LONDON/SINGAPORE/NEW YORK (Reuters) – Financial markets that had banked on avoiding trade wars are recalibrating the possibility of a sharp global slowdown, rekindled inflation and a pause to Federal Reserve rate cuts after Donald Trump declared tariffs on top U.S. trading partners.
The U.S. 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.
The initial risk-off reaction abated after Trump on Monday said he would pause new tariffs on Mexico for one month and engage in further negotiations. Later in the day, the U.S. also postponed tariffs on Canadian imports.
Trump, the self-declared “tariff man,” had been telegraphing his intentions for months, so some of the news may have been priced in. Plus, he is a dealmaker with a history of changing tack when he gets what he wants from trading partners. With no one sure what is coming next, volatility should remain elevated.
“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 and Canadian Prime Minister Justin Trudeau, who had announced retaliatory measures, spoke on Monday afternoon.
Trudeau said in a post on X that Trump will postpone threatened tariffs on Canadian imports for at least 30 days, lifting the Canadian dollar to its high of the day against the greenback.
China, where Monday was 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 U.S. currency. The Canadian dollar ended up on the day at C$1.4428 per U.S. dollar.
Mexico’s peso hit its lowest in nearly three years but reversed after the tariff pause was announced and jumped 1.35% versus the dollar at 20.406.
Pramol Dhawan, Head of EM Portfolio Management at Pimco, said Mexico is poised to emerge as a net winner in the longer term, despite the turbulence. He highlighted the Mexican government’s decisive move to align with the U.S. by restricting Chinese textile imports and its intensified operations to tackle migration, fentanyl and drug trafficking.
“Unlike with the first Trump administration, there’s no longer an element of surprise; Mexican authorities are ready to negotiate and collaborate with the US,” Dhawan said.
The euro, which briefly slid over 2%, was last off 0.49% and China’s offshore yuan rose 0.05% against the greenback.
Stock markets from Tokyo to London slumped, although U.S. and European markets pared declines after the tariff pause was announced, with the Dow Industrials briefly moving into positive territory. U.S. 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.
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 U.S. inflation.
Boston Federal Reserve President Susan Collins said on Monday the type of tariffs announced by the administration may drive up inflation, while Atlanta Fed President Raphael Bostic said the high degree of uncertainty around tariffs and other policies has made a cautious approach to further rate cuts appropriate.
Market expectations for a cut of at least 25 basis points at the Federal Reserve’s June meeting were scaled back to 60.6% from 66.9% in the prior session and 76.9% 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.
“It’s one of the things that we’re going to have to live with, these swings back and forth,” said Keith Lerner, co-chief investment officer at Truist Advisory Services in Atlanta.
“Some of these will go deeper and longer because in order for people to take these tariffs seriously, at some point you have to apply some of them, otherwise they are going to call your bluff.”
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 U.S. 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.
On the debt capital markets side, an executive who asked not to be named said deals closed on Monday with no change to terms, as markets considered the risk of tariffs being enacted for a long time as very low.
“If they last for weeks or for days, there will be no effect. But if tariffs last consistently for eight, nine months (they) would have a much larger impact and even create a recession,” the person said.
Markets have become much more used to working with higher levels of volatility, the executive said, without shutting down as in past crises.
‘TIT-FOR-TAT’
The outlook for currencies other than the U.S. 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 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 U.S. equities, also looked vulnerable as analysts expect a drag on U.S. company earnings while the benchmark S&P 500 index sits at a high valuation.
Morgan Stanley Chief U.S. 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.
The S&P 500 closed down 0.76%, after falling as much as 1.9% during the session.
Even with the brief tariff reprieve, 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.
“By the time you figure out what you want to buy and sell he (Trump) may (have) changed things again.”
(Reporting by Tom Westbrook, Yoruk Bahceli, Dhara Ranasinghe, Naomi Rovnick and Chuck Mikolajczak; Editing by Jacqueline Wong, Vidya Ranganathan, Dhara Ranasinghe, Alden Bentley, Catherine Evans, Rod Nickel, Deepa Babington and Nia Williams)
