Markets kicked off Monday’s session by reacting to weekend news. On February 1, defying the odds on Polymarket, the European Commission officially imposed trade tariffs: 25% on imports from Mexico and Canada (with a reduced 10% tariff on Canadian energy exports) and 10% on Chinese imports. The European Commission quickly responded, warning that the bloc would retaliate if necessary.
Needless to say, indices opened in the red in Europe, Canada, and the US while the dollar index rose. However, the biggest blow was dealt to cryptocurrencies, whose market cap plunged by more than 10% over the weekend. Why, given their scant links to the real economy? The reason is simple: when uncertainty increases, investors dump the riskiest assets first, and cryptocurrencies top that list.
Bitcoin fell to its lowest level in over three weeks, triggering a sell-off in the cryptocurrency market. Recent price fluctuations saw BTCUSD dip to $91,242 before rebounding to $94,611, marking a 4.19% decline in the last 24 hours.
The hope was that Monday's calls between Trump, the Canadian prime minister and the Mexican president (separately) could at least buy some time. And so it did, for both countries. The deadline was pushed back a month, and markets reacted immediately, with US futures trimming initial losses. But it is too early to breathe easy: it is not a matter of resolving the disputes but of extending the deadline for resolving them.
What would be the impact on the US economy?
With Canada, Mexico, and China accounting for more than 40% of US imports — and trade between them and the US worth more than $1.5 trillion a year — a full-blown trade war could hit even harder than the first. For context, a January 2021 study commissioned by the U.S.-China Business Council claimed President Donald Trump's trade policies cost the United States 245,000 jobs.
The real problem now is that, unlike before, the Fed does not have the same flexibility to cut interest rates to cushion the economic shock. Back then, low inflation made it possible to cut rates, but in today's environment, that is simply not an option. While it is unlikely to push the US into stagflation, it will certainly worsen the consequences of trade disputes. But that is not even a worst-case scenario.
The worst-case scenario for the US financial system would be a loss of appeal to global investors. This could weaken demand for US Treasury bonds, making government borrowing more challenging. On top of that, worsening relations with the rest of the world could put the dollar’s status as the world’s reserve currency at risk — something Trump has made clear he’ll do everything possible to prevent.
Industry-wise, tariffs — especially against Mexico and Canada — would affect roughly a quarter of the 16 million vehicles sold annually in the U.S., along with the parts and components that go into them. Among the hardest-hit companies would be General Motors, Ford, Stellantis, and Volkswagen, all of which have a portion of their production sitting in the newly labeled “danger zone.”
What happens next?
It depends on how events unfold. In an optimistic scenario, Mexico and Canada could agree to certain concessions, leading Trump to ease tariffs bringing relief to markets. In a more pessimistic case, this could escalate into a full-scale trade war with widespread retaliation, accelerating the shift to safe-haven assets. Betting everything in a single scenario could prove to be a costly mistake.