Will yields on government bonds continue to rise? – MarketWatch photo illustration/iStockphoto
Stock market bulls rallied last week, but concerns about the unusually strong rise in long-term Treasury yields likely haven’t gone away, especially given the uncertainty over what Donald Trump is likely to accomplish when he returns to the White House on Monday.
It’s not just that offerings do something otherwise they don’t work when the Federal Reserve cuts its interest rate, but that rising yields come when stocks are expensive — the S&P 500’s 12-month price-to-earnings ratio was 21.6 on Friday, according to FactSet, above a five-year average of 19.7 and a 10-year an average of 18.2.
Rising yields can make already expensive stocks look less favorable compared to bonds that have increasingly attractive yields. As analysts at TS Lombard said in a note on Friday: “Rising rates would make it difficult to raise already high valuations.”
Stocks found their footing, with the S&P 500 index SPX and the Dow Jones Industrial Average DJIA posting their biggest weekly gains since the week ended Nov. 8, which was a presidential election week. That comes after the S&P 500 briefly erased all of the 6.6% gain recorded between Trump’s presidential election victory on Nov. 5 and his intraday record set on Dec. 6.
Now, a lot depends on whether last week marked a peak in yields or was just a bounce back from a technical overload, said Jeff deGraaf, president and head of technical research at Renaissance Macro Research.
“The real question for the rest of the quarter, and likely much of 2025, is whether the recent overbought will show a temporary peak in yields that provides temporary relief for stocks, or will it prove more permanent and permanent with yields falling back towards 4.0%? ” he said in the note.
DeGraaf said the drop in yields put RenMac’s measure of stock market sensitivity to returns between the 70th and 80th percentiles, a zone that was in line with the S&P 500’s average returns over the next 65 trading days, or about 13 calendar weeks (see chart below ). .
– Renaissance macro research
Investors have spent a lot of time fretting over the level at which the 10-year yield could seriously dampen demand for stocks. Analysts have noted that markets can shake up not only the absolute level of yields, but also the speed at which they move.
History shows that stocks can usually handle gradual increases in yields quite well, according to analysts at Goldman Sachs. But the S&P 500 tended to struggle if the 10-year yield moved more than two standard deviations, which would currently equate to about 60 basis points, or 0.6 percentage points, in a month, they found (see chart in below).
– Research by Goldman Sachs
By Jan. 14, when yields were at a recent peak, 10-year yields were up about 40 basis points over the previous 30 days and about 50 basis points from their lows in early December, Goldman analysts noted.
So what drives the movement in yields? The relief last week came after December’s CPI reading, as well as remarks by Federal Reserve Governor Christopher Waller, who said policymakers could still deliver several rate cuts in 2025 – contrary to market expectations.
But yields rose significantly despite Fed cuts in 2024. Concerns about the growing US fiscal deficit and fears that Trump will do little to curb it and may increase it despite promises to cut spending have been cited as a potential driver, along with the potential for aggressive import tariffs to fuel inflation.
The rise in yields could reflect ideas that the Fed made a mistake by cutting interest rates by 100 basis points in 2024, analysts said. It may also reflect a strong economy, which could ultimately bode well for stocks despite temporary jitters over rising bond yields.
Investors, meanwhile, are bracing for volatility in financial markets after Trump is sworn in on Monday. News reports say Trump will issue as many as 100 executive orders.
Investors and traders are likely to spend a holiday-shortened week, with U.S. markets closed Monday for the Martin Luther King Jr. holiday, awaiting details on Trump’s approach to reshaping global trade and immigration policy, said Ian Lyngen and Vail Hartman, strategists. in BMO Capital Markets, in a note.
As for Treasury yields, this week’s pullback could provide some breathing room.
“The government bond market is firmly in consolidation mode for now and we struggle to envision a breakout in either direction,” they wrote. “What’s more, with 10-year yields now 20bp (basis points) below recent highs, US rates are well-positioned to respond to Trump’s headlines without any technical damage.”
