Market Overview May 20, 2025
Summary
The speaker’s core view is that the huge tail risk of late 2024 has receded, but the odds of a normal drawdown or a global valuation reset are rising meaningfully between now and year-end. CTA, vol-control and hedge-fund positioning is still lighter than at the end of last year, so any selloff may not be as fast or deep as April’s. The problem is that valuations have become elevated again while the economic backdrop has shifted from “strong” to “uncertain.” “The probability will become greater, but the depth and speed will not be as large.”
April’s crash came from concentrated positioning, high valuations and the tariff left tail hitting at once, while the recent rebound has mainly removed that left tail. The effective tariff rose from roughly 2% to the 25% announced on Liberation Day, then fell to about 12% after the US-China talks; the market also speculated that Scott Bessent could step into Navarro’s role. The executive put may have returned, but the Fed put may still be absent this year and return only next year, because a roughly 12% tariff would, in his estimate, inflict an economic hit of about 1.2% and push inflation up by roughly 1%–1.2%.
Both equities and credit are pricing a relatively optimistic economic outcome and have not truly priced in a recession. US equities trade at roughly 22x P/E; HYG spreads have narrowed from about 280bp at the start of the year and roughly 500bp at their worst to 320–350bp, still below the roughly 450bp ten-year average, while a typical recession can take them to 600bp and COVID took them to about 900bp. IG is currently around 120–160bp, also far below the roughly 280bp recession level he cites, so “betting now is expensive.”
In the speaker’s view, Moody’s downgrade and the so-called $9T maturity wall are not a substantive threat to US financing capacity. Much of the debt coming due consists of Bills used as cash and collateral; coupon-bond issuance, which actually affects supply and demand, remains fairly stable month to month. A downgrade could theoretically compress leverage through CSAs and haircuts, but banks would ultimately revise the rules to accommodate Treasuries. “The market will have to adapt to US Treasuries, not US Treasuries to the market.”
The clearest medium- to long-term rates trade remains a steepener, rather than a bet that long-end supply will immediately spiral out of control this year. Comparing DV01, the speaker said last year was about “1 billion” and this year “750 billion or 780 billion,” while describing the decline as 20%–25%; the figures and units are unclear and should not be converted. Over the longer term, fiscal issuance and inflationary forces will keep the long end elevated, while the front end will eventually fall with a slowing economy. “Once the issuance cycle starts, it is like taking drugs—you find it very hard to stop.”
Recent dollar shorts have been more about covering than fresh bearish conviction, but Asian currencies still face upside jump risk from tariff talks and hedge replenishment. The dollar’s weakening trend may pause temporarily by summer; real-money positioning has clearly increased. Taiwan holds about $1.5T of dollar assets, roughly $1T in the private sector and $500B in the public sector, while insurers’ hedge ratio has risen only from about 20% five years ago to 30%–40%. If the US pushes Asian currencies higher, Taiwan, South Korea and Japan could all replenish hedges. Rates are more certain than FX: South Korea’s Q1 GDP was already negative, leading the speaker to favor receiver swaps or shorting its long-end rates.
Deep dive
1. Lighter positioning has not made high valuations safe
At the end of 2024, CTA positioning was around 80%–90%; including vol-control and other systematic positions, the overall exposure was about $250B larger than today. Dealer desks and hedge funds were also heavily long on expectations of a “pro-business” Trump administration and tax cuts.
The market was then “squeezing oil out of a rock”: carry trades had harvested almost every available spread, the gap between implied and realized volatility was extremely narrow, VIX briefly fell to around 12 before the election, equity risk premium nearly reached zero, and CDX and European iTraxx were unusually tight.
Strong growth and low inflation could have allowed this structure to keep rising, but cheap options, extreme positioning and unknown policy left the market fragile. CTA has clearly added back exposure, but overall positioning remains light, so near-term price action is still “not fundamental-driven, but sentiment-driven and market-position-driven.”
2. The tariff left tail has weakened, but fundamental uncertainty remains
Liberation Day pushed the effective tariff from roughly 2% to the announced 25%; nobody knew how large the “left side” of Trump’s policy could be. The combination of heavy positioning, high valuations and collapsing fundamental expectations produced April’s sharp selloff.
Even at the trough, the speaker did not consider the S&P broadly cheap, especially relative to a potential recession. Some semiconductor and technology stocks were genuinely deeply discounted, but they did not represent the index as a whole.
After the US-China talks and Trump’s indication that he was willing to visit China, the effective tariff fell to roughly 12%. The market also speculated that Bessent could step into Navarro’s role, so “the left tail was cut off.” But Trump can reverse course at any time, and it remains unclear whether 12% is the final market-implied tariff.
At the end of 2024, the Fed put and executive put both existed; both disappeared in March and April. The executive put may now be back, but the Fed put may not be present this year and could return next year. Bessent is emphasizing growth first, but with inflation still present and the real economy not clearly weakening, the Fed lacks an immediate basis for supporting markets.
3. Credit spreads are denying a recession
Equities trade at roughly 22x P/E, and the market recovered the entire day’s loss after Moody’s downgrade. In the speaker’s view, prices already reflect very full growth expectations, while the fundamentals are merely “uncertain.”
