U.S. stocks have suffered a setback after recording their best weekly performance in 2024. The soaring stock market since Trump won the presidential election on November 5 may indeed be due for a correction. The only question is what the catalyst will be.

Fed Chairman Jerome Powell stepped up during an appearance in Dallas on Thursday. He reminded investors that the Fed is in no rush to make its next rate cut in the face of a resilient economy, striking much the same tone as his Nov. 7 news conference after the Fed cut rates by another 25 basis points to follow up October’s 50 basis point cut.

But investors seem to be hearing a different message, one that has neither fueled the immediate post-election euphoria nor raised concerns about the pace of future Fed rate cuts and the trajectory of market interest rates. These considerations, as well as the potential impact of Trump’s economic plans, could sway markets in the coming weeks.

Powell's comments came after U.S. inflation data released earlier last week was still slightly stronger than expected, and came as other Fed officials made it clear that a December rate cut was not a done deal. Treasury yields had already accelerated their rise following Trump's victory, and stocks quickly felt the pinch.

Larry Adam, chief investment officer at Raymond James, said in a report last Friday, "So far, the market has ignored the rise in U.S. Treasury yields. The S&P 500 has risen 6% since the 10-year Treasury yield bottomed two months ago. However, if the 10-year Treasury yield breaks through the 4.5% level, the stock market may face pressure and pull back in the near term."

The 10-year Treasury yield did briefly break above 4.5% during Friday’s trading, then appeared to attract buyers of Treasury bonds, closing the day near 4.46%.

Adam believes that "as long as the upward trajectory of corporate earnings remains unchanged and the economy achieves a soft landing," U.S. Treasury yields will not be a lasting problem for the stock market.

But stock market investors may still be at the mercy of bond market swings in the near term, BMO Capital Markets interest rate strategists Ian Lyngen and Vail Hartman said in a note.

“The feedback loop between rising Treasury yields and equity market volatility will be in focus in the coming sessions. If nothing else, the lack of any top-level data will leave investor sentiment vulnerable to swings in other asset classes,” they wrote.

The outlook for Treasury yields depends on how investors ultimately view Trump's economic plans. Analysts have been debating how much of the rise in Treasury yields since late September comes from concerns about Trump's reflationary policies, including import tariffs, tax cuts and continued government deficit spending.

Powell reiterated that policymakers would not make assumptions about fiscal policy and other measures, but Fed watchers and rate strategists wondered whether uncertainty about Trump’s agenda was prompting the Fed to want to keep more options open on the pace and scope of further rate cuts.

Krishna Guha, head of Evercore ISI's global policy and central bank strategy team, said in a report last Friday that Fed officials are "already factoring in potential reflation shocks, break-even inflation rates, evolving financial conditions, and reduced visibility into the economic outlook through 2025."

“We think this makes them more sensitive to upside surprises in inflation data, while also increasing their concerns about Trump-related ‘data dependencies’ that they cannot talk about publicly,” he wrote.

Guha said the current situation is still consistent with the expectation that the Federal Reserve will cut interest rates by another 25 basis points in December. He expects the Fed to slow down to 25 basis points per quarter by 2025, and the federal funds rate will eventually fall to 4%, but the timing and scope of the rate cuts are more uncertain. This should curb investors' interest in risky assets at the margin.

“Even in our base case, the Fed values ​​optionality as a hedge against the uncertainty created by Trump,” Guha wrote. “When the Fed is long options, risk-takers are short options, so even if the base case is not as hawkish as some fear, it is not particularly supportive of risk assets.”

Article forwarded from: Jinshi Data