Calm in Bonds Suggests It’s Time to Pencil in Stocks You Like – But Wait for Market-Moving Headlines from Washington

The bond market is sending a clear message to investors: hold your horses. As President Trump’s second term commenced, the U.S. government bonds experienced a tumultuous selloff that momentarily sparked fears of a resurgence in 5% yields for the benchmark 10-year Treasury note. The possibility of sustained higher long-term rates raised concerns over a potential negative impact on stocks and the broader U.S. economy. However, in an unexpected twist, longer-term bond yields retreated to around 4.5%, while equities oscillated amid a continuous stream of unpredictable headlines coming from Washington.

Uncertainty Reigns in Washington

According to John Kornitzer, founder of Kornitzer Capital Management and the Buffalo Funds, the landscape in Washington remains murky. On topics ranging from tariffs and foreign aid to oil policies and government spending, “everything is in disarray,” he stated. Nevertheless, a chaotic policy environment might not necessarily hinder stock pickers. Kornitzer suggested that investors could capitalize on market fluctuations, asserting that if a headline aligns with a long-term investment strategy, it might be wise to purchase shares of a company of interest.

Market Reactions to Economic Indicators

On Friday, stocks succumbed to losses following a consumer sentiment survey indicating rising inflation expectations among Americans. This downside came after a mixed January jobs report revealed increasing wage pressures, with the unemployment rate dropping to 4%. The situation worsened after Trump announced intentions to implement reciprocal tariffs on U.S. trading partners next week. While Trump had delayed a proposed 25% tariff on Canada and Mexico for a month, a new 10% tariff on China was allowed to go into effect without delay. Despite the tumult, the bond market appeared largely unfazed by these developments.

Bond Market’s Complex Relationship with Inflation

Concerns surrounding inflation persist in the bond market, particularly given the historic losses experienced in 2022 when the Federal Reserve aggressively raised interest rates. As a result, low-coupon bonds saw a significant decline in value alongside falling stocks. “The market is right to be cautious,” noted Matt Peron, global head of the solutions group at Janus Henderson Investors. He emphasized that Friday’s job data reinforced worries that the battle against inflation was far from over.

Despite these challenges, the 10-year Treasury yield ended the week at 4.83%, reflecting a decrease of approximately 14 basis points over the past two weeks. Interestingly, Peron remarked that if the yields stabilize at this level, “the market can handle that easily.” However, a sudden spike above 5% might signal that bond vigilantes are awakening.

Concerns and Future Outlook

Another significant worry for 2025 lies in Trump’s agenda concerning tariffs, immigration, and tax cuts, potentially exacerbating the already substantial U.S. budget deficit. If buyers of government debt retreat, yields could rise sharply, prompting Washington to act to constrain spending. Such circumstances would increase borrowing costs for companies, households, and the government. Treasury Secretary Scott Bessent recently shifted the administration’s focus toward reducing 10-year yields rather than pressuring the Fed to lower short-term rates.

Bessent’s initial decisions, particularly the quarterly refunding announcement, eased apprehensions in the bond market. Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott, remarked that the market expressed relief, noting no significant increase in longer-term debt issuance. The potential transition away from short-term bill issuance – a policy carried over from former Treasury Secretary Janet Yellen – had previously alarmed market participants. Nonetheless, this “fear factor” seems to have abated, although it could resurface in 2026, depending on the deficit scenario.

Residential Calm in the Bond Market

Recent tranquility in the bond market might signify that the most significant shocks on the journey towards more “normalized” interest rates have likely passed. Should yields continue to rise gradually, the market could absorb this change, as per Peron’s insights, while still noting potential volatility. Investors are encouraged to remain selective and prioritize higher-quality assets. Peron sees viable opportunities for stock investments within “GARP” equities, or growth at reasonable prices.

Positive Economic Indicators Bolster Stock Market Resilience

Unlike the post-COVID crisis period in 2020, the current U.S. economy appears robust, particularly with the unemployment rate holding steady at low levels. Additionally, overall earnings reported have been encouraging, despite mixed results surrounding major technology firms. As of Friday, around 62% of S&P 500 companies had reported their fourth-quarter results, pushing the blended quarterly earnings growth rate up to 16.4% from 11.8% at December’s end, according to FactSet.

The economic climate offers a solid case for the Federal Reserve to maintain a pause on further rate cuts. Having reduced the short-term policy rate by 100 basis points since September to a range of 4.25% to 4.5%, and with inflation persistently above the Fed’s 2% annual target, significantly lower rates remain improbable.

Market Predictions and Upcoming Events

James Ragan, director of Wealth Management Research at D.A. Davidson, notes that the bond market reflects optimism regarding the economy’s health and the likelihood of sustained higher interest rates for an extended period. Despite slight stock pullbacks, major indices maintain proximity to record levels, even without the technology sector’s previous leadership. According to Ragan, the market’s resilience amid a broader economic context bodes well for the year ahead.

As the market moves into a crucial week, investors will be tuned in to several Federal Reserve speakers, including Chair Jerome Powell’s upcoming testimony to Congress, as well as the critical consumer price index data due on Wednesday.