Uncertainty Squared
Doug Nolan
When you thought things couldn’t possibly get any weirder… (“Have a nice day, DJT!”)
“Uncertainty” is the word of the year, for an environment dominating by a unique array of uncertainties – policy, market, economic, geopolitical…
There are tariff and trade war uncertainties, highlighted by the President’s uniquely whimsical approach.
With a third of the 90-day pause period remaining, it’s unclear how many trade deals can be squeezed into such a short negotiations window – and how much hardball the administration is willing to play as the deadline approaches.
More specifically, complex trade agreements with the EU and China will require extensive, and likely protracted, talks.
While markets are said to abhor uncertainty, stocks these days seem to eat it up.
It’s basically uncertainty on top of uncertainty.
The world has never been so awash in speculative finance, ensuring aberrant market behavior.
Never has the global leveraged speculating community been as colossal and powerful.
Egregious Treasury “basis trade” leveraging drives unprecedented overall hedge fund leverage.
Household (loving dip buying) market participation is unparalleled, with the proliferation of online accounts, options trading, and herd-like speculation creating extraordinary market-moving power.
Importantly, the current remarkable backdrop creates a uniquely potent “risk on/risk off” market dynamic.
Case in point: From April 25th ‘24 lows to July 10th 24’ highs, the Bloomberg MAG7 Index surged 38%.
From July 10th highs to August 5th ’24 lows, MAG7 dropped 22%.
Then, from August 5th lows to December 18th highs, the index surged 51%.
From December 18th highs to April 7th ’25 lows, MAG7 sank 33%.
And from April 7th lows to Friday’s (June 6th) close, the index has rallied 35%.
One upshot is the incredible variability in perceived wealth (and “wealth effects”) for an index with $14.7 TN of market capitalization – a welcome tailwind during “risk on” and unnerving headwinds when “risk off” strikes.
There are also consequential market liquidity impacts.
For an index of companies at the epicenter of retail and institutional speculation, MAG7-related margin debt, options, and other related derivatives produce extraordinary liquidity effects (money market fund assets up another $67bn last week!).
Rising stock prices stoke self-reinforcing liquidity creation, while self-offs heighten risks of illiquidity, deleveraging, and market dislocation.
Loose conditions certainly reinforce the bullish notion of unlimited “money” available for massive AI investment requirements.
These days, it’s one extraordinarily fine line between boom and bust.
The Goldman Sachs Short Index surged 10.8% this week, having now rallied 40% off April 7th trading lows.
The equities “squeeze” has corresponded with dramatically lower CDS prices, narrower Credit spreads, and sharply reduced risk premiums.
Unique uncertainty and myriad clear and present risks beckon for market risk hedging.
But massive hedging and speculating only compound marketplace uncertainty and instability.
As we witnessed in April and last August, “risk off” now tends to quickly spiral into deleveraging, illiquidity, and dislocation.
Meanwhile, acute Bubble fragilities ensure swift policy responses (i.e., Trump’s tariff pause) that trigger destabilizing unwinds of hedges and bearish bets – along with “buy the dip” FOMO madness.
Orderly market adjustment no longer appears possible.
A speculative marketplace of such extremes creates an extraordinarily unstable liquidity backdrop.
Risk embracement (with leverage and derivatives) promotes liquidity excess, while bouts of risk aversion trigger deleveraging and resulting tighter financial conditions.
Loose financial conditions underpin economy activity, while “risk off” comes with a destabilizing tightening of corporate lending and debt issuance.
April’s major tightening saw a temporary halt to high-risk debt issuance (i.e., junk bonds and leveraged loans).
There are today two notably powerful countervailing forces.
The “risk on” squeeze dynamic is spurring speculative leveraging and the perception of abundant liquidity.
Meanwhile, global bond markets signal waning demand and fledgling liquidity issues.
Strong risk market gains, the perception of liquidity abundance, and attendant complacency work to mask mounting risks to Treasury and global bond market (i.e., Japan and UK) stability.
June 4 – Bloomberg (Alice Gledhill and Ruth Carson):
“A spate of poorly-received longer-dated sovereign bond auctions worldwide has raised questions about the willingness of investors to fund the spending plans of governments from the US to Japan.
Japan’s 30-year bond sale Thursday was the third in as many weeks to show signs of a cold shoulder from buyers, with one measure of demand the weakest since 2023.
