Close to a Melt-Down
Doug Nolan
Give Credit where Credit is due. Cooler heads prevailed.
It was in both the U.S. and China’s interests to end what was effectively a trade embargo between the world’s two rival superpowers.
Surely tough to swallow, President Trump, Secretary Bessent, and U.S. Trade Representative Jamieson Greer did what had to be done.
May 13 – Bloomberg (Chris Anstey):
“Former Treasury Secretary Lawrence Summers applauded the Trump administration’s walk-back from what he characterized as overly aggressive trade protection measures, singling out Scott Bessent in particular for his weekend work with China.
‘Many of the biggest failures in US history come from an unwillingness to pull back in the face of a mistake and to double down on the infeasible — that’s what Vietnam was about,’ as well as US conflicts in Iraq and Afghanistan,
Summers said… ‘When you make a mistake, when you’ve done something imprudent, it’s a good idea to salvage what pride you can and to retreat.’
Summers highlighted three elements of retreat since April 2… First came the 90-day pause on duties above 10% on all nations but China, then the ‘fig leaf of some kind of deal with Britain’ last week.
Most recent was the removal of most of the punitive tariffs on China.”
Bloomberg:
“Xi Jinping’s decision to stand his ground against Donald Trump could hardly have gone any better for the Chinese leader… The deal ended up meeting nearly all of Beijing’s core demands.”
WSJ:
“A U.S.-China agreement to pause bruising tariffs was cheered in Beijing as vindication for leader Xi Jinping and his defiant response to President Trump’s trade war…”
CNBC:
“Chinese officials, influencers and state-run media… were casting the initial trade agreement and 90-day tariff pause with the U.S. as a victory and a vindication of Beijing’s negotiating strategy.”
May 12 – Financial Times (Demetri Sevastopulo, Joe Leahy and Peter Foster):
“One overriding question has significant implications for the negotiations to come: did Beijing or Washington flinch first?
Trump… claimed victory, saying he had engineered a ‘total reset’ with China.
Meanwhile, Hu Xijin, former editor of national Communist party tabloid the Global Times, said on… the deal was ‘a great victory for China’.
‘The US has chickened out,’ said one popular Chinese social media post...
Economists agreed that the US might have overplayed its hand by raising the tariffs too quickly and too high.
‘The US blinked first,’ said Alicia García-Herrero, chief Asia-Pacific economist at French investment bank Natixis.
‘It thought it could raise tariffs almost infinitely without being hurt, but that hasn’t been proven right.’”
Markets couldn’t care less who flinched, blinked or backed down.
It was a deal that slashed untenably high tariffs, ensuring cargo ships would be quickly loaded and set sail across the Pacific.
The President certainly stoked market exuberance: “Yesterday, we achieve a total reset with China.”
“China will also suspend and remove all of its non-monetary barriers.
They’ve agreed to do that.”
He also stated his intention to speak directly with Xi Jingping, “maybe at the end of the week.”
De-escalation is indeed encouraging news, though high tariffs remain an issue.
The stock market is certainly in a celebratory mood.
After the shock and horror of seemingly losing sway over White House economic policy, equities rejoiced in the President’s hasty retreat on tariffs and the China trade war.
It was a bit harrowing, but markets did what they always do: they won.
“Trump put” lives.
But it’s much too early for “mission accomplished.”
The Geneva agreement was more a temporary truce than a trade deal.
In the grand scheme of things, it was a slam dunk to significantly reduce tariffs and curb the vitriol.
The first round was simply about egos.
It’s unclear why the administration thought Trump (“trade wars are good and easy to win”) hardball tactics would work with China.
Going forward, so many tough issues, fraught relations will require time and intense negotiations.
It’s worth noting that Beijing has so far been noncommittal for a Trump/Xi call.
There has also been nothing out of China to corroborate the President’s, “China will also suspend and remove all of its non-monetary barriers.”
The “Joint Statement” included much more specific language, stating that China will “adopt all necessary administrative measures to suspend or remove the non-tariff countermeasures taken against the United States since April 2, 2025.”
Beijing is certainly not proclaiming “reset.”
May 16 – Reuters (Joe Cash):
“The 90-day tariff truce agreed by the United States and China during trade talks… last weekend is too short, China’s state-backed Global Times said…, as envoys from the world’s two biggest economies regrouped in Korea…
The U.S. agreed to cut the extra tariffs it imposed on Chinese imports last month to 30% from 145% for the next three months, while China committed to cutting duties on U.S. imports to 10% from 125%...
Beijing also agreed to pause or remove the non-tariff countermeasures it has imposed against the U.S. since April 2, although China so far has only paused its decision to add around 50 U.S. firms to various lists restricting their ability to trade and invest.
