The Fate of the Post-Election Stock Market Rally May Rest With Bond Traders

Stock investors witnessed a notable rise in Treasury yields following midweek postelection results, but this didn’t stop equities from reaching record highs by Friday. Now, with Donald Trump’s election victory and the potential for a Republican-dominated government, the question remains: can the stock market handle further increases in market-based rates in the coming months and years?

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Trump’s victory on Tuesday, along with Republican control of the Senate and an expected majority in the House, suggests that Treasury yields may continue rising. This is due to anticipated policies such as corporate tax cuts, stricter immigration, and trade tariffs, which investors expect will boost U.S. economic growth, reduce the labor pool, and raise inflation risks.

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Wednesday’s trading provided a glimpse of what might lie ahead. An intense selloff in U.S. government bonds, sparked the night of the election as early results poured in, pushed the yield on the 30-year Treasury bond up by 15.3 basis points—a single-day increase not seen since June 2022. Meanwhile, yields on the 10-year and 30-year Treasury bonds hit four-month highs, and the five-year breakeven inflation rate reached 2.495%, near the 2.5% threshold that suggests heightened inflationary concerns.

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Although rising yields generally make it harder to justify high stock valuations and increase borrowing costs for businesses, this didn’t dampen postelection enthusiasm in the stock market. On Wednesday, the Dow Jones Industrial Average surged by 1,508.05 points, marking its largest postelection gain since 1896. The Dow, S&P 500, and Nasdaq Composite all closed at new record highs on Friday, underscoring investor optimism.

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Before Tuesday’s election, stocks faced some challenges adjusting to the 10-year yield rising above 4.3%, as it did in September and October of the previous year. Now, some financial experts, like Mark Heppenstall, president and chief investment officer at Penn Mutual Asset Management, are considering the possibility of a 5% yield on the 10-year bond—a level last briefly surpassed in October 2023. Heppenstall suggested that bond market rates are likely to keep rising, potentially reaching levels that may not sit well with the stock market.

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The upcoming week includes a key economic update with the release of October’s consumer price index (CPI) on Wednesday. This report could shape the Federal Reserve’s next steps on interest rates, either continuing to hold steady or resuming cuts in December. Yet, the report’s influence may be short-lived as market attention remains on the longer-term impact of Trump’s win on inflationary pressures.

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With a national deficit of $1.83 trillion, some analysts, including Heppenstall, think the bond market may press for fiscal discipline. He explained that if tax cuts and other fiscal stimuli materialize, the Fed might need to halt rate cuts sooner than anticipated. He sees the bond market’s reaction last week as a reflection of concerns about the federal deficit’s potential effects.

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On Friday, the earlier moves in long-term Treasury yields moderated as buyers returned to 10- and 30-year bonds, causing inflation breakeven rates to dip. Despite ongoing concerns about the fiscal landscape, demand for Treasurys remained robust.

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However, not everyone is convinced that Trump’s policies will trigger significant inflation. Some market watchers believe the inflationary impact might be overestimated, especially if Trump’s proposed tariffs—such as a 60% tariff on Chinese imports and additional tariffs on other imports—don’t materialize. Furthermore, Elon Musk, a close Trump ally, has hinted at potential austerity measures that could trim federal spending by up to $2 trillion. Although this target is widely doubted by budget experts, it adds an element of uncertainty to Trump’s fiscal plans and the government’s deficit outlook. Speculation about fiscal restraint also lingers due to the ongoing uncertainty around control of the House.

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Larry Adam, chief investment officer at Raymond James, which manages $1.57 trillion in client assets, noted that investor interest in U.S. government debt remains strong, with Treasury auction demand staying robust. Adam downplayed concerns about a potential “crisis” in the Treasury market, noting that historically, high debt and deficits haven’t significantly dragged down stock or bond performance. He highlighted that, on average, the equity market tends to rise by about 9% in the 12 months following an election, regardless of political outcomes.

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Looking forward, the question for investors is where to focus next. Mark Malek, chief investment officer at Siebert, which manages over $18 billion in assets, suggested that investors could capitalize on higher short-term yields, creating opportunities in Treasury bills and cash-equivalent instruments. Malek believes the administration’s policies could be economically stimulative, with a likely reduction in corporate taxes and a general trend toward lower tax rates.

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While Malek sees the administration’s approach as beneficial for the economy and stocks, he cautions against alarm over inflation, which he believes requires a wait-and-see approach. He added that investors expecting rapid Fed rate cuts may need to temper their expectations, as any rate cuts will likely be less aggressive than previously anticipated.

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With the bond market closed on Monday for Veterans Day, the week ahead includes key economic indicators. On Tuesday, the NFIB small business optimism index for October will be released. Thursday’s data will feature weekly jobless claims and the producer price index, followed by Friday’s releases of the Empire State manufacturing survey and October reports on retail sales, industrial production, and capacity utilization.

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