Attention now turns to US Treasury auctions of 10- and 30-year debt next week, a test of appetite after recent similar issuance from other sovereigns failed to ignite.
Tuesday’s auction of 12-year Australian government debt saw the weakest demand in about six years and Wednesday’s post-election South Korean 30-year sale saw the lowest investor appetite since 2022.”
June 5 – Financial Times (Ian Smith):
“Auctions of government bonds are usually so routine that they generate little attention.
But Japan’s sale of 20-year debt last month was an exception.
As financial newswires flashed the dismal results around the world, the prices of the longest dated Japanese sovereign bonds dropped sharply…
An auction of US 20-year bonds the following day also attracted a lukewarm response.
Close attention to the finer details of government bond auctions and higher yields on longer-dated debt are symptoms of the same thing: wobbling investor appetite for such instruments just at the moment when many finance ministries are planning record levels of issuance, and as the world economy enters a new and uncertain era.
For the first time in almost a generation, governments are starting to face resistance from the market when they try to sell long-term debt.
‘It’s a classic supply-and-demand mismatch problem, but on a global scale,’ says Amanda Stitt, a fixed-income specialist at… T Rowe Price.
‘The era of cheap, long-term funding is over, and now governments are jostling in a crowded room of sellers.’”
More from Jamie Dimon…
June 2 – Reuters (Suzanne McGee and Nupur Anand):
“JPMorgan… CEO Jamie Dimon said… the rising U.S. national debt is a ‘big deal’ that could create a ‘tough time’ for the bond market that causes spreads to widen, he told Fox Business...
‘If people decide that the U.S. dollar isn’t the place to be, you could see credit spreads gap out; that would be quite a problem…
It hurts the people raising money.
That includes small businesses, that includes loans to small businesses, includes high yield debt, includes leveraged lending, includes real estate loans.
That’s why you should worry about volatility in the bond market.’”
When Citadel is on edge…
June 5 – Reuters (Carolina Mandl and Davide Barbuscia):
“Citadel’s… CEO Ken Griffin said… it is ‘unfathomable’ that a financial instrument to protect against an eventual U.S. default is being priced at levels close to some European countries.
‘I never thought in my life I would see the U.S. priced higher in risk cost than a number of countries like Spain, Germany or France,’ he said…
‘You gotta be kidding me.’
Griffin said the credit default swap (CDS) market has some issues with liquidity which impact prices, but still he considered that conversations around how close the swaps are trading are ‘unfathomable’…
‘The United States’ fiscal house is not in order. You cannot run deficits of six or 7% at full employment after years of growth.
That’s just fiscally irresponsible,’ he said.”
June 6 – Bloomberg (Katherine Doherty and Bernard Goyder):
“Citadel Securities President Jim Esposito said the US deficit and mounting government debt levels are a ‘ticking time bomb,’ adding his voice to the chorus of financial executives soundings warnings about America’s deteriorating fiscal outlook.
Esposito… said how President Donald Trump’s administration responds to the situation will be ‘super important.’
‘I do think the stock of debt and the budget deficit is a ticking time bomb,” Esposito said… at a Piper Sandler conference.
‘No one is smart enough to predict when exactly it will rear its ugly head.’”
When Goldman and BlackRock turn more cautious…
June 5 – Financial Times (Martin Arnold and Brooke Masters):
“Goldman Sachs has reined in risk-taking due to market volatility triggered by Donald Trump’s trade war and fears that rising US debt will erode investor appetite for dollar-denominated assets, a senior bank executive has said.
John Waldron, president and chief operating officer…, told a Goldman podcast… the investment bank had ‘moderated our risk positioning’ since the US president announced an across-the-board tariff increase on its trading partners on April 2, adding, ‘that’s a sensible thing for us to do’.
The reduction in risk-taking by one of the world’s most influential financial institutions underlines how Wall Street traders have been unnerved by the shockwaves that ripped through markets after Trump unleashed his trade war.”
June 5 – Financial Times (Peter Eavis):
“BlackRock chief executive Larry Fink said the US was ‘going to hit the wall’ unless the economy grows quickly enough to manage higher deficits from government spending, as a growing chorus of financiers warn about the country’s mounting debt.
