Trade War Intensifies as New Tariffs Shake Markets
The US administration implemented fresh tariffs yesterday, raising duties on most Canadian and Mexican imports to 25% and doubling the tariff on Chinese goods from 10% to 20%. The response was swift—Canada unveiled a phased tariff plan affecting roughly $100 billion in US exports, Mexico is expected to introduce similar measures by week’s end, and China imposed tariffs of up to 15% on select US products.
Investors had previously downplayed tariff risks, reassured by Trump’s repeated delays and policy adjustments. However, this latest escalation signals a worsening in trade relations, amplifying concerns over a potential US recession. Investors have taken note, increasing the odds of the US economy contracting for two consecutive quarters this year from 23% last week to 37% today. Fixed-income markets reflect this shift as well, with traders now fully pricing in three Federal Reserve rate cuts before year’s end.
GBP
The British pound is climbing sharply against the US dollar as weaker US economic data erodes the narrative of American economic superiority. This shift has narrowed the performance gap between the US and other economies. GBP/USD has surged past both its 200-day and 200-week moving averages, approaching the $1.28 mark this morning—right in line with its five-year average and nearly 6% above its January low of $1.21.
With key resistance levels breached, market sentiment around GBP/USD has flipped from bearish to bullish. A pullback was initially expected before a rebound, but Trump-era trades appear to be unwinding faster than anticipated, and the dollar's tariff-related risk premium is rapidly diminishing. Investors are now shifting their focus from inflationary concerns to potential growth risks in the US. Meanwhile, expectations for UK interest rates suggest they may remain elevated longer than previously thought. Bank of England Governor Andrew Bailey recently projected four rate cuts in 2025, but persistent consumer price pressures and private sector wage growth could delay the timeline.
EUR
The Federal Reserve’s shift toward a more accommodative stance has propelled the Eurozone-US real rate differential to its highest level since September—an impressive rebound from its one-year low in December, just weeks before EUR/USD hit a two-year low. This changing landscape suggests the euro may have further upside potential in the coming weeks, moving closer to its fair-value range based on real rate differentials. Adding to the momentum, reports from Brussels indicate that the EU’s plans to increase defence spending could bolster economic growth prospects and temper expectations for aggressive European Central Bank (ECB) rate cuts.
As the ECB convenes on Thursday, markets have already priced in a 25-basis point rate cut. However, policymakers may tweak their messaging, signalling that additional rate reductions beyond March are no longer a certainty. Such a shift could prompt markets to reassess their outlook on future cuts, strengthening the euro’s position and fuelling further gains.
The saga continues
The US dollar is likely to face continued pressure throughout the remainder of the week. Market participants are closely monitoring trade developments, economic indicators and geopolitical tensions with on-going peace talks with the Russia/Ukraine conflict, all of which could influence the dollar's trajectory in the short term.
