Trump shocks markets with Mexico-tariffs

Right when market sentiment was likely least capable of coping with it, US President Donald Trump shocked the financial world on Friday by announcing his intention to slap tariffs on the US’s number-one trading partner, Mexico.

Mexico tariffs shock traders

Right when market sentiment was likely least capable of coping with it, US President Donald Trump shocked the financial world on Friday by announcing his intention to slap tariffs on the US’s number-one trading partner, Mexico. The basis of the decision was explained as a retaliation to Mexico’s accused inaction on managing the flow of human traffic making its way into the US through the US-Mexico border. It was entirely unexpected for financial markets, which had discounted nothing of a potential US-Mexico trade dispute since the signing of the USMCA agreement. Stocks have hence tumbled further, while safe havens continued to rally.

The weaponization of tariffs

The key concerns for financial market participants is twofold. On the one hand, the more practical, material and immediate issue: the proposed tariffs would almost undoubtably weigh even further on economic growth in North America, and at that, the globe. On the other hand, the more abstract, speculative, and long-term issue: US President Trump is leaning more-and-more on tariffs as a weapon to impose his diplomatic view point in the world. The latter is what is probably generating the greatest sense of fear. What was once considered an isolated feature of the US-China trade-war is shaping into a new policy-norm from the Trump administration.

Is this more Trump-bluster, or something more?

As seems so often the case for financial markets when approaching the actions of US President Trump, the essential question is roughly: will he actually follow through with this? Questions regarding how rational the decision to weaponize tariffs in the first-place have been generally foregone, with the immediate assumption, seemingly, that relying on the US President to behave in such away is a waste of traders’ mental energy. Instead, the financial commentary since the Mexico-tariff news broke on Friday has centred largely around whether this move from President Trump is a mere bluff, or a serious policy proposal.

Risk is being taken off the table

Of course, market participants in the short-term weren’t prepared to call-bluff on the mercurial US President. The market action on Friday was to take risk-off the table first and assess the balance of risks later. Consequently, as had largely been the case for several week’s as the US-China trade war escalated, anyway, stocks sold-off and safe-haven sovereign bonds rallied. Oil also tumbled considerably, dropping over 5% on Friday, while other growth sensitive commodities also faltered. And gold prices lifter, as growing pool of negative yielding safe-haven assets grove traders into holding marginally greater quantities of the yellow-metal.

Markets boost bets of rate cuts

On the surface of things, traders have been swift to price-in what appears to be a considerable global economic slow-down. Again: the price-action ought to be considered knee-jerk, given how unexpected the Mexico-tariff news happened to be. But in saying that, too, the developments did seem to accelerate what was a process already in motion, following May’s deterioration in US-Sino trade relations. Ultimately, markets have once more increased their bets of interest rate cuts from the world’s largest central banks. Most pertinently: in the minds of market participants right now, a rate cut from the US Fed is all but assured by year end.

Yield curves bent out of shape

A concerning phenomena extending from this logic is what is happening across sovereign bond markets. Global yield curves are bent horribly out of shape, portending, in the best-case scenario, aggressive rate-cuts across the global, and in the worst-case scenario, a looming global recession. US Treasury Yields are (considerably) below the overnight Federal Funds rate of 2.39% – and are all the way out until the current 30-year maturity. The phenomenon is just as pertinent in Australian fixed income markets too: forever the proxy for global growth, 10 Year Australian Government Bonds tumbled 7 points on Friday to 1.45% – a new record low.

Stocks keep selling-off

Naturally, all this risk aversion culminated in a white-wash for global equities on Friday. Asian stocks were broadly in the red, while the DAX dropped 1.47%, and the FTSE100 shed 0.78%. The S&P 500 sustained its recent downtrend, dropping 1.32%, with only income generating stocks in utilities and the real estate sector eking out gains on the sectoral map. Perhaps remarkably, Aussie stocks did manage to close in the green on Friday, however this could well be attributed some end-of-month re-balancing. The ASX 200 ought to swoon itself this morning, with SPI Futures indicating a 24 point drop at-the-open.

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