The global economic landscape has recently shown a slight easing, particularly in light of the unexpected drop in the U.S. core Consumer Price Index (CPI) for December 2024. The core CPI, which excludes volatile food and energy prices, fell to 3.2%, down from a stable 3.3% over the previous three monthsNotably, the super core services CPI, which excludes rent, also marked a significant low since July 2024, registering a modest month-on-month increase of just 0.21%. This data has provided a much-needed respite for the markets, hinting that the Federal Reserve might not be compelled to raise interest rates in the near future.

On January 16, following a robust rebound in U.S. stock markets, Asian markets also reflected this optimism with notable recoveriesThe Shanghai Composite Index and Hong Kong's stock exchange jumped by 0.28% and 1.23%, respectivelyConcurrently, the dollar index weakened to the 108 range, with the exchange rate stabilizing around 7.34 for the offshore yuanDespite the inflationary data, the rate markets remained firmly entrenched in their expectations, with predictions for only one interest rate cut from the Federal Reserve in 2024, albeit advanced from September to June.

Interviews with various investment managers and strategists from both domestic and foreign asset management firms reaffirmed that the logic behind a potential rebound in the Chinese stock market remains intact despite recent adjustmentsFactors contributing to this sentiment include anticipated policy stimulus, a valuation that has reached low levels following a decline in January (currently less than half of the valuations seen in U.S. markets), and historically-seasonal liquidity easing around the time of the Lunar New Year, which is anticipated to support market stabilityAccording to Shin Yufei, the Chief Equity Investment Officer at BlackRock, sectors such as technology, dividends, and consumer discretionary are identified as key areas for investment moving forward.

While the inflationary pressures in the United States may be showing signs of cooling down, the impact of a strong dollar is likely to persist for some time

Advertisements

The December 2024 CPI breakdown reveals that the primary driver for the rising CPI was a month-on-month increase in energy prices by 2.6%, alongside notable hikes in transportation services, particularly airfare costsRent, which accounts for roughly a third of the CPI, has seen moderate growth, with a year-on-year increase of 4.6% and a month-on-month rise of 0.3%. However, these rates remain higher compared to pre-pandemic averages.

Matt Weller, Global Research Director at Gain Capital, expressed that the stickiness of inflation might arise from the recovering energy prices and persistent housing costsParticularly, the subdued willingness to buy homes in a high-interest-rate environment has bolstered the demand for rentals, suggesting that rent levels may stay elevated for a whileThe impact of the recent wildfires in Los Angeles could further exacerbate rent and reconstruction costsFurthermore, any adjustments to rental prices are expected to lag, indicating that changes would take time to reflect in the CPI data.

Looking at the medium- to long-term horizon, there seems to be a multifaceted risk of inflation resurfacing due to a mix of domestic tax cuts, the expulsion of illegal immigrants, and high tariffs on importsRecent projections from the University of Michigan show that inflation expectations for the next year and for a 5 to 10-year horizon have risen to 3.3%, the latter marking the highest level since 2008. Heightened expectations of rising inflation could prompt both businesses and consumers to stockpile goods before the implementation of high tariffs, thus potentially stalling any immediate decline in inflation rates.

As such, one cannot conclude that inflation risks in the U.S. have been entirely mitigatedIn their December financial outlook, the Federal Reserve adjusted its inflation rate forecasts for 2025 and 2026 upward to 2.5% and 2.2%, respectively, while also reducing the anticipated frequency of interest rate cuts to two for the year

Advertisements

This indicates a clear signal of a deliberate slowdown in the rate of such cuts.

Some analysts maintain a more hawkish perspective, suggesting that only one rate cut may occur in 2025. Weller highlighted the recent surge in non-farm payroll numbers and wage growth far exceeding expectations; should such trends continue, he anticipates that the Federal Reserve may face challenges in enacting any rate cuts.

This prevailing sentiment among financial institutions tilts toward the idea that a strong dollar will be difficult to overcome in the short termAs noted, the dollar index has surged nearly 10% since late September 2024, primarily pushed by cooling expectations surrounding interest rate cutsShould this upward trend persist, the next key target for bulls would be the September 2022 high of 114.8.

Moreover, as the U.S. considers slowing or ceasing interest rate cuts, Europe might be forced into deeper cuts (with estimates ranging from 4 to 5 reductions), and the Bank of England is also likely to continue its easing policiesMeanwhile, China’s central bank is poised to maintain a moderately accommodative monetary stance, all of which could lend support to the dollarHowever, the Bank of Japan remains an unpredictable factor, with expectations that it will be the only major central bank likely to raise rates significantly this year, thus potentially reversing the dollar’s stronghold.

From a trade conflict perspective, if the U.S. government enacts a relatively mild approach toward its tariff policies, it may see the dollar retract some of its recent gains, and vice versa.

As the earnings season commences, U.S. stock markets are experiencing a reboundOn January 15, following previous corrections, stocks surged, driven not only by favorable CPI data but also incredibly strong earnings reports.

The S&P 500 index climbed 183 points to 5949, the Nasdaq-100 saw a rise of 231 points to 21237, while the Russell 2000 increased by 199 points to 2263. Additionally, the volatility index (VIX) dropped by 13.84% to 16.12. The consumer discretionary and communication services sectors fared the best, rising by 302 and 266 points, respectively

Advertisements

The financial sector also excelled, climbing 246 points, predominantly due to robust earnings reported by several major Wall Street banks.

