Financial markets that had anticipated trade wars could be avoided are recalibrating the risks of a sharp global slowdown, resurgent inflation and a pause to Federal Reserve rate cuts following Donald Trump’s tariffs on top US trading partners.
The US President’s weekend orders for additional levies of 25 per cent on imports from Mexico and most goods from Canada, as well as 10pc on goods from China, jolted markets that had assumed Trump was mostly bluff and bluster.
Initial market moves eased after Trump said he would pause new tariffs on Mexico for one month and engage in further negotiations.
“So we’re going to delay this for a month, which just leaves the tariff gun loaded but not fired,” said Art Hogan, chief market strategist at B. Riley Wealth in Boston.
“Because if he just went ahead and plowed this forward, you have a real opportunity for some sloppy markets.”
Trump was scheduled to speak later yesterday with Canadian Prime Minister Justin Trudeau, who has announced retaliatory measures.
China, where Monday is a holiday, said it would challenge Trump’s tariffs at the World Trade Organisation and take unspecified countermeasures, adding to the uncertainty.
The Canadian dollar, which recorded its longest monthly losing streak since 2016 to the end of January, slid further to its lowest in over 20 years at almost 1.48 to the US currency . The Canadian dollar was last down 0.32pc versus the greenback to C$1.46 per US dollar.
Mexico’s peso hit its lowest in nearly three years but reversed after the tariff pause was announced and strengthened 0.92pc versus the dollar at 20.48.
The euro, which briefly slid over 2pc, was last off 0.51pc and China’s offshore yuan was 0.12pc weaker.
Stock markets from Tokyo to London slumped although US and European markets pared declines after the tariff pause was announced. US and European stocks had hit record highs last month.
“Markets were a little complacent in wanting to believe that some of the threats wouldn’t be carried through,” said Mark Dowding, BlueBay chief investment officer at RBC Global Asset Management.
“It feels like there is further to run if there’s no last-minute olive branch from the US”
He noted that while currencies are moving sharply, they are still trading within recent ranges, leaving room for downside.
Canada’s and Mexico’s economies are at risk of recession, according to some analysts, while the euro zone economy could see further stagnation should Trump aim tariffs at the region.
Investors are also rethinking the monetary policy outlook as tariffs risk raising US inflation.
Market expectations for a cut of at least 25 basis points at the Federal Reserve’s June meeting were scaled back to 64.7pc from 66.9pc in the prior session and 76.9pc from a week ago.
With Europe still firmly in the firing line, traders slightly increased bets on European Central Bank rate cuts, now pricing in around 86 bps of easing by December.
Trump has said tariffs will “definitely happen” with the European Union, but not when.
Deutsche Bank’s global head of FX research George Saravelos said tariffs on Canada and Mexico would put American manufacturers at a severe competitive disadvantage, raising the pressure to apply tariffs on Europe.
“The economic pressure for the US to extend its tariff wall to other non-American producers still benefiting from integrated supply chains will be very high.”
Florian Ielpo, head of macro at Lombard Odier, said a 10pc tariff would curb growth by 0.3 percentage points over a year unless the euro declines by as much, while a 20pc tariff could halve euro zone growth from around 1pc expected for this year.
The outlook for currencies other than the US dollar was also seen as dire, with Nomura analysts warning “tit-for-tat” responses to the tariffs would only risk further depreciation.
Deutsche Bank’s Saravelos added that if the trade risks priced in during Trump’s first presidential term are taken into consideration, the euro could fall to $1, from around $1.025 yesterday.
If markets move to price in the ECB cutting interest rates to 1.5pc, compared to current expectations of roughly 1.85pc, the euro could fall to $0.98-$0.99 if Fed rates stay unchanged, he added.
Analysts also anticipated further weakness in China’s yuan, though the Wall Street Journal reported on Monday that China has pledged not to devalue its currency.
The yuan briefly slid to a record low in offshore markets on Monday.
Stocks, particularly US equities, also looked vulnerable as analysts expect a drag on US company earnings given high valuations.
Morgan Stanley Chief US Equity Strategist Michael Wilson said the tariffs reinforce the firm’s preference for service industries, citing financials, software, media, entertainment and consumer services in particular.
After falling as much as 1.9pc, the S&P 500 was last down 0.6pc.
Investors were bracing for further volatility.
“They don’t have a playbook where they can react so quickly to all these changes in policy implementation,” said Olivier d’Assier, head of applied research for Asia Pacific at investment consultant Simcorp.
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