Fink… characterised the deficit as one of the ‘two most consequential issues’ US politicians are ignoring, as President Donald Trump looks to pass tax cuts that will add $2.4tn to the national debt over the next decade.
‘We have a pending tax bill that's going to add $2.3tn, $2.4tn on the back of that,’ Fink said, pointing to the $36tn in existing US debt.
‘If we don’t find a way to grow at 3% a year… we’re going to hit the wall.’
‘If we cannot unlock the growth and if we’re going to continue to stumble along at a 2% economy, the deficits are going to overwhelm this country,’ Fink said…”
Ten-year Treasury yields jumped 12 bps Friday to 4.51%, following stronger-than-expected May non-farm payrolls data.
At 4.12%, five-year Treasury yields surged 16 bps this week to 4.12%, within five bps of the highest yield since February.
Until Friday, the Treasury market had for the most part disregarded rallying stocks and loosening conditions.
The preponderance of recent data has indicated a weakening of economic momentum.
ISM Manufacturing (48.5), factory orders, durable goods orders, vehicle sales and the ADP employment gain (lowest in two years) were all reported weaker-than-expected.
ISM Services in May posted the weakest reading (49.9) since last June, with a notable drop in New Orders.
But Friday’s stronger-than-expected jobs data struck a bond market nerve.
Labor markets don’t appear to be weakening sufficiently to restrain elevated wage growth – or to engender Fed concern.
Average Hourly Earnings rose 0.4%, with y-o-y gains of 3.9%.
This followed Tuesday’s JOLTS data, which had job openings rising almost 200,000 in April to 7.391 million (almost 300k above forecast).
While disappointing on job growth (37k), ADP’s report confirmed sticky wage inflation (“stayers” 4.5% y-o-y, “changers” 7.0%).
The ISM Services Employment component rose 1.7 points to an expanding (3-month high) 50.7.
Tariff price inflation is looming.
Garnering less attention, dollar weakness is also conducive to rising import prices.
Meanwhile, inflation fears have been held in check by expectations of a weakening economy.
Fragile bond market sentiment has also been underpinned by the view that the full-employment mandate would become the Fed’s primary focus.
This support is in jeopardy.
The rapid return of market wealth effects and significant loosening of financial conditions increase the likelihood of near-term upside economic surprises.
What’s more, the administration’s more aggressive approach with apprehensions and deportations has potential to reinforce labor market tightness and wage inflation.
And so much uncertainty with that “one big, beautiful bill”…
June 6 – Bloomberg (Erik Wasson):
“Congressional Republicans are siding with Donald Trump in the messy divorce between the president and Elon Musk, an optimistic sign for eventual passage of a tax cut bill at the root of the two billionaires’ public feud.
Lawmakers are largely taking their cues from Trump and sticking by the $3 trillion bill at the center of the White House’s economic agenda.
Musk… has threatened to help primary anyone who votes for the legislation, but lawmakers are betting that staying in the president’s good graces is the safer path to political survival.
‘The tax bill is not in jeopardy.
We are going to deliver on that,’ House Speaker Mike Johnson told reporters...
‘I’ll tell you what — do not doubt, don’t second guess and do not challenge the President of the United States Donald Trump,’ he added.
‘He is the leader of the party.
He’s the most consequential political figure of our time.’”
“The most consequential political figure” has his hands full.
June 6 – Bloomberg:
“In the early hours of Wednesday, Donald Trump declared that Xi Jinping was ‘VERY TOUGH, AND EXTREMELY HARD TO MAKE A DEAL WITH!!!’
Some 36 hours later, the US leader said he got what he wanted: A commitment to restore the flow of rare earth magnets.
It’s less clear what Xi got in return, apart from putting a lid on further punitive US measures…
‘This call provides tactical de-escalation for US-China relations,’ said Sun Chenghao, a fellow at the Center for International Security and Strategy at Tsinghua University in Beijing.
‘However, China’s core demands — equal sanction relief, reciprocal enforcement mechanisms, and an end to tech containment — remain critical for sustainable agreements…
Without substantive US adjustments in follow-up talks and policies, the consensus may not translate into long-term stability’.”
At this point, there’s ample confirmation that the Geneva trade agreement and “total reset” were less than advertised.
The Chinese have not wavered, and it has become clear that they have executed a thoughtfully crafted strategy to use rare earth minerals and magnets for trade war leverage.
