This week, we have the Federal Reserve meeting on Wednesday, followed by the European Central Bank (ECB) meeting on Thursday. Meanwhile, the Bank of Japan (BOJ) made waves last Friday by raising its policy rate to 50 basis points, signaling that they are far from finished tightening.
This move is significant because Japan has spent decades in a deflationary environment, and even small rate increases are a big deal. BOJ Governor Kazuo Ueda has suggested that Japan’s neutral rate might be around 1%, meaning we could see another 50 basis points of hikes throughout 2025. This marks a significant shift for Japan, a global low-rate anchor.
The Japanese yen has weakened substantially against the dollar, euro, and other major currencies, which has historically supported carry trades and added liquidity to global markets. However, the narrowing basis swap spreads for USD/JPY suggest that this trend may be unwinding.
Rising rates in Japan could also put upward pressure on global bond yields. Japan’s role as the world’s low-rate anchor is shifting, and if that base begins to lift, it could ripple through markets.
Week Ahead Packed With Key Economic Data
We’ll see new home sales, durable goods orders, and the S&P CoreLogic Home Price Index on Monday. Tuesday brings consumer confidence data and the Richmond Fed survey at 10 AM. The big event, however, will be Wednesday’s Federal Reserve meeting. While the market isn’t expecting any changes to interest rates, I believe the Fed would be wise to avoid signaling any cuts in the near term.
Inflation remains a concern, and recent data suggest that it may accelerate. For instance, the S&P Global report released on Friday indicated a pickup in inflation and hiring activity.
Many corporate surveys also point to rising inflation expectations over the next six months, a key indicator of where the inflation might be headed.
Even the University of Michigan’s five-to-ten-year inflation outlook remains elevated at 3.2%, near the higher end of its historical range. If I were in the Fed’s shoes, I’d view this as an uncomfortable position, as it signals that inflation expectations haven’t fully stabilized.
Thursday will bring the advance GDP report, with the market expecting 2.7% quarter-over-quarter growth. Personal consumption is projected to grow by 3.2%, and the price index is expected to increase by 2.5%. Together, that indicates a strong nominal growth rate of 5.2%. We’ll also get the core PCE price index for Q4, which previews Friday’s monthly PCE report. While the quarterly and monthly figures are related, they don’t always align perfectly, so any surprises on Thursday may not necessarily translate into Friday’s numbers.
On Friday, we’ll see the Employment Cost Index (ECI), expected to rise from 0.8% to 0.9%, reflecting accelerated wage growth in Q4. The monthly PCE inflation report will also be released, with estimates pointing to a 0.3% month-over-month increase, up from 0.1% in the prior month. The year-over-year core PCE is expected to remain steady at 2.8%. Notably, market expectations for core PCE were revised lower following the recent CPI and PPI reports. Still, the market has become adept at predicting these figures based on prior inflation data.
Earnings season also ramps up this week. Microsoft (NASDAQ:MSFT), Meta (NASDAQ:META), Tesla (NASDAQ:TSLA), and Apple (NASDAQ:AAPL) are all reporting after the close on January 29th and 30th, while Alphabet (NASDAQ:GOOGL) is scheduled for next week.
Implied correlations in the S&P 500 have been falling, with the one-month implied correlation index hitting 7.6 on Friday—the second-lowest level ever recorded. This trend aligns with earnings season, where implied correlations typically drop as individual stock volatility rises ahead of earnings announcements. However, as we exit earnings season, implied correlations tend to rise, which could signal increased market risk.
Historically, low implied correlations have coincided with market tops. As correlations rise and earnings season winds down, we may see heightened market volatility, particularly with the Fed meeting and key economic data releases on the horizon.
Additionally, the Treasury General Account (TGA) has risen sharply in recent weeks, draining liquidity from the financial system. Reserve balances have fallen as the TGA climbs to around $760 billion, adding another layer of potential pressure on markets.
From a broader perspective, the risk-reward balance in equities appears skewed. With tightening liquidity, low implied correlations, and potential for a more hawkish Fed outlook, the upside for equities seems limited compared to the downside risks.
Forward markets suggest that rates may rise slightly over the next 12–18 months, contrary to expectations of cuts. This reinforces the idea that the Fed is likely not done tightening and could surprise markets later in 2025.