From January sixth, twenty twenty-five to January eighth, twenty twenty-five

I. Foundation

resistance to change and hence greater dependability for the results shown in the past.

Divergence and Convergence: The Historical Relationship and Market Signals of US & CN10Y

The divergence between US10Y and CN10Y has characteristics similar to those seen before the global financial crisis of 05-06:

Chart: The last time this happened was nearly 20 years ago

When US10Y and CN10Y converged again after diverging, the previous cycle's $SPX peaked, roughly a year after CN10Y bottomed.The movement of CN10Y is often a signal of a bottom in China's economic cycle. Behind the divergence between Chinese and U.S. bond markets lie structural differences in global monetary policy and economic fundamentals.

Chart: Two possible paths toward convergence

The divergence in their trends will not continue indefinitely. The two may not cross, but their directions will eventually align.

The main macro shocks that 10Y is still digesting are the China-U.S. tariff issue and marginal policy measures. The time needed to absorb these two factors indicates when the downside potential for CN10Y may be nearing its end, namely,“Once the tariffs are absorbed and the major stimulus is digested, CN10Y should be close to bottoming out.”

When US10Y and CN10Y eventually converge again, Whether the former comes down or the latter bottoms out, either could mark a near-term top for the S&P in this cycle.

Chart: US 10Y Term Premiums vs. 10Y CGB Yield

2025.01.07

II. Insights

Our Viewpoints and ideas on market.

Divergent Market Bets: Lessons Learned

The past two years, equity and credit investors captured significant market alpha on the strength of their conviction in a soft landing,rate investors were whipsawed by the market's sharp swings, mainly because they relied too heavily on recession-risk assumptions and favored duration-heavy asset allocations:

The U.S. Treasury index significantly underperformed USD cash:

Equity and credit investors were the group focused on corporate fundamentals over the past two years, they place greater emphasis on identifying the health of the companies themselves. This focus on micro-level fundamental health reduces positions betting on deviations in macro risk or the soft-landing outlook, as we noted in our earlier Notes:

As long as the U.S. macroeconomic environment remains broadly stable, micro-level corporate earnings provide greater support to the market than macro risks do, corporate resilience is sufficient to offset uncertainty in the economic environment. In other words, strong earnings visibility is the core rationale supporting equity valuations and tight credit spreads.

Further reading:

Market Notes 24-10-31: Micro-level Earnings Matter More Than Macro Politics in U.S. Equities

This also means that trading throughout 25 will necessarily revolve around earnings visibility, which is the key risk point during earnings season.

By comparison, Rate investors' strategies rely more heavily on the idea of hedging against tail risk.A notable feature is their preference for UST duration long positions to hedge against recession. But this strategy has repeatedly faced headwinds over the past two years. First, negative carry has significantly weakened the appeal of long-duration bonds; second, an inverted yield curve has increased volatility in long-term bond yields, directly hurting rate investors' portfolio performance:

Divergent pricing of recession risk across asset classes is also one of the key factors, Over the past two years, equity and credit markets priced in too low a probability of recession, while the rates market priced in too high a probability:

This disconnect not only caused strategies to perform in diametrically opposite ways, but also further confirmed the long-term conflict between macro sentiment and the corporate-health narrative.

Two key points:First, In a market of diverging views, corporate fundamentals are crucial, following the market and relying too heavily on macro-driven strategies may cause investors to miss actual market signals. Second, an overly concentrated asset-allocation strategy, such as duration-heavy positioning, significantly increases risk exposure, especially when market pricing mechanisms are disconnected.

Further reading:

JPM：Flows & Liquidity, 10 lessons from the past year

JPM: Flows & Liquidity, Why equity and credit investors got it right while rate investors got whipsawed?

2025.01.06

Market Breadth, Pricing Variables, and the Endgame of Divergence

Although 2024 was another solid year for U.S. equities, performance in 12 was disappointing. The weak finish to an otherwise strong year may be attributable to several factors.

