Tariffs, economic brinksmanship and the markets

In his first month back in office, Donald Trump has embarked on multiple opening salvos of a trade war. What does this more aggressive approach to international trade mean for U.S. equities—and investors? It’s complicated. 

While Trump campaigned on the idea of a universal 60% tariff, his initial actions suggest a more targeted strategy. The administration announced 25% tariffs on Mexico and Canada, alongside an additive 10% on China, citing national security concerns and an attempt to address bilateral trade deficits. Notably, Canadian energy exports were given a lower 10% tariff rate. Initially set for February 5th, enforcement has been delayed by a month following discussions with Mexican President Claudia Sheinbaum and Canadian Prime Minister Justin Trudeau. 

Retaliatory measures were swift. Canada responded with 25% tariffs on $107 billion worth of goods, spanning industries such as spirits, fruit, clothing, and plastics. Mexico announced plans for countermeasures but withheld specifics. Meanwhile, China retaliated with tariffs on LNG, coal, farm machinery, and critical minerals while launching an investigation into Alphabet’s China practices. 

In a further escalation, the Trump administration is now considering “reciprocal” tariffs, which would match duties imposed on U.S. goods by foreign nations. This could have broad implications, particularly if the administration moves forward with invoking section 338 of the Trade Act of 1930, which allows the President to impose up to 50% duties on imports from countries that discriminate against U.S. commerce. While this approach aims to counter foreign trade barriers, it risks upending existing trade agreements and provoking further retaliation. 

It also hasn’t helped that the administration has introduced new tariffs on steel and aluminum, affecting key suppliers like Canada and Mexico. These measures threaten supply chains and could disrupt industries such as automotive and construction. The European Union has signaled potential countermeasures, with Germany pushing for negotiations while preparing retaliatory tariffs if needed. 

The stakes are high, given that China, Mexico, and Canada are the U.S.’s three largest trading partners. China, as the world’s manufacturing hub, faces tariffs at a precarious time when its economy is already grappling with deflationary pressures. Canada is a major supplier of U.S. energy and critical minerals, making any disruption potentially inflationary. Mexico, central to U.S. outsourcing and manufacturing, plays a crucial role in sectors like automotive production, where vehicles frequently cross the border multiple times before final assembly. 

The economic consequences of all this could be severe. If the 25% tariffs are enforced, both Canada and Mexico could slide into recession in a matter of months due to declining demand and reduced investment. China, already facing a slowing economy, will likely see further strain as tariffs erode its export-driven growth model, making its transition to a domestic-led demand even more challenging. In the U.S., consumers will face the effects through increased costs for fuel, utilities, clothing, and other essential goods. 

The market reaction has been rocky, with the foreign exchange market offering the purest reflection of trade war concerns. The Mexican Peso (MXN), Canadian dollar (CAD), and Chinese yuan (CNY) have all weakened against the dollar, highlighting fears over economic instability. A stronger dollar could further pressure emerging markets by tightening financial conditions and increasing dollar-denominated debt burdens. Meanwhile, equities have shown mixed reactions, with sectors reliant on global trade underperforming. 

Given this backdrop, we anticipate heightened market volatility is here to stay. While we remain invested in U.S. large-cap equities, we are shifting to a slightly more defensive posture, favoring value over growth and reducing our overweight to equities. Investors should remain vigilant, as the long-term implications of these policies remain uncertain and may significantly impact global supply chains, corporate earnings, and overall economic growth. 

Arjun Kaushik contributed to this article.