HYG spreads were about 280bp at the start of the year, around 320bp in between, and briefly widened to roughly 500bp before Liberation Day. They have now returned to 320–350bp. The ten-year average is about 450bp; recessionary periods such as 2018, 2020 and 2022 can reach roughly 600bp, while COVID reached about 900bp. Current pricing clearly does not reflect payment for large-scale defaults.
Spreads on LQD, which represents investment grade, are around 120–160bp—also far below the roughly 280bp recession range he cites. Even during the selloff, including March and April, there was no major foreign liquidation of US credit. CDX continues to trade at a premium to iTraxx, further showing that a US recession has not become the credit market’s base case.
4. Long-end rates will keep pushing uphill like Sisyphus’s stone
The speaker is extending last year’s view: once the US enters a government-debt cycle, Treasury yields will repeatedly rise “like Sisyphus pushing his stone.” The inflation generated by fiscal expansion will not be borne by the US alone; it will transmit across the entire dollar system.
This does not mean supply is already out of control this year. In the speaker’s ambiguous wording, DV01 was about “1 billion” last year and “750 billion or 780 billion” this year, which he described as a 20%–25% decline. The figures and units are unclear, so no conversion is made. Near-term issuance pressure in the ten-year sector is not particularly large.
The longer-term steepener logic remains intact: persistent issuance keeps the long end elevated, fiscal injections directly add to inflationary pressure, and a slowing economy will eventually pull down the front end. The debt cycle could also extend the secular bull market in US assets, ultimately becoming “a cycle of asset bubbles.” But the speaker stresses that this does not imply a genuine debt maturity wall this year.
5. The $9T maturity wall confuses Bills with coupon bonds
The supposed $9T concentration of maturities overlooks the fact that a large portion consists of one-month or one-year Bills. These are money-market instruments used by banks and the financial system as dollar cash, collateral and margin. In the speaker’s view, whatever volume of these Bills is issued can be absorbed.
The securities that could genuinely affect the term premium are coupon bonds with maturities of two years or longer, while the Treasury’s monthly maturity and issuance management remains fairly stable. The speaker’s conclusion is direct: “There is no problem of having to issue $9T this year and finding no buyers.”
His underlying metaphor is that “the dollar is the C++ language underlying all finance today.” Even if the US rating were cut to single C or D, or the country were labeled in default, the financial system still could not escape the dollar’s foundational role. A downgrade therefore has limited substantive significance.
The real issue to watch after a downgrade is collateral policy. AAA Treasuries typically carry only about a 1% haircut; if CSAs required larger discounts after a rating change, leverage across the market could theoretically contract. But investment banks have previously modified their rules to preserve Treasuries’ treatment, and Treasuries can be delivered to the Fed in exchange for 100% cash. The speaker therefore agrees with Bessent’s claim that the substantive impact is “zero,” while acknowledging that the short-term sentiment reaction is uncertain.
6. Historical downgrade shocks vary, but US private balance sheets remain strong
When S&P downgraded the US over the debt ceiling in 2011, stocks fell about 20% while Treasuries rose about 20%, as safe-haven and collateral demand forced investors into government bonds. In his review of the Fitch episode, stocks fell about 10% and TLT about 17%, with the move intertwined with the pandemic and increased issuance.
US debt cannot be assessed by looking only at the public sector. Corporate earnings, margins and balance sheets remain strong, while interest expense as a share of profits has declined over time. Nonfinancial corporate debt as a share of GDP has also fallen since 2020. The government has levered up while the private sector has delevered—what he calls “letting the wealth remain among the people”—so he sees the overall US debt picture as much better than China’s.
Neither investment grade nor high yield shows an imminent maturity wall in 2025, and household and corporate debt are not particularly severe. If the US restarts its debt cycle, the speaker sees it as more like China in 2009–2010 than 2018, with a long runway for balance-sheet expansion still ahead.
7. Fiscal timing and Asian hedge replenishment create the next trade
Bessent appears less committed to the original “3-3-3” framework and is no longer attributing the deficit solely to the Biden administration. His emphasis on continued issuance and protecting growth first is a relatively positive signal for the economy. But the tax bill is still only a draft: it must pass the House next week and then clear a Senate with a one-vote margin, so implementation could take months. The timing gap between a potential recession and tax-cut stimulus remains.
Over the past two weeks, dollar shorts have mainly been covering rather than giving way to a large wave of new dollar longs. If the dollar continues to weaken, that trend could pause temporarily by summer. Real-money positioning has clearly increased.
Taiwan is the clearest example: of its roughly $1.5T in dollar assets, about $1T is held by the private sector and about $500B by the public sector. Insurers’ hedge ratio has risen from roughly 20% five years ago to about 30%–40%. If the US brings exchange rates into tariff negotiations and demands a stronger Taiwan currency, hedge replenishment could amplify the Taiwan dollar’s move. The same mechanism could spread to the won and yen.
Asian export currencies that previously competed with one another could shift toward synchronized appreciation against the dollar, creating “jump risk.” Political factors are relatively less important on the rates side. As US demand weakens, Asian export economies—including China—will need to print money or maintain accommodative policy. South Korea’s Q1 GDP has already turned negative, making rate cuts, receiver swaps and shorting the long end the speaker’s higher-confidence expressions.