Tariff announcements create a risk-off environment
The CBOE Volatility Index (VIX) surged in early April on the back of a largely unanticipated downside risk—the broad U.S. tariff announcements of April 2. Markets reacted to three key concerns: the prospect of stagflation (potential for recession and inflation), the threat of major global trade disruptions, and a perceived willingness among policymakers to tolerate short-term economic and market pain.
Over the next week, as the VIX shot up from 22 (somewhat elevated) to 52 (extremely elevated) and the Standard & Poor’s 500 Index shed about 12%, risk-off dynamics were on full display. Equities fell sharply, with highly valued “Magnificent 7” stocks (and others in information technology (IT) and communication services) and cyclical sectors (consumer discretionary and industrials) leading the decline, while defensive sectors such as consumer staples, utilities, and health care held up relatively better.
Mirror images: Stock prices and near-term expected market volatility
The levels of the S&P 500 Index and the CBOE Volatility Index (VIX)
Notes: The chart reflects daily market data from December 31, 2024, through April 30, 2025. The CBOE Volatility Index or VIX (see the right-hand side of the chart) is a proxy for the expected magnitude of U.S. stock market price changes over the next 30 days. It is based on the prices of derivative contracts tied to expected increases and decreases in the S&P 500 Index (see the left-hand side of the chart). Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Source: Bloomberg.
Similar dynamics occurred in the corporate bond market. While aggregate credit spreads widened by 26 basis points (from 93 to 119, which was a measured response, all things considered), a flight-to-quality impulse was in the air.1 Spread widening was more acute for cyclical issuers and lower-quality bonds, with high-yield spreads widening by over 100 basis points. Within high yield, CCC-rated bonds underperformed B-rated bonds (which, in turn, underperformed BB-rated bonds.)
A road to recovery
However, starting April 9, sentiment began to shift dramatically following the announcement that the U.S. would pause the bulk of its tariffs for 90 days. With the immediate downside risk receding, markets staged a robust recovery. Over the following month, this recovery was bolstered by two additional developments. S&P 500 firms, led by those in IT and communication services, reported 12% growth in earnings, beating the market’s (subdued) expectation of 6%, helping to restore confidence. Also, a notable tariff de-escalation between the U.S. and China was announced on May 12. Equities rebounded, led once again by high-beta and growth stocks, and credit spreads tightened back to the historically low levels observed in late March.
What hasn’t changed—and what has
So where does that leave us? Two things stand out.
First, markets’ pricing of risk assets has not changed much. We have two sides of the same coin showing up in the equity and corporate bond markets. The equity market is supporting a historically high price-to-earnings multiple (21 times expected earnings for the next 12 months) on the strength of large U.S. firms’ consistent earnings growth and ability to expand margins. In the corporate bond market, all-in yield is attractive to many investors given the high risk-free rate. And historically low credit spreads are supported by healthy corporate fundamentals. When it comes to pricing risk, the tension between strong corporate fundamentals and historically rich valuations continues.
Second, two markets have not returned to their pre-April state: the yield curve for U.S. Treasuries is higher and steeper than it was, while the U.S. dollar remains weaker (down by about 4%). And this is likely for legitimate reasons. With the fog around tariff policymaking slowly receding, attention is shifting toward the fiscal outlook, with questions arising over the sustainability of U.S. deficits. On May 16, Moody’s became the last of the three major rating agencies to strip the U.S. of its top credit rating. Markets took notice, sending the yield on the 30-year Treasury bond briefly above the psychologically important 5% level on May 19. Increased scrutiny of fiscal sustainability, along with tariffs’ impact on the economy thus far and where it settles, will likely remain a market focus in the months ahead. – Kevin Khang, Vanguard Senior International Economist
Notes:
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1 A basis point is one-hundredth of a percentage point.