We might have reached the peak in the de-escalation trade

If this trade deal with the UK was announced two or three weeks ago, I would have said that it’s really good for the markets and would have been very upbeat on risk sentiment. The context is a bit different now, in my opinion.

Recall back in the middle of April, Fed’s Waller outlined his strategy to deal with tariffs. He had two scenarios in mind: tariffs around 25% on average and tariffs around 10%. The second scenario is the one that is playing out and it involves the Fed being less inclined to cut rates faster.

In fact, the market is taking this first trade deal as the more hawkish scenario for the Fed and the pricing is converging towards the original Fed’s baseline of two rate cuts in 2025 (the pricing is now showing 68 bps by year-end compared to 80 bps at the start of the week).

The problem here is that with new information throughout the weeks, the 10% has become a “meh” outcome. After April 9 pause, the market rallied on expectations that eventually the US would have gone for 10% reciprocal tariffs and would have lowered the tariffs on China back to the original 50-60% rate. This is what the whole “de-escalation trade” was based on.

We have now reached the peak in this trade because the US said that the 10% will be the floor for all other deals and we got a report from New York Post yesterday saying that the US is considering lowering the tariffs on China to 50-54%. Recall, the market was expecting 10% global tariffs and 50% on China before the April 2 surprise.

All of this should now be priced in and the market’s reaction to the news of the US lowering tariffs on China could be a hint. In fact, you would have expected a strong rally, but the market actually went in the opposite way. Nonetheless, this has opened up for a weekend risk scenario in which the market opens up with a positive gap next week, so the selling pressure into the weekend could be limited (I mean it doesn’t look good from a risk management perspective for the bears).

So, what makes this first trade deal a “meh” outcome is that not only we have some overstretched positioning but we also have the risk of retaliation now. The EU has been repeating that they won’t accept the 10% tariff rate and has been threatening a retaliation in case negotiations fail. But the US is saying that 10% is the best anyone can get and tariffs could be even higher.

Next week will be the tell. If we open up with a positive gap and the stock market then performs badly throughout the week, then it could be a signal that we have indeed reached the peak (at least in the short term). I would expect the bears to seize the opportunity and start selling at the start of the week. You either catch the top or you get it wrong, but from a risk/reward perspective it doesn’t look bad at all.