Trump's Trade War Moves Create Market Uncertainty

Financial markets that had hoped to avoid a trade war are now adjusting to the likelihood of a significant global downturn, increased inflation, and a pause in interest rate cuts from the Federal Reserve. This change follows President Donald Trump's decision to impose tariffs on major U.S. trading partners.

The president's recent announcement included additional tariffs of 25 percent on imports from Mexico and Canada, along with a 10 percent levy on Chinese goods. This news startled investors who believed Trump was primarily making threats.

However, initial market fears were somewhat eased after Trump announced on Monday a temporary halt on new tariffs against Mexico, allowing for another month of negotiations. Later, the U.S. also delayed planned tariffs on imports from Canada.

Known as the "tariff man," Trump had hinted at his intentions for some time, leading to speculation that much of this news was already factored into market prices. As a skilled negotiator, he often changes his strategy when he achieves his goals with other countries. The unpredictable nature of his decisions means that market volatility is likely to continue.

Art Hogan, the chief market strategist at B. Riley Wealth in Boston, remarked, "We’re going to delay this for a month, which just keeps the tariff gun loaded but not fired. If he had pushed this through immediately, it could have created significant turmoil in the markets."

On Monday, Trump spoke with Canadian Prime Minister Justin Trudeau, who had announced plans for retaliatory measures. Trudeau confirmed on social media that Trump would postpone the threatened tariffs on Canadian goods for at least 30 days, which led to a rise in the value of the Canadian dollar against the U.S. dollar.

China, meanwhile, pledged to challenge Trump's tariffs through the World Trade Organization and indicated that it might take additional countermeasures, further adding to market uncertainty.

The Canadian dollar began the year with its longest monthly losing streak since 2016, hitting a low of roughly 1.48 to the U.S. dollar. However, after news of the tariff pause, it improved to C$1.4428 per U.S. dollar. The Mexican peso also saw significant fluctuations, initially dropping to its lowest value in almost three years but bouncing back by 1.35 percent against the dollar to 20.406.

Pramol Dhawan, head of EM Portfolio Management at Pimco, expressed optimism for Mexico's long-term position despite the current turmoil. He noted that the Mexican government has taken decisive steps to cooperate with the U.S., including restrictions on Chinese textile imports and increased efforts to handle issues like drug trafficking.

He stated, "Unlike during Trump's first term, Mexican authorities are now prepared to negotiate and collaborate with the U.S." The euro briefly dropped over 2 percent but then settled down by 0.49 percent, while China's offshore yuan gained 0.05 percent against the U.S. dollar.

Stock markets faced declines across major cities, from Tokyo to London. However, after the announcement of the tariff pause, U.S. and European markets softened their losses, with the Dow Industrials even briefly turning positive. These markets had reached record highs just the month before.

Mark Dowding, chief investment officer at BlueBay, noted that markets had previously underestimated Trump's commitment to these threats. He warned that while currency fluctuations have been sharp, they remain within a manageable range, suggesting possible downsides ahead.

Analysts are concerned about the economies of both Canada and Mexico potentially heading toward recession, along with stagnation in the eurozone if Trump extends tariffs to European countries. The potential for tariffs to elevate inflation in the U.S. is causing investors to reconsider monetary policy projections.

Boston Federal Reserve President Susan Collins commented that the type of tariffs being considered could lead to inflation increases. Atlanta Fed President Raphael Bostic also mentioned that the uncertainty surrounding tariffs has made cautious approaches toward further interest rate cuts necessary.

As a result, market expectations for a 25 basis point cut in the upcoming Federal Reserve meeting have decreased, now standing at 60.6 percent compared to higher rates earlier.

With Europe still in the spotlight, traders are now more inclined to bet on rate cuts from the European Central Bank, expecting about 86 basis points of easing by December. Trump has indicated that tariffs will likely happen with the European Union, although the timeline is uncertain.

Keith Lerner, co-chief investment officer at Truist Advisory Services, remarked, "We must adapt to these fluctuations as they will continue. To make these tariffs credible, there needs to be a implementation at some point. Otherwise, miscalculations may arise."

Experts at Deutsche Bank caution that applying tariffs to Canada and Mexico could jeopardize the competitiveness of American manufacturers, prompting a potential need to apply similar tariffs on the European market.

Florian Ielpo, head of macro at Lombard Odier, pointed out that a 10 percent tariff could reduce growth by 0.3 percentage points over a year unless the euro declines by a similar amount. Meanwhile, a 20 percent tariff could significantly impact growth expectations for the eurozone.

In debt capital markets, some executives reported that deals were closed on Monday without changes to terms, as the prevailing view is that the likelihood of tariffs occurring is low. However, if these tariffs were to remain for an extended period, they could create significant impacts, even risking a recession.

Markets are becoming increasingly accustomed to higher volatility levels without shutting down as they did during past financial crises.

In the wake of these developments, market sentiment concerning currencies outside the U.S. dollar is deteriorating. Analysts at Nomura have indicated that retaliatory actions to tariffs could exacerbate currency depreciation.

Furthermore, expectations suggest that should trade risks from Trump's previous term be considered, the euro may potentially decline to $1 from its current levels.

If the ECB is expected to lower interest rates more significantly than earlier projected, the euro could plummet even further, especially if U.S. rates remain unchanged.

The Chinese yuan also faces continued risk of depreciation, though reports indicate China has vowed not to devalue its currency, despite it hitting a record low in offshore markets.

On the stock market front, particularly U.S. equities, analysts foresee pressure on corporate earnings due to these tariff strategies, especially since the S&P 500 index is perceived to be overvalued at present.

According to Morgan Stanley's Chief U.S. Equity Strategist Michael Wilson, the tariffs bolster a preference for investments in service sectors including finance, software, and consumer services.

The S&P 500 concluded the day down by 0.76 percent, after dipping as much as 1.9 percent earlier in the session. Even with the relief from tariffs, investors remain prepared for further market fluctuations.

As stated by Olivier d’Assier, head of applied research for Asia Pacific with an investment consultant, "Without a clear playbook for navigating these rapid policy changes, investors are left unsettled. By the time one decides which assets to buy or sell, Trump may have altered the situation again."

Trade, Markets, Volatility