In addition to easing the curbs, China agreed to lift export countermeasures issued after April 2, raising prospects for the lifting of restrictions on rare earth minerals, on which Beijing has not yet clarified its position.”
May 16 – CNBC (Anniek Bao):
“Chinese trade envoy Li Chenggang described talks with the U.S. as ‘good’ after their first high-level engagement… led to a thawing in trade tensions.
However, both sides have continued to trade thinly veiled swipes.
When asked… whether the dialogues were constructive, Li… answered, ‘definitely,’ without giving further details or clues on forthcoming meetings...
Li told reporters that he had no information on whether there would be a meeting or a call between… Donald Trump and… Xi Jinping.
On the same day, He Yongqian, spokesperson for China’s Ministry of Commerce, struck a similar restrained tone, offering no new details on the trade talks during a daily press briefing…
Trump had touted earlier this week that he might speak to Xi at the end of this week, while Beijing appeared tight-lipped on that prospect… The U.S. Commerce Department…
Tuesday warned companies not to use Huawei’s Ascent AI chips, drawing criticism from Beijing, calling it an act of ‘abusing export control measures.’
China’s foreign ministry on Friday toughened its tone a notch, decrying the U.S.’s ‘long-arm jurisdiction,’ saying China will ‘never accept it.’
Meanwhile, China is keeping a firm grip on its export controls on critical minerals.”
It's worth noting that Xi Jinping spoke Tuesday before the 33-member Community of Latin American and Caribbean States (CELAC) forum: “There are no winners in tariff wars or trade wars…
Bullying or hegemonism only leads to self-isolation.”
And the following day with Chilean President Gabriel Boric: “The international situation is in turmoil.
Unilateralism and protectionism are… dealing serious blows to the international trade order.
Against this backdrop, strengthened cooperation between China and Chile is all the more exemplary.”
Curiously, in his celebratory Monday press conference, President Trump was primed for tough talk.
The “European Union is, in many ways, nastier than China,” and the U.S. holds “all the cards.”
Made me think of a competitive athlete after suffering a tough loss: “Wouldn’t want to be the next team that has to play us.”
Joachim Nagel, Bundesbank President and member of the ECB Governing Council, offered insightful comments Wednesday at the New Economy Forum in Spain.
Below is an excerpt.
“We are strong countries in Europe.
And, so, we should go into such negotiations with the Trump administration as strong partners.
There should be a level playing field, and we should make this crystal clear to American colleagues when they would like to have such tariffs – and going into such tariff direction – then I believe there will be more to lose on the American side compared to the European side.
I’ll give you one example: all what I know from inflation and how tariffs might affect inflation, I think the country that is imposing tariffs is much more affected by inflation than those countries that have to pay the tariffs.
There is not one element that I can see [to] make the policy a win for the American side.
And I hope that there’s a learning curve on the American side over the next couple of weeks and the upcoming months.
Because if that is not the case, this uncertainty will remain.
All what we know from economics is that uncertainty is not good.
It’s not good for investment.
It’s not good for consumption.
It’s not good for financial markets.
And this example – or maybe the episode that we have on April 2nd, was a perfect example of how things can go really into a very, very complicated day.
I will not say it was luck.
But we were close to, let me say, a ‘tipping point’ where I believe financial markets after the second of April were really close to very, let me say - ‘disruptive’ is a nice description of what I had in mind after the second of April.
It was close to a meltdown – this was my understanding and was my perception.
We should be very cautious about all these things.
And it’s definitely not time for complacency.
But we as Europeans – we are strong economies. We should signal this.”
Remarkable candor from one of the world’s preeminent central bankers: “It was close to a meltdown.”
And there should be no doubt that this near meltdown instilled the fear of God in the Trump administration, forcing a retreat on tariffs and its foolhardy game of chicken with Beijing.
Inquisitive minds want to know: Was it tactical or strategic?
Using Dr. Nagel’s language, has there been a “learning curve on the American side?”
Did acute market instability fundamentally change the President tariff strategy, or might the markets’ speedy recovery only embolden a renewed focus?
The analysis could not be more important - or fascinating.
In the eyes of his opponents, has a chastened President Trump been weakened by tariff and China trade war fiascos?
With trade negotiators around the world watching with keen focus, Xi Jinping played hardball with Trump and walked away with a decisive win.
China’s global message of resistance and “strengthened cooperation” against “unilateralism”, “protectionism”, “bullying”, and “hegemonism” likely now resonates loudly and clearly.
Did the administration decide to fold after it became clear that its plan for a united front against China was dead on arrival?
Meanwhile, markets have turned sanguine, excited by a humbled administration - eager to assume the President will now move forward rationally with market-pleasing trade deals.
The stock market deserves a bit of Bubble analysis.
