The US market’s shock comeback | USAEMALL.com

Good morning. Yesterday, on the first of May, Donald Trump sacked his national security adviser Mike Waltz, after Waltz embarrassed the administration in the Signalgate controversy. It’s the first major personnel shake-up of the second Trump administration. An amusing side-note: on the betting site Kalshi, the biggest wager on the NSA was “Will Michael Waltz resign before May?” At least Waltz won that bet. Email us: robert.armstrong@ft.com and aiden.reiter@ft.com. 

Our excellent colleague Chris Giles and his Monetary Policy Radar team will be hosting a Q&A on central banks on Wednesday May 7. Watch and add questions at this link. 

Massive market comeback! Yay?

Take a moment, readers, and think of Wall Street’s poor traders. They have been hammered coming and going. A month ago, “liberation day” blew them out of their leveraged, low-vol, risk-on, American exceptionalism, Mag 7-heavy positions. But for the past two weeks, markets have staged a stunning comeback, which reached a peak as Microsoft and Meta reported strong results on Wednesday, sending tech stocks flying and dragging the indices with them. We are now within a few ticks of taking back all the liberation day declines: 

It’s been a classic rally out of the post-pandemic market playbook (with one exception, to be discussed shortly): tech on top, followed by cyclicals such as financials and industrials, with defensives such as healthcare and staples underperforming. And the same has happened to risk assets generally. BB-rated junk bonds’ yield spreads over Treasuries, which widened violently after liberation day, have retraced almost all the way (but note the small recent widening visible at right): 

The anti-risk asset of the moment, gold, has fallen 6 per cent from its mind-boggling highs: 

Even the asset that had the worst of it after liberation day, the US dollar, has started to crawl its way back:  

It is not, however, a perfect switcheroo from risk off back to risk on. There are a couple of signals that complicate the story. The most notable is oil, which — Opec’s production shenanigans aside — is telling an extremely dreary story about the global growth outlook: 

On a similar — or possibly similar — note, Treasury yields are back down to 4.2 per cent:

This is not happening because the long-term inflation outlook is improving; 10-year inflation break-evens are flat since the week of liberation day. But two-year yields have come down, suggesting that the Fed will soften policy in the face of slowing growth. 

How to make sense of stocks rallying, spreads tightening and gold falling — while oil and yields are telling you that the growth outlook continues to get worse?

Regular readers will not be surprised by Unhedged’s view that the recent rally has a lot to do with markets realising that the US administration does not have a very high tolerance for market and economic pressure, and will be quick to back off when tariffs cause pain. This is the Taco theory: Trump Always Chickens Out. But why doesn’t that translate to resurgent growth hopes, higher yields and more expensive oil? 

One might argue that even as Trump walks backward on tariffs, and protects the fortunes of individual industries such as Big Tech, a lot of damage has already been done to global trade and growth — both from ongoing uncertainty and the tariffs that have already stuck. But this feels a little tortured. What is bad for growth ought to be bad for stocks, too. 

Another theory is that the initial, wildly negative response was more of a technical or psychological phenomenon than a rational one, and what we have seen recently is that response working its way out of the system, while the economic fundamentals have remained largely unchanged.

The most salient aspect of the “liberation day” freakout, on this theory, was the massive jump in all forms of volatility. Here are the Vix index of implied equity volatility and the Move index of implied Treasury volatility:

So: Trump holds the Rose Garden press conference, everything he says is insane, there is a flash of panic, volatility jumps, and lots of big active traders are forced out of leveraged positions and sell everything that is not nailed down. This causes more volatility, and the situation feeds on itself. But once those positions are unwound, it becomes clear that the fundamental picture has not changed that much, and the old equilibrium largely reasserts itself. The key difference between this and the “Taco” theory is that the safe haven status of the US was never really in doubt; the world order was never on the cusp of a generational change. 

Unhedged fixed-income consigliere, Ed Al-Hussainy of Columbia Threadneedle, takes this view. As evidence, he points to the difference in yield between Treasures and the very highest-quality corporate issuers, triple-A’s such as Microsoft and Johnson & Johnson. The slightly lower payments from Treasuries are a “convenience yield” reflecting the special status of the US. If the US’s safe haven status had really been under threat, one would have expected the spread between the US and other AAAs to shrink. But it widened: 

The recent rally is only a few weeks old and it may turn out to be something of a blip, of course. But the very fact that market narratives can flip several times in a month remains a bad sign. 

Japan and Treasuries

The Bank of Japan held rates steady yesterday, extending the pause in its climb back to “normal” interest rates from negative territory. This was expected. But the elephant in the room — indeed, in all central bank meetings right now — was Donald Trump.

Two factors drove the pause. First, the components of inflation that the BoJ pays closest attention to are still below the bank’s 2 per cent target. Second, and more crucially, tariffs. In the meeting, the BoJ slashed its GDP growth expectations from 1.1 per cent growth to a measly 0.5 per cent this year, and downgraded growth expectations for 2026, too. Bank governor Kazuo Ueda was not shy about the cause: “extremely high uncertainty” over trade and “recent developments surrounding tariffs”. 

Pausing its rate-hiking cycle for now makes sense in light of growth concerns. Japan’s negotiations with Trump’s team are touch-and-go, and the BoJ does not want to raise rates right ahead of a growth slowdown. At the same time (barring a surprise Fed cut next week) lower rates keep the yen weaker compared with the dollar. Given Trump’s known hatred for weak foreign currencies and Japan’s big currency war chest, this should give Japan leverage.

But there is a longer-term tension here. The Japanese government, Japanese investors and Japanese households own a disproportionately large share of US Treasuries, agency-backed securities and equities. Japan’s government is the largest foreign sovereign holder of US Treasuries:

And Japanese private investors, particularly life insurance agencies, own a massive share of US assets, though that has shrunk in recent years:

There was a big sell-off of US assets by Japanese investors right after “liberation day” — part of what spooked Treasury markets. That seems to have slowed, but we are still waiting on the sovereign data and more information from the big Japanese life insurers. As James Malcolm, chief Japan economist at UBS, noted to Unhedged, it would not make much sense for the Japanese government or investors to sell off too many Treasuries; a large drop in Treasury prices would hurt their own balance sheets. But there is potentially something more concerning in the long run, he says: 

The only reason the government would sell Treasuries would be to strengthen the yen. But, perhaps more importantly, we have seen very aggressive foreign buying of Japanese bonds, and it is accelerating . . . There is a narrative that China [and other sovereigns] could be reallocating away from Treasuries and towards JGBs.

Japan has a trusted central bank and, as Brij Khurana at Wellington Management pointed out to us, the steepest yield curve of any developed country — suggesting that investors see Japanese rates rising in the future. Over time, Japanese investors are widely expected to repatriate their capital, too. The BoJ’s pause makes sense at the moment, and should sweeten the Trump administration for now. But the long-run outlook is for more foreign buying of JGBs, less Japanese buying of Treasuries, and, all else equal, a stronger yen.

(Reiter)

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Turncoat recruitment.

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