield is at its highest level since 2007, as bets increase that the BOJ will hike interest rates next week. There is a near 60% chance of a 15bp rate hike priced in by the market, which would mark the third rate hike in recent months, as the BOJ slowly normalise monetary policy. The yen is also in recovery mode on Tuesday as the dollar takes a back seat.

US stock market rotation as Nvidia gets hit by production problems

There was a notable rotation out of tech stocks and into value stocks on Monday, as the Dow Jones managed to outperform the S&P 500 and the Nasdaq. Nvidia fell nearly 2%, after there were concerns about the performance of the Blackwell chip, and concerns about it overheating. This could lead to a lower uptake of Blackwell chips, Nvidia’s latest and most expensive chip, with consumers preferring to stick with its Hopper chip, even if it is less energy efficient. Nvidia has had a bruising start to the year and is down 2% so far. There has been a big shift in investor preferences so far in 2025. Chip stocks are out, and instead, the equal weighted S&P 500 is outperforming the market cap weighted index. Added to that, the magnificent 7 has had a fairly lacklustre start to the year, although Tesla jumped more than 2% on Monday.

However, we continue to think that the US dollar will dominate overall risk sentiment. A strong dollar can erode global growth and boost inflation outside of the US. Thus, stock markets may move up and down based on what the dollar is doing for the short term, with a weaker dollar boosting market sentiment.