Trump Tariffs effect on Stock Market
There are a few big things here.
1. The Magnificent 7, consisting of Apple, Nvidia, Microsoft, Amazon, Alphabet, Meta, and Tesla, have lost their shine, at least for the moment. These seven stocks were responsible for most of the S&P 500’s performance over the last few years, but they are pulling the index down in 2025.
2. Tech stocks have been beaten up in general, with the Nasdaq falling nearly 5% so far in 2025.
3. Gold is up again, as investors look for a safe haven from stock market volatility.
4. More defensive sectors like Materials, Healthcare, and Consumer Staples have held up well and even grown so far this year.
5. The 10 Year Treasury is up slightly, with yields having fallen by nearly .5% since the beginning of the year. This is a big deal, which I’ll discuss in more depth below.
The Federal Reserve, Interest Rates, & The Fed Funds Rate
Interest rates are tricky, particularly the rate on US government bonds. The Federal Reserve sets interest rates for the front end of the interest rate curve, called the Fed Funds Rate, however all other rates are set by the bond market. There’s no way to directly crank rates up or down, as the rates are set based on what market participants are willing to pay for a given bond.
Short term rates do impact the 10-Year Treasury rate, but more important factors include inflation expectations, economic growth expectations, and the market’s evaluation of the US ability to repay the debt.
Here is how each of those factors affects the 10-Year Treasury Rate:
Inflation – When inflation is expected to increase, the Treasury rate increases. When inflation is expected to decrease, the Treasury rate decreases.
Economic Growth (GDP) – The faster the economy is expected to grow, the higher yield investors require to justify the opportunity cost of not investing. So higher expected growth means higher yields, whereas lower expected growth means lower yields.
Ability to Repay – Like with mortgages or auto loans, those with better credit scores pay a lower interest rate. This allows them to borrow on more favorable terms. The US has been running a deficit while our economy is nominally strong. This doesn’t show the US government to be fiscally responsible.
Understanding the Trump Tariffs - Why start a trade war?
(As usual, this isn’t political commentary. This is harder to differentiate than usual, but frankly, we’re in an unusual situation.)
“I’ll demand that interest rates drop immediately. And likewise, they should be dropping all over the world. Interest rates should follow us all over.”
President Donald Trump
“We’re seeing the hangover from the excess spending in the Biden 4 years. In 6 to 12 months, it becomes Trump’s economy.”
Treasury Secretary Scott Bessent
President Trump, along with Treasury Secretary Scott Bessent and Commerce Secretary Howard Lutnick, have stated that they’re focusing on intermediate Treasury rates, not the stock market. Their goal is to lower interest rates.
Scott Bessent is a genuinely smart guy with an incredible understanding of the markets. He spent the better part of his career working for George Soros, including time as the Chief Investment Officer at Soros Fund management. He’s no idiot.
Instead, I believe he’s taking a pragmatic, calculated approach based on his belief that assets, including stocks and housing, are overvalued and there needs to be a correction in prices. Likewise, I believe he thinks that inflation needs to be crushed. The administration sees Trump Tariffs as the most effective and efficient way to accomplish these goals.
I think Bessent believes a price correction is likely, no matter what the Trump Administration does. His political calculus is that it’s politically better for the correction to occur early in Trump’s term, when blame can be shifted to the Biden Administration. As he says in the quote above, in 6-12 months, it becomes Trump’s economy.
From this standpoint, it makes sense that they’re going full-bore in making changes.
The 10-Year Treasury has reacted to the changes by dropping more than .5% since the election. This drop in rates likely reflects a few things: either lower inflation or lower growth going forward, or both. It could also reflect an expectation of increased fiscal responsibility.
The most likely explanation for the drop in rates is a combination of lower expectations for both inflation and growth in the next few years.
The drop in intermediate-term rates increases pressure on the Federal Reserve to lower the Federal Funds rate. At the end of January, the market was projecting only one rate cut by the Fed this year. That projected number has now increased to three rate cuts in 2025.
These pressures will likely affect the stock market as well. Remember, stock prices are influenced by two things: fundamentals and sentiment. We haven’t seen any change in earnings yet, although some companies have revised their expectations lower for 2025.
More importantly, the sentiment around the market has changed. While the market shrugged off bad news over the last year, it feels as if sentiment is turning negative. This means that bad news will have more of an impact on the market, increasing market volatility.
So…why?
My pragmatic take is this: the Trump Administration believes that some short-term medicine is necessary to improve our long-term health.
They believe the economy is brittle, with solid top-line numbers hiding a weak base. To rebuild the economy in a stronger fashion, some things are going to be broken. This includes restructuring our current trading relationships.
Our current trading relationships are largely based on the post-WWII order in which the US both guaranteed free trade worldwide AND provided demand for manufactured goods from all over the world. This demand was in our national interest, pushing countries to align with the West against the USSR. Now that the USSR has been gone for 30 years, it makes sense to examine our relationships and ensure they’re still in our best interests.
They’re looking to better manage the national debt. Over the last few years, Janet Yellen has prioritized funding the Federal government by issues shorter-term US government bonds. The problem with short-term bonds is that the debt has to be refinanced every time those bonds mature, opening us up to increased payments if interest rates have increased during that time period.
Right now, parts of the yield curve are inverted. For example, the interest rate on a 3-month Treasury is 4.3% annualized, compared to 4.06% annualized for a 5-year Treasury. If the Trump Administration can push the 10-year rate down further, it will make sense to lock in the lower rate. The idea is like refinancing a mortgage when rates drop.
Likewise, our current spending isn’t sustainable. We’re running a 6% deficit while our economy is nominally strong. Deficit spending during a strong economy puts us in a rough spot if the economy does weaken. Cutting government spending is one way to lower the amount of deficit spending closer to the 3% level that Secretary Bessent has proposed.
President Trump floated the idea of a 100-year Treasury during his first term, an idea which was roundly mocked in the media. Looking back, it wasn’t a bad idea at all. Rates were nearly 0% at the time and demand for a 2-3% rate bond would have been significant. It wouldn’t surprise me if we hear the idea pop up again.
President Trump wants housing to be more affordable; one way to make houses more affordable is to lower the interest rates on mortgages. It’s possible that an overall economic slowdown would soften the demand for houses, pushing prices lower too.
They’re worried about inflation. Creating uncertainty around on-again, off-again tariffs and cutting government jobs, benefits, and payments is likely to lower demand. The US consumer was already showing signs of weakness, as I’ve mentioned previously. Add economic uncertainty and it’s likely they will cut their spending.
The Federal Reserve has spent the last few years fighting inflation by lowering demand through higher interest rates. The current uncertainty could work in a similar way to reduce demand from both consumers and businesses.
I've been talking about a lot of these ideas for a few months now, like high valuations, the possibility of a correction, and the need to push inflation down. Big picture, I'm not making any changes at the moment.