Equities are a historic speculative Bubble - an important component of the overarching global Bubble.
Especially after the post-pandemic speculative melt-up, there are serious market structure issues.
Typical of major Bubbles, today’s stock market is incapable of orderly adjustment.
The fundamental backdrop is deteriorating.
Acute fragilities have been revealed.
Yet the major indices have lurched back to near record highs.
In today’s world, huge amounts of risk are hastily transferred in myriad “hedging” strategies whenever instability begins to materialize.
Derivatives play prominently in this dynamic.
As we witnessed last month, equities are vulnerable to rapid declines, as derivatives-related “dynamic hedging” programs short stocks/ETFs on weakness to hedge market “insurance” exposures.
At the same time, this risk transfer creates latent market rally rocket fuel.
This market structure is prone to instability and dislocation, the type of dynamic that provokes policy responses – in this case the administration’s 90-day tariff pause and China trade war retreat.
The resulting short squeeze and unwind of hedges triggers a powerful rally, which ensures aggressive speculation and FOMO buying.
During the speculative cycle’s late-stage terminal phase, with such broad-based and impassioned participation, it can regress somewhat into “that which does not destroy the bubble, only makes it stronger.”
The widening chasm between inflating market prices and diminishing fundamental prospects turns only more perilous.
The pierced Bubble thesis is premised on several key analytical points:
First, global leveraged speculation passed an important inflection point.
Two, a most protracted U.S. Credit cycle has reached a critical juncture.
And three, the Trump administration has unleashed crisis of confidence dynamics for U.S. policymaking, the dollar and Treasuries, and U.S. prospects more generally.
Radical Trump administration policies compounded already extraordinary global risks, pronouncements, and behavior.
Corroborating the high-risk thesis, last month’s near meltdown confirmed the backdrop had turned inhospitable for leveraged speculation.
Markets were at the precipice of a very disorderly deleveraging crisis.
The current bout of “risk on” doesn’t alter the thesis.
It is instead fundamental to the process of acute instability, policy responses, disorderly market recoveries, disappointment, and the reemergence of greater instability.
I’ve argued that the post-subprime eruption policy-induced market rally, to October 2007 record highs, only exacerbated systemic fragilities.
The U.S./China “trade deal” certainly did the trick for the stock market.
I doubt it will meaningfully reverse the unfolding crisis of confidence in many things America (i.e., policymaking, the dollar, Treasuries and markets, and economic prospects).
Despite another big “risk on” week, the dollar index has mustered only a moderate rally.
Friday’s preliminary May confidence readings from the University of Michigan survey argue for caution.
Consumer Sentiment declined 1.4 to 50.8, less than a point away from June 2022’s multi-decade low (down from December’s 74).
Expectations slipped to 46.5 (down from November’s 76.9), the low all the way back to May 1980.
While still early, it’s notable that the administration’s tariff retreat and resulting stock market recovery have not reversed the collapse in household confidence.
I expect at least half the country to remain locked in a deep funk.
It’s worth noting that consumer sentiment was pressured by a 7% decline among Republicans.
Hopefully, reduced Chinese tariffs will at least somewhat take off the boil the highest one-year inflation expectations (7.2%!) since 1981.
Treasury market vulnerability (i.e., debt, deficits, inflation, waning international demand, risk of speculative deleveraging, etc.) is central to the faltering Bubble thesis.
And it was another curious week in Treasury market dynamics.
At early-Thursday intraday highs, 10-year yields were up 17 bps w-t-d to a three-month high of 4.55% - before reversing sharply lower to end the session at 4.43%. Treasuries were relatively quiet throughout Friday’s session, ahead of a jarring late-day Moody’s debt downgrade.
May 16 – Bloomberg (Michael Mackenzie):
“The US was stripped of its last top-tier credit rating on Friday after Moody’s Ratings downgraded the nation on an increase in government debt and a higher interest burden. Moody’s lowered the US credit score to Aa1 from Aaa…, joining Fitch Ratings and S&P Global Ratings in grading the world’s biggest economy below the top, triple-A position.
The one-notch cut comes more than a year after Moody’s changed its outlook on the US rating to negative.
The credit assessor now has a stable outlook.
‘While we recognize the US’ significant economic and financial strengths, we believe these no longer fully counterbalance the decline in fiscal metrics,’ Moody’s wrote…”
From Moody’s:
“If the 2017 Tax Cuts and Jobs Act is extended, which is our base case, it will add around $4 trillion to the federal fiscal primary (excluding interest payments) deficit over the next decade.
As a result, we expect federal deficits to widen, reaching nearly 9% of GDP by 2035, up from 6.4% in 2024, driven mainly by increased interest payments on debt, rising entitlement spending and relatively low revenue generation.
