Trade Truce Provides Temporary Relief, But Uncertainty Remains the Primary Market Driver

Key Takeaways

• Market Whiplash: Markets experienced historic volatility following President Trump's 90-day pause on reciprocal tariffs for most countries, with the S&P 500 recording its third-largest single-day gain ever (+9.5%) on Wednesday
• China Escalation: Despite the broader pause, US-China trade tensions intensified with tariffs reaching 145% on Chinese imports, while China responded with 125% tariffs on US goods
• Bond Market Stress: US Treasury yields surged unexpectedly amid the equity rally, with the 10-year yield jumping nearly 50 basis points in a matter of days, raising concerns about market functioning
• Economic Impact: Current estimates suggest US GDP growth could be reduced to 1.0% for 2025 (down from previous 1.6% forecast), with inflation potentially reaching 4.3% by Q3
• Consumer Sentiment Plunge: The University of Michigan sentiment index fell to 50.8, while inflation expectations surged to 6.7%, the highest level since 1981
• Sector Divergence: Defensive sectors like utilities, consumer staples, and healthcare have significantly outperformed technology and consumer discretionary year-to-date
• Asset Allocation Insight: Current conditions favor selective equity exposure balanced with high-quality fixed income, with particular attention to inflation-protected securities and defensive sectors

Asset Allocation Insights

• Equities: With the S&P 500 rebounding off key 2022 highs after a 21.5% drawdown, further downside may hinge on earnings deterioration and tariff clarity, while alpha-driven strategies in value and quality stocks are expected to outperform as market leadership broadens.
• Fixed Income: The recent dramatic yield curve steepening and elevated long-end rates suggest heightened policy and fiscal uncertainty, positioning the 5–7 year segment as a potential sweet spot for attractive returns amid expected Fed easing in 2025.
• Credit: Credit markets' resilience—despite rising spreads—implies corporate fundamentals remain intact for now, but elevated yield levels in IG bonds and preferreds point to continued income opportunities if recession risks remain contained.
• Currencies: The dollar’s weakness reflects Fed easing expectations and trade-driven growth concerns; USD/JPY’s drop toward 147 may extend to 139.5 support if US-Japan trade talks progress.
• Commodities: Gold’s surge past $3,200 highlighted its safe-haven appeal, while oil and copper remain vulnerable to tariff-driven demand risks despite potential stimulus support.
• Alternative Investments: Private markets may offer temporary valuation stability, but deteriorating macro conditions could erode fundamentals across both public and private assets.

(A more detailed analysis of each asset class is provided in a separate section of the article)

Market Volatility Spikes Amid Policy Reversals

Last week delivered some of the most dramatic market swings since the 2008 financial crisis. After initially implementing sweeping tariffs that would have returned global trade to conditions not seen since the 1930s, the White House suddenly announced a 90-day pause on reciprocal tariffs for over 75 countries, excluding China. This led to an extraordinary market reversal, with the S&P 500 surging 9.5% on Wednesday – its third-largest daily gain in history and fifth-largest absolute move in either direction in nearly 18,000 trading days.

The extreme volatility underscores that policy uncertainty – not fundamentals – is the primary driver of markets. What made last week particularly unusual was the corresponding behavior in the bond market, where Treasury yields spiked sharply instead of declining during the initial equity market stress. The 10-year Treasury yield jumped from around 4.0% to nearly 4.5% in a matter of days – on track for its largest weekly rise in four decades.

This atypical bond market reaction appears to have been driven by three key factors:

1. The unwinding of leveraged arbitrage trades, including basis trades, swap spreads, and off-the-run government bonds
2. Concerns about reduced foreign investment in US Treasuries amid escalating trade tensions
3. The potential inflationary impact of tariffs complicating the Federal Reserve's path toward rate cuts

The S&P 500 has now declined over 21% from its peak at last week's low, officially entering bear market territory. While such corrections are not uncommon – we've seen 20%+ drawdowns in 2022, 2020, and 2018 – the rapidity of the decline is notable. Historical precedent suggests that after reaching such drawdown levels, markets often find a footing, especially when technical indicators show extreme oversold readings.

