Takeaways of Trump 2.0 two weeks in

Summary

A lot has happened since President Trump took office for his second term. In this report, we examine a few of the key takeaways from President Trump's first few weeks in office, including why the European Union could be Trump's next tariff target and why Trump has less leverage over China this time than during the first trade war. Tariffs and associated uncertainties should be consistent with a stronger U.S. dollar, although we acknowledge that “tariff fatigue” may set in and become less supportive of the greenback over time.

“Escalate to negotiate” tactics are still the preferred course of action for President Trump. During the first two weeks of his second administration, President Trump has threatened tariffs and other forms of economic consequences on a number of U.S. trading partners and geopolitical allies. Those nations already being targeted include Canada, Mexico, Colombia and Panama—countries likely singled out due to their heavily reliance on the United States. Trump has seemingly reverted to his negotiation style of exploiting that reliance on the U.S. to seek concessions on perceived issues related to immigration, trade imbalances, cross border flow of narcotics (Canada, Mexico, Colombia and China) and geopolitical alignment (Panama). In approaching discussions with each nation, Trump has escalated threats meaningfully—particularly tariff threats but also expropriation—as a platform for negotiations. Trump has indeed secured concessions from all of these nations, and while “a deal” may not be finalized with any country just yet, drawing from President Trump's first term would suggest de-escalation is a plausible next step, at least in the very near term. To that point, we believe, for now, the U.S. administration will not impose direct tariffs on Canada, Mexico or Colombia after recent arrangements. In the case of Panama, secured concessions are also likely to shift Trump's focus away from the Panama Canal for the time being, but possibly longer-term if Panamanian authorities pursue additional appeasements to the U.S. government.

Expect a similar escalate-style approach to discussions with the European Union. President Trump has consistently referred to the high likelihood that the European Union will be targeted for tariffs. In our view, now that tariff decisions on Canada, Mexico and China have been made, despite those decisions perhaps being short-term in nature, Trump is now likely to direct focus toward the EU. With that said, Trump may suggest a lower tariff rate relative to the tariffs proposed on other U.S. trading partners, but ultimately with the intention of seeking concessions from EU countries. In our view, one area Trump might focus on is getting EU countries to increase their defense spending commitments in the context of the stipulations of the joint NATO defense pact. In the scope of concessions, defense spending may be the easiest to achieve as countries can make those budget decisions on their own as opposed to at the EU level. To that point, Trump may also use tariffs as means to seek access to EU markets—for example, related to agriculture products—while Trump has also called on Europe to buy more oil and gas from the United States. However, those “wins” may be more challenging as the EU as an economic bloc regulates market access, not individual countries, while purchases of oil and gas will also largely reflect the decisions of private sector rather than government entities. Achieving concession on market access or achieving purchase targets may be tricky.

Trump's “negotiate from a position of power” approach may not work as well on China this time. Yes, China has plenty of economic vulnerabilities that could be exploited, most relevant of which to the U.S. is China's export driven economic model. But the U.S.-China trade relationship is significantly weaker today relative to Trump's first term. The U.S. imports significantly fewer goods relative to 2017, while China has found replacement trade partners intra-Asia and has set up manufacturing capabilities in Mexico to circumvent tariffs. U.S. tariff influence may not be as powerful, as China has made some necessary adjustments. In fact, an argument can be made the U.S. has become more dependent on China as a source of critical imports. Maybe a greater U.S. dependency on China is why Trump implemented softer tariffs relative to the tariffs proposed on Canada, Mexico and Colombia. And maybe why China opted for a more strategic and targeted retaliation rather than matching U.S. tariffs dollar for dollar. China may not want a trade war, but in our view, China is also unlikely to back down from one. Lastly, a question we have been asking ourselves is: what concessions can China even offer the United States? Buy more U.S. products. But if China has developed new trade relationships, is turning more inward looking, and possibly at the point where authorities' deploy large fiscal stimulus, what incentive does China have to make a new trade deal with the United States?

Dynamics surrounding further U.S. dollar strength remain in place...although we expect a fair amount of volatility along the way. Further tariff threats are likely to induce market participants to seek out safe haven currencies, in particular the U.S. dollar. As far as threats, as mentioned, we believe Trump will target the EU next, which may unsettle market participants' sentiment toward risk assets. We also think the Trump administration will pursue a universal tariff as well as further tariffs on China. Combined with threats directed toward the European Union, a universal tariff and sharply higher tariff rates on China should prompt investors to continue directing capital toward the U.S. dollar. However, —and this is where Trump's negotiation strategies come into play for FX markets—if Trump continues to make deals with foreign nations to delay or avoid tariffs, the U.S. dollar could also experience episodes of weakness as markets experience a relief rally. We observed sharp dollar depreciation as tariffs on Mexico and Canada were delayed, while only modest levies on China and soft retaliation also prompted dollar weakness. We are also cognizant of the markets' ability to become fatigued with tariffs. Meaning constant tariff threats, especially on countries with little influence over global financial markets or the global economy, could be ignored by market participants, especially if threats do not yield any trade policy changes. Should a tariff fatigue set in, the dollar would be driven by more economic fundamentals (i.e., central bank monetary policy, etc.) rather than headlines. Essentially, a tariff fatigue scenario by itself is neutral for the dollar, but market participants would seek alternative catalysts for FX markets.