Specifically, JPMorgan Chase (JPM) saw its shares increase by 2%, bolstered by earnings per share (EPS) surpassing expectations at $4.81 against the anticipated $4.10, combined with a favorable outlook for net interest income (NII) in 2025. Citigroup shares surged by 6.5% following its revenue forecast exceeding expectations, unveiling a $20 billion stock repurchase planWells Fargo (WFC) also reported a 6.7% increase due to net interest income exceeding predictions.

The technology sector was particularly impressive, with Tesla (TSLA) rising by 8%, Nvidia (NVDA) by 3.4%, and Amazon (AMZN) by 2.6%. In retrospect, the U.S. market saw its seven leading tech giants collectively gain an astounding $6 trillion in market value throughout 2024, with artificial intelligence (AI) being the primary driver of this growthNvidia and several “super-scale” companies, including Microsoft, Google, Meta, and Amazon have significantly contributed to the S&P 500’s total return of 25% by accounting for 41% of this performance.

Analysts project that the trajectory of U.S. stock market growth in 2025 will lean heavily on profit-driven momentum, with forecasts suggesting a yearly earnings increase of approximately 12%. Additionally, the excitement surrounding AI is likely to sustain; with the official release of Google’s Gemini 2.0 and the frequent updates from OpenAI, there’s a renewed collective anticipation for advancements in AI technologies through 2025.

Meanwhile, prospects for the Chinese stock market are equally promising, as expectations point towards a favorable seasonal rallyOver the preceding fortnight, tensions surrounding U.S. monetary tightening and the corresponding decline in tech stocks had adversely impacted the Asian markets, including the Shanghai Composite Index and Hong Kong stocks, which saw temporary dips.

However, signs of recovery have been apparent this week

Institutions currently believe that the spring rally in the Chinese market, coupled with incremental stimulus measures and appealing valuations, could serve as a notable support structureAs Shin Yufei noted, the S&P 500’s price-to-earnings (P/E) ratio stands at 24, whereas the valuation for A-shares within the CSI 500 sits at 12, indicating that Chinese stocks remain undervalued.

In agreement, Meng Lei, a strategist from UBS Securities, stated that the A-share market’s valuations are at historical lows, with the equity risk premium remaining high, which indicates a favorable price-to-value ratioWhen compared to emerging markets globally, Chinese A-shares are demonstrably undervalued, and should any narrowing of this valuation gap occur; it would likely lead to an uptick in stock prices.

Recent liquidity trends are also likely to offer supportDespite a dip in trade volume at the beginning of 2025, individual investors dominate the A-share market, and increased consumer confidence alongside excess savings is anticipated to drive further capital inflows.

Beyond these factors, expectations around upcoming stimulus measures remain crucialLian Ping, Chief Economist at Guotai Junan, shared insights indicating that the government plans to stimulate the economy through more aggressive fiscal policies aimed at boosting fiscal revenues and optimizing expenditure structuresProjections suggest a fiscal deficit rate may exceed 4% with deficits surpassing ¥5.5 trillionFurthermore, central government transfers to local governments are projected to exceed ¥11 trillion to ensure baseline fiscal stabilityIn addition, special local bonds are expected to hit ¥4.5 trillion to support various projects.

Moreover, the issuance of special government bonds may increase to ¥2 trillion, focusing on state-owned bank capital and consumption sectors, nudging the broader deficit rate closer to 9%. These fiscal measures are expected to be accompanied by monetary loosening, including potential reserve requirement ratio cuts aimed at bolstering bank lending and enhancing market liquidity

Lian Ping expects that the central bank may lower the reserve requirement by 1% or reduce policy rates by 0.4% to 0.5%, with potential further cuts to the Loan Prime Rate (LPR) on the horizon.

Currently, institutional enthusiasm around specific themes continues to influence trading dynamicsShin Yufei emphasized that three main themes are currently appealing: Technology remains the most notable sector to watch; dividend-paying stocks are deemed secure, especially with the backdrop of steady economic recovery; and the consumer sector shows potential for gradual improvements fueled by policy drives and new consumption trends.

From a broader perspective, there’s a consensus that Chinese enterprises stand to benefit significantly from the global wave of AI developmentsPredictions indicate that by 2025, capital may diversify away from U.S. tech titans toward Chinese firmsThis notion was not widely accepted in market circles just a year or two ago, signifying a shift in sentiment.

Research conducted by UBS Securities highlights that progress in Chinese large language models (LLM), such as ByteDance’s Doubao and DeepSeek V3, has exceeded expectations, showcasing significant advancements in reasoning capabilities and multimodality, including visual, vocal, and video generation abilitiesBenchmark tests indicate that leading Chinese foundation models are closing the performance gap in comparison to OpenAI's GPT-4. Moreover, the costs associated with training and inference of these models have significantly declined due to innovations in both software and hardware.

The enhanced cost-efficiency of AI technologies affords Chinese firms a competitive edgeZhang Weixuan, an analyst in the Chinese software industry at UBS, pointed out that innovations in training and inference technologies are expected to lower the entry barriers for AI applications, inviting a broader array of manufacturers and users into the marketCompanies like Kingsoft Cloud, Kingsoft Office, and iFLYTEK are anticipated to benefit from their AI applications in cloud and edge computing, presenting an optimistic outlook for their future endeavors.

Advertisements

Advertisements