We anticipate that the federal debt burden will rise to about 134% of GDP by 2035, compared to 98% in 2024.”
A FT article quoted Vanderbilt professor Yesha Yadav, who referred to the “latest reality check on an increasingly bleak prognosis for US government debt management”.
Debt “mismanagement” is more apt.
The House’s “big, beautiful bill” is in some trouble.
May 16 – The Hill (Mike Lillis, Mychael Schnell and Emily Brooks):
“President Trump’s legislative agenda is hanging by a thread as House Republican leaders scramble to make last-minute changes to their ‘big, beautiful bill’ and cut deals to appease warring factions of the party.
The latest setback came Friday, when four spending hawks tanked a key vote in the House Budget Committee to advance the legislation as they dug in on demands for further cuts.
The failed vote came despite Trump urging GOP lawmakers to ‘STOP GRANDSTANDING’ and unify, and it forced the committee into an extended recess.”
The loss of the last AAA rating comes at a tenuous period for the Treasury market.
Treasuries are suffering a nascent crisis of confidence.
Unless there are some major changes (i.e., big cuts to Medicaid), the “big, beautiful bill” will be long on tax breaks and short of spending cuts.
A bond vigilantes Liz Truss dynamic remains a possibility.
Despite this week’s encouraging inflation data, tariff price hikes loom large.
And this stock rally and “risk on” have loosened financial conditions, ensuring a huge supply of corporate debt issuance to help underpin the economy and price pressures.
Meanwhile, sticky market yields will pressure increasingly vulnerable real estate markets and the consumer sector more generally.
May 13 – Bloomberg (Maria Eloisa Capurro and Jonnelle Marte):
“The share of outstanding US consumer debt that’s in delinquency rose in the first quarter to the highest in five years, reflecting an end to the pandemic-era pause on reporting delinquent student loan payments on credit reports.
Some 4.3% of debt was delinquent in the first three months of this year, the most since 2020 and up from 3.6% in the prior quarter, the New York Fed said… in its Quarterly Report on Household Debt and Credit.”
May 14 – Financial Times (Stephanie Stacey):
“Millions of borrowers of US student loans who are behind on their payments face collections for the first time since 2020, creating a potential drag on consumer spending at a time when the American economy is stumbling.
Nearly one in four borrowers with payments due were behind on their student loans in the three months to March…
The Trump administration has restarted involuntary collections on defaulted federal student loans, and has said it will begin garnishing [or deducting] wages and confiscating tax refunds and social security benefits ‘later this summer’.
Resuming collections of student loans could pose a challenge for US growth…”
It has been virtual clockwork in the past: stock market rallies drive a reflexive surge in confidence, spending and output.
That the Trump administration has wrecked this dynamic is an important element in the pierced Bubble thesis.
A Friday afternoon NBC headline:
“Trump Administration Working on Plan to Move 1 million Palestinians to Libya.”
Trump:
“I had a little problem with Tim Cook yesterday. I said to him, ‘Tim, you’re my friend.
I’ve treated you very good.
I don’t want you building in India.”
Perhaps we’ve passed peak tariff madness, but I doubt the President and his administration have any desire to tone down “disruption” absurdity.
There’s still tremendous tariff and trade work to grind through.
It will be fascinating to see if President Trump’s power – domestically and internationally – has waned.
Even more fascinating will be how he might now respond to recalcitrants – albeit Republican lawmakers, judges, or foreign officials, including our newfound pals in Beijing.
More importantly, are the bond vigilantes preparing for round two.
Things got a “little bit yippy” not many weeks ago.
May 16 – Bloomberg (Jennifer A. Dlouhy):
“President Donald Trump said he would set tariff rates for US trading partners ‘over the next two to three weeks,’ saying his administration lacks the capacity to negotiate deals with all of its trading partners.
Trump said Friday that Treasury Secretary Scott Bessent and Commerce Secretary Howard Lutnick ‘will be sending letters out essentially telling people’ what ‘they’ll be paying to do business in the United States.’
‘I think we’re going to be very fair.
But it’s not possible to meet the number of people that want to see us,’ the president said…
The US president asserted there are ‘150 countries that want to make a deal.’
He didn’t say how many, or which, nations would receive letters.
The countries that get them ‘could appeal it,’ Trump added, without explaining how that process would work.”
With hedging strategies proving futile again, the next stock market downdraft will find a less hedged and more vulnerable marketplace.
Masked during rallies, festering liquidity issues will be revealed during the next downturn.
I expect Treasury and bond market deleveraging to continue over the coming months, exacerbating systemic vulnerability to market illiquidity and dislocations.
If luck is on our side, successful budget and trade negotiations will hold crisis of confidence dynamics at bay.
As ECB President Nagel stated, “it’s definitely not time for complacency.”
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