The U.S. stock market’s post-election rally, powered by President-elect Donald Trump’s victory, met resistance last week as Federal Reserve Chair Jerome Powell tempered expectations for rapid interest rate cuts. This shift in sentiment follows a euphoric rise after Trump’s economic agenda boosted investor optimism.
A Post-Election Rally Hits a Snag
After hitting record highs early last week, the major stock indexes stumbled:
Dow Jones Industrial Average: Down 1.3% for the week.
S&P 500: Dropped 2.2%.
Nasdaq Composite: Slid 3.3%.
Russell 2000: Fell more than 4%, reflecting vulnerability in small-cap stocks tied to "Trump trades."
The initial surge was driven by expectations of pro-growth policies, including tax cuts and regulatory easing. Since Election Day, the S&P 500 has still gained 1.5%, while the Dow and Nasdaq have risen 2.9% and 1.3%, respectively.
Powell’s Comments Shift the Narrative
In a speech last Thursday, Powell signaled the Fed's cautious stance on further rate cuts, citing resilience in the U.S. economy and persistent inflation. Investors now expect a more gradual easing of monetary policy, with only a 58% chance of a December rate cut, down from 80% earlier in the week.
The shift came as Treasury yields climbed, with the 10-year yield briefly breaching 4.5% on Friday before settling at 4.46%. Rising yields often pressure equities, particularly in growth sectors like technology, by increasing the attractiveness of fixed-income investments.
The Bond Market and Stock Market Feedback Loop
Higher Treasury yields have created turbulence in equities, especially as investors weigh the impact of Trump’s economic policies. Analysts at BMO Capital Markets noted the interplay between bond market moves and equity market sentiment could dominate the coming sessions.
Key Risks:
Reflation Concerns: Trump's tax cuts and deficit spending plans could stoke inflation fears, keeping yields elevated.
Fed Uncertainty: While a December rate cut remains likely, the Fed appears to be prioritizing flexibility, leaving markets uneasy about the timing and scale of future cuts.
Economic Outlook: Balancing Optimism and Risks
Despite these challenges, some analysts remain optimistic, citing robust corporate earnings and a potential soft landing for the economy as key supports for the market. Larry Adam of Raymond James emphasized that as long as earnings growth continues, rising yields may not pose a lasting threat.
However, Krishna Guha of Evercore ISI warned that the Fed's cautious approach to rate cuts reflects uncertainty over the Trump administration’s policies. This uncertainty could suppress investor appetite for riskier assets, creating a more volatile market environment.
What’s Next?
As the Fed navigates inflation risks and economic resilience, markets are likely to remain reactive to key data releases and fiscal policy developments. The interplay between Trump’s policy agenda, inflation dynamics, and Fed actions will dictate the market's trajectory in the months ahead.
Conclusion: While the initial rally has cooled, the long-term direction of the market will hinge on how effectively Trump’s economic policies can sustain growth without triggering higher inflation or further tightening from the Fed. Investors should prepare for heightened volatility as these factors play out.
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