The past couple of weeks have been rough for the markets, to put it mildly. Just on Monday, Hong Kong’s Hang Seng index plunged 13% — its worst drop since 1997. Japan’s Nikkei 225 closed down 7.9%, while the broader Topix lost 7.7%. European markets didn’t fare much better, with major indexes like the DAX, Euro Stoxx 50, and CAC 40 also ending in the red.
The reason behind the sell-off isn’t a sudden realization that valuations are too high or that markets are overheated. Instead, Trump's trade war primarily drives the growing uncertainty surrounding the global economy. That’s why even a glimmer of hope for negotiations sends markets soaring, as we have clearly seen with U.S. indices recently — namely the S&P 500, Dow Jones, and the Nasdaq Composite.
So it's not hard to connect the dots: investor optimism could return if the rhetoric around tariffs eases. But that's still a long way off. On Monday, Trump once again doubled down on his plans to raise tariffs on China by 50% and ruled out any talk of a pause in reciprocal tariffs.
Things are not looking much better on the European front, either. According to the U.S. president, the European Union was “created to hurt the United States in trade,” and the $350 billion trade deficit must disappear as soon as possible. Instead of fighting back, Europe seems to be preparing to play along. Ursula von der Leyen has declared that the EU is ready to negotiate tariffs with the US and is already forming a team.
Speaking of tariffs, it is worth remembering how well they worked in the past. In June 1930, President Hoover signed the infamous Smoot-Hawley Tariff Act, which raised import tariffs on foreign, mainly European, goods to 60% to protect U.S. producers. The result? The volume of U.S. trade plummeted, and the measure contributed to the Great Depression.
Will history repeat itself this time?
Goldman Sachs, JPMorgan, HSBC, and S&P have increased the probability of recession in their forecasts, now placing it between 35% and 60%. If a recession does occur, it will not only affect commodities such as oil (whose prices have already fallen in the forecasts but will also hurt key US trading partners such as Canada due to falling demand.
Some hope could come from the Fed signaling its willingness to cut rates if necessary, but that hasn't happened so far. In his speech last week, Jerome Powell acknowledged that the outlook remains highly uncertain, with elevated risks of rising unemployment and inflation. More importantly, he emphasized that the Fed sees no need to rush into any decisions now.