The Trump administration insisted it wouldn't be deterred from tariffs by the stock market. But a decline in equities, bonds and the currency may have done the trick. Still, Trump's reversal doesn't mean all the damage will be quickly undone.
On Wednesday, the S&P 500 skyrocketed after Trump's announcement of a 90-day pause on certain tariffs to most countries. The change in direction came after a market rout that quickly spread, particularly the all-important Treasury market. Bonds initially rallied after the unveiling of "Liberation Day" tariffs, but have been under pressure for the past few sessions. The selloff intensified late on Tuesday and overnight: At one point, the yield on the 10-year note rose as high as 4.47%. Yields rise when bond prices fall.
What made this more concerning is the U.S. dollar headed lower, as the market switched to a "sell everything American" mode reminiscent of what sometimes happens to emerging economies.
Now, investors can at least get relief from the knowledge that there is some level of market distress that could change the course of U.S. economic policy. It echoes the experience of Britain in 2022, when short-lived Prime Minister Liz Truss was forced to reverse her economic policies after markets seized up.
Still, it is notable that Wednesday's snapback in the S&P 500 didn't spread everywhere else to the same extent. The WSJ Dollar Index, which measures the greenback against a basket of other currencies, did edge back a bit, but was lower relative to a day earlier. And 10-year Treasury yields hovered above 4.3%, compared with below 4.2% on April 2.
Wall Street analysts were caught off guard by several of the market's reactions. Rather than rise against most major currencies immediately after the tariffs, the dollar fell. And long-term Treasury yields remained stubbornly high, which is odd: If tariffs are bad for the economy, they should eventually lead to lower interest rates.
Yet the selling spree that started Tuesday was scarier. The difference, or spread, between bond yields and rates on interest-rate swaps, which are another way to trade where rates are expected to be in the future, suddenly widened. Tellingly, this was more pronounced among short-term maturities. Yields on one-year Treasury bills bounced back even as swaps pointed to interest rates going lower.
Much of that spread narrowed again later on Wednesday, but short-term bond yields remain higher than they were on April 2, even though they initially fell significantly, reflecting the belief that the Federal Reserve would cut rates several times over the next year.
Such signs of forced selling may point the finger at hedge funds, which in recent years have engaged in large leveraged bets on Treasurys through something known as the "basis trade": This entailed buying the bonds while selling similar futures to asset managers. The goal was to make money from the small spread between both contracts.
As the market turmoil of March 2020 showed, these trades can unwind quickly and place the Treasury market under big stress -- particularly if hedge funds are doing this because dealer banks, as a result of stricter regulations, no longer have the balance-sheet capacity to absorb too many bonds when things go south. The swap-spread widening suggests this is still the case.
However, that the dollar isn't gaining on the back of higher bond yields and an equity rebound underscores that the confidence of foreign investors isn't restored merely by a tariff pause.
They are no longer just selling U.S. stocks because of fears of a recession or a loss of long-term productivity in the American economy, they are now dumping safer assets, too.
It still seems unlikely that large foreign holders such as the Chinese government, which has about $800 billion in Treasurys, are dumping them as part of their retaliation against tariffs, or the moves would likely be even larger.
Also, the possibility of a full-on financial crisis hasn't reared its head, otherwise short-term funding markets would have frozen up. Small signs of stress have appeared, but remain contained. Even if the financial plumbing were to eventually crack, the Fed would almost certainly step in. Ultimately, the U.S. isn't an emerging market.
But kicking the can down the road in regards to the trade war may only deliver so much relief to the market, not the least because the negative impact that uncertainty is having on firms and consumers across the global economy is far from resolved.
Wednesday's reversal has bolstered the market's confidence that it has the power to stop a worst-case scenario. A sustained rebound may need a bit more than that.
Levies Still Coming for AI Boom
President Trump threw out what appeared to be a lifeline to technology companies by suspending tariffs that sent their stocks spiraling downward. It is too early to breathe a sigh of relief.
