Mike Wilson, a Morgan Stanley analyst, says rate markets will be “the most important variable to watch” in the first few months of the year. Stocks are looking to shake off their late-December lull. Wilson and his team previously highlighted that 4%-4.5% on the 10-year Treasury yield was likely the sweet spot for equity multiples.
However, they now see the correlation between stocks and Treasury bond yields as “decisively negative.”
This could prove crucial as the Treasury prepares a trio of benchmark bond auctions valued at around $119 billion, including a key sale of $39 billion in 10-year notes. Markets will also navigate labor-market data releases over the shortened trading week, with the stock market closed Thursday to mark the passing of former President Jimmy Carter. The key reading arrives Friday with the Labor Department’s December employment report, expected to show 150,000 new hires and a 4.2% jobless rate.
Bond markets will particularly scrutinize this report for wage gains amid lingering inflation pressures. Inflation erodes the present value of future coupon and principal payments, making bonds especially sensitive to inflation forecasts. As traders sell off bonds in anticipation of rising inflation, yields increase, presenting an attractive risk-free option for investors while indicating potential headwinds for corporate earnings and the broader economy.
Benchmark 10-year Treasury note yields touched the highest levels in eight months last week, last marked at 4.632%, which could indicate near-term pressure for stocks if it continues higher.
Wilson discusses crucial rate market trends
Wilson notes that the rise in yields comes when stock market breadth, the amount of stocks driving recent gains, is narrowing.
He and his team have pegged the S&P 500 at around 6,500 points by year’s end, an 8% advance from current levels, while their bull case sees benchmark 10-year Treasury note yields falling to 2.2% and lifting the index as high as 7,400 points. For the market to separate from the risk of higher yields, more stocks need to improve their recent performance, and the S&P 500 needs to rely less on megacap tech names. This likely depends on a combination of lower rates, a weaker dollar, clarity on tariff policy, and stronger earnings revisions.
At present, LSEG data suggest collective S&P 500 earnings will rise to $275 a share this year, a 14.2% advance from 2024, with tech and financial stocks leading near-term gains. Treasury yields could also jump if the U.S. breaches its current debt limit, pegged at $31.4 trillion but suspended in 2023, later this month. Treasury Secretary Janet Yellen has urged Congress to protect the full faith and credit of the United States.
Louis Navellier of Navellier Calculated Investing highlights the challenge of managing the massive amount of government debt rolling over in the next two years, which may increase borrowing costs and complicate federal interest expenses. In summary, bond market movements and their correlation with stock performance are critical factors to watch as 2025 unfolds. The interplay between inflation, interest rates, and stock market breadth will be pivotal in driving market trends and investor sentiment.