President Trump has been fond of claiming that trade wars are “easy to win.”
He and his administration taunted the Chinese for having such a weak hand to play.
But a country that processes 90% of elements critical for producing automobiles, aircraft, military armaments, high tech components, clean energy, and such - has cards strong enough to make competitors sweat.
June 6 – Reuters (Laurie Chen):
“China has signalled for more than 15 years that it was looking to weaponise areas of the global supply chain, a strategy modelled on longstanding American export controls Beijing views as aimed at stalling its rise.
The scramble in recent weeks to secure export licences for rare earths, capped by Thursday's telephone call between U.S. and Chinese leaders Donald Trump and Xi Jinping, shows China has devised a better, more precisely targeted weapon for trade war.
Industry executives and analysts say while China is showing signs of approving more exports of the key elements, it will not dismantle its new system.
Modelled on the United States' own, Beijing's export licence system gives it unprecedented insight into supplier chokepoints in areas ranging from motors for electric vehicles to flight-control systems for guided missiles.
‘China originally took inspiration for these export control methods from the comprehensive U.S. sanctions regime,’ said Zhu Junwei, a scholar at the Grandview Institution, a Beijing-based think tank…”
June 6 – New York Times (Daisuke Wakabayashi and Berry Wang):
“During his phone call with President Trump, Xi Jinping leaned on a maritime analogy to try to salvage the fragile trade truce that seemed to be fracturing from a series of escalating punitive economic measures.
The Chinese leader compared the relationship between the United States and China to a large ship, with the two men serving as powerful captains holding the rudder firmly to maintain the proper course.
The analogy also came with a warning. Do not let others steer the ship off course and jeopardize the relationship…
In a readout from the Chinese government, Mr. Xi emphasized on the 90-minute call that the two leaders needed to ‘steer clear of various disturbances or even sabotage’…
Yun Sun, director of the China program at the Stimson Center…, said China saw an opportunity to use ‘top leader diplomacy’ to send this message to Mr. Trump directly: ‘Hold off your hawks.
The responsibility is on the top leaders.
If you want a good relationship, don’t let your cabinet members or team run freely with their crazy ideas.’”
Thursday’s Trump/Xi was a positive development.
It makes sense that Beijing believed it was time for President Trump to hear China’s perspective directly from the horse’s mouth.
Chinese officials have criticized the administration’s “two-faced” approach.
So, with President Trump so eager to chum around with Xi Jinping, why not use the opportunity to pry some distance between the President and his more hawkish advisors?
“If you want a good relationship, don’t let your cabinet members or team run freely with their crazy ideas.”
What if “crazy” radiates from the top?
The President and his administration are determined to thwart China’s global superpower ambitions.
They’ll continue to approach this objective on multiple fronts (tariffs, export controls, sanctions, military power, etc.).
Beijing will view these as unacceptable efforts to contain China’s rising power.
Both sides will see it to their advantage to make marginal concessions in pursuit of domestic priorities.
Meanwhile, the U.S. and China will continue to move aggressively to decouple.
A pair of Friday headlines: “China Allows Limited Exports of Rare Earths as Shortages Continue.”
“China issues rare earth licenses to suppliers of top 3 US automakers, sources say.”
In the case of the three auto manufacturers, the granted export licenses were “temporary.”
Beijing will likely use rare earths and magnets to extract concessions on U.S. semiconductor and high-tech export controls.
And we’ll wait to see if President Trump plays tough or retreats again.
I just have a difficult time envisaging the two nations mending relations.
There will be ebbs and flows, but the rival superpowers face years of ongoing antipathy and escalating conflict.
Returning to the markets, it’s an interesting juncture for “risk on” and loose financial conditions.
Might TACO (“Trump Always Chickens Out”) be more of a market “risk off” phenomenon?
An emboldened (resolved to display fortitude) President may welcome testing China’s resolve – of which they have plenty.
On the subject of tests, it would not be surprising to see the bond market vigilantes make their presence known as budget reconciliation negotiations reach the final stretch.
And the more that surging stocks foster complacency (on inflation, the budget, tariffs, China, trade wars…), the greater the pressure that befalls vulnerable Treasury and global bond markets.
Stocks can celebrate having arrived at the summer doldrums in one piece.
But there’s an awful lot that could go wrong.
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