Market Thoughts: All better now?

My brain constantly bounces music around as a life soundtrack. The song that popped into my head when I heard the White House hit pause on reciprocal tariffs? Earl Greyhound’s “All Better Now.” Really?

I mentioned in my last note the concept of anchoring as a negotiating tactic. The White House did just that when it kicked off its tariff attack. With average tariffs in the U.S. of around 2.5%, had they simply said 10% is the new ‘magic number’ on all imports and moved on I believe markets would nevertheless have rioted. The headline would have been the U.S. quadrupled import tariffs.

Trading partners would have escalated from there. I believe we would have had an out of the gate tit-for-tat trade war. It’s easier to retaliate off a low number. Instead, the Trump administration snuck in what looked like a ‘low-ball’ 10% floor and threw absurdly higher levels out to re-anchor expectations. A blanket 10% import tax now looks like a win to trading partners and investors. It isn’t.

I’ve read quite a few headlines that said Trump capitulated. Whew, thank goodness, we can all stop worrying. The White House created fear and allowed investor imagination to quickly jump to worst possible outcomes. In his words, people were getting “yippy.” He hit pause for the ‘greater good’ and to steady nerves. It was politically opportunist to keep Congress in line as well.

A pause is nothing more than that. The phenomenally higher opening offers on tariffs were a negotiating ploy. Maybe with the exception of China. All aboard the tariff crazy train cries abated for good reason. The most extreme outcomes seem off the table. I don’t believe they ever were the end goal.

Import tariffs are going higher from where we started. The White House hasn’t buckled, it’s getting what it wants. Those taxes will weigh on growth, initially add to inflation, ultimately weigh on earnings and the job market. The “just how bad” impact has yet to be calculated. We can’t do that until we see where negotiations land with Europe and China – I believe the real focus of the administration.

China and the U.S. have gone from reciprocating reciprocal tariffs to retaliation. Markets will cautiously watch to see how mounting animosity gets resolved. Near term, I expect neither side to back down. Egos have been bruised. When negotiations turn personal, bad outcomes are more likely. Because it’s the U.S. and China, those bad outcomes impact the global economy.

‘De-Americanization’ is a phrase I’ve increasingly heard whispered from pundits, policymakers, trading partners and C-suite execs. A new world order, anchored on pulling away from the U.S. as dependable partner. Splendid isolation; apologies to Warren Zevon.

Markets continue to bounce in the same very broad ranges we’ve been trading in. Don’t lose sight of that. Greed to fear, fear to greed. Repeat. We’ve seen leaks in U.S. funding market plumbing. Should Treasury markets more forcefully be pressured, the Fed will be forced to step in. We saw that as the world entered covid lockdown. For now, it’s been pushed off by Trump hitting his tariff pause button.

Covid proved an exogenous supply shock cured with forceful policy action. What we’re seeing may feel similar but add to it the backdraft of a demand shock. It’s that backdraft which is ramping up concern of recession. With no visibility on where this lands, how long it drags on, or what the final tariff tax bill looks like, recession risk will keep circling.

As a ‘wet finger in the wind’ exercise, I think risk of recession over the next year hovers around 35-40% with a 15-20% chance we see sub-trend growth. It argues a base case that we muddle through at a global level. That said, it’s not a market moment to entirely trust a model. It’s part of why you see Wall Street analysts revising forecasts up and down almost daily.

Like all things in fast and furious motion, the guardrails around any forecast today can change with a headline. If I’m off directionally in my guestimates above, it’s to the downside. A polite word to describe sentiment? Exhausted.

If the pause on reciprocal tariffs holds and we land on the administration’s 10% blanket tax level, markets will try their best to move on. Expect to see earnings revised lower. Also, valuations stay grounded. They’re still expensive. The one constant? Expect the unexpected. Tariff roulette.

The U.S. Treasury market saw abrupt volatility again this week. Some of it was ‘good old fashioned’ deleveraging. Some driven by an increasing realization the Fed isn’t aggressively cutting policy rates this year. If they do, the world’s truly gotten to a bad place.

In good times leverage amplifies returns on what are perceived as ‘low risk’ trades. When leverage bites back, it does so viciously. Treasury markets are suffering that turbulence. We’ve seen it happen before. So far, we’ve only seen quakes reflecting rising uncertainty. High hopes tamed. Reality sinking in.

Expect more headlines like “the best or worst day for markets in two, three, five, ten years.” If there’s one certainty for investors, volatility is more likely than not to remain high. In a moment like the one we’re in traders take profits quickly, on short and long positions. Expect sharp intraday market moves, don’t chase them.

Control the controllable. Focus on what you know and can do something about. Fear in volatile markets can devolve into having what I’ll call a misguided “pretense of precision.” Intraday volatility has gotten to a point where what you think you may be trading can leave you with less or more of a position than intended. Like playing darts in the dark.

All better now? Not Yet. Really.