Tariff rollercoaster continues as China slapped with 104% levies

The curious case of the US Dollar

The reaction in currencies has not been as predictable.

The clear winners so far remain the safe-haven Japanese yen and Swiss franc, no surprises there, while the euro has also emerged as a quasi-safe-haven given its high liquid status. The best proxy globally for the Chinese economy, and the yuan, is the Australian dollar, which has been completely battered since Wednesday (down >4%).

Interestingly, the Asian currencies are holding up reasonably well and those in Latin America (that outperformed initially) have since struggled amid concerns that a growth slowdown in China could spell doom for commodity prices. Economic logic would suggest that higher US tariffs would be bullish for the dollar, not least because the safe-haven currency tends to rally during periods of heightened uncertainty and market stress.

Yet, in a break from traditional norm, this has not been the case this time around. We attribute this to both fears that the tariffs could tip the US economy into a recession (Polymarket now suggests a 59% chance of one in 2025), and the bizarre and unsound process followed to establish the amount of the tariffs, which has dented confidence in the US institutional set up.

A US recession: Inevitable or avoidable?

Forecasts for the global economy had already undergone downward revisions since Trump’s tariff announcements, and they will no doubt be subject to many more depending on where the average tariff rate ultimately ends up.

One thing we do know for sure is that the tariffs are not good news for global growth, and if the restrictions remain in place anywhere near current levels, the global outlook will be significantly worsened, not least due to the below:

1) Trade flows will contract, and the sourcing of alternate trade routes will take time.

2) Supply-chains are set to be disrupted.

3) Businesses are likely to delay investment and hiring decisions due to the tariff and economic uncertainty.

4) Lower equity valuations will likely hurt consumer spending, as individuals tighten their purse strings due to the feeling of being ‘worse off’.

While we see Asia as among the most exposed to a tariff-induced growth slowdown, the focus for now is clearly on the impact of the levies on the US economy, which will be hit by the double-whammy of not only weaker sentiment, but higher inflation. It will be very interesting to see how the Federal Reserve responds to the stagflationary risks posed by the tariffs.

We continue to think that the focus will be largely on inflation and that current market pricing (90bps of cuts by year-end) is excessive - Powell’s comments on Friday seem to suggest so.”

A very public game of chicken

We think that the direction of travel for markets from here very much depends on the progress made in upcoming negotiations.

Will Trump soften his stance on the tariffs? And will these measures be temporary?

In the past 24 hours at least, a semblance of cautious optimism has returned to markets, as investors cling onto hope that compromises can be struck that limits the severity of the tariffs. Stocks rebounded on Tuesday (the Stoxx 600 index posted its best day since October 2022) after comments from Treasury Secretary Scott Bessent, who said that some “good deals” could be reached with those countries willing to come forward and negotiate.

Yet, just when a veneer of confidence appeared to be returning to markets, the news that Trump has pushed forward with his additional 50% tariff on China (taking the tax hike to an eye-watering 104%) has soured risk sentiment once more. As of this morning, equity markets are down again, and EUR/USD has risen back above the 1.10 level.

We are of the view that deals will be struck that ultimately limit the economic damage of the tariffs. Yet, uncertainty remains sky-high, as we have little real read or indication as to where the average tariff rate will eventually land, and the timeframe for when any agreements will be reached.

Risk appetite looks set to stay fragile for the time being, and our expectation is that the safe-havens should remain well bid as long as Trump sticks to his ultra-protectionist policies. In this environment, we would expect the dollar to regain at least some of its safe-haven status. Indeed, the US Dollar Index has already clawed back the majority of its “Liberation Day” losses at the time of writing.”