The adage “investors hate uncertainty” had become somewhat of a cliché, at least until the uncertainty surrounding President Donald Trump’s intermittent tariff plans left them searching for a way to measure the volatility that has caused stock, bond, and other asset price volatility in 2025.
Market players are attempting to ascertain if tariff-driven uncertainty is at or close to its top, which has significant ramifications for traders and investors hoping to avoid the next significant spike in volatility. Recent market and even bond selloffs may have reached their limit if the United States has reached or is approaching this pinnacle of uncertainty. On the other hand, subsequent selloffs may still be possible if the peak is still a ways off.
Since its introduction in the early 2010s, the Economic Policy Uncertainty Index has gained popularity among economists and strategists at various financial institutions.
As of last Saturday, the latest day for which weekly data can be produced, the Economic Policy Uncertainty Index increased to 600, surpassing the level of just above 500 at the beginning of the COVID-19 epidemic in March 2020. As you can see from the most recent weekly average of daily numbers below, growing trade tensions are making doubt about U.S. economic policy all but disappear.
“One of our preferred measures of uncertainty” is the Economic Policy Uncertainty Index. Adam Schickling, Vanguard’s senior economist
“We won’t know whether we’ve hit peak uncertainty, because it very much depends on what happens to policy,” said Steven Davis, who co-created the index and is the director of research at Stanford University’s Hoover Institution. “If we continue with on-again, off-again policies, then uncertainty will remain quite high and will continue to be in place as long as there are policy gyrations.”
According to Davis, there are three key lessons to be learned from this reading. One is that consumers will reduce their spending, especially on discretionary and durable products, as uncertainty rises. The second reason is that “businesses will cut or defer investments because they can’t make sensible decisions about where to invest, what products to produce and so on.” Thirdly, there will be fewer job openings and a lower need for labor.
Since Trump unveiled his tariff ideas on April 2, stocks, bonds, and other assets have experienced dramatic fluctuations. The S&P 500 SPX had its worst four-day performance since the beginning of the epidemic five years ago after plunging more than 12% over the next four sessions. On April 9, it recovered 9.5% for its largest one-day return since October 2008.
The S&P 500, Dow Jones Industrial Average DJIA, and Nasdaq Composite COMP all posted losses during a holiday-shortened week leading up to Good Friday, which was characterized by Federal Reserve Chair Jerome Powell’s sobering assessment of how tariffs may result in rising inflation and slowing growth. Stocks are still far below their April 2 levels.
At the start of 2025, investors hoped that a second Trump administration would bring deregulation, tax cuts, and other market-friendly policies, keeping the U.S. economy strong. Fears of a recession have instead been heightened by concerns about tariffs imposed by the United States and retaliatory actions by other nations.
Both the Nasdaq Composite COMP and the S&P 500 SPX had its worst quarterly results since 2022 at the end of March, the first three months of the year. In contrast, U.S. government debt largely recovered in the first quarter, mirroring the customary flight to safety responses that occur during times of uncertainty or panic.
Many believed that the uncertainty would peak and the future would become clear when Trump announced what he called retaliatory tariffs on commodities from other nations on April 2. That did not occur. Rather, the tariffs that Trump declared on what he referred to as “liberation day” were worse than most analysts had predicted and larger than anticipated.
Despite Trump’s decision on April 9 to impose a 90-day tariff freeze for the majority of countries, with the exception of China, uncertainty has only increased.
The current surge in uncertainty is distinct from previous occurrences, including the onset of the global financial crisis in 2008 and the 2020 pandemic, in that it was “entirely engineered by ill-advised policy decisions,” according to Davis. It’s not as though this was brought on by outside forces. It is astounding how much damage can be caused by a single president, who might not be paying attention to his advisors or receiving sound counsel.
Trump and administration officials contend that the short-term suffering is outweighed by the long-term advantages of reorganizing the world trading system.
