President Donald Trump put an end to a week of stock market losses and economic tumult by backing down from most of his promised tariff hikes on Wednesday afternoon.
For banks and other financial market participants,
"It provides some certainty that there will be some negotiation and there will be an effort to ensure the full scope of tariffs laid out last week do not go into effect," said David Portilla, a partner and financial institutions attorney at the law firm Davis Polk. "That's more certainty than we had a day ago, but there's still some amount of uncertainty yet to be resolved."
Trump announced a 90-day pause on most tariff increases. In a post on his social media platform Truth Social, the president said the pause applied to the 75 countries that did not announce retaliatory measures.
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The announcement was light on details, but noted that duties imposed on Chinese goods were increased from 104% to 125% in response to China's 84% retaliatory tariff on U.S. imports announced earlier in the day. Presumably other jurisdictions that increased their duties on U.S. imports — including the European Union and Canada — will still face higher levies.
Trump added that the U.S.'s retaliatory tariff rate would be set at 10%, but it was not immediately clear which countries would be subject to that levy.
Despite the lack of specificity, markets responded boisterously to the news that the full scope of the increases would not take immediate effect. After a week in near free fall, major U.S. stock indexes rallied Wednesday afternoon. The Dow Jones Industrial Average closed the day up 7.9%, the S&P 500 increased 9.5% and the Nasdaq composite jumped 12.1%.
Bank stocks likewise closed the day higher. JPMorgan was up 8.4%, Bank of America 6%, Citi 9.1% and Wells Fargo 7%. Large investment banks saw greater jumps, with Goldman Sachs and Morgan Stanley closing the session up 12% and 11.3%, respectively. The S&P Regional Banks Select Industry Index, which tracks 142 institutions across the country, climbed 7.8%. The KBW bank index rose 9%.
Before the announcement, major bank executives were cautioning that Trump's tariff plan — which would have increased the average import duty from 2.5% to 22.5% — would likely weigh on their performance. In an interview with Fox Business on Tuesday, JPMorgan CEO Jamie Dimon said he expected to see an uptick in loan defaults.
"If you have rates going up a little bit, and inflation is sticky, and credit spreads are gapping out, which they're going to, I think you'll see more credit problems than people have seen in a long time," Dimon said.
Analysts were likewise warning about slower loan growth and other strains on bank balance sheets. In a note, Laurent Birade, banking industry practice lead at Moody's, wrote that funding costs could be on the rise as financial markets become less liquid. He urged investors to closely track earnings commentary around deposit levels and compositions.
"Any signs of strain here, potentially exacerbated by geopolitical friction or central bank actions, evoke the latent risks of liquidity squeezes seen in late 2019, testing banks' true funding resilience beneath the surface of reported Q1 metrics," Birade wrote.
One of the clouds hanging over bank funding and liquidity is a sell-off of 10-year Treasury notes, which showed little signs of slowing down despite Trump's pause announcement.
Much of the sell-off has been attributed to an unwinding of the cash-futures basis trade, in which hedge funds take short positions on the Treasury futures market via swap contracts with counterparties looking to hedge long-dated exposures. To hedge their bets, these funds also buy Treasuries and profit off the price difference between the two.
Anil Kashyap, an economics professor at the University of Chicago's Booth School of Business, said these hedge funds are likely pulling back from the trade to free up liquidity to cover losses and meet margin calls on other investments, or simply as a means for de-risking their books. But should these adjustments continue at scale, they could destabilize the Treasury market — a development that could have ripple effects throughout the financial system.
Kashyap said the banks most exposed to Treasury market trading and related derivatives are the largest and most diversified banks, which also have the most capital to bolster them against such volatility. Because of this, the basis trade unwind would not harm the banking sector directly, but knock-on effects could hit some banks harder than others.
"There's lots of stuff that's priced relative to Treasuries, so if Treasury prices stay down, then other things are going to reprice as well," Kashyap said. "Thats how it starts spreading out and causing trouble."
This basis trade unwound quickly in March 2020, during an episode referred to as the "dash for cash." At the time, the Fed was able to stabilize the market through large-scale asset purchases. But, unlike five years ago, Kashyap said, the Fed does not have a clear outlook on the direction of monetary policy.
"In March of 2020, the economy was tanking, so the fact that the Fed was going to step in and buy was something that they weren't having any real doubts about," he said. "Right now, given the outlook for both growth and inflation, the Fed's been pretty clear that they're not really ready to pick a lane yet. So, if they end up having to buy, they'll have to do a lot of communicating to convince the world that it's about market function and not a dramatic shift in interest rates policy."
Fed officials have said they would like to wait and see how new tariff policies unfold and how the economy responds to them before adjusting monetary policy, though views differ widely on what that response might look like. Futures traders have largely priced in a percentage point or more worth of rate cuts this year, while economic forecasters say the Fed is likely to hold rates steady. Meanwhile, some monetarists say the Fed should be ready to raise interest rates, should tariffs kick off a fresh round of inflation.
Last week, Fed Chair Jerome Powell said it is
"We will continue to carefully monitor the incoming data," Powell said. "We are well-positioned to wait for greater clarity."
