Market Horizon: The Path to January 2026

As markets move into the final weeks of 2025, the investment backdrop is shifting from headline-driven optimism to a more disciplined, policy-led phase. Thin year-end liquidity, rising long-term yields and renewed central-bank influence are likely to drive short-term volatility, even as the broader outlook remains constructive. The focus is no longer on whether rates will fall, but on how persistent inflation, uneven growth and policy normalisation—particularly in Japan—interact with stretched valuations, especially in AI-linked equities. Against this backdrop, investors are being rewarded for selectivity rather than speed, with market breadth, yield behaviour and sector rotation emerging as the key signals to watch in the weeks ahead.

1) Thin liquidity and year-end mechanics will dominate price action
As markets move through year-end and into early January, liquidity will be thinner and price moves more exaggerated. Year-end rebalancing, window-dressing, and tax-related positioning—particularly in the US—will matter more than incremental fundamentals.

Expectation: higher short-term volatility without a decisive break in trend.

2) The macro narrative remains “soft landing, but rate volatility persists”
The core question has not changed: is inflation easing fast enough without growth cracking? Recent disruptions have made US data harder to interpret, while Europe remains constrained by wage dynamics. Importantly, Japan is now a genuine source of global rate volatility, no longer a passive anchor.

Expectation: markets remain highly sensitive to inflation and wage surprises, especially at the long end of yield curves.

3) AI remains central — but the filter has changed
The market has clearly moved beyond the simple “AI = up” phase. The focus is now on:

• Capex discipline

• Timing of monetisation

• Earnings delivery rather than narrative

Expectation: continued sharp rotation within AI (hardware vs software, platforms vs infrastructure), rather than a broad-based sell-off.

4) China stays stable, cautious, and incremental
Policy direction continues to prioritise financial stability over aggressive stimulus. Any support is likely to be targeted and gradual rather than headline-grabbing.

Expectation: China remains a stabiliser, not a catalyst, for global markets.

5) January becomes a “policy reset” window — with added data risk
January traditionally resets market narratives, and 2026 will be no exception:

• Bank of Japan (late Jan): markets will assess whether Japan tightens again or pauses after its move to ~0.75%.

• Federal Reserve (late Jan): the first FOMC meeting of the year often resets tone and forward guidance.

Crucially, the US also faces a post-shutdown “data dump” risk. As agencies clear reporting backlogs, multiple months of revisions could be released in quick succession, raising the risk of abrupt re-pricing of growth and inflation assumptions.

Implications for Portfolios

Equities

• Base case: choppy but constructive — progress with interruptions.

• US mega-cap / AI: structurally supported, but returns increasingly driven by earnings validation and factor rotation.

• UK equities: more exposed to weak domestic demand; upside likely valuation- or rate-driven rather than growth-led.

• Japan: higher rates may pressure valuations in the short term, but a stronger wage and normalisation cycle can support select domestic sectors — particularly financials benefiting from positive net interest margins after decades of zero rates.

Portfolio implication: diversify by region and factor, avoid over-concentration in a single AI sub-theme.

Bonds / Debt Securities

• The primary risk is persistently high or rising long-end yields.

• Japanese policy normalisation can transmit volatility globally through term premia and FX hedging costs.

Portfolio implication: manage duration deliberately; avoid “accidental” long-duration exposure.

Foreign Exchange

• JPY becomes more two-way: rising Japanese rates increase funding costs, challenging the traditional yen carry trade and making short-JPY positions riskier.

• GBP: remains sensitive to domestic growth disappointment and the pace of BoE easing.

• EUR: largely a rates-differential and relative-growth story.

Portfolio implication: FX exposure should be treated as an active risk decision, not a passive residual.

Credit

• In the absence of a growth shock, credit fundamentals remain sound.

• However, thin liquidity can cause temporary spread widening, particularly in crowded trades.

Portfolio implication: favour quality; be cautious with lower-rated or illiquid exposures into year-end.

ESG

• Near term, ESG remains secondary to rates and growth.

• Capital is increasingly rewarding practical ESG: grid investment, energy security, and disciplined transition spending rather than broad labels.

The Key Signal to Watch

The most important tell in the coming weeks is market breadth.
If breadth improves while yields stabilise, the market is transitioning from a narrow, AI-led rally to a healthier, broader advance. If breadth deteriorates while yields stay elevated, the risk of another pullback rises.