BREAKINGVIEWS-Markets send Trump a risky message on tariffs

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Neil Unmack

LONDON, Feb 3 (Reuters Breakingviews) - Markets are still pinning their hopes on the art of the deal. Stocks may have fallen on Monday as investors digested U.S. President Donald Trump’s decision to whack tariffs on Mexico, Canada and China, yet they don’t seem to be assuming a prolonged global trade war. The risk is Trump gets emboldened.

The tariffs are hardly unexpected, but hitting close neighbours Mexico and Canada immediately with 25% levies is a blow to those who had expected a gradual approach. Their scale is roughly five times as large as all trade actions taken by Trump in his first administration, Deutsche Bank analysts reckon. For the most exposed assets, the moves have been stark: the Mexican peso hit its lowest level versus the dollar in nearly three years. The news also implies Trump may back up aggressive words regarding higher tariffs on Europe and China.

Yet while stocks have fallen, investors are not yet assuming a long-lasting trade war that cripples earnings. Barclays analysts expect the latest tariff spat could take nearly 3% off earnings per share among stocks in the S&P 500, even before factoring in the damaging effects of further tariff battles with Europe and China. Futures for the S&P 500 were down just over 1.5% on Monday morning.

Some European stocks have admittedly fallen way more than the STOXX 600’s 1.3% dip. Shares in $37 billion carmaker Stellantis STLAM.MI, which faces higher tariffs on cars and parts it imports to the U.S. from Mexico or Canada, fell over 6%. But that’s less than the 12% potential hit to earnings from the first wave of tariffs estimated by RBC analysts.

Bond markets too are only starting to grasp what could be coming. True, short-dated U.S. Treasury yields rose, a sign that tariffs will put up inflation, making it harder for Federal Reserve Chair Jerome Powell to cut rates. Yet, at 4.26%, two-year yields are still lower than the level a week ago, which hardly implies a sudden likely increase in rates, or an end to Powell’s cutting cycle.

The relatively muted market reaction can be explained. Companies may find ways to offset the pain – they could hike prices, or shift production to the U.S. Even if Trump’s opening salvo is aggressive, he may struggle to apply equally steep tariffs to all his big trading partners at once, suggesting a series of protracted squabbles rather than a global war. Most of all, the new wave of tariffs may not last: Trump may use them to negotiate a quick win in talks with Canada and Mexico.

The downside is that Trump’s incentive to cut a deal probably hinges on his pain threshold. If domestic stocks suffer, hurting consumer confidence, or if bond markets threaten to stop funding his plans, then he will need to back down. That looks unlikely: long-dated U.S. bond yields are actually falling, lowering the cost of funding the United States’ vast deficit. And the S&P 500 Index is still comfortably up since Trump’s election. An end to the tariff war may first require markets to get a lot more perturbed.

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CONTEXT NEWS

European stocks fell on Feb. 3, as President Donald Trump’s 25% tariffs on Canadian and Mexican imports raised fears of a global trade war.

Europe’s benchmark STOXX 600 Index fell 1.3% as of 1148 GMT. S&P 500 futures were down around 1.5%. Japan’s Nikkei 225 Index closed down 2.7%.

Shares in carmaker Stellantis were down over 6%, while sports car group Porsche fell 4.5%.

European government bond yields also fell, on expectations that future tariffs would hit growth, with German two-year yields falling around 6 basis points, to around 2.049%.

U.S. two-year Treasury yields rose by 4 basis points on Feb. 3, to around 4.28%.

The Mexican peso fell to its lowest level in nearly three years at 21.2882 per U.S. dollar, while the Canadian dollar slumped to 1.4792 per U.S. dollar, a level not seen since 2003.