For the bond market The 2025 began with some sudden variationsa, dictated by developments in the trend of inflation and the conditions of the labor market.
Underlines it Tannuzzo gene, Global Head of Fixed Income of Columbia Threadneedle Investment explaining that until December last year, the attention of the Federal Reserve focused on a series of indicators that suggested that inflation was becoming sticky. In the first quarter of 2024 the market reacted with nervousness to slow down the rhythm of reducing inflation; In the end, inflation continued to go down, allowing the Fed to cut rates for the first time in September. In essence, the markets can be excessively optimistic at a given moment and not be enough immediately after.
Which indicators suggest that inflation will continue to decrease?
A key indicator is the Growth of wages. Historically, wages were a lasting mechanism of transmission of inflation: when employers pay higher wages to attract labor, they transfer these costs to consumers, creating a cycle of price increase. The growth of wages has been in constant decline for over two years (fig.1) and the Fed has recognized that wages are currently not fueling inflation.
Another important indicator is the average truncate of the PCE, which excludes the highest and lower values of expenditure for personal consumption (PCE) to focus on the trend of core inflation. Both the annualized variation rate at a month and the six-month one indicate that the situation has almost returned to the pre-covid levels
It is important to underline – explains the expert – that the data continue to show a slow but constant slowdown of the labor market. The resignation rate, which measures the availability of workers to leave the job to pursue better opportunities elsewhere, is less than the 2019 levels, indicating a lower dynamism of the labor market. In addition, the average monthly variation of non -agricultural paychecks has decreased every year, without any imminent reversal signal.
What prospects?
In light of these observations, “we believe that inflation will continue to decrease due to the continuous weakening of the labor market in the United States. This, in turn, could push the Fed to reduce the rates more than what is currently expected for 2025. However, the impact of the economic agenda of President Trump remains an unknown, just as the effects that will have on inflation remain uncertain “.
In our opinion, “the approach that the Fed qUeast will be dictated by two risks. The first is the overheating of the economy fueled by a negative shock of the offer, in turn deriving from the duties and the policy on immigration, to which is added a positive shock of the demand deriving from tax cuts and the increase in tax expenditure. This combination of factors could prevent further reductions in inflation and lead to a sudden interruption of the Fed loosening cycle “.
The second risk is that the trends taking place in the labor market continue And that wages continue to represent a weak mechanism of transmission of inflation. With inflation under control, the Fed can focus on the adaptation of monetary policy in order to better support the slow but constant decline of the labor market.
Patience keyword
This was the scenario that dominated the sentiment of the market in the early days of 2025, with the returns of the medium and long -term Treasury who almost reached the maximum cyclicals. Despite having a view of the evolution of inflation and the labor market, “we believe that the yields of the fixed income will depend more on the starting assessments than on a specific macroeconomic scenario. For example, today the bond returns are high because the Risk-free rate has increased, not because the credit spreads are wide. The increase in these rates – and in particular of real returns – suggests that investors are compensated more appropriately in the face of a risk of more solid growth, of greater uncertainty about inflation and/or an increase in public deficits. On the other hand, the credit spreads remain close to the minimums from the 2008 global financial crisis, creating an asymmetrical risk of increasing spreads, which in turn would erode returns compared to the Treasury, neutral in terms of duration. Therefore, we consider the risk of duration preferable, not because we are betting on the FED but because we are compensated in a more appropriate way for the risk “.
Patience is therefore the key word of 2025. We do not know exactly when there is the turning point, but we are positioned in order to make the most of the high returns and mitigating, at the same time, the potential reduction deriving from the enlargement of the spreads, and focusing on higher quality opportunities in the shorter deadlines, where prices historically demonstrate less volatility.
