Investors look likely to initially favor the US dollar, propelling it to new highs, and shun stocks after President Donald Trump carried out his threat to impose general levies of 25% on Canada and Mexico and 10% on Chinese goods starting on Tuesday, sparking commitments to retaliate from other governments.
Talk of tariffs alone has benefited the dollar since Trump’s election. Last week was its best since mid-November, with the Bloomberg Dollar Spot Index up nearly 1%. US stocks fell on Friday with carmakers and China-exposed companies leading the slide. Bond traders must decide whether to focus on elevated risk in markets or inflation concerns.
“Trade tensions may escalate in the short run as other countries are politically obligated to retaliate or mimic the US policies,” said Stephen Jen, chief executive at Eurizon SLJ Capital. “This for the shorter-term should support more dollar strength and higher US yields.”
Behind the bullish dollar position is the bet that tariffs will fuel inflationary pressures and keep US interest rates elevated, while also hurting foreign economies more than the US and adding to the greenback’s safe-haven lure. Foreign currencies get hurt as American demand declines for costlier imports.
GLOBAL REACT: Trump Tariffs Risk 1.2% US GDP Hit, 0.7% PCE Boost
“While a statement from President Trump indicating that the dollar is too strong could impact financial markets, the overall outlook remains unchanged —- tariffs and domestic inflationary pressures are likely to sustain the fundamental trend of dollar appreciation,” said Shoki Omori, chief global desk strategist at Mizuho Securities in Tokyo.
Long-dollar bets remained elevated at the end of last week. The Canadian dollar and Mexico peso could suffer anew in the coming days, while the risk-sensitive Australian dollar, seen as particularly exposed to the threat of US tariffs against China, could continue to underperform.
“We expect selling pressure to hit the peso and Canadian dollar at tomorrow’s Asia open, but it’s difficult to assess just how severe the move will be,” said Karl Schamotta, chief market strategist at Corpay in Toronto. “Financial markets may undergo a painful adjustment process in the coming weeks as participants begin to take the president seriously and literally.”
Marco Oviedo, a strategist at XP Investimentos in Sao Paulo, said tariffs are “clearly contractionary” for Mexico. With indefinite, across-the-board tariffs, the peso should be at 23 per dollar, said Olga Yangol, head of emerging market research and strategy at Credit Agricole. That’s far below the 20.67 per dollar were the peso was last trading Friday.
Net short positions on the Australian dollar, worth $4.5 billion, are now at their highest in nearly a decade. Trump has also made threats against the European Union, which could leave the euro undermined, and potentially reaching parity with the dollar as early as March, according to Mizuho EMEA.
“Navigating currency markets right now feels like trying to interpret chaos theory in real time,” said Tifo Rouane of Conyers Trust in Bermuda. “With the current surge in geopolitical tensions, policy unpredictability, and divergent economic recovery trajectories, it’s no surprise that FX markets are behaving with heightened sensitivity.”
Stock Whiplash
Traders are on alert for big swings in stock markets in sectors that are considered the front lines of any trade war. A UBS Group AG basket of stocks at risk from the proposed tariffs sank almost 4% on Friday on concerns levies would fan inflation and hit bottom lines.
Automakers such as General Motors Co. and Stellantis NV, which have global supply chains and massive exposure to Mexico and Canada, could see significant moves. Electric vehicle manufacturers Tesla Inc., and Rivian Automotive Inc. could also feel the pinch. Mentions of the word “tariffs” are already surging on earnings calls.
The Nasdaq Golden Dragon China Index, which is comprised of companies that do business in China but trade in the US, fell 3.5% on Friday.
“No matter what the negotiating outcomes are, higher tariffs and retaliation are on the horizon,” said Prashant Newnaha, strategist at TD Securities in Singapore. “Supply chain headaches are back and higher costs and higher prices beckon.”
While Trump said last week he was unfazed about the response of markets to his trade policies, Ed Al-Hussainy, a rates strategist at Columbia Threadneedle Investment, said the president had now “embarked on the riskiest tariff strategy with a high probability of retaliation.”
“I expect a tightening of financial conditions,” he said. “Think a drawdown in equities, wider credit spreads.”
Treasuries were able to eke out a gain at the start of the year amid cooler-than-forecast inflation data. But fixed income traders will need to now balance an elevation of risk in markets against the inflationary-consequences of tariffs and Trump’s bias to restricting immigration and easier fiscal policy.
The Bloomberg US Treasury index is up about 0.5% for the year. “If there is a sell off in equities I expect investors to flock to the safety of bonds,” said Subadra Rajappa, head of US rates strategy at Societe Generale. “Inflationary impact of higher tariffs could lead to higher inflation expectations and flatter curves.”
The fixed-income market faces some other challenges in the coming days. Data on jobs and inflation are looming that will help shape expectations for the Federal Reserve after policymakers paused their easing cycle last week and signaled they’re in no hurry to cut again. Also ahead, is the first Treasury refunding announcement under President Trump’s administration on Wednesday.
“Higher yields, lower risk. It would be a ‘mistake’ in our view to attach to any one view, thus the higher volatility,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. “It will be choppy for sure in rates. You name it, it’s on the table right now. And the Fed’s in no hurry to do anything now.”
--With assistance from Maria Elena Vizcaino, Michael O'Boyle and Esha Dey.
