The questionable logic of Wall Street’s Trump TACO trade

 Fascinating story about market psychology from Matt Egan.

President Donald Trump is once more threatening to lob massive duties on a wide swath of US imports, everything from copper and pharmaceuticals to goods from Japan and Russia.

Yet Wall Street is barely flinching, with some investors betting Trump will repeat his tendency to back down from his most extreme threats.

The muted response is just the latest instance of what’s known as the TACO trade, short for Trump Always Chickens Out.

“He steers us toward disaster and then — at the last minute — steers us away from disaster and says, ‘Look, I saved us,’” Michael Block, market strategist at Third Seven Capital, told CNN in a phone interview on Tuesday.

That’s what happened in early April. Trump announced sky-high “Liberation Day” tariffs that alarmed investors, convincing many that a recession was imminent.

The market freakout — both in stocks and bonds — was so intense that it convinced Trump to back down. He abruptly froze those “reciprocal” tariffs for 90 days, setting off an epic market recovery that continues today.

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“At the end of the day, no one really anticipates most of these tariffs will go into effect. The TACO trade is still the market’s expectations,” said Ed Mills, Washington policy analyst at Raymond James.

Yet there could be a flaw in Wall Street’s TACO trade logic.

If investors widely bet that Trump will blink, that means there is no market freakout. And no market freakout in turn means no one is holding Trump’s feet to the fire, pressuring him to back away from policies that could damage the economy and corporate profits.

“It’s a dangerous game when you need a market reaction to get a policy change,” Mills said.

It’s the market version of a chicken and egg problem.

Bob Elliott, CEO of alternative investment firm Unlimited, noted on X that TACO is “consensus and already fully priced in at these levels.”

“Trouble is, without the pain of falling markets, he won’t chicken out,” said Elliott, a former executive at hedge fund giant Bridgewater Associates.

While I'd argue that most Wall Street types are not nearly as smart as they think they are, they are not, as a rule, stupid either. Nonetheless, they appear to have taken away from this experience the exact opposite of the lesson they should have learned. It’s as if mice in an experiment pulled the lever, saw the food pellet drop, and concluded that the food would just fall on its own without any action on their part.

It's dangerous to try to psychoanalyze, but when smart—or at least non-stupid—people start doing stupid things, it's reasonable to look for less rational explanations.

My take is that this comes down to a couple of factors. At the risk of gross oversimplification, you can divide people into two categories when it comes to averted disaster. The first group (of which I am very much a member) comes away from a near miss inclined to be extra cautious in the future. The other group walks away even more confident in their good luck and ability to dodge bullets. I strongly suspect that the second group is overrepresented in the world of investment, particularly in the bubble-rich economy we've had for the past few years.

The second factor I suspect is the same denial we've seen from the establishment across the board with the rise of Trump—be it his initial hostile takeover of the Republican Party, his attempted insurrection, his continued hold on the Republican Party that has returned him to the White House, or just how far he is willing to go in his second term.

Tariffs are only one of the many swords of Damocles hanging over the U.S. economy, and probably not the worst: destroying the independent Fed; mass deportation of workers who are absolutely essential; stagflation; ballooning deficits; massive corruption; the collapse of the legal structure necessary for commerce. If things go badly, they have the potential to go very badly indeed.

It is almost impossible to argue that these conditions merit a bull market—unless the people in the market desperately want to believe.