Investors were caught off guard as the U.S. announced significant tariffs on imports from Mexico, Canada, and China, escalating fears of a trade war. Stock markets reacted negatively, with major declines noted globally. Tariffs are expected to strain businesses and impact economic growth, particularly in the automotive sector. While some investors consider adjusting portfolios, the long-term effects on inflation remain uncertain. Analysts suggest that the administration may soon face pressure to de-escalate these trade tensions.
Many investors were taken by surprise this past weekend as the prospect of a trade war under Donald Trump became a reality. The U.S. government revealed plans to implement a 25% tariff on imports from its two largest trading partners, Mexico and Canada, while also raising tariffs on Chinese goods by 10%.
On Monday, Trump further escalated tensions by announcing potential tariffs on European products. In response, Brussels vowed to take “decisive” action if these tariffs were enforced. Mexico, Canada, and China also signaled their intention to retaliate. Additionally, Trump hinted at levies on steel, copper, aluminum, semiconductors, and pharmaceuticals.
These bold moves have sparked concerns about a global trade war, causing stock markets to react negatively. Major European indices like the DAX and the French CAC40 opened significantly lower, with the Swiss SMI also experiencing losses. In Asia, markets such as the Nikkei in Tokyo, Hang Seng in Hong Kong, and the Seoul Exchange faced substantial declines.
The duration for which the new U.S. president will tolerate declining stock prices and a robust dollar amid market uncertainty remains uncertain. However, his steadfast commitment to his political agenda may jeopardize the investment landscape for many.
Why the Stock Market’s Unexpected Volatility?
During his campaign, Donald Trump made it clear that tariffs would be a cornerstone of his trade strategy. However, his first term saw a more restrained tariff approach that impacted only select sectors in Europe. The markets, anticipating a gradual implementation, were caught off guard by the sudden announcement of tariffs on Canada and Mexico, set to take effect imminently.
According to Karsten Junius, chief economist at Bank Safra Sarasin, the sweeping tariffs that Trump has opted for are the “worst economic scenario.” Targeted tariffs, like those he previously implemented, would have resulted in less economic disruption. Many believed that the threats would remain just that, akin to previous tensions with Colombia, and that negotiations would quickly resolve the disputes.
Impact of Tariffs on Businesses and Affected Sectors
Tariffs impose significant burdens on businesses, squeezing their profit margins. Companies often cannot fully transfer the increased material costs to consumers, resulting in diminished sales. According to Citigroup’s estimates, a 10% tariff on European imports could reduce corporate earnings by 1 to 2 percent, ultimately leading to lower stock valuations.
Junius predicts that the trade war will likely impede overall economic growth, with cyclical and industrial firms bearing the brunt of the impact. The automotive industry, including manufacturers like Stellantis and Volkswagen—who produce roughly 65% of their U.S. deliveries in Mexico—are particularly vulnerable. Interestingly, the Swiss stock market might fare slightly better, given its more defensive investment strategy, according to Junius.
Nevertheless, Swiss firms are not immune. Estimates from Bank Vontobel highlight that automotive suppliers and companies such as Landis + Gyr, Logitech, and Pierer Mobility may face adverse impacts. Should these tariffs lead to shifts in supply chains, logistics companies like Kühne + Nagel or product inspectors like SGS could potentially benefit.
Riskier assets, including cryptocurrencies, have also been severely affected by the trade war. Bitcoin plummeted more than 8% over the weekend, falling below $95,000, while other cryptocurrencies like Ether and Ripple experienced double-digit losses. Conversely, gold, often viewed as a safe haven, continues to see price increases, bolstered by central bank purchases.
Should Investors Consider Portfolio Adjustments?
At this stage, taking rapid action to adjust portfolios may be too late. Strategic moves could have involved divesting from stocks heavily dependent on U.S. markets or those with minimal local U.S. production, suggests Thomas Heller from Frankfurter Bankgesellschaft. However, this approach raises questions about future benefits; a calming of tensions could leave those without these stocks at a disadvantage.
How Can Investors Shield Themselves from This Scenario?
If there’s an expectation that future damage may exceed current losses, investors could consider hedging their portfolios using puts or futures, according to Heller. However, this strategy has its downsides; opting for downside protection means missing out on potential gains during a market recovery.
Central Banks’ Potential Responses to Tariffs
The tariffs targeting Mexico and Canada could induce a temporary price shock, potentially hindering the Federal Reserve’s ability to continue lowering interest rates.
Junius notes that the Fed is well-prepared for such scenarios, having linked interest rate adjustments to the political landscape. “For now, we do not expect further interest rate cuts,” he states, although reductions remain a possibility given the current favorable economic conditions.
Conversely, the likelihood of an interest rate hike appears minimal, as the tariffs exert pressure on the economy. Initially, the tariffs will function as a one-off event affecting inflation, but the Fed will only need to raise rates if second-round effects materialize.
Thomas Heller also suggests that the tariffs will not create substantial inflationary pressure; any increase in price levels is likely to be transient. By the following year, these effects should dissipate, indicating that the tariffs will not have a lasting impact on inflation. Currently, market expectations show no significant shifts in inflation forecasts.
When Might Trump Face Consequences from His Tariff Policies?
With a robust U.S. economy supporting his administration, Trump is operating from a position of strength. Recent economic indicators suggest sustained growth, while disinflation trends are anticipated to persist.
However, analysts from ZKB caution that prolonged tariffs could adversely affect growth and inflation. Trump is particularly sensitive to a strong dollar and declining stock prices, leading ZKB experts to believe that the trade dispute will likely de-escalate in the near future.