It must be unicorns

We’re back to square one in terms of the US tariff disaster, as the US has started sending letters to countries revealing their tariff rates—and the rates don’t look much different from those announced on the so-called Liberation Day. 25% for South Korea and Japan, 25% for Malaysia; 30% for South Africa; and 40% for Myanmar and Laos.

There’s no fresh news regarding Taiwan and India, but the levies on some Asian nations are clearly pointing the finger at China—due to transshipments. Looking at the first wave of numbers, only one country appears to have pulled itself out of the tariff turmoil with minimal damage: the UK, with a tariff rate of 10%. The EU could also pull off a 10% rate as soon as this week—which would be great. But for the rest, the tariffs don’t look good, and the three-month risk rally is in jeopardy—even though markets remain on a surprising wave of optimism that defies the renewed tensions Asian tariffs will place on supply chains and prices.

The S&P 500 retreated 0.70% from an all-time high on Monday, but futures are positive on news that the new tariff negotiation deadline has been pushed to August 1. The Nikkei was down yesterday but is up again today on hopes that negotiations will continue and that the 25% levies could be reversed. The Stoxx 600 was also in the green yesterday, on optimism that Europe could pull off a good deal.

But this is all too much unexplained optimism. The deadline extension is not good news, per se. It simply adds to the uncertainty. It’s yet another sign that the deadline won’t be a line in the sand, and that tariffs set in the coming days and weeks won’t be carved in stone, either. They will be constantly changed—raised, lowered—and used as a go-to threat in every situation.

Repricing risks?

It’s probably time to start pricing back in the trade risks that were priced out far too quickly—under the umbrella of the so-called TACO trade. Trump isn’t chickening out, and inflation is knocking on the door. One reason why the tariff-led price pressures were initially contained is that many companies chose to swallow the costs while waiting to see if the tariffs were just a negotiation tactic. But if the tariffs are here to stay—and are constantly changing—businesses will have no choice but to adopt prices.

According to Goldman, companies are set to pass on 70% of the tariff costs through higher prices.

So one of the following scenarios will likely play out:

1. Consumers absorb the tariffs, companies continue exporting to the US, and earnings stay intact—but inflation rises, upsetting the Federal Reserve (Fed) and pushing back (or reversing) rate-cut expectations. That could upset investors given relatively high valuations.
2. Consumer spending crumbles, US GDP slows—possibly offsetting some of the tariff-led inflation—and company earnings take a hit. But the Fed could step in if inflation pressures remain tolerable.

Reality will probably fall somewhere in between: prices will rise, earnings will be pressured, the Fed will wait as US growth slows and inflation risks loom—and global investors may increasingly cut exposure to US assets, repatriating funds to alternative markets like the EU and Japan. Note that, a potential wave of Japanese repatriation could further weigh on US Treasury yields and amplify a broader risk-off move. And rising Japanese yields are also becoming an additional threat to the risk rally. The 10-year JGB yield is back to 1.50% this morning. When JGB yields rise, they become more attractive to Japanese investors—especially institutions like pension funds and insurers—who have historically been major buyers of US Treasuries and global equities, including US stocks. The ongoing trade tensions between the US and Japan could accelerate such repatriation—even though Japanese authorities earlier this year said they wouldn’t use capital flows as a negotiation tool. But things are moving too fast to rely on what was said a few months ago.

In FX, the US dollar rebounded yesterday and is consolidating gains on the back of the optimism stemming from the deadline extension to August 1. But if you think that deadline will be the only one—and not just one of many in Trump’s tariff playbook—then buying dollars on trade optimism looks like a weak reason. The EURUSD remains bid below 1.17. The AUDUSD is bouncing back today after the Reserve Bank of Australia (RBA) surprised by not cutting rates, contrary to expectations. Instead, policymakers cited strength in the labour market and a more balanced inflation outlook for keeping rates unchanged.

In energy and metals, US crude rallied to the 200-DMA but is seeing resistance at that level, as both a larger-than-expected OPEC output hike and renewed trade tensions weigh on the oil outlook. Copper futures on COMEX are retreating from the highest levels since April 2. That’s one area where price action actually makes sense.

In summary, markets continue to react in a suspiciously optimistic way, ignoring the risks and implications of tariffs on supply chains, earnings, inflation and growth. Assuming everything will be magically resolved in the next three weeks is like seeing unicorns in the sky. Something must give.