Volatile Times

In a month that saw Donald Trump’s inauguration for his second term as president, arguably the two most market-sensitive events in January had very little to do with the bellicose leader.

First, slightly softer-than-expected UK and US core Consumer Price Index (CPI) prints on 15 January triggered sharp reversals in the prices of longer-dated government bonds. Second, news that the Chinese AI model DeepSeek matched the performance of far more expensively trained models from US companies sent technology share prices tumbling during the final week of the month.

Both events are notable because they run counter to prevailing sentiment. Market narratives around inflation have grown increasingly cautious in recent months. While few commentators are predicting a return to 2022 levels of inflation, many expect it to remain above central bank targets and for it to prove harder to bring down.

As a result, long-dated bond yields had drifted significantly higher since around mid-September last year, prompting trend-following hedge funds and other speculative macro capital to build substantial short positions in longer-dated government debt.

The rally in government bonds following the CPI prints—most notably the US 10-year yield dropping 25 basis points over four trading days—can therefore be seen as a bout of position clearing. Not that UK Chancellor Rachel Reeves will mind; murmurs about the cost of financing the UK deficit were swiftly silenced by the move.

But zoom out, and little has changed. Market expectations for interest rates remain broadly where they were at the start of the year (even after the announcement of tariffs in early February!)—two rate cuts from the add (Fed) afterwards in 2025, with the first widely forecast for May or June. This still feels at odds with a sticky inflation narrative. Regardless of whether a single CPI print comes in 0.1% higher or lower than expected, inflation expectations above 2% are unlikely to persuade central bankers to cut rates.

Ironically, despite his pressing for lower rates, here are three Trump actions that could block a looser monetary policy:

1. Tariffs. For all the initial noise we must wait to see what impact they will have on inflation. Enough ink has been spilled explaining that many of the implications of the initial rounds of tariffs are negative for the US consumer. It doesn’t help the forecaster when tariffs are imposed and then retracted in short order, as they were with Canada and Mexico. In our view, while lighter tariff policy than expected doesn’t magically solve the inflation problem, it could lead to another bond market reaction.

2. The economy. If Trump succeeds in sensible deregulation and stimulating growth, there would be little reason to cut rates. The US economy would remain strong, inflation would stay above target (and arguably should be allowed to rise slightly to accommodate robust GDP growth), making rate cuts unnecessary.

3. A rhetorical stand-off with the Fed. Trump’s public calls for lower interest rates could create friction with the Fed, increasing the risk of a policy error. There is a small chance that individual central bankers might lean towards slightly higher rates to assert their independence.

The DeepSeek situation appears to have tested a more fragile consensus trade: the long tech/long AI theme that has driven equity markets — particularly US equities — to new highs, with record levels of narrow market leadership. US equity indices have recovered much of the initial shock, suggesting that broader appetite for equities remains intact. For a small dip to be viewed as the start of a prolonged drawdown rather than a buying opportunity, more widespread concerns would likely need to emerge.

Even after the moves of the last week of January, many US tech market leaders are still trading at forward price-to-earnings valuations that require significant revenue expansion for at least the next five years. Regardless of whether DeepSeek proves to be asdisruptive to the industry as it initially appears, the genie may already be out of the bottle. 2025 could become a year of reckoning for whether such lofty valuations can be sustained in this fiercely competitive segment of the economy. After two years of largely following the momentum trade—buying whatever has risen the most—equity investors may find that this year marks the return of the value trade: buying cheap and selling expensive.

Key drivers of hedge funds' performance: An early January snapshot

Equity Long/Short (ELS):

• Despite a tech-centric correction spurred by the DeepSeek shock on 27 January, global equities generally began 2025 on a strong footing, led by European and US equities
• Early evidence from hedge fund performance data shows that it was a strong month for equity long/short strategies. This appears to be a mix of both beta (average net leverage ratios have ticked higher) and alpha. Crowded names on both sides of the book appear to have performed quite well in January and generated a positive spread, generally a good sign for alpha generation in the fundamental ELS space
• There was net selling across the space and managers appeared to become a bit more cautious. The reaction to the DeepSeek news showed how fragile and reactive the investor base in the AI and related names theme is, and while most managers remain positive on it, chips have come off the table and hedges have been added