Trade Policy Developments: Tactics or Strategy?

The abrupt shift in tariff implementation highlights the tactical nature of the administration's approach. The baseline 10% universal tariff remains in place, along with targeted 25% duties on steel, aluminum, and autos. However, the more dramatic "reciprocal" tariffs that would have raised the average effective US tariff rate to approximately 24% have been paused for 90 days on most trading partners.

China is the glaring exception, with tariffs now raised to 145% on Chinese imports (up from the previously announced 104%), prompting China to increase its tariffs on US goods to 125%. This escalation represents a profound shift in US-China relations and significantly increases the risk of a more fractured global trading system.

The administration's decision to pause broader tariffs appears motivated by several factors:

1. Severe market reaction, including bond market stress that threatened financial stability
2. Mounting pressure from Republican congressional members, corporate leaders, and small businesses
3. The opportunity to negotiate individually with trading partners from a position of strength

More than 70 countries have reportedly reached out to negotiate, with Japan, South Korea, Vietnam, and India reportedly among the first in the queue. The outcome of these negotiations will be critical in determining the longer-term impact on global trade flows, inflation, and economic growth.

Economic Impact Assessment: Growth and Inflation Tradeoffs

The economic consequences of the current trade policy remain highly uncertain, but early estimates suggest a material impact on both growth and inflation. We have lowered our 2025 US GDP growth forecast to 1.0% from a previous estimate of 1.6% (and 2.0% before that). While not currently forecasting a recession, it noted that US growth still risks contracting should uncertainty or financial instability put additional downward pressure on the economy.

On the inflation front, the impact could be substantial. We expect US core consumer inflation to spike to 4.3% by Q3 from 2.8% in March due to tariff-related price pressures. Yale Budget Lab estimates that the "Liberation Day" tariffs (if reimposed) would raise the average US tariff to 22.5%, the highest since 1909, with a short-run impact of:

• 2.3% additional rise in US consumer prices
• 0.9 percentage point reduction in GDP growth
• 0.5 percentage point increase in the unemployment rate

The impact varies significantly by country, with the most severe GDP reductions projected for:

• United States: -0.57%
• China: -0.42%
• Canada: -2.03%

Despite these concerning projections, recent economic data has shown surprising resilience. The March employment report revealed 228,000 job gains, above expectations, while inflation continued to moderate with headline CPI falling to 2.4% year-over-year. However, the immediate reaction to tariff announcements has been dramatic in sentiment indicators, with the University of Michigan consumer sentiment index plunging to 50.8 – the lowest level since June 2022 – and inflation expectations surging to 6.7%, the highest since 1981.

International Market Divergence: Uneven Impact

The response to trade tensions has varied significantly across global markets, reflecting different exposures and policy responses.

European markets initially fell sharply, with the STOXX Europe 600 dropping 12% month-to-date. However, there are signs that Europe might navigate the current situation better than initially feared. The European Commission has coordinated a response to US tariffs, pausing planned retaliatory measures for 90 days to match the US pause. Additionally, Italy's Prime Minister Giorgia Meloni is scheduled to meet with President Trump on April 17 to discuss the tariff situation, potentially leveraging her relatively warm relationship with the US administration.

Asian markets have shown a mixed response. Japanese and Korean markets rallied strongly after the tariff pause announcement, with the Taiwan Stock Exchange Weighted Index jumping 9.3% on Thursday. However, Chinese markets have been more subdued given the escalation in US-China tensions. The offshore Hang Seng Index climbed just 2.1% despite the broader market rebound, as investors assess the impact of 145% US tariffs on Chinese exports.

