Schwab Market Perspective: Markets vs. Economy

January 19, 2025

9 minute read

by Liz Ann Sonders, Kathy Jones, & Jeffrey Kleintop, Charles Schwab & Company Ltd.

Strong U.S. economic data has spurred a strong rise in Treasury yields but a tepid response in the stock market. Uncertainty likely will continue in coming months.

The U.S. stock market has responded weakly to recent strong economic data—the same data that sparked a surge in Treasury yields—as investors consider future growth and reassess the potential for Federal Reserve rate cuts. Meanwhile, the possibility of a Bank of Japan rate hike in January has some investors wondering whether there could be another unwinding of the yen carry trade, an event that caused global market volatility last summer.

U.S. stocks and economy: Stocks vs. the economy

The U.S. labor market ended 2024 on a strong note, with a net 256,000 jobs created in December, a move down in the unemployment rate (to 4.1% from 4.2%), and an increase in the prime-age employment-population ratio (the percentage of people aged 25–54 who are employed versus the total working-age population). Hiring breadth—the net share of industries adding jobs—remained healthy and wage growth was firm, underscoring that at the aggregate level, the labor market was not flashing a recessionary signal by the end of the year.However, as we pointed out throughout 2024, there were several cracks under the surface that started to show increasingly worrisome signs for labor. One of those was the growth in full-time employment, which (in year-over-year terms) slipped into negative territory in the beginning of the year, thus flashing a classic recession warning. However, as you can see in the chart below, the trend flipped positive in December.

Back to (full-time) work

The chart shows the year-over-year change in U.S. full-time employment dating back to 1971. Gray bars are overlaid to represent recessions. The trend turned positive in December 2024, ending a long streak of declines.

Source: Charles Schwab, Bloomberg, Bureau of Labor Statistics, as of 12/31/2024.

It's one of the many dynamics—including an unusually stable unemployment rate—that has been unique to this cycle. In a typical cycle, a decline in full-time employment is consistent with a broad-based recession; so far, that hasn't been the case this time around.While that is cause for celebration, the stock market hasn't responded in a kind way. The strong jobs report helped send Treasury bond yields higher, which coincided with a weak response for stocks. As shown in the chart below, the rolling 30-day correlation between the 10-year Treasury yield and the S&P 500^® index has fallen back into negative territory. All else being equal, that means bond yields have been rising for the "wrong" reasons (i.e., inflation concerns), which has put downward pressure on stocks.

Stocks and bonds not getting along

Chart shows the rolling 30-day correlation between the 10-year Treasury yield and the S&P 500 dating back to 2015. The correlation has fallen into negative territory, indicating that stock and bond performance has become less correlated.

Source: Charles Schwab, Bloomberg, as of 1/10/2025.

Correlation is a statistical measure of how two investments historically have moved in relation to each other, and ranges from -1 to +1. A correlation of 1 indicates a perfect positive correlation, while a correlation of -1 indicates a perfect negative correlation. A correlation of zero means the assets are not correlated. Past performance is no guarantee of future results.

While the pullback for the S&P 500 has been mild thus far (in percentage change terms), there has been a much stronger hit to breadth. As shown in the chart below, the percentage of members of the S&P 500 index trading above their 50-day moving average has fallen sharply over the past month to a new one-year low.

2025 starts with bad breadth

Chart shows the percentage of stocks in the S&P 500 index trading above their 50-day and 200-day moving averages. The percentage of stocks trading above their 50-day moving average has fallen sharply over the past month to a new one-year low.

Source: Charles Schwab, Bloomberg, as of 1/10/2025.

A moving average is a technical indicator that shows the average closing price of a security over the past specific number of days (such as 50 or 200 days). Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

For now, the market's longer-term breadth—the percentage of members trading above their 200-day moving average—hasn't been hit as hard. There might still be some downside, which wouldn't necessarily end the bull market, and if further weakness does unfold, we'd keep a close eye on the recovery in breadth. If the market resumes its trek toward new all-time highs without a commensurate improvement in underlying strength, the likelihood of a protracted drawdown would rise.

Fixed income: Treasury yields jump as Fed expectations change

Treasury yields continue to surge as strong economic growth, stalled inflation, and uncertainty about fiscal policy in the long run have shifted expectations about how much more easing by the Federal Reserve is likely (remember that yields move inversely to prices). Over the past six months, the market has gone from pricing in four to five rate cuts (or 100 to 125 basis points) in the federal funds rate this year to pricing in just one.

Markets are pricing in only one rate cut

Chart shows the estimated number of Federal Reserve moves priced in by December 2025 based on the World Interest Rate Probability Implied Overnight Rate for the U.S. Futures Model. The data in the chart goes back to August 2024. As of January 13, 2025, the futures market was pricing in roughly one downward move in 2025.

