Markets tumbled on Monday after President Trump hit Canada, Mexico and China with sweeping tariffs. Canada immediately announced it would retaliate with both tariff and non-tariff countermeasures targeting more than $100 billion of American goods. The Chinese and Mexican governments have also vowed to respond – despite US threats that retaliation will result in escalation. President Trump has also stated his intent to issue steep tariffs on the European Union, signalling this could just be the start of a lengthy and far-reaching trade war.

On Monday morning shares across Europe and Asia were down, while the Canadian dollar fell to its lowest level in more than two decades. Investors are bracing for volatility in US markets where an extended period of growth could be rudely interrupted by the prospect of an all-out trade war. With international trade set to be stunted, the knock-on effect on economies around the world could be serious.

Investors warned over trade war risks

For investors, a trade war can pose very real risks. The interconnectedness of global trade means sectors across the board are likely to be caught up in volatility as a result of supply chain disruption. But as in any war, there will be winners and losers, with some industries poised to benefit from protectionist policies. Finance chief Nigel Green urged investors to act now to seize opportunities and mitigate risk. Speaking on Monday, he said:

“This was entirely foreseeable. Yet, too many market participants buried their heads in the sand, convinced that the worst wouldn’t materialise. Now, the consequences are here, and investors need to act—fast. “Trump’s tariffs are having an impact across asset classes, from equities to bonds to commodities. The bet is that tariffs will stoke inflation and force central banks to maintain or even hike rates. This is a dangerous game.”

Mr Green, who heads up one of the world’s leading independent financial advisory firms, shared his view on where opportunities might be found amid the volatility. He said:

“The markets will remain highly reactive in the coming days and weeks. Investors must position themselves strategically to mitigate risks and seize opportunities as assets reprice.

“European banks appear inexpensive. At the same time, they have dropped the Euro because they dropped interest rates in Europe, which gives them a competitive advantage.

“In other places like defence stock which again are going to increase in value. Gold is continuing to do well, there are other investments right now but it’s not the time for being risky.”

Markets slide on trade war news

US stock market futures fell on trade war news with the Mexican peso and Canadian dollar tumbling. European stocks slid in anticipation not just of the fallout but in fear of the EU becoming the next target of Trump’s tariffs. US automakers, which rely on parts imported from plants in Mexico, were among the biggest losers on Monday, CNBC reported, with General Motors down 7 per cent.

Similarly, European carmakers were left reeling, with the prospect of tariff barriers on the lucrative American marketplace compounding existing troubles which have seen a number of big-name German carmakers issue profit warnings in recent months. On Monday shares in BMW, Volkswagen and Porsche were all down.

The UK stock exchange was not spared from the turmoil, with the FTSE 100 on track for its worst one-day performance in months. Although the US President has indicated the UK won’t become party to the trade war, business is nervous about soaring energy prices and wide reaching inflationary pressure.

Ahead of US markets opening on Monday investors were braced for impact after an early selloff and falling stock futures across the board. Investors are now expecting interest rates to remain higher for longer, pushing the dollar to a two-year high. As Bloomberg reported:

“Driving the rally in the dollar is the expectation 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. Fears the action will stoke price pressures also spurred a rise in two-year US Treasury yields.”

Crypto was also caught in the crossfire, with Bitcoin falling to almost $92,000 from its seven-day high of $105,000. Bernstein analyst Gautam Chhugai said in a note the sell-off was ‘not unexpected’ and would be ‘short-term’ in a note.

After market opening the Dow Jones fell 1.25 per cent, the S&P 500 was down 1.5 per cent and the Nasdaq was down 2 per cent in early trading. In comments to the AP, Yung-Yu Ma of BMO said the fallout could just be the ‘tip of the iceberg.’ He said:

“The uncertainty at this stage is tremendous – not only of how these eventual negotiations will play out but worries about how this is only the tip of the iceberg and more tariffs are on the horizon,”

Who will win the trade war?

If the history of war is anything to go by, it is more likely than not that this trade war will be brought to a halt by a settlement, rather than be fought to the bitter end. In public at least, President Trump has not set out specific conditions for the tariffs to be lifted, but rather has complained about the travel of illegal migrants and drugs – the latter he says emanate from China – across America’s land borders.

The President has also taken issue with the USA’s trade deficits with many of its major trading partners, which sees cars from the EU, goods from China and machine parts from Mexico enjoy the benefit of the US internal market – while denying US exporters the same access to their own markets.

While the new tariff schedule will hit many American businesses and consumers in the pocket, the US can more easily endure the trade shock than the retaliating parties. The Canadian economy relies on trade, with two-way trade accounting for more than two-thirds of the country’s GDP in 2023.  An enormous 77 per cent of Canadian exports are sent to the USA – with no other country in the world accounting for more than 5 per cent of Canadian exports, according to a report from Scotiabank. On the other hand, just 17 per cent of US exports are sent to Canada.