Policymakers in China appear to be preparing additional stimulus measures to offset the impact of higher tariffs, potentially including interest rate cuts, lower reserve requirements for banks, housing market support, and consumption-boosting initiatives. Given their monetary and fiscal policy tools, Chinese authorities may be better positioned to manage deflationary pressures than the US is to handle inflation risks.

An important long-term consideration is the potential acceleration of de-dollarization trends. The dollar's share of global currency reserves has declined over the years and is now at approximately 57%. If fewer dollars are being sent abroad through trade and fewer are recycled back into US Treasuries and equities, this could lead to higher risk premiums for both bonds and equities going forward.

Market Sector Analysis: Defensive Leadership

The recent market turmoil has accelerated existing rotations in sector and style leadership. Year-to-date through April 11, the worst-performing S&P 500 sectors have been:

1. Energy: -15.0%
2. Technology: -11.4%
3. Financials: -11.3%

Meanwhile, the most resilient sectors have been:

1. Consumer Staples: +1.3%
2. Utilities: -0.8%
3. Healthcare: -1.2%

This defensive rotation reflects growing concerns about economic growth and rising inflation. Companies with strong pricing power or those less vulnerable to trade disruptions have outperformed the broader market. In the technology sector, software companies appear less exposed to direct tariff impacts than hardware manufacturers, while communication services companies with domestic revenue bases offer relative stability.

Outside the US, European industrials stand to benefit from increased fiscal spending on defense and infrastructure, while European banks with primarily domestic exposure offer insulation from trade tensions. In China, high-dividend state-owned enterprises with domestic exposure provide relative stability, while the Hang Seng Technology index offers potential upside from AI developments and policy stimulus.

The magnitude of the current drawdown, coupled with the sharp erosion in 2025 earnings estimates (from $278 late last year to $268 currently), suggests that markets are pricing in meaningful economic impact from tariffs. However, relative to historical downturns, credit spreads have widened only modestly, potentially indicating that the hit to earnings may be contained rather than representing the beginning of a deeper economic contraction.

Fixed Income Market Dislocations: Opportunity Amid Volatility

The fixed income market experienced extraordinary volatility last week, with Treasury yields surging despite growth concerns. The 10-year Treasury yield ended the week at approximately 4.5%, up nearly 50 basis points from the previous week.

The rapid yield increase was driven by several factors:

1. Technical unwinding of leveraged trades rather than fundamental economic reassessment
2. Concerns about reduced foreign investor appetite for US assets amid trade tensions
3. The inflationary impact of tariffs complicating the Federal Reserve's rate cut path

Current market pricing indicates expectations for approximately 75 basis points of Fed rate cuts by year-end, down from over 100 basis points at the height of market stress. The Fed faces a challenging balancing act between addressing potential economic weakness and managing inflationary pressures from tariffs. The most likely outcome appears to be 50 basis points of cuts in the second half of 2025, with the first reduction potentially coming in June if labor market conditions deteriorate.

Should the bond market remain disorderly, the Federal Reserve might step in to restore market function by buying bonds, not as a policy directive (QE) but in its role to maintain orderly markets and provide liquidity. This would follow the precedent set by the Bank of England in 2022, which restored order to the GILT market after the Liz Truss fiscal announcement. In that case, the BoE needed to buy only $19 billion in long GILTs and was able to sell them a few months later.

Despite the volatility, fixed income markets offer compelling value for investors seeking income and diversification. Several analysts note that yields and spreads across various sectors are now at attractive levels relative to historical averages:

• Investment grade corporate bonds: Yield at 84th percentile, spreads at 50th percentile
• Preferred securities: Yield at 84th percentile, spreads at 52nd percentile
• Municipal bonds: Yield-to-Treasury ratios at multi-year highs (5-year: 82%, 10-year: 82%, 30-year: 96%)

The most attractive opportunities appear to be in sectors with lower tariff exposure, such as preferred securities (dominated by financial issuers) and municipal bonds (which generally don't purchase or sell goods across borders).

