Quick Take: Market Uncertainty and the Trading Environment
Massive Uncertainty, Elevated Trading Costs
- The Trump administration’s tariff announcements generated enormous uncertainty. A popular index of economic policy uncertainty reached a post-1985 high (top chart).
- The global trading environment has reflected the uncertainty in a combination of explosive volatility, wide bid/ask spreads, and elevated market volume, a perfect recipe for elevated transaction costs. The VIX spiked above 50—its highest close outside of the ‘87 Crash, the GFC, and COVID—consistent with expectations of daily market moves exceeding 3% over the next month.
- Despite high volumes, liquidity and price discovery have been challenging. Bid-ask spreads have widened considerably (bottom-left). Quantities available to trade at the prevailing spreads, i.e., top-of-book quote sizes, have shrunk, reflecting market makers’ reduced appetite for risk (bottom-right). For S&P 500 constituents, average bid/ask spreads have been 60-65% wider than pre-“Liberation Day” levels.
To Trade or Not to Trade?
- When market uncertainty spikes, expected market impact becomes expensive. The higher expected costs to enter or exit positions could swamp perceived benefits (e.g., alpha pickup).
- Moreover, structural mechanisms, including circuit breakers and “limit up limit down” (LULD) thresholds that exchanges and regulators impose to curb the magnitude of intraday stock moves and preserve market integrity, can also limit the ability to transact. When uncertainty hits, understanding the implementation risks that these mechanisms introduce is key to deciding whether to trade or to hold out for calm.
- If trading is required, proceed with caution. Revising transaction cost estimates to reflect the current environment and employing an execution strategy cognizant of intraday spread, volatility, and liquidity dynamics are essential to controlling costs.
U.S. Economic Policy Uncertainty
Daily News-Based Index, 5D MA
Trading Conditions
S&P 500 constituents
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