Credit:

• January was a volatile but strong month for risk assets, with US high yield credit spreads ending the month near post-Global Financial Crisis (GFC) tights. US high yield, loans, and investment grade markets all delivered positive returns, driven by further compression of the risk premium between lower- and higher-rated credits
• Corporate credit managers posted positive returns, with many sub-strategies ending the month in the green. Stressed and distressed credits benefitted from the strong market backdrop, while certain performing loans attracted strong bids. Government-Sponsored Enterprise (GSE) preferred securities delivered another solid month. Convertible bonds also contributed positively, as managers capitalised on elevated realised volatility in certain issuers (e.g. in the tech and crypto sectors), while credit spreads remained stable to tighter. Unsurprisingly, portfolio-level hedges were a drag for some managers
• Structured Credit managers also posted positive returns driven by carry and spread tightening across certain sectors

Event Driven:

• January was a positive month for most hard catalyst Event Driven strategies, e.g. merger arbitrage in Europe benefitted from material progress in several transactions, but there were also some challenges for special situations
• Good activity levels reported in all regions, with Europe scene to multiple hostile banking deals in Italy and Spain, e.g. Monte dei Paschi di Siena announced a EUR 13.3bn takeover offer for its rival Mediobanca. In the US, Johnson & Johnson is seeking to acquire Intra-Cellular Therapies for US$ 14.6bn. And in Japan, Paloma Rheem Holdings is offering to buy out Fujitsu General for US$ 1.6bn, at a 24% premium
• However, there have also been some setbacks; the Department of Justice sued to block the US$ 14bn horizontal acquisition of Juniper Networks by HP Enterprise, and Bureau Veritas and SGS ended talks on their US$ 35bn merger as they disagreed on terms

Quant strategies:

• Statistical arbitrage strategies look to have had a positive month. Technical, alternative data and factor-based approaches are all up and have in some cases taken advantage of volatility in US tech names caused by the emergence of DeepSeek as a potential AI challenger
• Regional performance has been a little weaker in Europe versus North America though both are up for the month
• Factor-wise, Momentum has seen positive performance once again, despite a weaker final week of the month as AI names were impacted by the market’s digestion of DeepSeek’s success. On a sector-adjusted basis, Quality and Low Volatility factors both detracted, despite underlying names benefitting from some risk-aversion-driven buying. Value also lagged over the month
• While data is limited, quantitative credit strategies appear to have been flat over the period

Systematic Macro:

• Trend-following strategies were generally flat through 30 January, with some managers posting slight gains while others struggled. The reversal in the strength of the US dollar negatively impacted many programmes, with gains from equity long positions offsetting these losses. Managers with larger allocations to agricultural commodities benefitted from renewed appreciation in coffee and cocoa prices, partially driven by US tariff threats. Similarly, long gold positions benefitted from this geopolitical dynamic. However, short bond and rates positions proved unhelpful. The Société Générale (SG) CTA Index (through 29 January) was up 0.1%, while the SG Trend Index was down 0.5%
• Alternative trend-following strategies appear to have delivered mixed performance. Losses in alternative energy were notable, with long positions in US and EU carbon emissions and electricity being the worst offenders. Similarly, long US dollar positions detracted against a range of emerging market (EM) currencies
• Broader systematic macro programmes were up in January. Fixed income positioning has been more profitable than trend-following strategies, with short Bunds contributing positively. The majority of gains have come from long equity exposures, with commodities also providing an additional boost

On the radar:

• The short-term focus will be on whether the leading tech stocks recover the ground lost in the last week of January following the DeepSeek news. Given the narrowness of the US equity market, further weakness in these names is likely to pose a headwind for the broader indices reaching new highs from here.
• The other major focus for 2025 will be Trump’s true impact on markets. His first term saw a mix of market-friendly and market-unfriendly actions, making it difficult to draw clear parallels to this term. Immediate concerns centre on how his tariffs are implemented and whether Trump’s hardline approach will stabilise or destabilise global geopolitics.