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Policy uncertainty drives market choppiness

Policy uncertainty drives market choppiness

08/04/2025
Yago Dias
Policy uncertainty drives market choppiness

In 2025, financial markets have become unpredictable battlegrounds as shifting policies and geopolitical tensions fuel volatility across asset classes.

This article explores the rise of policy uncertainty, its measurable impact on markets, and offers practical strategies for investors to navigate these turbulent times.

Defining Policy Uncertainty

Economic policy uncertainty encompasses unpredictable fiscal, monetary, and trade policy moves, along with geopolitical risks that are difficult to forecast or hedge against.

Unlike routine business cycles, policy uncertainty arises from sudden announcements or negotiations that catch markets off guard, leading to pronounced sharp market reactions and increased risk premiums.

Key Metrics and Notable Spikes

Analysts commonly cite two main indices to gauge uncertainty: the Economic Policy Uncertainty (EPU) index and the Trade Policy Uncertainty (TPU) index.

In early 2025, the global TPU index reached an unprecedented 900 points—over ten times its 2015–2024 average of 85. A single February spike pushed it to 2446, seventeen times the long-term norm.

Volatility measures such as the VIX in the US and VSTOXX in Europe tripled from historical averages, reaching 52 in April 2025.

Drivers of Market Turbulence

  • Geopolitical tensions and conflicts intensify uncertainty when retaliatory trade measures are threatened or enacted.
  • Policy fragmentation and protectionism emerge as countries prioritize domestic agendas over multilateral cooperation, leading to frequent tariff changes.
  • Fiscal sustainability worries weigh on investor sentiment as government debt levels surge globally, heightening default risks.
  • Disconnect between market momentum and policy signals makes volatility unpredictable, especially during equity downturns.

These factors converge to create an environment where strategic planning and rapid response are critical for portfolio resilience.

Empirical Market Impacts

Recent data highlights how policy uncertainty manifests across different asset classes:

1. Equity Markets: Following the US tariff announcement on April 2, 2025, major indices suffered sharp sell-offs, aligning closely with surging EPU readings.

2. Credit Spreads: Corporate bond spreads widened significantly as investors demanded higher yields for increased risk, only retreating when policy clarity emerged.

3. Safe-Haven Assets: Gold soared to a record USD 3,200/oz, while the US dollar weakened atypically against the euro, yen, and franc, underscoring cross-currency risk management.

4. Interest Rates: Short-term yields fell in Europe, Japan, and the UK amid easing expectations, while long-term US Treasury yields swung widely on concerns over fiscal sustainability.

Macro-Economic Consequences

Empirical studies reveal that a 10-percentage-point rise in tariffs can trim GDP growth by approximately 1.1% over the subsequent five years.

Prolonged uncertainty dampens business investment decisions, hitting small and trade-dependent economies the hardest due to limited buffers and greater exposure.

Investor Responses and Strategies

Facing heightened risk, market participants have adopted a range of tactics:

  • Increased demand for hedges and safe-haven assets like gold and quality government bonds.
  • Sector rotation from cyclical equities into defensive assets such as utilities and consumer staples.
  • Active rebalancing to mitigate headline risks and capture opportunities when volatility subsides.

Experts recommend proactive portfolio strategies are favored over reactive ones, emphasizing disciplined asset allocation and timely adjustments.

Practical Tips for Navigating Choppy Markets

1. Diversify broadly across geographies, asset classes, and sectors to reduce concentrated exposures to policy shocks.

2. Maintain liquidity buffers to capitalize on market dislocations when panic sells create attractive entry points.

3. Use derivatives strategically for hedging currency, interest rate, and equity risks without incurring excessive costs.

4. Stay informed through reputable sources and monitor key indices like EPU and TPU daily to anticipate potential volatility spikes.

5. Keep a long-term focus: short-term volatility can obscure strong fundamental growth prospects in high-quality assets.

Looking Ahead with Confidence

While policy uncertainty remains a formidable headwind, investors who combine rigorous research with disciplined risk management can turn volatility into opportunity.

The current environment underscores the value of sector rotation and defensive asset shifts, as well as the importance of clear policy signals to restore market confidence.

By adopting structured strategies, building resilience through diversification, and remaining vigilant, market participants can navigate the turbulence and position themselves for sustainable growth when uncertainty subsides.

Yago Dias

About the Author: Yago Dias

Yago Dias