Oil prices have breached the triple-digit mark and the Federal Reserve has begun its tightening cycle, yet Wall Street remains convinced that Donald Trump will once again step back from confrontation. This strategy, known as "TACO," is now facing its most severe test since it first emerged.
The conflict between Washington and Tehran has now dragged on for nearly seven months, with tensions escalating around the Strait of Hormuz and the Red Sea. West Texas Intermediate crude is trading above $100 per barrel, the Fed has raised rates for the first time in three years, and the 10-year Treasury yield is approaching the critical 4.946% threshold.
According to multiple US media reports over the weekend, despite ongoing hostilities, the US government has agreed to allow Iranian leaders to attend next week's high-level UN General Assembly meeting in New York. Trump stated on Wednesday that he hopes the war will be "over soon" and claimed to have been in "direct" communication with Iran, which briefly pushed oil prices lower. But the real question for markets is this: if Trump does not back down this time, how will the TACO trade ultimately unfold?
Andrew Bishop, research director at geopolitical advisory firm Signum Global, said the firm's "Hormuz TACO Index," which tracks signals of de-escalation in the US-Iran situation, is still flashing warning signs, though private negotiations may already be underway. Kathleen Brooks, research director at XTB, pointed out that if a US-Iran agreement is reached, oil prices could fall rapidly, bond markets could rebound, and yields could decline, providing vital support for equities.
The TACO Trade: From Joke to Market Force
"TACO" is an acronym for "Trump Always Chickens Out," a phrase originally coined by a Financial Times columnist in a joking manner. It has since evolved into a formidable trading force on Wall Street.
The core premise of this strategy rests on Trump's extreme sensitivity to financial market performance. He has historically treated stock market movements as a barometer of his administration's success, and markets widely believe he is particularly wary of turmoil that could jeopardize Republican prospects in the midterm elections.
The defining moment for the TACO trade came on April 9, 2025, when Trump announced a 90-day pause on reciprocal tariff increases for most trading partners, halting a selloff that had pushed major indices to the brink of bear market territory. Since then, whenever markets have come under pressure, investors have tended to buy the dip, betting that Trump will pivot once again.
Signum Global has built a mathematical model based on this dynamic to predict the timing of Trump's policy shifts. The model successfully forecast a de-escalation signal in July this year, when Washington and Tehran briefly stood down and delegations traveled to Qatar for indirect negotiations. However, disputes over alternative shipping routes and alleged US detours subsequently reignited tensions.
Market Resilience Undermines Trump's Retreat Incentive
The fundamental assumption of the TACO trade is that stock market declines will force Trump to seek reconciliation. But right now, this transmission mechanism appears to be weakening.
Following the Fed's rate hike on Wednesday, US stocks recorded their worst single-day performance in three months, yet quickly stabilized and recovered. The Dow Jones Industrial Average is down 2.6% for the month, but the S&P 500 and Nasdaq Composite have declined only 0.6% and 0.1%, respectively.
This creates a thorny paradox: precisely because stocks have not fallen sharply, the pressure on Trump to pursue negotiations has correspondingly diminished. According to MarketWatch, some market participants are concerned that the relative resilience of equities may actually embolden Trump to take a harder line with Iran.
Brooks noted that traders are gradually abandoning their bets on Trump backing down this time. "As tensions and attacks continue to escalate in the Strait of Hormuz and the Red Sea, market expectations for TACO are fading."
The Bond Market Holds the Real Pressure Valve
Against the backdrop of resilient equities, the bond market has become a more critical indicator for gauging Trump's potential policy pivot.
The 10-year Treasury yield has climbed to 4.946%, approaching the level that markets widely view as a trigger point for a stock market correction. Bishop pointed out that when Treasury yields are at this level, history suggests equity adjustments tend to follow.
The impact of rising yields extends well beyond stocks. Higher interest rates directly increase government borrowing costs while also raising mortgage, auto loan, and credit card rates for American households, making Trump's "affordability" agenda for his second term increasingly difficult to deliver.
Meanwhile, US consumers are currently paying an average of $4.40 per gallon for gasoline. High oil prices have always been a political liability for the incumbent party in elections, and the pressure on Republicans ahead of the midterms is building.
Negotiations May Be Advancing Behind the Scenes
Despite the pessimistic market sentiment, Signum Global believes that de-escalation may already be underway below the surface.
Andrew Bishop told MarketWatch: "People often forget that the exact starting point of each previous round of de-escalation only became clear after the private talks were made public." He added that while a Gulf-Iran leaders' meeting originally scheduled for Monday in Oman has been postponed, negotiations are, to his knowledge, continuing and "making progress."
Trump told reporters on Wednesday evening: "We're hopefully close to the end of the war. They want to make a deal. We'll see." He also said he had been in "direct" communication with Tehran without providing details. These remarks, combined with news that Saudi Arabia is seeking to restore about half of the capacity of a cross-border pipeline halted after Houthi attacks, together pushed oil prices lower on Thursday.
For investors, the central contradiction in the current situation is that the market pressure the TACO trade relies upon has not yet fully materialized, while geopolitical risks continue to accumulate. This time around, Wall Street's patience may be harder to reward than ever before.
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