Trade Wars 2.0

Global markets

Global equities pulled back last week reflecting lingering concerns over the AI outlook, but also Friday’s announcement that the US would impose new tariffs on key trading partners. 

Global equities are facing an onslaught of challenges at present. First came sticky US inflation and news that the Fed is in no hurry to cut rates further. Then came the DeepSeek shock, which has raised question marks over US tech valuations once again. Then on Friday came what markets have long dreaded: significant new tariffs on key trading partners and the start of Trump Trade Wars 2.0.

Countering these negatives are the resilience of US economic growth and corporate earnings (at least for now) and reasonable hopes – prior to the new tariffs – that US inflation would likely fall further. The near-term outlook is messy to say the least, and the risk of a deeper correction in equity markets has escalated.  

So what’s at stake? Trump has proposed a 25% tariff on both Mexican and Canadian imports (though only 10% on Canadian energy imports), with a 10% extra tariff on Chinese imports. As it covers more than just China, the increase in the average effective US tariff is up to five times larger than in 2018-19 – which was also a time when US inflation was of less concern.

This time around, a new concern is that Trump seems to see tariffs as a way to raise revenue to fund tax cuts – rather than a temporary negotiating tactic against trade partners.  

Canada and Mexico account for around 15% of US imports, and China around 17%. Energy accounts for 30% of Canadian exports to the US. In turn, imported goods account for around 10% of US consumption. So the effect of these tariffs – if fully passed on to consumers – would be to raise consumer prices by a chunky 0.8%.

Given current solid US consumer spending and customer familiarity with rising prices in recent years, conditions have rarely been better for importers to be able to pass on these tax increases to consumers (despite what Trump says). What’s more, the evidence from the Trump trade war of 2018-19 was that a good chunk of the – more limited – tariff increases were passed on into prices. So it’s reasonable to expect a lift in prices of perhaps around 0.5%, which would severely threaten the hope of further US disinflation and Fed rate cuts this year.  

All this is not considering the inevitable counter-measures – with all three major trading partners vowing retaliation.     

One potential inflation offset, of course, would be a rise in the US dollar and a weakening in US economic growth. If the growth outlook became weak enough the Fed could still cut rates this year – but for bad rather than good reasons.  

In other news last week, the US Fed kept rates steady and the Europe Central Bank cut rates 0.25% – both as expected by markets.  

Global week ahead

A key focus this week will obviously be tit-for-tat exchanges on the trade war front. How significant will retaliation be? Will Trump suggest room for negotiation or instead ratchet up the pressure? Sadly, it may take a deeper equity market correction for Trump to change his mind. 

Also of note this week will be Friday’s US January payrolls report, with another solid employment gain of 170k expected. In Europe, the January CPI inflation report will guide thinking on when the ECB can next cut interest rates.  

Global market trends

In terms of global trends, so far this year we’ve seen a pull-back in the relative performance of the NASDAQ-100 and global growth over value, replaced by a lift in Europe’s relative performance.  

Australian market

Local stocks enjoyed a bounce last week – helped by a lower-than-expected inflation report – though have been hammered this morning in the wake of the new trade war threat. 

First the good news. As I suggested last week, the Q4 CPI did surprise on the downside, with annual trimmed mean inflation slowing to 3.2% from 3.5% in Q3. Less widely reported, the monthly trimmed mean annual inflation rate dropped to 2.7% in December from 3.2% in November. 

All up, this was enough for me to think the RBA will cut rates this month, and the market – and now most economists – agree.

My base case is that at this stage new global trade war risks don’t threaten this month’s likely RBA rate cut. Though a trade war is potentially inflationary to the extent the $A weakens further, more than likely offsetting this risk for the RBA are new downside concerns with global and local economic growth if the tariff fight escalates.    

There’s a smattering of local data this week, including retail sales today. Sales are expected to drop back in December after Black Friday-driven strength in November. 

Have a great week!