Oil prices and interest rates are rising, but US stocks still trust TACO

Oil prices have broken through $100, the Federal Reserve has initiated a rate hike, yet Wall Street remains convinced that Trump will back down again. This trading strategy, known as "TACO," is now facing its toughest test since inception.

The conflict between the U.S. and Iran has lasted nearly seven months, with tensions escalating in the Strait of Hormuz and the Red Sea. West Texas Intermediate crude prices are lingering above $100 per barrel, the Federal Reserve has raised rates for the first time in three years, and the U.S. 10-year Treasury yield is nearing the critical 4.946% threshold.

According to Xinhua News Agency and several American media outlets on the 17th, despite ongoing hostilities between the U.S. and Iran, the U.S. government has agreed to allow Iranian leaders to attend the high-level meeting of the United Nations General Assembly to be held in New York next week. On Wednesday, Trump stated that he hoped the war was "coming to an end" and that he had "direct" communications with Iran, which temporarily pushed oil prices down. But the real question for the market is: If Trump doesn't back down this time, how will the TACO trade end?

Andrew Bishop, research director at the geopolitical consultancy Signum Global, says the firm's "Hormuz TACO Index," which tracks de-escalation signals between the U.S. and Iran, is still flashing warnings, but closed-door negotiations may be underway. XTB research director Kathleen Brooks points out that if the U.S. and Iran reach an agreement, oil prices could fall rapidly, the bond market may rally as yields decline, and this would provide crucial support for stocks.

TACO Trade: From Joke to Market Mainstay

"TACO," short for "Trump Always Chickens Out," was initially coined in jest by a columnist for the Financial Times, but has since evolved into a significant trading force on Wall Street.

The logic behind this strategy is rooted in Trump's extreme sensitivity to the financial markets. He has always regarded market performance as a barometer of his administration's success, and is perceived to be particularly wary of market volatility that could harm Republican prospects in the midterm elections.

The hallmark moment for the TACO trade occurred on April 9, 2025—when Trump announced a 90-day suspension of reciprocal tariffs for most trade partners, effectively halting a selloff that had nearly pushed major indices into bear market territory. Since then, whenever markets come under pressure, investors tend to buy the dip, betting that Trump will reverse course again.

Based on this, Signum Global built a mathematical model to predict the timing of Trump’s policy pivots. The model successfully anticipated a de-escalation signal this July—when Washington and Tehran briefly paused, and delegations from both sides conducted indirect talks in Qatar. However, disputes over alternative shipping routes and alleged U.S. bypasses reignited tensions soon after.

Stock Market Resilience Weakens Trump's Incentive to Concede

The core premise of the TACO trade is that a stock market decline would force Trump to seek reconciliation. But now, this transmission mechanism is weakening.

The Federal Reserve announced a rate hike on Wednesday, and U.S. equities suffered their worst single-day performance in three months but quickly stabilized. The Dow Jones Industrial Average is down 2.6% for the month, while the S&P 500 and Nasdaq Composite are only off by 0.6% and 0.1%, respectively.

This presents a tricky paradox: precisely because the market has not suffered a major drop, the pressure on Trump to push for negotiations is reduced. According to MarketWatch, some market observers worry that the stock market's resilience may actually embolden Trump to take an even tougher stance toward Iran.

Brooks notes that traders are gradually abandoning hopes of a Trump retreat this time. "As tensions and attacks continue to escalate in the Strait of Hormuz and the Red Sea, expectations for the TACO trade are fading."

The Bond Market: The True Pressure Valve

With the equity market holding up, the bond market has become a more crucial indicator of potential Trump policy shifts.

The yield on the 10-year U.S. Treasury has climbed to 4.946%, nearing a critical level often seen as a trigger for equity corrections. Bishop points out that historically, yields at this threshold have frequently precipitated stock market adjustments.

The impact of higher yields extends far beyond the stock market. Increased rates directly raise government borrowing costs and lift rates for home loans, auto loans, and credit cards for American households—making it even harder for Trump to deliver on his second-term "affordability" agenda.

Meanwhile, the average price U.S. consumers pay for gasoline is now $4.40 per gallon. High energy prices have long been a political liability for the party in power, and public pressure is mounting on the GOP ahead of the midterms.

Negotiations May Be Underway Behind the Scenes

Despite growing market pessimism, Signum Global believes the de-escalation process may already be quietly unfolding below the surface.

Andrew Bishop told MarketWatch: "People often forget that the exact start of each prior de-escalation only became clear once the behind-the-scenes negotiations were made public." He added that although the Gulf-Iranian leaders' meeting in Oman scheduled for Monday was postponed, he understands that negotiations are still ongoing and "making progress."

On Wednesday evening, Trump told reporters: "Hopefully we're nearing the end of the war. They want a deal, and we'll see." He also claimed to have had "direct" communication with Tehran but provided no details. These remarks, along with news that Saudi Arabia is seeking to restore roughly half of the cross-border pipeline capacity disrupted by Houthi attacks, drove oil prices lower on Thursday.

For investors, the core dilemma in the current situation is: market pressures underpinning the TACO trade have yet to fully materialize, while geopolitical risks continue to build. This time, Wall Street’s patience may be harder to reward than ever before.