Markets 1, Trump 0

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Good morning. The Nasdaq rose 12 per cent yesterday — its biggest rise since 2001 — and the S&P 500 jumped by 9.5 per cent. Why, then, don’t we feel much better? Email us: robert.armstrong@ft.com and aiden.reiter@ft.com. 

Breaking point

Now we know Donald Trump’s pain threshold: 12 per cent down on the S&P 500, followed by a 60-basis point jump in the 10-year Treasury. 

Trump withdrew the craziest of his “reciprocal” tariffs before the liberation day sell-off could even wipe out a year’s stock market gains, and before the Fed even had to face hard questions about intervening in the Treasury market. Trump was not prepared to take markets all the way to the edge.  

Investors were right to celebrate. Not because the remaining 10 per cent universal tariff and a full-on trade war with China will do no damage to corporate earnings or economic growth. It will take a while to recalibrate how bad the harm will be. But we now know the market has Trump on a leash, and we have an initial estimate of its length. Whether “this was the plan all along” is an academic question. Whatever the plan may have been, its extent and its timing were ultimately determined by the movement of capital. Good.

Amid the relief, a couple of dour points to bear in mind:

The existence of a market guardrail trims the range of possible outcomes, but uncertainty is still high. In particular, the tariffs that remain are plenty high enough to have inflationary implications, a risk the market does not seem to be taking particularly seriously right now (as we wrote yesterday).  

The valuations of all risk assets, but especially large-cap US stocks, are right back to uncomfortable highs. It won’t take much to kill yesterday’s burst of upward momentum, which already looks like an overshoot. 

The bond market, unlike the stock market, has not retraced its losses. Zoom out to a five-day chart and yesterday afternoon’s relief rally is hardly even visible (see next piece). This is probably a better gauge of the balance of risks than equity prices. 

Risk is meaningfully lower today. It is not low. 

Treasuries

Perhaps imposing high tariffs picked by a chatbot, only to withdraw them after 13 hours, was indeed Trump’s master plan. Treasury secretary Scott Bessent insists it was. But if it wasn’t, then the bulk of the credit for the president’s change of mind goes to the Treasuries. Tuesday night and Wednesday morning, Treasuries were starting to really frighten people. Yields on the 10-year Treasury jumped more than 60 basis points in less than 48 hours:

The Treasury market is the largest and most liquid in the world, and Treasuries are the preferred form of collateral for just about every other market that matters. What happens in the Treasury market does not stay in the Treasury market. In past market crashes (1987, 1997, 2001 and 2008), bond prices mostly rose (and yields fell) while equities dropped — but not in spring 2020, when the Fed had to provide liquidity to all markets by purchasing more than $1tn of Treasuries. With bond prices plummeting alongside equities this week, a systemic failure — a failed Treasury auction, a big hedge fund going bust, whatever — looked possible. 

At a high level, the problem was a rapid increase in volatility, both realised and expected, forcing investors to cut back on risk in a hurry. More proximally, an auction of three-year Treasury bonds met with weak demand on Tuesday, which sent yields of all maturities soaring. Margin calls on non-Treasury positions likely forced cash-raising Treasury sales, pushing yields up further. This in turn forced the unwinding of popular hedge fund Treasury trades (see Robin Wigglesworth’s overview here).

Some pundits have suggested that China, the second-largest holder of US Treasuries, might have begun dumping them punitively in retaliation for Trump’s tariffs. This is pure speculation. There is no real-time data about particular sellers, and China holds a lot of its Treasuries offshore. And, though China is signalling that it will continue to retaliate against the US — including by letting the Renminbi depreciate, as it did a little yesterday — dumping US Treasuries would endanger China’s own financial stability. “China has been selling US Treasuries slowly but steadily for some time,” as Alicia Garcia-Herrero at Natixis told us, but it will take time to find out if the pace is picking up. 

All of this happened against a fragile market backdrop. As we said yesterday, the market expects the Fed to cut three times this year, even after the tariff climbdown. But an inflationary world in which they don’t cut at all is easy to imagine. And we are already entering a deficit showdown. Last night, Republican house speaker Mike Johnson scrapped a vote on Trump’s budget plans, as it was opposed by some Republican deficit hawks. A debt ceiling fight kicks off sometime this summer. Bond investors will be made nervous by the possibility that a handful of Republican defectors will trigger another debt crisis. 

A 10-year Treasury auction yesterday — which Brij Khurana at Wellington Management described as the most closely watched auction in his career — saw plenty of demand, Chinese rumours notwithstanding. Yet bond yields remain high. The 10-year has only dropped 15 basis points since Trump called off the tariffs. 

The “reciprocal” tariffs may return. The White House has been telling tales of 75 obsequious phone calls from trading partners, but not all the responses are likely to be friendly. Trump blinked, but keep your eyes open for more volatility. 

(Reiter)

One good read

A very unfortunate typo.

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