The market's January slump could stabilize or even reverse course depending on how investors react to a series of key events this week that could help define the driving force behind the surge in U.S. Treasury bond yields.
Wall Street remains divided on the key factor in the ongoing surge in Treasury yields, which has taken benchmark 10-year note yields, one of the world's most important financial-market metrics, to the highest levels since late 2023.
The paper has added some 25 basis points, or 0.25 percentage point, since Election Day and nearly a full percent since mid-September.
Some analysts say the moves are tied to renewed inflation risks and reflect concern that the Federal Reserve made a policy error in lowering its benchmark lending rate by 50 basis points in September even as price pressures lingered and the economy defied forecasts for a slowdown.
Bond markets are suggesting that Fed Chairman Jerome Powell and his colleagues made a policy error when they lowered rates by half a percentage point in September. Win McNamee/Getty Images
Others say the broader economic agenda of President-elect Donald Trump — which is likely to include expansion of both record debt and budget deficits to fund a series of tax cuts, immigration promises and spending guarantees — is driving yields, a proxy for U.S. borrowing costs, to multiyear highs.
Market volatility returns in a big way
That debate could be the reason that the market's benchmark volatility gauge, CBOE Group's VIX index, is trading near the highest levels in a month and has risen more than 26% over the past five session.
At its current level of $20.72, investors are expecting daily swings of around 1.3%, or 75 points, for the S&P 500 over the next 30 trading days.
"Continued bouts of volatility around Trump plans, inflation data, economic data, etc., are to be expected, and investors have to just try and take advantage of it," says Eric Clark, portfolio manager at Rational Dynamic Brands Fund.
The nature of the moves will also prove crucial for stock market performance as higher yields tied to economic performance are likely to correspond with corporate-earnings growth, the lifeblood of a sustainable bull market.
The opposite, however, is also true: If the surge in yields is more closely linked to inflation and debt concern, stocks are likely to deepen their early January decline.
Lisa Shalett, CIO of Morgan Stanley Wealth Management, thinks the former might be the more likely explanation.
"While some have raised concerns about the incoming administration’s policies and their inflation impact, bond buyers have kept inflation expectations in check, instead repricing the two other components of interest rates: real yields and the term premium," she said. She cites the difference between nominal yields and the inflation rate as well as the extra return investors demand to hold longer-dated paper.
"This could be seen as healthy — reflecting stronger growth, a higher long-run neutral rate and normalizing monetary policy," Shalett added.
Investors will likely get a glimpse of the potential for stronger domestic growth prospects when fourth-quarter earnings season starts later this week, specifically with updates from the country's five biggest lenders.
Bank earnings will be in focus this week
"Bank earnings are always an effective way to get a pulse on the economy and the consumer, especially as it relates to credit usage and repayment," said Michael Landsberg, chief investment officer at Landsberg Bennett Private Wealth Management in Punta Gorda, Fla.
"The big banks often give us a good insight into what we can expect to see from the more consumer-oriented companies, which report earnings later on in earnings season," he added. "If credit card usage is up, that typically bodes well for companies that sell directly to consumers."
Bank earnings are also likely to contribute a significant share of the market's estimates for S&P 500 profits, which are forecast to rise 9.5% from the year-earlier Q4 to a share-weighted $519.9 billion.
LSEG data suggest investors see financials delivering around $91.2 billion, or 17.5%, just behind the $135 billion expected from the information technology sector, which includes Microsoft (MSFT) , Advanced Micro Devices (AMD) and Micron Technology (MU) .
At the same time, the Commerce Department's December consumer inflation report, due Jan. 15, is likely to show an uptick in headline and core price pressures. Both remain firmly north of the Federal Reserve's 2% target, with higher oil prices and potential trade tariffs from the Trump administration expected to keep them elevated well into the new year.
Faster inflation might prompt further bond selloff
Should bank earnings fall shy of analysts' estimates, or the outlooks on growth from bank CEOs come overloaded with caveats tied to Trump policies, a faster inflation reading could fuel another selloff in Treasuries.
Again, though, the flip side remains important: A bullish outlook from banks, tied to looser regulations, a better backdrop for dealmaking and a solid domestic economy could easily offset a hotter-than-expected inflation reading and provide an entry point for a stock market that is now largely flat to where it traded on Election Day.
"We think U.S. equity gains could roll on [but] we’re watching for elevated vulnerabilities in financial markets, including an already jittery bond market," said Jean Boivin, who heads BlackRock's Investment Institute.
"We expect bond yields to climb further as investors demand more term premium for the risk of holding bonds," he added.
The rise in yields could increase corporate borrowing costs and "challenge the business models of companies that assumed interest rates would remain low," he noted.
