Trade tariffs spook investors

They say a week is a long time in politics. It can be an eternity in financial markets too. A week ago, everyone was fretting about China’s DeepSeek, and the threat it poses to the dominant artificial intelligence (AI) narrative lifting markets higher. This week investors have a new, perhaps bigger thing to worry about. There’s only one story this week - tariffs.

Trade war

Unlike the DeepSeek drama, the threat of a trade war did not come out of the blue. Donald Trump has been warning us about tariffs since long before the Presidential election in November. No-one can say they didn’t expect the levies announced over the weekend.

What has taken the markets by surprise is the speed of the proposed delivery of the tariffs. They are due to come into force at midnight tonight. And levied at 25% of the value of all Canadian and Mexican exports to the US (except Canadian energy which faces a 10% hit), the scale is significant. China faces a separate 10% tariff.

The market reaction has been meaningful. Asian markets opened sharply lower, as did Asian currencies. Car makers were hard hit, with Toyota, Nissan and Honda all more than 5% lower. Other risk assets were early casualties with crypto in the spotlight. Ethereum, the second biggest coin, was 27% lower. Bitcoin fell 4%.

At the European open, the same themes continued. European car makers like BMW, Volkswagen and Mercedes were all sharply lower. They helped drag the Stoxx 600 and FTSE 100 indices down by more than 1%.

How serious is the President?

The big question facing investors is whether they should take the tariff threat seriously or view it as another - albeit high risk - negotiating ploy by this most transactional ‘Art of the Deal’ President. The tariffs have been framed as a response to border issues, both immigration and drugs, notably fentanyl.

By positioning the trade war in this way, optimists say the President has left himself an ‘off ramp’, a mechanism for de-escalating the tariff threat while still being able to claim a political victory at home. Indeed, earlier this week it seemed that Mexico and the US had quickly found a way of reducing tension after the US's southern neighbour agreed to send troops to the US border to tackle drug smuggling. The implementation of tariffs was postponed for a month.

The less optimistic view is that the threat is serious, and it will cause a big economic growth hit, both for the US and its trading partners, as well as an inflation surge in America.

That would limit the ability of the US Federal Reserve to cut interest rates further from their current 4.25% to 4.5% range. In turn that would push the dollar higher, creating problems outside the US, especially in emerging markets.

The consensus, outside the Trump administration, is that tariffs are bad news. Certainly, for investors they come at a bad time, just as the AI narrative is reeling from the DeepSeek blow a week ago. The risk is that the combination of the two unnerves investors, already fretting about the durability of the bull market.

Silver lining

At times like these it is important to view the threat to markets in context. January closed out on a high. Global shares rose by 3.4% during the month, with the S&P 500 up 2.8% and the equal weighted version of the same index up 3.5%.

Part of the market’s strength is down to another positive earnings season. We are currently about 40% of the way through the fourth quarter reporting round and 80% of the companies to have announced so far have beaten expectations. This side of the market equation remains intact.

Valuations remain a concern, with US shares currently standing at a 70% premium to those in the rest of the world, on the basis of the ratio of share prices to earnings. Even here, though, it is possible to argue that this is justified by America’s better productivity and profitability. Soon, we will get the latest update on the US labour market, and it is expected to show another 170,000 new jobs were created in January, in line with the past three-month average.

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Please note that the views expressed in this article are my own.