January 2025 was a month of sharp reversals and shifting narratives, defined by a dramatic tug-of-war between interest rate volatility and the dawn of a new political era. After a quiet start, markets were seized by a fierce sell-off in long-term bonds, only to be rescued by benign inflation data that propelled equities to new all-time highs. However, this rally was met with underlying caution as investors braced for a gauntlet of policy changes, pivotal central bank meetings, and the core of the Q4 earnings season, setting a tense and uncertain stage for the months ahead.
The Fixed Income Rollercoaster: From Bear Steepener to Bull Flattener
The dominant story of the month unfolded in the bond market. The second week of January saw a synchronized global sell-off in long-term sovereign debt, resulting in a "bear steepener" where long-term yields rose significantly faster than short-term ones. The U.S. 3-month to 10-year Treasury spread widened to 41 basis points, fueling concerns of stagflation and placing immediate pressure on equity valuations.
U.S. Treasury Yield Curve Evolution
The concept of the "term premium" (the compensation for holding longer-duration debt) returned to the forefront of market discourse.
This created a "bull flattener," with yields falling across the curve. The market effectively priced in the equivalent of a 50-basis-point rate cut in a single week, reinforcing the "soft landing" narrative of disinflation alongside a resilient economy. While the Treasury market ended the month in a state of calm, the volatility highlighted its sensitivity to data. The focus shifted squarely to the upcoming Federal Reserve meeting on January 29, along with anticipated rate cuts from the Bank of Canada and a surprise rate hike from the Bank of Japan.
Equities: New Highs Mask Underlying Caution
The equity market's journey mirrored the volatility in bonds. The S&P 500 began the month below its peak, fell during the rate scare, and then surged to a new all-time high of 6,101 on January 23rd. However, this strength was not uniform. Small-cap indices like the Russell 2000 (IWM) lagged, and early-month data from FactSet showed a significant jump in negative S&P 500 EPS guidance, particularly from the Information Technology, Consumer Discretionary, and Materials sectors.
Key Market Indicator
Despite the new highs, investor sentiment was cautious. The put/call ratio on the S&P 500 rose to 2.7 by late January, indicating that investors were actively buying downside protection.
This apprehension stems from the central challenge facing equities in 2025: the high "hurdle rate" set by cash and bonds. With 3-month T-bills yielding over 4% and 10-year bonds offering compelling returns, the S&P 500 needs to deliver substantial gains (potentially reaching 6,700 or higher) to justify its inherent risk, leading many to believe 2025 is more likely to be the "year of the bond" after two stellar years for equities.
The Policy Gauntlet: A New Administration and Global Tensions
The presidential inauguration midway through the month ushered in a period of significant policy uncertainty. The final week of January was marked by a series of executive orders from the new Trump administration, providing an initial glimpse into its priorities:
Trade and Tariffs
An executive order initiated a study to find legal justification for future tariffs under Section 301 of the Trade Act, signaling that tariffs are a matter of when, not if.
Deregulation and Energy
A national energy emergency was declared to boost domestic production, coupled with a directive for all federal agencies to review and eliminate "burdensome" regulations.
Federal Governance
A federal hiring freeze was implemented, and all Diversity, Equity, and Inclusion (DEI) programs were ordered to be eliminated.
These actions, while largely procedural, laid the groundwork for potentially significant economic shifts, with the market awaiting clarity on the scope and timing of future tariffs.
Key Thematic and Sector Developments
Forward Outlook
January concluded with the market at a crossroads. The economic data points towards a resilient "soft landing," but this constructive backdrop is overshadowed by looming policy risks, particularly on trade. For the rally to be sustained, investors will need to see a continued downtrend in long-term bond yields and, crucially, gain clarity on the new administration's policy agenda. February will be dominated by the Federal Reserve's guidance, the bulk of Q4 earnings reports, and the market's reaction to the first concrete policy actions from Washington.
Key Takeaway
While the market appears to have found its footing after January's volatility, the path forward remains uncertain. Investors should remain vigilant and prepared for potential policy-driven market shifts in the coming months.