Treasury Market Fragility: Beyond Technical Factors

The sharp decline in swap spreads last week signaled mounting stress in U.S. fixed income markets, driven by a mass exodus of real money investors from Treasury securities. This retreat—triggered by growing concerns over erratic fiscal policy, regulatory shifts, and geopolitical dislocation—left leveraged traders to absorb the sudden supply, as reflected in the spike in SOFR volumes. The move highlighted deeper systemic fragilities, with traditional buyers of U.S. debt stepping back, raising alarms about liquidity conditions and overall market stability.

While many initially blamed overextended basis trades for the turmoil, the root causes appeared more complex. Investors had positioned for a regulatory easing and favorable duration environment following the election, but those expectations unraveled swiftly. The episode was not merely a technical breakdown, but a broader crisis of confidence in U.S. policy direction—one with significant implications for the Treasury market, long considered the backbone of global finance.

This fundamental shift in market confidence is visible in the dramatic repricing of interest rate expectations. As depicted in the 1y1y Overnight Indexed Swap forwards chart, market projections for Fed policy have experienced extreme volatility, reflecting not just changing economic fundamentals but deeper uncertainty about the stability of the U.S. financial system itself. The divergence between short-term rate expectations and longer-term neutral rate projections suggests a market struggling to balance immediate growth concerns against longer-term structural risks to U.S. debt sustainability.

Investment Implications

The current environment warrants careful portfolio positioning that balances risk and opportunity. Key recommendations include:

1. Maintain strategic asset allocation: The extreme volatility and rapid reversals underscore the importance of adhering to long-term investment plans. The S&P 500 has gained 61% of the time following 10% drawdowns, with median returns of 12.2% over the subsequent nine months during non-recession periods.
2. Selective equity exposure: Focus on companies with strong pricing power, minimal supply chain disruption risk, and domestic revenue bases. US communication services and technology software companies appear better positioned than hardware manufacturers. European industrials benefiting from defense spending and Asian technology firms supporting AI infrastructure offer potential diversification.
3. Emphasize quality fixed income: Attractive opportunities exist in preferred securities (6.8% yield) and municipal bonds, particularly short-duration high yield munis offering 5.0% yield with 4.4 years duration. Investment grade corporate bonds and Treasury Inflation-Protected Securities (TIPS) provide additional portfolio balance.
4. Consider defensive safe havens: The Japanese yen and Swiss franc have been effective safe havens during recent volatility. The potential for further Bank of Japan rate hikes makes the yen particularly attractive, with USD/JPY likely to test support at 139.5.
5. Incorporate inflation protection: With tariffs threatening to reignite inflation, TIPS offer portfolio protection. Consumer inflation expectations have surged far above current readings, suggesting markets may be underpricing inflation risks.
6. Tactical rebalancing: Use extreme market moves as opportunities to rebalance toward long-term targets. Historical data shows that investors who stay fully invested through volatility achieve significantly better returns than those who attempt to time the market.

Historical market patterns suggest that the current setup may follow a trajectory similar to the 1998 LTCM crisis, with an initial impulse low followed by a sharp recovery that falters at previous breakdown points, leading to a retest of lows. If these new lows are rejected with bullish divergences from breadth or momentum indicators, a more sustainable recovery could follow.

Key Asset Allocation Takeaways

Equities

US equities experienced a significant drawdown of 21.5% at last week's low, comparable to corrections in 2018 (20%), 2011 (21%), and 1998 (22%), which did not develop into deeper bear markets. The S&P 500 has found support at the 2022 high, though there remain significant headwinds including tariff uncertainty and potential earnings deterioration. Calendar year 2025 earnings estimates have declined from $278 to $268, with growth expectations now at 8.7%.

