Stocks began trading lower last week, continuing the selloff after President Trump’s “Liberation Day” tariff announcements on Wednesday, April 4, which sparked the stock plunge in the previous week. The S&P 500 reached bear market territory intraday on Monday, down 21% from the mid-February closing high, as concerns about negative economic consequences from the tariffs grew. On Wednesday, President Trump announced a temporary reduction in the reciprocal tariff rates to 10% for 60 countries previously hit with higher tariffs. The tariff rate on China was increased to 125%. Stocks reacted with a record-setting one-day rally on Wednesday as the perceived risk of a global recession and trade war was reduced.
Market Performance
The easing in tariff worries sent stocks 5.7% higher last week. After this week’s rally, the S&P 500 sits 12.7% below its mid-February high. Though the Magnificent 7, consisting of Microsoft (MSFT), Meta Platforms (META), Amazon.com (AMZN), Apple (AAPL), NVIDIA (NVDA), Alphabet (GOOGL), and Tesla (TSLA), outperformed last week, the group remains in bear market territory at 22.5% below the mid-December all-time high.
Bond Yields
Notably, in a change from earlier in the tariff-related stock weakness, the yield on the 10-year US Treasury rose instead of falling. For example, during the week of March 31, when the S&P 500 fell 9.1%, the 10-year yield fell from 4.2% to 4.0%. Last week, yields continued to rise even while stocks were soft in the first half of the trading week. This is important because lower yields can help the economy and are the typical bond reaction during worries about economic growth. In addition, the usual flight to US Treasuries as safe assets helps diversified investors offset some of the stock losses during bear markets. Recall that bond prices rise when yields fall and vice versa. President Trump even said the bond market was “getting a little queasy” when he paused the higher tariff rates for 90 days last Wednesday.
Why Did US Treasury Yields Rise?
Interestingly, the rise in yields did not come from higher inflation expectations. Instead, the 50 basis point (0.50%) increase in the 10-year Treasury yield from April 4 to April 11 was from an increase in the real yield demanded by investors. This means investors are demanding more compensation for owning US Treasuries. Typically, this happens when expectations for economic growth increase since investors are less interested in safety and are offered attractive expected returns on risk assets like stocks during these periods.
Given the likelihood that higher tariffs will effectively act as a tax increase, they should be a headwind to economic growth. So, the typical primary reason for higher real yields is not the most plausible. Instead, investors in the 10-year Treasury demanded higher yields to invest in US debt for another reason. The drivers probably include several reasons, including increased perceived risk plus seasonal and bond market structural factors.
Unwinding Of Large Treasury Swap Trades
The financial market volatility surrounding the tariffs has likely pressured some common trades and arbitrages within the bond market. One way to see this risk is by looking at Treasury asset swaps in which one side pays the fixed coupon on the 10-year U.S. Treasury and receives the variable Secured Overnight Financing Rate (SOFR). The volatility of the US swap spreads around the tariff announcements suggests that some of these trades could have been liquidated and helped send yields higher.
Looking at a past period of financial stress, similar periods of rising Treasury yields can be seen as swap spreads become volatile. This chart shows swap spreads and the 10-year yield around the collapse of Silicon Valley Bank on March 10, 2023.
There is also talk that some parties had highly leveraged basis trades in place and were forced to unwind them during the volatility, pushing yields higher. Basis trades attempt to profit from the difference between a futures price and a similar bond price.
Selling By Other Countries
The recent decline in the US dollar relative to other countries’ currencies could be evidence that other countries are selling some US Treasuries. Investors from different countries might also be demanding a higher yield to compensate them for the falling value of the US dollar relative to other currencies.
Seasonally, one could also expect some pressure on yields as tax payments are due on April 15. Both individual and corporate taxpayers could be liquidating or not demanding at many Treasury bonds to have cash available to make their tax payments. In addition, with the robust rally in risk assets last week, higher yields should be expected.
In summary, it looks unlikely that the tariffs caused permanent damage to the status of the U.S. dollar and Treasuries as a safe haven.
What To Watch This Week
The primary focus will likely remain on tariffs, with markets watching for any changes in US policy and retaliation or concessions from other countries. Late last Friday, smartphones, computers, and other electronics were excluded from the tariffs, including those from China. Companies like Apple (AAPL), which sources significant electronics from China, should see some relief.
Since the consumer is the key to US economic growth, Wednesday’s retail sales remains notable. The data will still be looked at skeptically since the full brunt of the tariffs will not be reflected in the March numbers.
First quarter earnings season began slowly last week, with a few large banks reporting on Friday. The pace picks up slightly this week, with more banks and notable companies like Johnson & Johnson (JNJ), American Express (AXP), and Netflix (NFLX) scheduled to report earnings. While the last quarter’s earnings always take a back seat to future guidance, this season’s situation will be even more extreme, with investors trying to determine the upcoming earnings bite from the tariffs and any retaliation.
The Only Thing We Have To Fear Is Fear Itself – Franklin D. Roosevelt
The VIX index, which is also called the fear gauge, can help illustrate the level of fear that gripped the markets around the tariff announcements. The CBOE Volatility Index (VIX) measures the expected volatility in the price of the S&P 500 over the next 30 days, using the implied volatility of options on stocks.
Some market participants use volatility to measure risk since it is the only thing that can be easily measured. In reality, price volatility does not indicate risk for long-term investors. Still, the probability of a permanent capital loss is not easily measured, so volatility is used instead. Within the plumbing of financial markets, higher volatility tends to cause a reduction in liquidity across most assets as those parties typically providing liquidity reduce the size of their capital at risk. This lower liquidity can cause large swings to the downside and the upside.
What’s Next For Stocks?
Last Wednesday, the S&P 500 had its third-largest one-day gain since 1950. Some have posited that extreme one-day gains are associated with bear markets rather than a positive stock outlook. Using data from Strategas Research Partners, the shorter-term periods following these large jumps have indeed seen mixed results. For example, the S&P 500 was higher 58% of the time in the three months after the 25 most significant one-day gains since 1950. Things look significantly better when the investment horizon is lengthened to a year, with the S&P 500 higher almost 92% of the time.
Further bringing home the point, the range of returns for those shorter periods following the outsized one-day gains is quite sizable. If history is a guide, the risk versus reward for investors looking out a year looks appetizing.
It seems reasonable from the history of stock returns following the largest one-day gains and the unsettled tariff situation that investors should expect volatility to persist for some time. Stocks have provided the highest long-term annualized return of any asset class, but the price for that stellar history is periods of intense volatility and temporary steep declines. Stock’s dominance in growing wealth relative to other investments was achieved through world wars, trade wars, severe economic downturns, financial crises, and pandemics. So, there is no reason to believe that increased tariffs, a hotter trade war with China, or a recession will change the long-term positive outcome, though it can make the short-term uncomfortable.
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