One Spike Leads to Another, Part II
US stocks rallied on Friday, closing out a turbulent week on a high note as hopes for a potential US-China trade deal lifted investor sentiment.
The S&P 500 climbed 1.8%, the Nasdaq rose 2%, and the Dow jumped 618 points.
On the economic front, the University of Michigan’s survey showed consumer sentiment at its lowest since 2022, with inflation expectations hitting a peak not seen since 1981.
Meanwhile, the earnings season kicked off with mixed bank results—Wells Fargo slipped 1%, while Morgan Stanley gained 1.4% and JPMorgan surged 4% after posting record revenue.
For the week, the S&P 500 jumped 5.7%, the Nasdaq soared 7.3%, and the Dow rose nearly 5%, marking their best weekly performances in over a year, fuelled by a historic rally on Wednesday.
Last week (here), we talked about how a spike in uncertainty led to a spike in the high yield credit spread which is a measure of perceived debt market credit risk (company defaults) which implies a rising probability of recession.
As an update, the spread increased from about 3.4% to 4.5% this week.
During the week, we experienced an overnight spike in the 10-year U.S. treasury interest rate on Tuesday from 4.1% to 4.5%. Although the Fed may cut the Fed Funds rate, a short-term lending rate between banks, the 10-year treasury rate sets many commercial loan rates including mortgage rates. It also impacts Federal borrowing costs which places further strain on a ballooning deficit. It increases the discount rate used to value stocks. A spike in the 10-year treasury rate implies a tightening of financial conditions and further pressure towards an economic slowdown and job loss.
Normally, when the stock market is experiencing high uncertainty/volatility and depreciation, investors flock to safety. They buy U.S. treasuries which causes interest rates to decline.
The top two holders of U.S. treasuries are Japan and China. When foreign countries sell goods to the U.S., they receive U.S. dollars. They may earn interest on these dollars by buying U.S. treasuries.
Given the heated nature of the recent tariff announcements, especially with China, it is possible that China sold treasury securities in a demonstration that it has the ability to tighten financial conditions in the U.S. fOne indication that the Tuesday night rate increase was primarily driven by actions taken by China was rates increased overnight between 8pm and 3am ET, a time when foreign markets are open, and the U.S. is asleep. 24-hour trading platforms like BrokerTec and CME Globex allow foreign central banks, sovereign wealth funds and institutional investors to trade anytime.
Mid-day Wednesday, Trump announced: “I have authorised a 90-day pause, and a substantially lowered reciprocal tariff during this period, of 10%...” Not included in this announcement was China.
Based on investor uncertainty and exceptionally high market volatility, it is clear tariff wars have ripple effects. The pace of tariff news moves fast. A positive turn in the China tariff negotiation would likely cause the U.S. stock market to leg higher.
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