Federal Reserve Chair Jerome Powell’s remarks helped cool the stock market rally sparked by Donald Trump’s election victory. – MarketWatch photo illustration/Getty Images, iStockphoto
The U.S. stock market’s post-election rally hit a speed bump. It was probably due for a pullback after surging in the wake of Donald Trump’s Nov. 5 presidential election victory, the only question was what would be the catalyst.
Up stepped Federal Reserve Chair Jerome Powell in a Thursday appearance in Dallas.
Powell reminded investors that the Fed wasn’t in a rush to deliver the next interest rate cut in the face of a resilient economy, singing much the same tune he warbled after the Fed’s Nov. 7 rate cut — a 25-basis-point reduction that followed October’s 50-basis-point cut.
But it seemed to land differently on the ears of investors, absent the immediate postelection euphoria, raising concerns about the pace of future Fed rate cuts and the path ahead for market interest rates. Those considerations and how they intersect with Trump’s economic plans are likely to call the tune for markets in the weeks ahead.
Major stock indexes extended modest losses after Powell’s remarks on Thursday. They took a leg sharply lower Friday, leaving the Dow Jones Industrial Average DJIA with a weekly loss of 1.3%, the S&P 500 SPX down 2.2%, and the tech-heavy Nasdaq Composite COMP off 3.3% after all three ended at records Monday. The small-cap Russell 2000 RUT, a prime beneficiary of so-called Trump trades, suffered a weekly drop of more than 4%.
The pullback follows the best week of 2024 for U.S. stocks. Since the market close on Election Day, the S&P 500 holds a gain of 1.5%, the Dow is up 2.9% and the Nasdaq up 1.3%. The small-cap Russell has added 1.9% over that stretch.
Powell’s remarks also followed U.S. inflation data that remained a bit firmer than expected earlier in the week. They also came alongside comments from other Fed officials who made clear a December rate cut isn’t baked in the cake. Cue a rise in Treasury yields, which had already accelerated their upswing in the wake of Trump’s victory, and stocks were soon feeling the heat.
“Up until now, the markets have looked past the rise in rates — with the S&P 500 up 6% since 10-year yields bottomed two months ago. However, if the 10-year Treasury yield breaches the 4.5% level, the equity market could come under pressure and lead to a near-term pullback,” said Larry Adam, chief investment officer at Raymond James, in a Friday note.
And Friday’s session did indeed see the yield on the 10-year note briefly trade above 4.5% before appearing to attract buyers, leaving it to end the day near 4.46%.
Adam contends yields won’t be a lasting problem for stocks “as long as the upward trajectory for earnings remains intact and the economy achieves a soft landing.”
But stock-market investors may remain at the mercy of moves in the bond market in the near term, said Ian Lyngen and Vail Hartman, rates strategists at BMO Capital Markets, in a note.
“The feedback loop between higher Treasury yields and wobbles in the equity market will take center stage during the next few sessions. If for no other reason, the lack of any top-tier data will leave investor sentiment vulnerable to swings in other asset classes,” they wrote.
The outlook for yields, in turn, depends on what investors ultimately make of Trump’s plans. Analysts have debated how much of the yield rise since late September are explained by fears of reflationary Trump policies, including import tariffs, tax cuts and continued government deficit spending.
Powell has reiterated that policymakers don’t make assumptions about fiscal policy and other measures, but Fed watchers and rates strategists wonder if uncertainty over the Trump agenda has contributed to the Fed’s desire to create more options in terms of the pace and scope of further rate cuts.
Fed officials “will already be thinking about potential reflationary shocks, market inflation break-evens, shifting financial conditions, and reduced visibility into 2025,” said Krishna Guha, head of the global policy and central bank strategy team at Evercore ISI, in a Friday note.
“We think this makes them more sensitive to upside surprises in the spot inflation data, while also loading onto ‘data-dependence’ Trump-related concerns they cannot speak openly about,” he wrote.
That’s still in keeping with another quarter-percentage-point Fed rate cut in December, he said, slowing to one quarter-point cut per quarter in 2025. The path remains for the fed funds rate to fall toward 4%, but the timing and scope of cuts is more uncertain. And that should serve to crimp investor appetite for risky assets at the margin.
“Even in our base case the Fed will prize optionality as a hedge against Trump uncertainty,” Guha wrote. “When the Fed is long an option, risk-takers are short the same option, so this is less risk-friendly, even if the baseline is not as hawkish as some fear.”
