Macro
Heightened geopolitical risks have contributed to a more volatile market environment. Volatility skews have shifted decisively, with implied volatility on puts materially higher and downside protection trading at a premium. This contrasts with parts of 2025, when skews were episodically upside-rich, driven by AI-related demand for calls. The current skew configuration appears to signal strong demand for downside hedging and reflect persistently elevated investor concerns over the risk of a sharp market drawdown.
[1]
Concerns around potential Fed leadership changes have resurfaced amid market wariness of hawkish policy risks. Current macro conditions—low unemployment, stabilising inflation, pro-growth fiscal agenda—tilt policy toward accommodative stance with negative real rates to address debt burdens.
Unemployment risks remain skewed to the upside as labour supply weakens and AI-related investment proves far less labour-intensive than traditional capital formation. A stark illustration is the contrast between Meta’s $1.5 billion data-center project in El Paso, Texas—expected to support roughly 100 permanent jobs—and AESC’s $1.6 billion battery cell manufacturing facility in Florence County, South Carolina, which is projected to support around 1,620 jobs. [2] For a comparable level of capital expenditure, the employment intensity differs by an order of magnitude.
More broadly, the AI capex cycle may itself act as a headwind to labor demand, by pushing up the cost of capital and crowding investment away from more employment-sensitive sectors of the economy. With inflation pressures remaining subdued, the macro backdrop appears consistent with the Federal Reserve continuing its easing cycle. However, the pace and terminal extent of rate cuts may remain highly data-dependent, particularly on labor-market and activity indicators.
Equities
Equity markets have evolved in line with our base-case scenario, with increasing indications of a broadening in market participation. Within the US, small caps had a strong start to the year, up 5%, while the Magnificent Seven stocks rose only 1% in January. In terms of regions, emerging markets were the best performing, up 9%, followed by Japan’s Topix, which rose 5% over the same period. [3]
Earnings growth has been a key driver of recent market performance. Emerging markets have exhibited comparatively strong earnings momentum, supported by factors such as China’s recovery, increasing adoption of AI, resilient domestic demand, and strength in technology-related sectors. Recent upward revisions to earnings estimates have reinforced this constructive backdrop. [4]
In addition, improvements in corporate governance—particularly across parts of Asia—have contributed to higher return-on-equity metrics and have provided support for valuations [3]. Despite recent gains, emerging market valuations appear relatively attractive compared with global peers, while continued under allocation by global investors suggests scope for incremental re-engagement.
Fixed Income
Fixed Income returns, as measured by the Global Aggregate index, have been muted for the month of January, largely due to better than expected economic activity data and renewed risk-taking appetite. The Global Aggregate index returned a modest 1% in January. [5]
[6]
Heightened geopolitical risks stemming from Trump’s actions in Venezuela, combined with rising long-term inflation expectations and worsening fiscal dynamics have resulted in higher term premia and inflation compensation. This has pushed up the long end of the yield curve. US treasuries have also had a relatively large sell-off in the front-end of the curve, as the positive economic data has pushed rate cut expectations further back. (Seen in the graph below, as of 3 February)
[7]
Looking forward, the speed and degree of rate cuts are uncertain and highly dependent on incoming economic data. Given this uncertainty, market participants should selectively manage duration across the curve amid rate volatility concerns.
Foreign Exchange & Commodities
The US dollar weakened sharply in January, falling 2.6% on a DXY basis, following a substantial 9.4% decline over 2025. [8] Confidence in the dollar has been undermined by heightened geopolitical tensions and U.S. policy uncertainties, including tariff prospects and Fed commentary. Taken together, these developments support our base case of anticipated continued dollar depreciation in 2026, though risks include safe-haven flows and policy shifts.
The yen began 2026 in a similar fashion to how it ended 2025, under selling pressure driven by concerns over Japan’s fiscal and monetary policy mix. These concerns were amplified by rising inflation expectations following the announcement of a huge 21.3 trillion fiscal package by Takaichi, equivalent to 3.5% of Japan’s GDP. [9]
Despite this, the yen recovered modestly in January, strengthening against the US dollar from 156.59 to 154.32 on London closing rates, and against the euro from 184.09 to 183.35. [5]
The USD/JPY cross-currency basis has been trending higher from deeply negative levels toward more normalised territory, signalling easing dollar funding stress and providing support for the yen.
[10]
We have seen outsized moves in frothy markets, most notably across precious metals. What began as a historic rally in gold and silver abruptly reversed on Friday and extended into Monday, as traders unwound what had become an extremely crowded, one-sided positioning.
Silver, in particular, had attracted sustained inflows from institutional, professional, and retail investors over recent months, with price action turning increasingly parabolic. That excess left the market vulnerable to a sharp correction, as liquidity proved insufficient to absorb a sudden wave of forced selling.
While the initial catalyst was the speculation around potential Fed leadership changes—which supported a rebound in the US dollar—the severity of the sell-off was driven by a cascade of futures liquidation linked to the unwinding of ETF and options positions. [11]
Despite the sharp drawdown late in the month, gold still finished January strongly, delivering a 13% gain overall.
Source:
[1] Bloomberg Terminal
[2] The Macro Implications of the AI Capex Boom | Bridgewater Associates
[3] Review of markets over January | JP Morgan Asset Management
[4] UBS House View – February 2026 | UBSZ
[5] Review of markets over January | JP Morgan Asset Management
[6] Bloomberg Terminal
[7] Bloomberg Terminal
[8] Monthly Foreign Exchange Outlook (February 2026) | MUFG
[9] Market Review & Outlook, 2 February 2026 | J. Safra Sarasin
[10] Bloomberg Terminal
[11] Market Quick Take – 2 February 2026 | Saxo Bank Strategy Team
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