Trump’s tariff grenade hits the global economy

There has been a big response from financial markets to the reciprocal tariff announcement in the US. European equities are lower across the board, the Eurostoxx index is down 2% and the FTSE 100 is down 1.2%. Asian stocks were mixed. The Nikkei was lower by 2.77%, the Hang Seng fell by 1.7% and the Vietnamese stock index fell more than 6%, as its economy received one of the highest levies from the US. There have been big declines for crude oil, Brent crude is lower by 3%, even though oil was exempt from most of the US tariffs, and the gold price is also down a touch on Thursday.

Bond yields crumble as tariffs throw hand grenade into global economy

The bond market is a big winner. Yields are falling sharply everywhere. The UK and European 2-year yields are lower, as the market rushes to price in rate cuts from the ECB and the BOE, as central banks are likely to step up to ease some of the pain from the US’s new global trade policy. 10-year yields are also lower, for example the 10-year Gilt yield in the UK is down 6bps so far on Thursday. The UK yield curve is flattening, which is a sign that bond investors are pricing in the chance of a recession. US yields are also lower, but not by the same amount as Europe, suggesting that bond investors could be worried about the inflationary impact on the US economy.

Shipping stocks take a knock

The decline in the oil price is another sign of fears about global growth, this is also reflected in the sell off in shipping stocks. Freight rates are also tumbling, as the shake up in global trade is likely to have major repercussions for ocean freight container prices, especially from Asia to the US.

European stock market outlook

There are many themes that are playing out in financial markets right now. The hardest hit sectors in Europe include industrials, tech, consumer discretionary and financials. The sell off in tech, industrials, and consumer discretionary can be explained by their exposure to global growth and global supply chains, while financials in Europe are selling off as the prospect of deeper rate cuts by the ECB could knock the banks’ net interest income in the coming months.

Adidas, DHL, BNP Paribas, UniCredit and Banco Santander are some of the biggest decliners in the European market right now. There are also heavy losses for the luxury sector. Markets are down, but they are not out. Investors are still seeking out areas of safety, including utilities, real estate, healthcare and consumer staples, which is helping to prop up some European indices including the Eurostoxx index and the FTSE 100. Real estate is holding up well in the face of tariffs, even if materials are under pressure. If interest rates fall sharply, then this could boost the sector, and UK homebuilders are key outperformers on Thursday.

Europe vs the UK

The impact of US tariffs is shifting the dynamics between UK and European stocks. The UK is subject to 10% tariffs, while the EU is subject to 20%. This could lead to some arbitrage opportunities. For example, in the FTSE 100, Next and Diageo are some of the top performers on Thursday, even though Diageo has a large export market to the US, and Next has a global supply chain. In contrast, in Europe, jewellery maker Pandora and Adidas are both down sharply on Thursday at 11% and 9% respectively. This suggests that investors might be favouring UK apparel makers in favour of European brands due to the lower tariff rate in the UK. Added to this, drinks maker Diageo is also outperforming today, and its stock price is up nearly 3%, vs. a 1.4% increase for Pernod Ricard in France. This suggests two things, 1, that the market thinks booze sales could be relatively unscathed by Trump’s tariffs, and 2, that UK drinks companies could be better positioned than their European counterparts.

Tariffs: The FX impact

Donald Trump’s trade weighted tariff rate of more than 20% is wreaking havoc on global trade, it is also sinking the dollar. The yen and the Swissie are attracting strong safe haven flows on Thursday. Although Europe’s stock markets are selling off and yields are tumbling, the euro is higher vs. the USD, and is higher than the pound, even though the UK is subject to lower tariffs compared to the EU. EUR/USD is higher by more than 1% and is above $1.0950. The pound is also higher, and has broken through the $1.30 barrier, it is currently trading at $1.3130. The pound may start to look like a safer corner of the FX market in the future, since the UK economy could feel the effects of tariffs less intensely than elsewhere. However, that is a theme that could play out in the coming months.

The risk for the euro is that announcements regarding retaliatory tariffs from the EU could knock sentiment towards the single currency, so we could see some FX volatility in the coming days, and EUR/USD 1-month volatility is at its highest level for more than a month.

The euro could be catching a bid on Thursday, as the market rushes to price in rate cuts from the ECB. This could protect euro area growth in the long term. There has been a rapid recalibration in European rate expectations, including an 88% chance of a rate cut in April and a 74% chance of a cut in May. Rates are now expected to fall below 2% in the middle of the year. This could protect the Euro area from the worst of the US tariffs. In contrast, the market is not expecting the Federal Reserve to react as intensely to the tariffs. There are three cuts priced in for this year, but by year end, US interest rates are expected to be significantly higher than the Eurozone’s at 3.5%.

Trump’s tariff grenade hit the global economy

Overall, stocks are down around the world, but these are not traditional panic moves, suggesting that there is still some expectation that deals can be cut to reduce some of the impact from tariffs. The FX market is not moving on the back of yield differentials today, instead it is moving on the back of growth outlooks after the US trade policy threw a grenade into the global economy.