In a significant week for Wall Street, stocks made a notable recovery, offsetting losses from April’s tariff concerns. Corporate America engaged in substantial bond sales, and speculative assets such as cryptocurrencies and unprofitable tech companies experienced surges.
Despite this rally, driven by hopes of forthcoming trade deals, financial markets are showing cautionary signs. Signals from the bond market suggest the Federal Reserve is in a challenging position, casting doubt on its ability to mitigate the impact of tariffs swiftly. The dollar’s movements are diverging from Treasury yields, and similar discrepancies are observed in credit and equities amid rising bankruptcies and declining earnings estimates.
According to Phil Pecsok, Chief Investment Officer of Anacapa Advisors, the current market environment is uncertain. The unpredictability surrounding tariffs, tax policies, and potential retaliations complicates the fundamental narrative.
As quickly as traders exited due to tariff threats, they have returned, boosting U.S. stocks over nine consecutive sessions—a streak not seen in two decades. Credit spreads have narrowed amid numerous bond issuances, and Bitcoin, previously as low as $77,053, is nearing the six-figure threshold again.
This market upswing is based on speculation that President Trump’s trade policies have reached their peak threat and data indicating the U.S. economy’s resilience, with the unemployment rate steady at 4.2%.
However, market skepticism persists, questioning the rapid $5 trillion equity recovery. Measures of market anxiety have decreased but remain high. Despite a three-week decline, Bank of America Corp.’s global financial stress indicator remains elevated compared to the months before Trump’s warnings in early April.
Traders are betting on imminent Fed easing, even though inflation expectations show only modest signs of cooling. Derivatives traders have adjusted their forecasts for interest-rate cuts following recent employment data but still predict three reductions in 2025.
Early April saw one-year inflation swaps reach their highest level since 2022 due to tariff concerns on import prices. Although they have decreased, they remain over 70 basis points higher than in January.
Henry Allen, a macro strategist at Deutsche Bank AG, suggests this expectation may be misguided given Jerome Powell’s recent hawkish comments and previous underestimations of the Fed’s inflation control efforts.
Allen also notes the weakening relationship between the dollar and fixed income. Typically, the U.S. currency is expected to appreciate against the euro when 10-year Treasury yields rise relative to German bonds, as higher yields generally draw investment. Yet, this relationship remains unstable since early April.
Lawrence Creatura, a fund manager at PRSPCTV Capital LLC, views the dollar’s weakness as indicative of the U.S.’s diminishing influence with global trade partners, reminiscent of the Smoot-Hawley Tariff Act’s effects during the Great Depression.
The risk-on surge occurs amid weakening fundamentals. Economists are lowering growth forecasts due to the trade war, and analysts are revising corporate earnings estimates downward for this year and the next. Meanwhile, credit market risk premiums for high-yield debt have tightened since early April, even as bankruptcy filings hit a five-year high.
The options market also reflects ongoing concerns. The Cboe Volatility Index has maintained its spot prices above six-month futures contracts since late March, the longest inversion since the 2020 pandemic crisis, indicating trader concerns focused on immediate risks.
Overall, lingering Wall Street tensions highlight the period of policy uncertainty under President Trump’s second term, according to Maria Vassalou, head of the Pictet Research Institute. Vassalou points out the shift from the post-Cold War era of free trade, globalization, and peace toward a new and undefined equilibrium.
