The S&P 500’s rebound mid-week was epic, but questions remain as to whether it was driven by oversold conditions and short covering rather than a fundamental resolution. Yesterday’s weak follow-through suggests investors are still prone to sell rallies until the economic impact of tariffs becomes clearer.

The U.S.-China trade war has long been a source of economic uncertainty, but recent developments suggest the conflict could further spill over into financial markets, triggering a broader crisis. While President Trump’s 90-day pause on reciprocal tariffs has provided temporary relief, the underlying risks of capital flight, currency wars, and stagflation remain unresolved.

The bond market is displaying warning signs. With China holding trillions in U.S. Treasuries, any move by Beijing to dump dollar assets could destabilize global markets. China, the second-largest holder of U.S. Treasuries, has the power to disrupt global markets by selling dollar assets. This move could advance pressure on the bond markets at a time when equity market volatility is at profound levels. As both stocks and bonds weaken in tandem, financial capital flight is evident via the dollar trading at three-year lows. Both the yen and euro have been rising since the stock market selloff.  There’s no concrete evidence of China ditching U.S. Treasuries as a countermeasure to tariffs, but China has made a noticeable move by allowing the renminbi to weaken against the dollar. This raises the danger of a currency war, where competitive devaluations could escalate financial tensions.

Meanwhile, the Federal Reserve faces a policy dilemma: Should it cut rates to stave off recession or hold firm to prevent inflation? If tariffs stifle growth, the Fed may need accelerated rate cuts. If tariffs drive up import prices, the Fed may delay cuts to stymie inflation. Either way, potential stagflation has no easy policy fix and corporate earnings estimates this season are likely to be conservative at best. 

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