Currency markets are headed for another bruising open when trading begins in Asia tomorrow afternoon after President Donald Trump delivered another set of letters threatening to impose higher tariffs on Mexico and the European Union. In two missives posted to his social media platform, the president said taxes on imports from two of America’s most important trading partners would rise to 30 percent on August 1, separate from other sectoral tariffs on products like steel, aluminum, and automobiles.
In his communication to President Claudia Sheinbaum, Trump acknowledged “Mexico has been helping me secure the border,” but said “what Mexico has done, is not enough. Mexico still has not stopped the Cartels who are trying to turn all of North America into a Narco-Trafficking Playground”.
To President of the European Commission Ursula von der Leyen, Trump said “We have had years to discuss our Trading Relationship with The European Union, and have concluded that we must move away from these long-term, large, and persistent, Trade Deficits, engendered by your Tariff, and Non-Tariff, Policies and Trade Barriers. Our relationship has been, unfortunately, far from Reciprocal”.
To both, the president said “These Tariffs may be modified, upward or downward, depending on our relationship with your Country*”.
To some extent, foreign exchange traders were prepared for such an action—the US dollar appreciated against the peso, the euro, and most other major currencies through much of the last week as participants hedged against the possibility that more draconian measures could be taken—meaning that today’s action could be, to a large extent, priced in. But we suspect that most traders anticipated tariffs between 15 and 20 percent—not the 30-percent level that has been proposed. This suggests that a flurry of position adjustment could take place and drive both the peso and euro lower amid thin trading conditions tomorrow afternoon—at least until the shock wears off and the dollar resumes its longer-term decline.
More broadly, we are increasingly convinced that tariff risks have not been appropriately discounted in financial asset prices. Lags in supply chains and pricing methodologies have thus far obscured the impact on the US economy, front-running effects have artificially lifted growth numbers in major trading partners, and the president’s repeated climbdowns have lulled investors into a false sense of complacency. Stock markets look too high, foreign exchange trading ranges too narrow, and measures of background volatility too low, given the material threat that looms over the world economy.
A moment of reckoning is approaching, whether in markets themselves, or in the White House, when the true impact of America’s turn toward isolationist policies hits home. We don’t know who will blink, but someone will.
*Yes, that is how the letter to the 27-member European Union really reads.