The rotation from growth to value appears likely to continue, with quality stocks offering better downside protection in an uncertain environment. Notably, we may be entering a period where alpha (stock selection) becomes more important than beta (market exposure), as the 10+ year secular bull market shows signs of aging and market leadership broadens beyond the Magnificent 7 stocks.

Internationally, non-US markets have shown relative resilience, with the potential for further outperformance if we see dollar weakness. European equities, particularly industrials benefiting from fiscal stimulus and defense spending, appear well-positioned. In Asia, selectivity is essential with China-facing substantial trade headwinds while Japan and other markets might benefit from supply chain reconfigurations.

Fixed Income

The US yield curve has steepened dramatically, with the difference between 2-year and 30-year yields expanding by more than 1% in just three days. This unusual steepening alongside equity weakness signals both policy uncertainty and concerns about future Treasury demand.

For the short-term, the 2-year Treasury yield at 3.96% is pricing in approximately 75 basis points of Fed rate cuts in 2025, reflecting expectations that growth concerns will ultimately outweigh inflation fears. The intermediate (5-7 year) portion of the curve offers an attractive balance of yield and duration risk, with current levels providing historically strong returns over subsequent periods.

Long-term (10-30 year) yields have risen dramatically, with the 10-year at 4.49% and the 30-year approaching 4.8%. These levels reflect increased term premium resulting from concerns about persistent budget deficits and foreign investor appetite. Key resistance for the 10-year yield sits at 4.5-4.6%, with a breach potentially signaling further stress.

Credit

Credit markets have shown surprising resilience during the equity selloff, with high-yield spreads widening to approximately 420 basis points over Treasuries – elevated but still well below recession-level stress. This relative stability suggests that corporate fundamentals remain solid, with strong interest coverage ratios across all ratings except CCC.

Investment-grade corporate bonds now offer yields in the 84th percentile of their 10-year range, with spreads at the 50th percentile, suggesting reasonable value. Preferred securities also offer compelling yields with relatively modest duration (3.8 years) and are less directly exposed to tariff impacts given their concentration in financial issuers.

Municipal bonds have become increasingly attractive with muni-to-Treasury yield ratios at multi-year highs. Short-duration high-yield munis offer particularly compelling value with a 5.0% yield and limited direct exposure to trade disruption.

Currencies

The US dollar index has fallen below 100 for the first time in almost two years, challenging its traditional role as a safe-haven during market stress. This unusual weakness reflects concerns about US-specific growth impacts from tariffs and expectations for more aggressive Fed easing.

EUR/USD has strengthened to 1.13, its highest level in three years, supported by German fiscal expansion plans and relatively lower direct exposure to US-China tensions. Further upside may be limited at current levels until the economic impact of tariffs becomes clearer.

USD/JPY has declined to around 147, with the yen benefiting from safe-haven flows and bullish options positioning. Technical analysis suggests potential further downside to test 139.5 support, particularly if US-Japan trade negotiations prove constructive.

USD/CNY has risen above 7.34, reflecting the direct impact of escalated US-China trade tensions. While China has historically managed its currency to maintain export competitiveness, significant weakening could risk capital outflows and regional currency pressures.

Commodities

Gold has been the standout performer, briefly surpassing $3,200 per ounce as investors seek safe-haven assets amid policy uncertainty. Despite some pullback during peak market stress (likely due to margin-call liquidations), gold's long-term outlook remains positive as a hedge against geopolitical uncertainty and potential currency debasement.

Oil prices have weakened with WTI crude falling to around $61.50 per barrel on concerns about global demand. While supply remains relatively tight, the potential growth impact of tariffs creates downside risk to the $55-60 range before likely stabilization.

Industrial metals like copper have faced pressure from manufacturing slowdown concerns, though infrastructure spending initiatives in Europe and potential stimulus in China may provide offsetting support.

