Federal Reserve Chairman Jerome Powell reinforced expectations for a September rate cut on Tuesday, citing recent inflation data. Yet while short-term interest rates are expected to head lower, the 10-year Treasury yield has bolted higher in recent days on growing confidence that former President Trump will win a second term as Republicans take control of Congress.
Fed Rate-Cut Outlook
"We are getting back on a disinflationary path," Powell said at a European Central Bank forum, though policymakers will look to see more good data before pivoting to rate cuts.
Following Powell's comments, the Labor Department reported that job openings rose to 8.14 million in May. Economists had expected a further decline to 7.9 million from April's downwardly revised 7.919 million.
Markets are pricing in 69% odds of a Fed rate cut at the Sept. 18 meeting and 68% odds of two quarter-point cuts by the end of the year. Very short-term Treasury yields, which reflect current economic conditions and the Fed rate-cut outlook, haven't felt a Trump effect.
10-Year Treasury Yield
Yet long-term bonds have thrown investors focused on soft data a curve ball in recent days, Deutsche Bank strategist Jim Reid wrote in an early Tuesday morning note. "A narrative has built up that due to the aftermath of the Trump/Biden debate, markets should be pricing in a higher probability of a Trump victory and larger fiscal deficits."
BCA Research's Daily Insights also tied rising long-term yields to the prospect of larger fiscal deficits under Trump. "We believe that the bond market could riot" as those deficits start to materialize.
The 10-year Treasury yield slipped as low as 4.26% after Friday morning's core PCE price index, the Fed's primary inflation gauge, showed the smallest monthly price increase since late 2020. Then the focus turned back to President Biden's disastrous debate performance on Thursday night, which has thrown the Democratic Party into crisis and made a Trump victory look much more likely.
The 10-year yield reversed higher on Friday, closing at 4.34%, then shot up to 4.48% on Monday, before easing back to 4.45% this morning. The Supreme Court's Monday ruling on presidential immunity cleared one potential hurdle to a Trump victory by assuring that he won't face a potential conviction for his efforts to overturn the 2020 election before voters go to the polls in November.
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Treasury Yield Curve
The 10-year Treasury yield is up 19 basis points from Friday morning's low, while the two-year yield bounced six basis points to 4.73% and the one-year yield hasn't budged from 5.09%.
The inverted yield curve, in which long rates are lower than the short-term rate, is beginning to flatten. Eventually, Fed rate cuts should create a more normal yield curve in which long rates are higher. That's good for banks' net interest income, since they generally borrow at short-term rates and lend at longer-term rates.
That helps explain the recent rise in bank stocks such as JPMorgan Chase, which is on the cusp of a buy point, according to MarketSurge. Bank of America is near a buy point from a three-weeks-tight pattern. Banks also may benefit from lighter regulation under a Trump administration.
But the news isn't all positive for investors. The modest bounce in the two-year Treasury yield is a sign that the Fed rate path might feel some Trump effect by 2026.
Deutsche Bank fixed-income strategist Matthew Raskin and colleagues noted two potential reasons for a shift upward in interest-rate expectations. More expansionary fiscal policy should raise the term premium, which is the compensation investors demand for the risk that interest rates will rise, which lowers the values of outstanding bonds.
On top of that, the Deutsche Bank strategists see "more restrictive trade and immigration policies" under Trump putting upward pressure on inflation.
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S&P 500
Long-term bonds and financials aren't the only securities pricing in a likely Trump effect. First Solar and other green energy stocks have dived on concern Trump will try to repeal incentives in the Inflation Reduction Act.
Homebuilders are tumbling, in part on rising mortgage rates. That also isn't good news for residential solar.
Trump's disregard for the Affordable Care Act could pose a risk to Medicaid expansion and the health insurance exchanges for purchasing coverage outside the employer market. That's triggered selling in hospital stocks, particularly HCA Healthcare.
But the broad S&P 500 hasn't budged much, finishing Monday's session just 0.2% off its record closing high.
Be sure to read IBD's The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
