If This Rate Continues to Rise, Stocks Will Struggle Under Trump

December’s sharp rise in U.S. Treasury yields has set a challenging tone for the incoming Trump administration, adding complexity to the economic and political landscape leading up to Inauguration Day on January 20. The Republican "red sweep" in November’s elections reflected voter discontent with the U.S. economy, but addressing Wall Street’s concerns over the fiscal implications of President-elect Donald Trump’s “pro-growth” agenda may prove to be an immediate hurdle.

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A key focus for Trump’s team will be calming the fears of “bond vigilantes” who have contributed to the recent Treasury selloff. These investors are wary of how Trump’s policies might escalate the already substantial U.S. debt.

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“We still think there is room for Treasury yields to move higher from current levels,” wrote a CreditSights team led by Zachary Griffiths in a note to clients on Friday. This expectation aligns with recent market trends, where the benchmark 10-year Treasury yield climbed to 4.596% on Friday, capping off 2024 with its largest annual increase since the bond market’s challenging year in 2022.

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This surge in yields carries significant economic implications. Treasury yields serve as a foundation for various types of borrowing, including mortgages, car loans, and corporate financing. Higher yields increase borrowing costs and reduce the present value of future earnings, making it harder for equity valuations to remain elevated.

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Evercore ISI strategists, led by Julian Emanuel, have noted that rising Treasury yields represent a major obstacle to the stock market’s bullish momentum. They caution that a 10-year yield exceeding 4.75% could trigger “a longer and deeper equity correction.”

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Economic data surprises no longer appear to be the main driver of rising bond yields. Instead, the recent “bear steepening” of the Treasury yield curve suggests that market participants are increasingly concerned about the U.S. fiscal outlook, in addition to the possibility of higher Federal Reserve policy rates for an extended period.

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The CreditSights team highlighted this trend by comparing the Citigroup Economic Surprise Index—a measure of economic performance relative to expectations—with the trajectory of the 10-year Treasury yield over the past year. Despite a decline in the surprise index in December, Treasury yields continued to rise, signaling a shift in market dynamics.

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Neil Dutta, head of economics at Renaissance Macro Research, echoed this sentiment in a client note on Wednesday. He challenged the notion that rising bond yields reflect a repricing of recession risks, instead attributing the increase to fiscal concerns tied to Trump’s policies. Dutta pointed to the potential for greater debt issuance relative to demand, the Federal Reserve’s ongoing balance sheet reduction, and rising overseas bond yields in countries such as Japan and the U.K.

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In the U.S., political developments added to the uncertainty on Friday as Louisiana Republican Mike Johnson narrowly secured re-election as House Speaker. Internal divisions within the Republican Party could complicate Trump’s efforts to implement his agenda, which includes tax cuts, increased tariffs, and stricter immigration policies.

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Meanwhile, U.S. stocks, which had a stellar performance in 2024, faltered in the year’s final week. The Dow Jones Industrial Average gained 0.8% on Friday, snapping a five-session losing streak. The S&P 500 and Nasdaq Composite also posted gains of 1.3% and 1.8%, respectively, according to FactSet.

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As the Trump administration prepares to take office, it faces the dual challenge of addressing investor concerns over fiscal policy and managing the broader economic implications of rising Treasury yields. The bond market’s reaction suggests skepticism about the sustainability of Trump’s pro-growth agenda without exacerbating the federal debt.

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Increased borrowing costs tied to higher yields could pose a significant headwind for both the economy and the stock market. Additionally, the prospect of political discord within the Republican Party further complicates the path forward, potentially undermining Trump’s ability to deliver on key campaign promises.

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The outlook for Treasury yields remains uncertain but tilted toward further increases. Rising yields could ripple through the financial system, affecting everything from household borrowing to corporate financing. At the same time, the interplay between fiscal policy, Federal Reserve actions, and global bond market trends will likely remain a central focus for investors in the months ahead.

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As markets navigate these dynamics, the ability of the Trump administration to articulate a clear and credible fiscal strategy will be crucial. Without this reassurance, fears of ballooning deficits and elevated borrowing costs may continue to weigh on both the bond and equity markets, shaping the narrative for 2025.

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