Investors’ alarm
A significant increase in uncertainty usually triggers a flight-to-safety reaction among financial market participants, which drives investors to scramble for U.S. assets and raises the price of Treasury bonds and the dollar, Davis said over the phone.
The opposite occurred last week, alarming investors: The 30-year bond, BX:TMUBMUSD30Y, and the 10-year Treasury note, BX:TMUBMUSD10Y, both aggressively sold off, resulting in the biggest weekly yield increase in decades. Additionally, the dollar dropped precipitously against its main competitors; on Friday, the ICE U.S. Dollar Index DXY hit a three-year low.
“The way I read it is that many investors are having doubts about the reliability of the U.S. as a trading partner and the U.S.’s ability to deliver sensible policy-making decisions,” Davis stated. “We’re still not out of the woods, and the likelihood of a recession has gone up a lot since [Trump’s] inauguration.”
The Economic Policy Uncertainty Index was developed by Davis, Stanford economics professor Nick Bloom, and associate finance professor Scott Ross Baker of Northwestern University’s Kellogg School of Management in response to the policy uncertainty that emerged from the 2008–09 financial crisis. Known by their colloquial names, Baker, Bloom, and Davis, the three initially gained notoriety under the Obama administration more than ten years ago when their index was utilized to assess the financial effects of the Affordable Care Act of 2010.
Their index’s construction contributes to its distinctiveness.
Baker, Bloom, and Davis used dozens of people to read thousands of randomly chosen newspaper stories in order to create the index. In order to maximize computer computations, the three then developed computer instructions that were modeled after how a human would typically read a novel.
The Economic Policy Uncertainty Index’s daily metric is based on a news database that tracks over 1,000 American newspapers. Articles that contain at least one term from each of the following three sets—”economic” or “economy,” “uncertain” or “uncertainty,” and “legislation,” “deficit,” “regulation,” “congress,” “federal reserve,” or “white house”—are used to calculate the index.
According to studies, uncertainty surrounding U.S. economic policy frequently causes delays in capital expenditures, hiring, and investment, all of which can increase the volatility of the financial markets. Mark Carney, the prime minister of Canada and a former governor of the Bank of England, has called uncertainty in general a “form of economic post-traumatic stress disorder.”
This could be the reason why the Baker, Bloom, and Davis index is becoming so popular. These include economists like Lindsey Piegza and Lauren Henderson of Stifel, Nicolaus & Co. and Adam Schickling of investment behemoth Vanguard, as well as strategists Blake Gwinn of RBC Capital Markets and Adam Turnquist of LPL Financial.
“We are aware that uncertainty has an impact on the economy, influencing everything from how companies make long-term investments to the regular purchases made by individuals. Uncertainty measurement is less clear. “Unlike interest rates, inflation, or unemployment, it is not directly measurable,” Schickling stated in an email to MarketWatch.
Schickling stated that the Economic Policy Uncertainty Index “is one of our preferred measures of uncertainty,” referring to the monthly index that also incorporates dispersions in expert economic projections and changes in tax policy. “We incorporate this uncertainty measure in several of our economic models to understand how elevated levels of uncertainty affect business investment, consumer discretionary spending and job growth, just to name a few.”
“It’s important to remember the utter complexity of a large economy like the United States that can be more sensitive or less sensitive to increases in policy uncertainty depending on the broader economic environment,” he said, adding that the index can be a useful forecasting tool.
The index, according to Gwinn, head of U.S. rates strategy at RBC Capital, “gives some weight and visual appeal to something we all know to be anecdotally true anyway: Uncertainly has been rapidly rising.”
In a report published last week, he and fellow strategist Izaac Brook came to the conclusion that increased tariffs and general uncertainty have “closed the path to our prior, more optimistic, base case.”
Additionally, the index is “one of the things that we are watching because for the stock market – in our view, at least – to have a sustainable bottom, policy uncertainty needs to peak,” according to Turnquist, chief technical strategist at LPL Financial. Although there are few quantitative methods to assess this, we do believe that we are at, close to, or past the stage of peak policy uncertainty.
