Market wrap: Tariff shock, treasury turmoil, and the basis beast awakes

Markets

Treasuries extend their slide, and European stocks get hammered after President Trump hikes tariffs to a century-high, cranking up pressure on China and sending shockwaves through global markets.

The 30-year Treasury yield spikes to the highest since November 2023, driven by a basis trade unwind that’s starting to feel more like a tremor in the plumbing. Whether it’s technical or a broader vote of no confidence in U.S. sovereign paper — doesn’t matter. The takeaway’s the same: the old playbook of “buy bonds, buy dollars” during stress? Not working. The dollar weakens for a second straight day. As I told a reporter earlier this week, it might be time to keep some cash at home or spread it across a few currencies — no one knows which fiat wins this race for me, it is the long dollar in Asia and the long Euro in G-10.

Europe’s main stock benchmark dumps more than 3%. Oil gets clubbed again, hitting a fresh four-year low. The only thing rallying is volatility.

U.S. equity futures are flashing some green, and treasuries trimmed losses after China signalled that it was open to dialogue, but let’s not sugarcoat it. Beijing also reiterated it has the "will and means to fight to the end." Translation: they’ll throw the kitchen sink at this before backing down.

And we’re already seeing it — China's equity ETFs just saw massive inflows as the National Team steps in to stabilize markets. State-directed buying is back in full force, with government-linked funds hoovering up shares to blunt the fallout. Chinese stocks bounced for a second day, defying the global risk-off move — a rally already being spun by the usual suspects as a “pre-stimulus” wave.

But let’s not confuse nationalized buying with investor confidence. This is a state prop job, not price discovery. And in a tape this fragile, hope gets faded fast.

Beijing may be backstopping equities, but it feels more like a Band-Aid on a bullet wound. Keep your stops tight — the real volatility may just be warming up.

As we flagged earlier this week — when volatility hits these levels, something always breaks. And right now, it looks like the basis trade is snapping.

What’s the basis trade, and why should you care?

Something odd hit the tape yesterday: long-end Treasury yields spiked 20bps, even as stocks were selling off. That’s not your textbook flight-to-safety move. One likely culprit? A rapid unwind of the basis trade — the quiet monster lurking in the plumbing of U.S. fixed income.

The “basis” is the spread between a Treasury bond and its corresponding futures contract. Under normal conditions, this spread narrows as the futures approach expiry. Hedge funds — often heavily leveraged, sometimes 50-100x — bet on that convergence. In theory, it’s a near-arb. In reality, it’s an accident waiting to happen when liquidity dries up.

How big is this trade? Try $800 billion, and that’s just what we know. It's embedded deep in the $2 trillion of prime brokerage exposure, and with Treasury issuance ramping, it’s only getting bigger.

Why is it a problem? Because these positions are often repo-financed and housed with dealers who themselves are balance sheet constrained. If something shocks the system — like a policy surprise, a collateral squeeze, or a disorderly auction — those cash bonds can get dumped into a market with no bid. And when that unwind starts, it’s every fund for themselves.

Think COVID flashback: the Fed had to buy $100 billion/day at peak to keep Treasuries liquid when this trade blew up in 2020. We’re not there yet — but the signs are flashing.

More supply from the Treasury? QT continuing? Dealer balance sheets full? That’s the recipe for repo stress, wider bid-asks, and futures dislocations — all of which torch the long leg of the trade.

The basis trade is supposed to be safe, “risk-free” carry. But in a market this fragile, it’s starting to look like a fuse — and if it goes, the Fed may get dragged back to the rescue, whether Powell likes it or not.

We’re in a regime where cross-asset volatility exposes hidden leverage — and the basis trade is leverage on steroids. Watch this space.

In forex land

Just when the dollar looked like it was finding its feet, the White House dropped the hammer — a 104% tariff hike on China, with no exceptions across the board.

Safe havens like the yen and Swiss franc are still in the driver's seat, holding firm despite another push higher in global sovereign yields. Interestingly, euro and pound caught a bid too, as traders lean into the idea that Europe’s more measured tariff response could grease the wheels for a quicker deal with Washington.

But here's the key: what’s hurting the dollar isn’t just tariffs — it’s the lack of a stimulus backstop. With no fiscal shock absorber, that’s starting to chip away at confidence in the dollar as the global go-to heaven.

That said, we’re not in ‘sell America’ territory just yet. Yields are rising across the board — not just in Treasuries — and that’s a big tell. The red flag moment is when US yields spike while the Bunds rally. That’s when you know something’s broken and capital is bailing stateside. We're not there yet… but the setup is getting twitchier by the day.