Trump's trade war salvo only the start of market pain
The US President's weekend orders for additional levies of 25% on imports from Mexico and most goods from Canada, as well as 10% on goods from China, jolted markets that had assumed Trump was mostly bluff and bluster
Financial markets that had bet trade wars could be avoided are reassessing 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% on imports from Mexico and most goods from Canada, as well as 10% on goods from China, jolted markets that had assumed Trump was mostly bluff and bluster.
Trump said he would speak on Monday with the Canadian and Mexican leaders, who have announced retaliatory measures, but downplayed expectations they would change his mind.
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China, where Monday is a holiday, said it would challenge Trump's tariffs at the World Trade Organization 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.
Mexico's peso hit its lowest in nearly three years, the euro briefly slid over 2% at one point, and China's yuan tumbled in offshore trade.
Stock markets from Tokyo to London slumped over 1% while US equity futures pointed to hefty falls on Wall Street later. US and European stocks had hit record highs just last month.
"Markets were a little complacent in wanting to believe that some of the threats wouldn't be carried through," said BlueBay Asset Management's chief investment officer Mark Dowding.
"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 and Mexico's economies are at risk of recession, some analysts reckon, while the euro zone economy faces further stagnation if tariffs hit it.
Investors are also rethinking the monetary policy outlook as tariffs risk raising US inflation.
They pared back their bets on Fed interest rate cuts and now price in 38 bps of reductions by year-end. That means around a 50% chance of two cuts, compared with the high chance priced in on Friday.
With Europe still firmly in the firing line, traders slightly increased bets on European Central Bank rate cuts, now pricing in around 85 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 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 10% tariff would curb growth by 0.3 percentage points over a year unless the euro declines by as much, while a 20% tariff could halve euro zone growth from around 1% expected for this year.
'Tit-For-Tat'
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.
JPMorgan said that without a prompt resolution, the Mexican peso could eventually depreciate between 8%-12% against the U.S. dollar, while the Canadian dollar could drop another 2%.
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 on Monday.
If markets move to price in the ECB cutting interest rates to 1.5%, compared to current expectations of roughly 1.85%, 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 ones also looked vulnerable as analysts expect a drag on US company earnings.
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.
"There's no way to move institutional money that fast. By the time you figure out what you want to buy and sell he (Trump) may changed things again."