The Canadian economy is smaller than the economy of Texas, and the country relies on selling energy, machine parts and raw materials like lumber and iron to the USA. Put simply, import duties on Canadian goods would mean higher prices for Americans – but a potential crisis for Canada. The US internal market of more than 330 million people is, its President has wagered, large enough to absorb much of the product which would ordinarily go to export. Canada’s population of 40 million is not.

Similarly, more than 80 per cent of Mexico’s exports went to the US last year, while US exports to Mexico accounted for just 15 per cent of total exports. In 2022 16.2 per cent of Chinese exports were sent to the US, while just 7.5 per cent of US exports were sent to China. With regard to the EU, 20 per cent of its exports went to the US in 2023, while 17 per cent of US exports travel the other way. While that margin is slimmer, it’s worth considering the population of the EU is around 120 million larger than the US.

Altogether that would mean if Mexico, Canada, China and the EU retaliate with like-for-like tariffs the US could face additional duties on around half of its exports. However, in 2023 just 11 per cent of US GDP came from exports whereas the economies of Mexico Canada and China are export-driven. So, while the US won’t come out unscathed from a trade war, it won’t suffer as acutely as Canada for example.

What are the benefits of tariffs?

Tariffs, or import duties, make imported products more expensive. Inflating the price of goods naturally involves many obvious downsides, such as creating inflationary pressures and inefficiencies in the marketplace. But are there any benefits to imposing tariffs?

Tariffs aren’t all downside, otherwise, Canada and Mexico would not be retaliating against tariffs with tariffs of their own. In many modernised economies, the cost of regulation, labour and raw material means many industries are unable to compete with developing economies. Countries with little regulation and low wages are often able to produce goods and ship them around the world cheaper than they can be made in a country like the US or UK.

Since the free market will look to maximise profits and minimise costs, buying materials like steel from China or energy from Russia are obviously attractive options. But this can mean domestic industries suffer and eventually collapse. Besides the immediate impact on jobs and communities, there is a strategic interest in, for example, maintaining a domestic steel industry, for both its essential civilian and military applications.

The German example is instructive on the risks of outsourcing a strategic sector. The European manufacturing powerhouse wagered it could beat off industrial decline by closing down its power plants in favour of importing gas from Russia, figuring the cheap energy would afford a comparative advantage to its manufacturing industry. However, Russia’s invasion of Ukraine left Germany uniquely exposed to high energy costs and its manufacturing sector is now in steep decline as a result.

So, while tariffs can make materials and products more expensive for businesses and consumers, they can offer a longer-term strategic value. By artificially making imported goods more expensive, foreign imports become less competitive and domestic industries can be shored up. As Jamie Dimon said in a recent interview with CNBC “If it’s a little inflationary but good for national security, so be it.”

However, analysts have been surprised at how broad-based President Trump’s tariffs have been. Rather than targeting tariffs at specific industries, the US is imposing near blanket tariffs on a number of its major trading partners. Rather it would appear the US is trying to create a maximally enticing environment for foreign companies to set up shop in the US – while also trying to inflict pain on its neighbours to meet its demands over border security. President Trump has already outlined his plans for a 15 per cent corporation tax for companies which make their products in the USA, which together with tariffs could be seen as a two-pronged approach to prevent firms from setting up in neighbouring Mexico and shipping their goods over the border, as has become increasingly common in recent years.

What does a trade war mean for investors?

The imposition of sweeping tariffs by President Trump on imports from Canada, Mexico, and China has precipitated significant upheaval in global financial markets. The U.S. is set to enact 25 per cent tariffs on almost all Canadian and Mexican imports and 10 per cent on Chinese goods. In response, Canada has announced retaliatory measures targeting over $100 billion worth of American goods, while China and Mexico have also vowed to implement counter-tariffs.

As of Monday, it was reported Mexico won a temporary reprieve after it committed to deploy 10,000 National Guard soldiers to its border with the US. The tariffs are now set to be delayed for one month while negotiations continue.

In Europe, the pan-European STOXX 600 index fell by 1.3 per cent, marking its most significant one-day decline this year. Major European car manufacturers, including Volkswagen, Stellantis, Toyota, Honda, and BMW, experienced substantial stock losses. In the U.S., the S&P 500, Nasdaq, and Dow Jones indices were all down. Asian markets were not spared, with indices such as Japan’s Nikkei 225 and South Korea’s Kospi closing significantly lower.

Analysts express concern that these tariffs could exacerbate inflationary pressures in the U.S., potentially leading to higher consumer prices and influencing Federal Reserve monetary policy. The interconnected nature of global supply chains means that trade disruptions can have cascading effects across various sectors, from manufacturing to technology. The automotive industry, for instance, is particularly vulnerable due to its reliance on cross-border supply chains. The broader economic implications are significant. For countries like Mexico and Canada, which have substantial portions of their exports destined for the U.S., these tariffs could lead to economic slowdowns or even recessions. In the U.S., while certain domestic industries might benefit from reduced foreign competition, consumers could face higher prices, and businesses that depend on imported components may see increased costs.