The stock market rallied in the immediate aftermath of Donald Trump's election, but now Treasury yields have been spiking as Inauguration Day approaches.
Geopolitical fears, a more hawkish Fed and uncertainty around the policies of the incoming Trump administration have all weighed on indexes. The Nasdaq composite and S&P 500 are well off recent highs.
The most recent jobs report underlined the fact that labor demand continues to be robust. This has bolstered the case among central bankers who believe the need for rate cuts in 2025 has reduced. That is especially true as annual inflation has been stubbornly sticky, remaining around the 3% level.
There was a small rally in bonds following this week's producer price index and consumer price index reports, with investors taking heart from a cooler-than-expected core CPI reading. As a result, the 10-year Treasury yield fell from 4.79% on Jan. 13 to 4.62% on Thursday. Nevertheless, this remains way above the recent low of 3.63% in September.
Treasury Yields Soar Ahead Of Trump Inauguration
Nicholas Colas, cofounder of DataTrek Research, said in a note to clients that the 10-year yield now sits at a level "rarely seen over the last 20 years."
"The last time was in June-July 2007, at the peak of the early 2000s cycle," he said. "While the U.S. economy can likely handle 5% 10-year yields, equity markets may not like testing that theory."
Rates have risen to levels that are beyond the experience of an entire generation of stock market and finance professionals.
Swissquote Bank senior analyst Ipek Ozkardeskaya says it is important that yields cool if equities are to outperform going forward.
"For the stock market rally to broaden beyond the tech companies and beyond the U.S., the yields must come down and let the lower borrowing costs benefit to more cyclical and non-tech pockets of the market," she said in a note to clients. "If yields continue to climb and remain high, the rally is unlikely to extend beyond the tech sector, and even within tech, it could falter due to already high valuations."
Here's How Trump Tariffs, Policy Could Affect Yields
A number of potential issues surrounding the incoming Trump administration are weighing on markets, Sage Advisory co-chief investment officer Thomas Urano told Investor's Business Daily.
"Policy expectations for the incoming administration are focused on tariffs and immigration which have sparked concerns over rising import costs and elevated wage costs," he said. "An upcoming political battle over tax cuts, fiscal spending, and the debt ceiling also have investors on edge. Further pressure on the deficit comes with concerns about rising TSY [treasury securities] supply, helping to push yields higher."
Urano believes that the current market dynamics have led to a sharply steeper yield. He said the market has priced in a substantial jump in term premium. That should compensate investors for both inflation risk and rising price volatility in the long end of the yield curve.
Stock Market Investors Should Remember This
But CFRA chief investment strategist Sam Stovall said it is key that investors do not allow their emotions to become their portfolio's worst enemy.
"Remember that S&P 500 declines of up to 20% since (World War II) have taken an average of only four months to recover all that was lost," he told IBD.
He noted the sectors likely facing adverse effects from higher rates include consumer discretionary and real estate. Higher rates typically dampen consumers' enthusiasm toward spending. Higher bond yields also offer an attractive, low-volatility substitute to real estate investment trusts and utilities.
"Remember, however, that the dividends from higher yielding stocks, though susceptible to the attractiveness of rising bond yields, are taxed at a much lower rate than the interest from bonds," Stovall added.
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