Source: Bloomberg.

WIRP Implied Overnight Rate for the U.S. - Futures Model (US0ANM DEC2025 Index), daily data as of 1/13/2025.

The World Interest Rate Probability (WIRP) Implied Overnight Rate for the U.S. is a market estimate of where the federal funds rate (the rate U.S. banks charge each other for overnight loans) will be after a future Federal Reserve meeting, in this case by December 2025. The implied rate is the difference between the current rate and the forward rate, which indicates the expected number of moves. Futures and futures options trading involves substantial risk and is not suitable for all investors. Please read the Risk Disclosure Statement for Futures and Options prior to trading futures products. Past performance is no guarantee of future results. For illustrative purposes only.

Treasury yields have risen by more than 100 basis points, or 1%, in just four months, with 10-year yields coming close to 5%, a level reached only once since 2007. We expect that yields will continue to move higher in the near term, as long as the economy looks to be on solid ground and there is policy uncertainty on the horizon.

Treasury yields have neared 5%

Chart shows the 10-year Treasury yield dating back to 2006.

Source: Bloomberg.

U.S. Generic 10-year Treasury Yield (USGG10YR INDEX). Daily data as of 1/13/2025.

Past performance is no guarantee of future results.

On the positive side, the market has gone a long way toward discounting the uncertainties ahead. Real interest rates—adjusted for inflation—are at the highest levels in 15 years and consistent with ongoing strength in the economy.

Real interest rates are at the highest levels in 15 years

Chart shows the 2-year and 10-year Treasury Inflation-Protected Securities yields dating back to 2010. As of January 13, 2025, the 2-year TIPS yield was 1.6% and the 10-year TIPS yield was 2.3%.

Source: Bloomberg, as of 1/13/2025.

US Generic Govt TII 5 Yr (USGGT5Y Index), US Generic Govt TII 10 Yr (USGGT10Y Index). Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

In addition, the term premium—the extra yield investors demand to hold longer-term bonds versus reinvesting in short-term bonds—has moved up sharply in the past few months. After a long stretch in negative territory, the term premium has moved up sharply. It's now positive by about more than 60 basis points for 10-year Treasuries. It could still move higher based on past history, but its rapid rise indicates that much of the uncertainty about the outlook for Fed policy has been discounted.

Chart shows the 10-year Treasury term premium dating back to 1995. As of January 9, 2025, the premium was 63 basis points.

Source: Bloomberg. Adrian Crump & Moench 10-year Treasury Term Premium (ACMTP10 Index). Daily data as of 1/9/2025.

The term premium is the compensation that investors require for bearing the risk that short-term Treasury yields do not evolve as they expected. The term premium in the chart above is obtained from a statistical model developed by New York Federal Reserve Bank economists Tobias Adrian, Richard K. Crump, and Emanuel Moench. Past performance is no guarantee of future results. For illustrative purposes only.

As a result of the relative strength of the U.S. economy compared to other major developed countries and divergence in interest rates, the value of the U.S. dollar has been rising sharply. On a broad trade-weighted basis it is at new highs in nominal terms and nearly that high in real terms.

Chart shows the performance of the Nominal Broad U.S. Dollar Index and the Real Broad Dollar Index dating back to 2008. As of December 31, 2024, the nominal index was at 127 index points and the real index was at 121 index points.

Source: Board of Governors of the Federal Reserve System (US), Nominal Broad U.S. Dollar Index (DTWEXBGS) and Real Broad Dollar Index (RTWEXBGS). Monthly data as of 12/31/2024.

The Nominal Broad U.S. Dollar Index is a weighted average of the foreign exchange value of the U.S. dollar against the currencies of a broad group of major U.S. trading partners. The Real Broad U.S. Dollar Index is an inflation-adjusted weighted average of the foreign exchange value of the U.S. dollar against the currencies of a broad group of major U.S. trading partners. Past performance is no guarantee of future results. Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

We expect the dollar to continue to remain strong and potentially appreciate. Investors continue to favor holding U.S. dollar-denominated securities due to the wide interest rate differentials with other major countries and potential for investment gains in the U.S. economy.

U.S. interest rates are high compared to those in other countries

Chart shows the yield for the Bloomberg Global Aggregate ex-USD Index and the Bloomberg US Aggregate Bond Index dating back to January 2015. As of January 13, 2025, the U.S. Agg yield was 5.1% and the Global Agg ex-USD yield was 2.7%.

Source: Bloomberg.

