By Amanda Cooper and Dhara Ranasinghe
LONDON (Reuters) -Global markets have been sucked into a down-draft after U.S. President Donald Trump’s sweeping tariffs, setting investors’ go-to warning lights flickering but not yet flashing red.
Stocks have seen some $3 trillion wiped off Wall Street so far this week. European and Japanese markets have lost almost $500 billion in an uncomfortable reminder of past crises, such as the 2008 global financial crisis and the 2020 COVID-19 pandemic outbreak.
So far, indicators of market stress reflect the nervousness that high volatility brings, but no signs yet of full-on panic.
VIX ON THE MOVE
Wall Street’s closely-watched fear gauge, the VIX volatility index, has hit its highest since August’s stocks slide.
It’s set for its biggest two-day percentage jump since December in a sign of growing market unease.
But even after this week’s spike, the VIX – at around 40 points – remains well below levels seen during the COVID crisis and in 2008.
The MOVE bond volatility index, also appears relatively contained.
BONDS SHINE
One classic indicator of market stress is investors piling into safe-haven government bonds and so Friday’s 20-basis point fall in two year Treasury yields and the 15 bps fall in German Bund yields is notable.
Over the last two days, Treasury yields have fallen over 30 bps, their biggest two-day move since August.
Still, Analysts said the world’s biggest government bond markets appeared to be functioning well.
“There are no concerns right now on that front (trading conditions), it’s all very orderly. There’s no stress in that sense,” said PIMCO fund manager Konstantin Veit.
BANKS WOBBLE
Japanese mega banks ended the week with the biggest losses since 2008 in one of the markets’ most unsettling signals so far about the consequences of Trump’s trade war.
European and U.S. banks slumped over 9% and 7% respectively on Friday and the cost of protecting against bank defaults has risen.
“Sentiment is driving bank equities down, there’s profit taking, there’s worries about global growth,” said Altaf Kassam, Europe head of investment strategy and research, State Street Global Advisors. “But it doesn’t feel like a genuine credit or liquidity crunch right now.”
CROSS-CURRENCY BASIS SWAPS
These derivatives measure non-U.S. investor demand for the dollar, which is often the safe haven of choice in times of turmoil. This dynamic is not playing out at all right now, as investors shun the dollar and snap up the yen and the Swiss franc.
Spreads for the euro have narrowed this week, to around 4.25%, from closer to 8% last week, but this is roughly where the spread was in mid-March. Spreads for the yen and the pound are often heavily influenced at this time of year by fiscal year-end currency flows and have shown similar stability.
FRA/OIS
The interbank market, where financial institutions lend to one another for their day-to-day activities, can often serve as an early warning for extreme risk stemming from markets.
The so-called FRA/OIS spread reflects the difference between the three-month forward rate agreements and the overnight index swap rate. The spread can be volatile, but at -1.89 basis points for the euro, it is well below the highs above 25 seen in 2020 and the 132 reached in 2008, LSEG data shows.
The corresponding dollar rate is at 25 bps, and has remained fairly consistently around this level for some time. It traded above 120 both in 2020 and 2008.
“No issues with repo market, no periods of no bids or no offers, there’s the same liquidity as there has been for weeks and months, however it feels like there’s more cash coming into the market,” said Curvature Securities Executive Vice President Scott Skyrm.
SWAP SPREADS
One measure of strain in the bond market are swap spreads, which capture the premium on the fixed side of an interest-rate swap, which investors use to hedge against rates risk relative to bond yields.
The pressure building in the U.S. bond market is starting to become apparent. U.S. two-year swap spreads – the difference between two-year swap rates and the two-year Treasury yield – were set for their biggest one-day contraction on Friday since the March 2023 regional banking crisis, down 4 bps to -23 bps, the lowest since November, according to Tradeweb. Two-year notes dropped as much as 26 bps on Friday to 3.465%, the lowest since September 2022.
European swaps were more muted. The two-year spread hit its widest since October 2024, at some 20 basis points, but held below the 75 bps seen in the March 2023 crisis.
JUNK BOND SPREADS
U.S. and European junk bond spreads, which reflect the premium investors get for betting on risky debt, rather than government bonds, have blown out to multi-month highs.
These risky assets, which typically outperform other assets when confidence is running high, are often the first investors ditch when trouble appears.
The iTRAXX Crossover Index an index of five-year European junk bonds hit 380 bps on Friday, the most since November 2023, its biggest two-day jump since March that year.
For comparison, it hit 500 in 2020 and topped 1,000 at one point in 2008. The ICE BofA U.S. High Yield Index is heading for its largest weekly rise since January 2024 for an effective yield of 8.1%, again, well below 2008’s 22%.
(Reporting by Amanda Cooper and Dhara Ranasinghe; Additional reporting by Yoruk Bahceli, Naomi Rovnick and Davide Barbuscia; Editing by Nick Zieminski)
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