First, the sharp rally from 9 to 11 largely exhausted near-term upside momentum and absorbed almost all of the macroeconomic tailwinds.Support came in waves from macro drivers such as Fed easing, the Federal Reserve's rate cut 50bp (kick-off new easing cycle), and the Republican election victory (Pro-market outcome). But these positive factors have now been fully priced in, Such a rapid rally is never sustainable, and the unwinding of large hedging positions at the start of 12 further amplified volatility.

Second, the rebound in the 10Y Treasury yield is undoubtedly the key variable behind the change in market pricing.From the interest-rate low in the summer of 2024 to now, yields have recovered about 100 basis points, despite the Fed having already cut rates by 100 basis points.

This suggests that the bond market may be questioning whether the Fed cut rates too early or too aggressively.

The widening of the term premium is another notable signal., widening by 77 basis points from the low in 9; this may be a second reflection of uncertainty about the Fed or fiscal sustainability;And indeed, the S&P 500 index’s price-to-earnings ratio peaked in early 12, exactly when the term premium broke above 50 basis points.

Chart: Term premium and the S&P 500

Third, rising interest rates and Trump’s election victory strengthened the dollar, and its strength has now reached a level that may weigh on stocks with a high share of overseas sales., with the low base effect from last year, the dollar index is approaching +10% year over year, which will be a key topic during the fourth-quarter earnings season for some multinational companies.

All of these factors are jointly suppressing market breadth, which still looks fragile. The gap is very wide between the S&P 500 index’s ratio to its 200-day moving average and the percentage of stocks trading above their 200-day moving average, The market’s rise is still driven more by a handful of mega caps than by a broad-based recovery.

This divergence could narrow in either of two ways:Either breadth improves, or the S&P 500 index pulls back toward its 200-day moving average. The former would require lower interest rates, a weaker dollar, greater clarity on tariff policy, and stronger earnings revisions.Absent these developments, 2025 may follow a “weak first half, strong second half” pattern, with more challenges in the first half and policy changes in the second half (such as extending or expanding tax cuts and reducing the term premium through greater government efficiency) potentially more favorable to equities.

2025.01.08

III. Market Pulse

Our latest Comments on the economic and market environment

Early-year selloff in European bonds and market pricing of ECB rate cuts

In the first week of the year, Real Money investors carried out large-scale selling of the long end of German government bonds (especially outright Bund positions) and spread trades against 10-year U.S. Treasuries.These sales may have been intended to address the pressure from large European government bond supply over the next two weeks.

Looking back at the selloff during the last two weeks of 12, its causes can be summarized in two points

1) Fast Money reduced positions for risk-management reasons

2) Expectations of large European bond supply at the start of 1 prompted a market correction

CTA remain long European interest-rate duration, and if the market trades sideways, they are expected to sell mainly key contracts such as Schatz, Bobl, and Bund.

At the short end of the yield curve (short-term government bond yields), as natural gas and crude oil prices rise in tandem with the dollar, Markets revised the potential scale of rate cuts at the European Central Bank (ECB) 2025 9 rate decision, reducing rate-cut expectations by 10 basis points.

ECB Executive Board member Stournaras said that rates would reach about 2% in the autumn. His remarks triggered selling at the short end of the curve.Although Stournaras is not the most influential member of the Executive Board, his stance is extremely dovish and no other board member has pushed back., a new narrative has emerged in the market:“European markets have priced in too many rate cuts”, so the risk-reward favors shorting euro-area rates. This suggests that the first two trading days of the new year were driven mainly by selling pressure amid poor market liquidity.

Looking ahead to this week, European inflation data and the U.S. nonfarm payrolls report (NFP) will be key drivers. As most market participants return, liquidity is expected to improve.

2025.01.06

European market divergence: The Gravitational Effect

From the perspective of economic uncertainty, European valuations should have declined, but the “gravitational effect” of U.S. market valuations continues to pull global valuations broadly higher:

Chart: European market divergence

If the U.S. session continues to move sideways without breaking higher, mean-reversion trades will also begin to emerge in Europe. In the U.S. session, we are watching 10Y; markets are interconnected beneath the surface.