The uncertainty over trade barriers is still rattling tech giants and the global economy. That is likely to become a drag on the AI boom no matter which way the pendulum swings. Trump's reprieve pushed Nvidia's stock above where it was before he imposed tariffs last week, but the trade war with China is escalating and huge uncertainty remains. The president even promised additional "sectoral" tariffs specifically on semiconductors in short order.
All of that adds up to a still-significant risk of a recession or substantial slowdown, which presents a challenge for the big tech companies that largely bankrolled AI's growth. Microsoft, Meta Platforms, Alphabet and Amazon.com together plan more than $270 billion of capital spending on data centers this year, according to a Citigroup estimate.
Sustaining the boom hinges on the tech companies' willingness to stick with current and future spending plans against a rapidly weakening economic backdrop.
That is a lot to ask. Probably too much.
Some of the businesses that give big tech companies their big pockets aren't exactly recession-proof. Meta is almost entirely funded by ad sales, an area that could come under threat with higher tariffs that send prices up and make consumers wary. Google also is ad-dependent: About three-quarters of its revenue came from ads last year.
Tech companies were already pretty far over their skis with spending on AI before tariffs came into the picture. They were set to lay out some $325 billion next year in capital expenditures on data centers, according to a Citi estimate in February.
That spending wouldn't necessarily be unsustainable if it weren't for a troublesome fact -- AI is still trying to find its own legs as a business. So far, AI hasn't been enormously profitable for anyone -- at least not commensurate with the investment it requires.
John Blackledge, a tech analyst at TD Cowen, said Amazon's cloud-computing arm historically generated $4 of incremental revenue for every $1 of capital spending. With investments in generative AI, the ratio is currently something like 20 cents for every dollar -- although Blackledge estimates it will get closer to the usual $4 return in the next several years.
Given the promise AI holds, there is an argument that tech companies will take tariffs as a cue to spend more on AI while dialing back other parts of their business. Some analysts believe they will stick to their big spending plans.
The more probable scenario is that at least some of them dial back. They will likely use tariffs as an excuse to moderate spending. In many ways, the spending boom had been driven by not wanting to fall behind competitors who are also spending massively on the technology.
In what might be a taste of things to come, Microsoft is already slowing data-center construction across the globe, including a $1 billion project in Ohio. The company is sticking with plans to spend more than $80 billion on infrastructure this fiscal year, but the moves signal a more cautious stance in the longer term. Analysts at TD Cowen said in a note last month that Microsoft canceled leases in the U.S. and Europe, which the analysts attributed partly to an oversupply of data-center space relative to the company's demand forecasts.
Tech companies have shown they can adjust quickly to changed circumstances. They did so a few years ago when Covid hit: Google delayed ad launches and slowed hiring, and Meta pledged to moderate spending growth.
That crisis was also lined with opportunity in a way this one isn't. With more people learning and working from home, demand back then rose for a lot of the services tech companies supplied. There is no such opportunity when prices are on the upswing and people rein in spending.
Meta is perhaps most sensitive to economic weakness of any of the tech giants, given its relative lack of revenue streams beyond ads.
Microsoft, Amazon and to some extent Google might be more resilient. Those three companies have big cloud-computing divisions that largely serve corporate customers. There, the return on AI investments is more straightforward, even if it is no slam dunk. That said, Google is still largely ad-driven and Amazon is exposed to consumer weakness in its e-commerce and ads businesses.
The other big casualty in a tariff-induced AI slump would be Nvidia, whose chief executive, Jensen Huang, was touting near-limitless spending on AI data centers just last month. "We've got to go and work with the supply chain upstream and downstream, to prepare the world for hundreds of billions of dollars, working towards trillions of dollars of AI infrastructure build-out," he told analysts.
Such pronouncements were taken at face value by investors eager to cash in on the next big thing. Now, in the blink of Trump's eye, they might prove to be a pipe dream.
