Trump Tariffs & Their Ripple Effect on Global Markets

Archive edition · Market data and company circumstances reflect 8 February 2025, when this newsletter was sent.

Trade War 2.0: How Markets Are Responding

The global markets were shaken this week as President Trump signed executive orders imposing a significant new wave of tariffs, escalating tensions and introducing fresh concerns about inflation, economic growth, and global trade stability.

The latest measures include a 25% tariff on imports from Mexico, a 25% tariff on Canadian imports (excluding energy, which faces a 10% tariff), and a 10% tariff on Chinese imports.

These tariffs are being layered on top of existing ones, further complicating trade relationships and market expectations.

The ramifications of these policy shifts are wide-ranging, affecting equities, inflation expectations, currency markets, and broader macroeconomic conditions. While the exact long-term impact remains uncertain, markets are already reacting, and investors must assess the risks and opportunities that lie ahead.

Tariffs Disrupt the Optimistic Outlook

Coming into 2025, the macroeconomic outlook had been relatively benign. Solid growth, moderating inflation, and the expectation of gradually declining interest rates in the U.S. and other major economies painted a promising picture for investors. However, this optimism has now been challenged by the re-emergence of trade tensions.

Goldman Sachs previously estimated that a sustained 25% tariff on imports from Canada and Mexico would increase the effective U.S. tariff rate by 7 percentage points, resulting in a 0.7% rise in core PCE prices and a 0.4% drag on GDP. While the 10% tariff on energy products slightly moderates the impact, these measures still represent a significant inflationary shock and a headwind to growth.

From a market perspective, the announcement raises critical questions about the Federal Reserve’s policy stance. If tariffs drive inflation higher, will the Fed delay rate cuts, or even consider rate hikes? And how will this affect investor sentiment in equities and fixed-income markets?

The Equity Market Response

The immediate reaction in equity markets has been negative. Over the past year, U.S. equities had been pricing in strong growth with little downside risk from tariffs. However, this confidence is now being tested.

Why Equities Are Falling:

Historically, non-U.S. markets have underperformed U.S. markets when tariff fears escalate. This trend may continue, with European and emerging market equities likely to feel the most pressure. However, U.S. stocks could also face increased volatility if investors reassess the administration’s willingness to take risks with economic policy.

• Increased tariffs create an inflationary shock, making it harder for the Fed to ease rates.
• Uncertainty over further policy actions raises risk premiums across markets.
• Potential retaliatory measures from affected nations could dampen global trade further.

Interest Rates and Inflation

So far the market has traded greater risk of more inflation persistence from tariffs.

The bond market has responded with an initial rise in yields, reflecting concerns that tariffs could lead to more persistent inflation. However, the historical precedent suggests that after the initial shock, yield curves tend to flatten as markets price in slower growth and the possibility that the Fed will need to hold rates higher for longer.

Three key insights emerged from last Friday’s trading activity:

Ultimately, we expect a return to a flatter curve as markets digest the reality of these measures and as focus shifts to long-term growth concerns.

• Markets had been relatively relaxed about the likelihood of full tariff implementation until the latest announcement.
• Traded inflation expectations indicate that investors see tariffs as a longer-term inflation risk rather than a one-time price shock.
• Increased tariff risks have led to a steeper yield curve, diverging from past trade war responses, which tended to flatten the curve as investors anticipated a growth slowdown.

Canada & Mexico: Economic Fallout

The newly imposed tariffs present a major challenge to Canada’s trade-driven economy. While energy products face a relatively modest 10% tariff, the broader 25% levy on other goods is expected to drag on economic growth. As a result, the Canadian dollar could weaken by as much as 13% if these tariffs remain in place.

The Bank of Canada (BoC) has signaled a shift toward a more dovish stance, aiming to provide economic stability. This could lead to a lower terminal rate path, potentially making Canadian assets less attractive compared to their U.S. counterparts.

The impact of a 25% tariff on USD/CAD and USD/MXN would be about 13% and 17%, respectively.

With over 80% of its exports destined for the U.S., Mexico faces significant economic risks from the new tariffs. Although the peso has shown resilience due to already high risk premiums, further depreciation toward USD/MXN 22 appears likely.

Banxico may be forced to pause its rate-cutting cycle as inflationary pressures rise. Additionally, spillover effects from U.S. interest rate movements could heighten volatility in Mexican markets.

China’s Calculated Response

So far, China’s reaction has been restrained, with the primary response being a new WTO case. However, the possibility of a more aggressive reaction remains, especially as Chinese policymakers return from the Lunar New Year holiday.

A key factor to watch is whether China allows greater flexibility in the yuan’s exchange rate, as this could set off ripple effects across global FX markets.

Additionally, any retaliatory tariffs from China could have broader implications for global supply chains, particularly in technology and manufacturing sectors. Investors should be prepared for potential volatility in Chinese equities and yuan-denominated assets.

Europe: Next in Line?

While Europe was not targeted in this round of tariffs, indications suggest it may be next in line. The eurozone’s trade surplus has long been a point of contention, and new tariffs could be on the horizon.

Even without direct tariffs, the European economy may feel secondary effects as global trade uncertainty rises.

The European Central Bank (ECB) is likely to maintain an easing bias, especially if economic sentiment deteriorates. This divergence in policy stance between the ECB and the Fed could contribute to further euro weakness.

Archive note

This article preserves the analysis in our weekly newsletter sent 8 February 2025. Market prices, forecasts and company circumstances reflect the time of publication and may have changed.

This material is general information, not personal financial advice or a recommendation to trade. Investing and trading involve risk, including loss of capital.