Markets think they hold all the cards over Trump

To be clear: I don’t know. I can’t make out a grand plan that explains the wild policy swings, but both market vigilantes and the Kremlinology of which advisers have access to the Oval Office on any given day seem like plausible explanations.

On Tuesday and Wednesday, markets turned very positive with stocks and the dollar up, and Treasury yields and gold down. The rout in American assets stopped after Trump said he wouldn’t fire Federal Reserve Chairman Jerome Powell and The Wall Street Journal reported that tariffs on China could be halved. In short: Trump caved, at least for now.

The case that Trump changed his mind because of the market reaction is easy to make, and repeats his reversal two weeks ago, when he delayed his so-called reciprocal tariffs after signs of serious trouble appeared in financial markets. This time, the dollar reached its weakest in three years despite the sharp rises in bond yields, while gold hit new highs. Markets didn’t like what Trump was saying on the Fed and doing with tariffs, and Trump didn’t like how markets reacted.

For investors, this interpretation is reassuring, as it sets a limit on the dumbest ideas—akin to the “bond vigilante" reaction that ejected Liz Truss from her seat as British prime minister faster than a lettuce could wilt.

The power of the markets isn’t magical. Asset prices are just many people assessing the prospects for the economy and future returns, and concluding that neither 145% tariffs on China nor Trump interfering in setting interest rates would be good for them. Markets are a live opinion poll of money.

In that sense, they matter to Trump. But there is no assurance that he will be ruled by them. Sometimes doing what’s best for the country might be bad for stocks (tax rises) or bad for bonds (tax cuts) or bad for the dollar (rate cuts or a war, for example).

Traders worked on the New York Stock Exchange floor on Wednesday.

The combination of all three is different, though. The only policy I can think of that would be at least arguably good for the country but bad for stocks, bonds and the dollar all at once would be a new pandemic lockdown (please, no!)—and even then, fiscal and monetary support should be a major offset. The triple plunge typically means capital flight is underway, something no government should be pleased by.

Britain experienced this in 1976, an ignominious year when stocks, bonds and the pound all fell until the new prime minister called in the International Monetary Fund to stop a fiscal crisis. Countries that ignore capital flight eventually end up isolated and poor—think Venezuela or Zimbabwe.

The U.S. is a long way from this sort of catastrophe, but I’m hopeful that the markets have imposed some limits on what Trump is willing to do. That’s good for investors, but comes with three big caveats.

First, don’t assume that Trump has put a floor under prices—the S&P 500 low earlier this month of 4835 wasn’t the key, nor was the ICE U.S. Dollar Index below 100 or even the 30-year Treasury yield approaching 5%. If it was the markets forcing a reversal, it was probably the signs of capital flight, and the simultaneous losses, not some sort of “Trump put" in stocks or sensitivity to a particular bond yield.

Second, it shows just how much risk Trump is willing to take before reversing. It should be obvious that attacking the Fed’s independence would hurt markets, yet he did it anyway. It should be obvious that imposing 145% tariffs on your biggest supplier of goods would hurt markets, yet he did it anyway. If prices have to fall hard before he drops his next market-unfriendly plan, that’s cold comfort for investors during the fall.

Third, this all rests on the assumption that Trump reversed course because of the markets, and we can’t be sure that’s true. Trump might talk to a different adviser next time. Or he might be making it up as he goes along. Investors shouldn’t get complacent about their supposed hold over the president.

Write to James Mackintosh at james.mackintosh@wsj.com