Trump 2.0 starts next week, and everyone is sure it will be an attention grabber if the trailers have been any indication. In this Ethos, we talk a bit about the likelihood of politically-driven volatility and dive into bond yields. At these yield levels, the equity market appears sensitive to ticks that are higher or lower.
We have seen the trailers for Trump 2.0: tariffs, efficiency, border, absorbing Greenland, and renaming large bodies of water. Trailers, for movies anyhow, often highlight the most attention-grabbing content, lacking context and details. This week, the actual show begins.
There is no shortage of content floating around saying if they do this, then that, if they do that, then this. We, too, have contributed to that wave of content. The challenge with all this political science talk is threefold:
- Nobody knows what will become policy,
- Will policy announcements get backpedalled, as was often the case during Trump 1.0, and
- How or will the market react? It may prove more resilient or ambivalent.
Of course, we could rely on logic. For example, a tariff on Canadian energy would have a rather quick impact on U.S. inflation – something that is not desirable. The red sweep was arguably most attributable to voters' distaste for enduring inflation. Or farmers' reaction if a large tariff on potash imports? The state governors, congressmen or senators have remained rather quiet during the ‘trailer’ period and will likely become more vocal as policies get closer. Then again, anything is possible. Trade uncertainty, based on a business conditions survey in the U.S., is near the peak from Trump 1.0.
The only things everyone can agree on are that the headlines are going to become more exciting, and volatility will climb in 2025. Volatility in 2024 was certainly on the lower side, with the VIX averaging 15.5. A repeat of this is rather unlikely. As is a repeat of 20%+ returns, given rather lofty expectations heading into 2025.
So far, though, would have to say even with the increased uncertainty, markets have held in rather well. Volatility picked up a bit, but that appears to be driven by concern over higher yields than politics. There is an invisible line in the sand for the equity markets, and if bond yields (10-year Treasury) move close to this line or above it, the equity market starts to care. And when we say care, we mean go down as higher bond yields put downward pressure on valuations.
This bond/equity relationship is anything but constant. The fact is, rising bond yields on better economic data are often positive for equities. But if it goes too far, too fast, well, then equity prices are not a fan. Complicating things further, this line in the sand for yields moves. Back in 2021, the markets didn’t care as yields moved up from 0.50% to 1.0%. Didn’t care at 1.5%, but as 2.0% approached? Then, equities fell. Once over 2% and all the way to 4%, it was a really strong correlated market between equities and bonds.
Then things cooled down, and the relationship softened. That was until bond yields started rising through 4.0%, and equities started to care again about bond yields. Yields touched 5% as the equity market bottomed, then yields fell, and equities recovered. Once again, the relationship softened, and when bond yields marched above 4% again, equities didn’t care about this level. That was until yields got closer to 4.5 or 4.75%, then it started again.
Here is some math on it. In 2024 and so far in 2025, the median 10-year Treasury yield has been 4.25%. Equities and bonds had almost no correlation when yields were below 4.25% and much higher above that level. In fact, even higher north of 4.4%.
This really highlights the instability of equity/bond correlations and the fact it is often level-dependent – with a level that changes over time.
Final Thoughts
A couple of final thoughts. On yields, we are close to levels that the stock market seems to care about. This means if yields push higher, given the tilt of economic surprises being positive, that is going to be a big headwind. If yields retreat, well, that could prove a tailwind for equities. At the moment, appears to be more likely a risk, given the data.
Regarding the start of the ‘show’, it is likely going to be a wild ride headline-wise. And markets will react, as markets always react to new information. If they overreact, that may be the opportunity, given that even announced policy often gets massaged once other voices weigh in. Or sometimes things have been said and then never heard again.
Let the show begin.
— Craig Basinger is the Chief Market Strategist at Purpose Investments
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Sources: Charts are sourced to Bloomberg L. P.
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