Why investors keep believing Trump won’t follow through

In the weeks following "Liberation Day"—a euphemism traders now use to describe the moment tensions between the US and China appeared to cool—stock markets have roared back to life. Benchmark indices have not only erased their losses but surged to levels last seen before tariffs, threats, and retaliatory measures dominated the headlines.

The sudden rebound, however, isn’t rooted in economic recovery or geopolitical resolution. Instead, it hinges on a peculiar piece of market psychology: the assumption that US President Donald Trump will ultimately back away from full-scale confrontation. On Wall Street, this phenomenon has earned a nickname—the “Taco trade”—a reference to the idea that Trump always “chickens out” when real consequences loom.

While this narrative may offer short-term comfort, it’s an unstable foundation for sustained growth. The Taco trade is speculative by nature, inflated by passive fund flows and optimism rather than underlying improvements in trade, inflation, or corporate health. And like most bubbles, it may burst just as quickly as it formed.

Markets thrive on expectation. The recent bounce has been interpreted as a vote of confidence that cooler heads will prevail in Washington and Beijing. But this belief ignores a fundamental truth: little has actually changed.

The tariffs remain largely in place. Core disagreements over technology transfer, intellectual property, and economic sovereignty are unresolved. Supply chains have been disrupted, and businesses across Asia and North America are already adjusting to a new normal that assumes trade friction is not an aberration, but a structural shift.

Nonetheless, investors have chosen to see this as a temporary disruption. Why? Because they believe in the Taco doctrine—that when real escalation becomes likely, Trump retreats. This belief has worked before: markets have often rebounded after fiery rhetoric fades or deadlines are pushed back. But each time, the underlying issues have remained, unresolved and potentially more entrenched.

Fueling this speculative rally is another force less talked about but equally potent: the role of the “Big Three” passive asset managers—BlackRock, Vanguard, and State Street.

Together, these firms control over $20 trillion in assets, a scale that allows them to influence markets passively but profoundly. Their business model is based on maintaining and growing assets under management, which means they benefit when markets rise and suffer outflows when fear takes hold.

This incentive structure doesn’t mean these firms are manipulating markets. But it does mean that their behavior—heavily weighted toward maintaining stability and confidence—can magnify optimism, even when it’s not fully warranted. When index funds buy across the board, they create a self-fulfilling cycle: prices go up, volatility drops, and more investors pile in.

In the context of the Taco trade, this passive momentum can turn a shaky narrative into an outsized rally. Retail investors, seeing the rebound, may interpret it as a signal that “things are fine,” reinforcing the cycle even further. But this isn’t reflective of improved fundamentals—it’s a feedback loop detached from underlying economic signals.

Even as markets climb, the macroeconomic picture is flashing warning signs. Global manufacturing is slowing. In several developed economies, business confidence has dipped below key thresholds. Inflation, once declared “transitory,” is now more stubborn than expected, forcing central banks to tread cautiously.

Meanwhile, the US economy is showing signs of fatigue. Wage growth is uneven, household savings are thinning, and consumer credit levels are rising. These aren’t catastrophic signals on their own—but when paired with geopolitical uncertainty and a market that’s pricing in perfection, they represent a volatile mix.

If the assumption underpinning the Taco trade proves wrong—if Trump escalates, or if China retaliates in unexpected ways—the market reaction could be swift and severe. With little margin for error, sentiment-driven rallies become extremely sensitive to disappointment.

The heart of the Taco trade is a bet on psychology, not policy. It assumes that Trump values market performance above all else and will therefore avoid decisions that trigger downturns. But that assumption may no longer hold.

Trump’s second-term agenda appears more ideologically driven than his first. Surrounded by more hawkish advisors and with less concern for re-election, he may be more willing to follow through on threats. Already, whispers from within the White House suggest that renewed pressure on Chinese tech firms, tighter export controls, and even capital market restrictions are on the table.

Markets have yet to price in these possibilities. Instead, they’ve clung to the past pattern of retreat and relief. But patterns break. If Trump views confrontation as a legacy-defining stance—or as a lever to force domestic economic concessions—he may ignore the short-term market pain.

And if that happens, the Taco trade evaporates. The resulting correction could be sharp, especially if passive funds start seeing outflows and automatic rebalancing turns into forced selling.

For investors, the current rally presents a trap of complacency. While it may be tempting to ride the wave, those who fail to hedge against downside risk may be caught off guard if the political winds shift. It’s a moment to diversify, not double down.

For corporations, the rebound may send false signals. Business leaders planning capital expenditures or hiring based on market optimism may find themselves exposed if trade conditions worsen or inflation eats into demand.

For regulators and policymakers, the episode underscores how deeply financial markets are shaped not just by fundamentals, but by narratives amplified by structural forces like passive investing. It raises important questions about systemic risk, market resilience, and whether current oversight is sufficient for a market so top-heavy and sentiment-sensitive.

The Taco trade is not a strategy—it’s a stall. It reflects Wall Street’s enduring belief that markets can bully politicians into restraint. But as history repeatedly shows, policy doesn’t always follow portfolio preferences. Bluffing works until it doesn’t.

Markets may well continue to float upward in the short term. But when sentiment is the only thing holding the ceiling up, even a small shock can bring the whole structure down. Investors, business leaders, and policymakers would do well to stop assuming restraint and start planning for volatility. The era of trading on vibes is wearing thin. Eventually, reality demands payment.

What’s more, the overreliance on mega-managers like BlackRock and Vanguard to signal stability is dangerous. These institutions are not immune to shocks; they’re simply structured to delay them. A passive index doesn’t cushion a fall—it just spreads it. If the narrative shifts, liquidity could dry up quickly. That’s when the Taco trade reveals itself for what it is: an echo chamber of wishful thinking. Responsible strategy now requires humility, not hubris—a willingness to question whether markets are rising on real strength, or simply floating on borrowed confidence.