Bloomberg U.S. Aggregate Bond Index Total Return (LBUSTRUU Index) and Bloomberg Global Aggregate ex-USD Total Return Index (LG38TRUU Index). Daily data as 1/13/2025.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

The dollar's strength can help offset some of the inflationary pressures in the economy and from tariffs. It also makes U.S. Treasuries attractive to hold, helping to mitigate some of the upward pressure on yields.Overall, the next few months are likely to see yields remain elevated or move higher. In the longer run, as the outlook clears about policy, yields should stabilize and potentially move lower in the second half of 2025. For now, however, we are cautious about interest rate risk.

Global stocks and economy: Another yen carry trade unwind?

Trump's pick for Treasury secretary, hedge fund manager Scott Bessent, has proposed a "3-3-3" economic plan for the U.S. that echoes Japan's "three arrows" plan, part of the "Abenomics" policies launched at the end of 2012. The details of the plans differ, but Bessent's enthusiasm for Japan's economic program is reflected in an essay he wrote in 2022, which includes this recollection from 2012: "I'm not sure whether it will work, but it will be the market ride of a lifetime." The chart below suggests that he wasn't wrong about that.

Japan's stock market reclaimed its prior peak in 2024

Chart shows the performance of the U.S. S&P 500 index and Japan's Nikkei 225 index dating back to 1950. A red line marks the beginning of "Abenomics" in December 2012.

Source: Charles Schwab, Macrobond data as of 1/7/2025.

"Abenomics" refers to a set of economic policies introduced in Japan by then-Prime Minister Shinzo Abe. Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

What is next for Japan? One of the 2012 "three arrows" was easing monetary policy to bring back inflation. That era finally ended last year with inflation appearing to be sustainable and the Bank of Japan (BOJ) lifting rates from negative territory. Now, there could be a chance of another rate hike announcement at the BOJ's next meeting on January 24. The last time the BOJ hiked rates, in July 2024, it sparked a three-day selloff amounting to a -20% move for the MSCI Japan Index and -6% move for the S&P 500 Index as the yen carry trade unwound. Those who had positioned themselves against a rising yen had to quickly sell assets to close out their short positions in the Japanese currency.The markets are divided on the prospects for another rate hike at the January meeting. Some market participants believe the BOJ could hold off for now amid uncertainty over U.S. trade policy toward Japan under the Trump administration. Yet, because Japanese companies are the U.S.'s largest source of foreign direct investment and the second-largest foreign employer in the United States, Japan may be better positioned than most U.S. trading partners to withstand U.S. policy changes.

The summary of opinions for the December 2024 BOJ meeting hinted that some board members see a need to increase borrowing costs sooner rather than later. And BOJ Governor Kazuo Ueda on January 6 sent a fresh reminder that he's planning to raise rates should the economy continue to improve this year. However, he kept his options open on the timing of the next rate hike by saying it will depend on the economy, inflation, the outlook for wage growth, and financial conditions.

That uncertainty has kept the yen at a relatively weak level thus far. The yen could jump if the BOJ hikes rates. If so, might we see another sharp selloff in stocks? That seems unlikely. Current market vulnerability to a reversal in the yen isn't the same as it was in July 2024. Speculators' yen positioning is close to neutral, unlike the record short positions ahead of the BOJ hike last July, as you can see in the chart below.

Yen speculators current positioning close to neutral

Chart shows the net positions, either long or short, of speculative Japanese yen futures holders in the United States. As of January 7, 2025, the net position was 21,510 contract positions to the short side, a relatively neutral level.

Source: Charles Schwab, Commodity Futures Trading Commission, Bloomberg data as of 1/7/2025.

The Commodity Futures Trading Commission's (CFTC) weekly Commitments of Traders report provides a breakdown of the net positions for "non-commercial" (i.e., speculative) traders in U.S. futures markets. All data corresponds to positions held by participants primarily based in the Chicago (Chicago Mercantile Exchange, or CME) and New York futures markets. The Commitments of Traders report is considered an indicator of market sentiment. A long position (green area in the chart above) is when an investor buys an asset with the expectation of selling it later at a higher price. A short position (red area in the chart) is when an investor borrows an asset to sell it, with the expectation of buying it back later at a lower price.

Nevertheless, risks of a longer-term unwind remain. In his 2022 essay, Bessent warned about a potential global financial crisis stemming from a reversal of the yen carry trade, focusing not on short-term speculators, but the amount of Japanese capital that has funded other longer-term investments both in and outside of Japan that may need to be liquidated to repay borrowings as costs rise.

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Strong U.S. economic data has spurred a strong rise in Treasury yields but a tepid response in the stock market. Uncertainty likely will continue in coming months.