Alternative Investments

Gold and Bitcoin continue to trade in alternating leadership patterns based on their Sharpe ratios. While gold represents pure "hard money," Bitcoin combines aspirational hard money characteristics with more speculative elements. This complementary relationship suggests potential benefits to diversifying across both assets for store of value exposure.

Private markets may offer relative stability as they mark to market with a lag, but investors should be mindful that economic deterioration will eventually impact private valuations. The biggest risk to any strategy, public or private, remains a significant economic downturn that reduces consumer spending, corporate revenues and asset valuations.

Hedge fund strategies, particularly those focused on relative value and market-neutral approaches, may benefit from the increasing dispersion across sectors and regions. Macro strategies can also capitalize on policy divergence across central banks and shifting currency relationships.

Outlook

The trade policy landscape remains highly fluid, with significant implications for economic growth, inflation, and market performance. Three potential scenarios appear most likely:

1. Base case (60% probability): The US reaches agreements with key trading partners that reduce tariffs from currently threatened levels. Economic growth slows but avoids recession, with the Fed delivering 50 basis points of rate cuts in the second half of 2025. Under this scenario, the S&P 500 could end the year around 6,000-6,200.
2. Downside scenario (30% probability): Negotiations fail and tariffs are implemented more broadly, triggering a mild recession and forcing the Fed to balance growth and inflation concerns. The S&P 500 could retest the 5,000 level, with the 10-year Treasury yield falling toward 3%.
3. Upside scenario (10% probability): Successful tariff negotiations combined with monetary and fiscal stimulus globally drive a more robust economic recovery. The focus shifts to tax cuts and deregulation, with the S&P 500 potentially reaching 6,500-6,600 by year-end.

In the immediate term, market attention will focus on trade negotiations, particularly the upcoming meeting between Italian Prime Minister Meloni and President Trump on April 17. The European Central Bank's expected rate cut this week will also influence global market sentiment, as will the stream of first-quarter earnings reports beginning to arrive.

Essential Monitoring Framework

1. Trade negotiations: Follow developments with key trading partners, particularly Japan, South Korea, Vietnam, and India, along with responses from China to the escalated tariff situation.
2. Fixed income market functioning: Monitor Treasury market liquidity and foreign investor participation for signs of stress that could prompt Federal Reserve intervention.
3. Consumer data: Watch retail sales (due this week) and consumer confidence for evidence of how tariff concerns are affecting spending patterns.
4. Corporate earnings guidance: Pay close attention to forward guidance during Q1 earnings calls, especially regarding supply chain adjustments, pricing power, and margin pressures.
5. Central bank communications: Track Federal Reserve speeches for insights on how officials are balancing growth and inflation considerations in their policy outlook.
6. Inflation indicators: Closely follow upcoming Producer Price Index and Consumer Price Index releases for signs of tariff pass-through to consumer prices.
7. Labor market dynamics: Monitor weekly jobless claims and the April employment report for evidence of weakening in the previously resilient job market.

Conclusion

Last week's dramatic market volatility serves as a stark reminder that policy uncertainty – not economic fundamentals – is the primary driver of current market conditions. The administration's decision to pause reciprocal tariffs for most countries while escalating tensions with China creates a complex investment landscape that requires careful navigation.

Despite the significant market gyrations, several positive factors remain: corporate balance sheets are generally strong, near-term maturity walls are manageable, and the banking system appears well-capitalized. These fundamentals provide some cushion against the policy-induced volatility and suggest that markets could recover as uncertainty diminishes.

The coming weeks will be critical in determining whether the 90-day tariff pause leads to productive negotiations and a more moderate trade policy or merely delays an eventual broader implementation. Investors should expect continued volatility but remain focused on their long-term strategic allocations while looking for tactical opportunities created by market dislocations.

The most prudent approach in this environment is to maintain diversified exposure across asset classes, emphasize quality in both equity and fixed income allocations, incorporate appropriate inflation protection, and remain vigilant for signs that policy uncertainty is meaningfully impacting economic fundamentals.