The dollar is losing altitude once again after Donald Trump reignited trade tensions with a fresh round of tariff threats, unsettling global markets and complicating the outlook for monetary policy. Trump sent letters to 14 countries last night—including close allies and key trading partners Japan and South Korea—threatening them with the reimposition of tariffs from August 1, and more are expected today. The greenback is sitting on losses equivalent to roughly half of yesterday’s gain, Treasury yields are up across the curve, equity futures are pushing lower ahead of the open, and the Canadian dollar, Mexican peso, and euro are all advancing amid choppy trading conditions.
The dollar climbed briefly yesterday afternoon as Trump published the series of nearly-identical missives on his social media feed, setting out an updated tariff schedule that appears to be based on the original, widely-derided formula (the bilateral US deficit with each country, divided by that country’s exports to the US), and saying that the levies are designed to reduce persistent trade imbalances. Tariffs for Japan, Kazakhstan, Malaysia, South Korea, and Tunisia were set at 25 percent, South Africa and Bosnia and Herzegovina at 30 percent, Indonesia at 32 percent, Bangladesh and Serbia at 35 percent, Cambodia and Thailand at 36 percent, and Laos and Myanmar at 40 percent. According to the White House, these “reciprocal” tariffs won’t be applied to products that are covered under separate national-security tariffs, which currently hit steel and aluminum imports with a 50-percent tax, and automobiles with 25 percent.
Another round of tariff increases could complicate the Federal Reserve’s path. Chair Jerome Powell, speaking last week, noted that rates “would likely be lower” were it not for the expected pass-through from tariffs into consumer prices. While inflation has eased in recent months, household expectations remain elevated, and any reacceleration in import costs could delay the Fed’s first rate cut until late autumn—or beyond. Market pricing now reflects a roughly 65 percent chance of a cut in September, down from 90 percent at the start of July.
But investors are not backing off the TACO (Trump Always Chickens Out) trade. Trump signalled he was open to negotiation yesterday: he signed an executive order pushing his tariff deadline out to August 1, extending a pause that was previously scheduled to expire on Wednesday, his letters say “we will, perhaps consider an adjustment” if countries open their markets to US goods, noting that “these tariffs may be modified, upward or downward, depending on our relationship with your Country,” and in a later interview, he called the August 1 deadline “firm, but not 100-percent firm. If they call up and say we’d like to do something a different way, we’re going to be open to that”.
Market participants overwhelmingly expect the administration to keep kicking the can down the road. Although heightened uncertainty levels will unquestionably take a meaningful toll on business investment in the near term, Trump is seen raising effective tariff rates incrementally—perhaps ending the year around the 15-percent threshold—while stopping short of inflicting a devastating supply shock on the American economy. Equity indices are off marginally as traders brace for a modest hit to corporate profitability, fixed income markets haven’t suffered a major realignment in long-term expectations, and implied volatility levels are well within historical norms. This might ultimately prove ill-advised—relatively placid markets may induce more policy extremism from the president—but for now, sentiment indicators are pointing to more risk-taking from investors.
Interestingly, the European Union did not receive a letter, suggesting that the administration believes it is close to reaching an understanding with European leaders. After months of negotiation, no one expects a comprehensive settlement by tomorrow—despite the administration’s earlier commitment to “90 deals in 90 days,” it typically takes several years to conclude a single, legally-binding trade agreement—but observers expect a high-level agreement-in-principle to emerge from talks in the near term.
We are unsure as to the exact shape that this might take, but suspect that the Trump administration’s 10-percent “baseline” tariff will remain in place, and that the European Union could join the US in imposing additional trade restrictions on China. Echoing our own perspective on the matter, European Commission President Ursula von der Leyen earlier today stepped up her rhetoric against Chinese trade imbalances, telling the European Parliament “If our partnership is to move forward, we need a genuine rebalancing—fewer market distortions, less overcapacity exported from China, and fair, reciprocal access for European businesses in China”. “China invested early in many of the technologies of the future,” she said. “But then it started flooding global markets with cheap, subsidised goods, to wipe out competitors”. Monthyly data from the (smaller) euro area shows this clearly, with the bloc’s trade surplus against the US increasingly offset by its deficit with China.
Tariffs on China could expose the euro to some of the same economically-deletrious dynamics that have weighed on the dollar in recent months. Positioning in the currency options markets remains overwhelmingly skewed toward further gains over the next year, but it is worth considering the risk of a shift in sentiment, with traders potentially becoming much less bullish in the event that trade hostilities escalate and growth expectations slide.
