Market Brief: Rally Fades As Uncertainties Remain

Traders are trimming risk after yesterday’s relief rally took market valuations a little too far. A rebound across Treasuries, equity indices, and the US dollar – initially driven by the Trump administration’s rapid retreat from tariff threats against the European Union and hints of a possible shift in Japan’s bond issuance strategy – is retracing against a still-uncertain policy backdrop. In currency markets, the greenback's gains are fading, while the Canadian dollar, euro, British pound, and Japanese yen are giving back some of their losses.

Long-dated government bond yields are inching higher in most developed economies after another bout of weaker-than-anticipated demand for Japanese issuance underlined a growing sense of investor caution. An auction of 40-year Japanese government bonds last night saw the bid-to-cover ratio – a key gauge of investor appetite – drop to 2.21, down from 2.92 in March, marking its weakest level since July 2024. We don’t think this suggests that the “bond vigilantes” (semi-mythical investors who express discontent with fiscal policies by selling bonds) are on the march: instead, just as in the US, a gradual reduction of the central bank’s role in bond markets has put the onus on price-sensitive participants to absorb an increasing share of issuance over the last year, intensifying the global competition for capital.

American consumers turned more optimistic on the economy in May after five months of declines. The Conference Board yesterday said its confidence index surged 12.3 points to 98 – the most since 2011 – with the future expectations sub-index jumping by 17.4 points to 72.8, while views on the present situation climbed 4.8 points to 135.9. According to the Board, about half of the survey responses were collected after President Trump’s reversal on China tariffs – and the resultant surge in stock market valuations – suggesting that a more widespread adoption of the TACO (‘Trump Always Chickens Out’) thesis could help boost household spending activity in the months ahead.

We don’t think investors should react in a significant way to this afternoon’s Federal Reserve meeting minutes. At the time of their May 7 get-together, officials had little choice but to stay in wait-and-see mode as the administration’s policy changes rippled across the economy – and that backdrop hasn’t changed in the intervening weeks. It remains impossible to know exactly how consumer and business behaviour patterns will change in the months ahead, and rate cut expectations have accordingly shifted out across the forecast horizon since early April.

Nvidia’s first-quarter earnings report could prove more meaningful. The chipmaker – along with its artificial intelligence-driven brethren – has driven a spectacular rise in market capitalisation since the release of OpenAI’s ChatGPT model in late 2022, as ten consecutive earnings surprises have helped lift American equity indices far above their international peers, reinforcing US exceptionalism and attracting cross-border capital flows. Another positive report could keep things moving in the same direction, but we worry that a self-referential feedback loop – in which investors push the big technology firms into enormous capital expenditures on artificial intelligence infrastructure, boosting valuations and in turn generating more spending – could eventually run into financial reality, delivering a serious knock to global risk appetite. Forgive us for sounding like Chicken Little, but the situation seems reminiscent of the conditions described by Chuck Prince, chief executive of Citigroup in 2007, who said “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.”

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