From January sixth, two thousand twenty-five to January seventh, two thousand twenty-five

I. Foundation

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

Divergence and Convergence: The Historical Relationship Between US and CN10Y, and Market Signals

The divergence in the movements of US10Y and CN10Y shows features similar to those seen before the global financial crisis of 05-06:

Chart: The previous occurrence was nearly 20 years ago

When US10Y and CN10Y converged again after diverging, the previous cycle’s SPX peaked; this was roughly one year after CN10Y bottomed.The movements of CN10Y often signal a bottom in the Chinese economic cycle. The divergence between Chinese and US bond markets reflects structural differences in global monetary policy and economic fundamentals.

Chart: Two possible paths toward convergence

The divergence in their movements will not continue indefinitely. They may not cross, but they will ultimately move in the same direction.

The macro shocks that 10Y is absorbing mainly comprise the remaining US-China tariff issues and marginal policy measures. The time needed to absorb these two factors indicates when the downside for CN10Y may be nearing its end, namely,“Once the tariffs and the major stimulus measures have been absorbed, CN10Y will be close to its bottom.”

When US10Y and CN10Y ultimately converge again, Whether the former moves down or the latter bottoms, either could mark an interim top for the S&P in this cycle.

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

2025.01.07

II. Insights

Our Viewpoints and ideas on market.

Contrarian 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 the recession-risk assumption and favored duration-heavy asset allocations:

U.S. Treasury indices have significantly underperformed USD cash on an excess-return basis:

Equity and credit investors were the group that focused on corporate fundamentals over the past two years They placed greater emphasis on identifying the health of the companies themselves. This focus on the health of micro-level fundamentals leads to fewer positions betting on macro risk or a deviation from the soft-landing scenario, as we mentioned in our earlier Notes:

As long as the US macroeconomy remains broadly stable, micro-level corporate earnings provide more support to the market than macro risks Corporate resilience is sufficient to offset uncertainty in the economic environment. In other words, strong earnings visibility is the central rationale supporting equity valuations and tight credit spreads.

Further reading:

Market Notes 24-10-31: Micro-level performance outweighs macro politics in the US equity market

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

By comparison, rate investors’ strategy relies more on the idea of “hedging against tail risk.”Their distinguishing feature is a preference for UST going long duration to hedge against a recession, but this strategy has frequently faced headwinds over the past two years. First, negative carry has significantly reduced 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:

Differences in how asset classes price recession risk are another key factor, Over the past two years, equity and credit markets priced the probability of recession too low, while rate markets priced it too high:

This disconnect not only led to sharply divergent strategy performance but also further confirmed the long-term conflict between macro sentiment and the corporate-health narrative.

Two key points:First, corporate fundamentals are crucial in a market marked by divergence, following the market and relying too heavily on macro-driven strategies may cause investors to miss actual market signals. Second, overly concentrated asset-allocation strategies (such as duration-heavy positioning) significantly increase risk exposure, especially when there is a disconnect in the market’s pricing mechanism.

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

III. Market Pulse

Our latest Comments on the economic and market environment

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

During the first week of the year, real-money investors made large-scale sales of long-dated German bonds (particularly outright positions in Bunds) and spread trades versus US 10-year Treasuries.The selling may have been intended to prepare for 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 triggered a market adjustment

CTA are currently maintaining long positions in European interest-rate duration. If the market moves sideways, they are expected to sell mainly key instruments 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 rose in tandem with the dollar, The market revised its expectations for the possible scale of rate cuts at the European Central Bank (ECB) 2025 9 rate decision, pricing out 10 basis points of expected cuts.

ECB Executive Board member Stournaras said that rates would reach around 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 challenged it, a new narrative has emerged in the market:“European markets have priced in too many rate cuts”, so the risk-reward profile favors shorting euro-area rates. This suggests that selling amid thin market liquidity was the main force driving the first two trading days of the new year.

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

2025.01.06

Divergence in European Markets: The Gravitational Effect

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

Chart: Divergence in European markets

If the US session continues to swing without managing to move higher, convergence trading in Europe will also begin. In the US session, we are watching 10Y; markets are linked beneath the surface.