Analyzing Trump's Tariff Threats and Their Impact on European Markets

Some market observers are warning that global investors may be underestimating U.S. President Donald Trump’s resolve to follow through on his latest tariff threats. In his latest trade policy update, Trump announced he would be levying a 30% tariff on goods imported into the U.S. from the EU and Mexico starting August 1. The European market’s reaction to the news was tepid, with the pan-European Stoxx 600 index closing down just 0.06% on Monday (the first trading day after Trump’s letter to the EU). Tuesday saw a slightly deeper selloff, with the index falling 0.4%, but market sentiment was primarily suppressed by concerns over economic growth following rising inflation in the U.S.

Compared with the plunge that immediately followed the so-called “Liberation Day” declaration earlier this year, this week’s market moves mark a stark contrast in market sentiment — even though the looming EU tariff rate is even higher than the one floated in April, markets have started to “trade as usual.”

On April 3, the day after Trump announced his equivalent tariff list including a 20% across-the-board tariff on EU goods, the Stoxx 600 fell 2.7%. The two trading days that followed saw the index plunge 5% and 4.5%, respectively.

Why the Muted Market Reaction Now?

Part of the reason for today’s less dramatic market reaction may be that investors are doubling down on so-called “TACO” — or “Trump Always Chickens Out” trades, in which market participants insist that the White House’s tariff threats are merely a negotiating tactic and unlikely to actually materialize.

Indeed, many seem convinced that the EU and U.S. will reach an agreement before Trump’s looming August 1 deadline.

“When it comes to the latest tariff threats, investors just aren’t worried,” Morningstar’s European market strategist Michael Field said on Wednesday. “Sure, you could put that down to complacency… but their experience over the last few months would suggest that tariff threats so far are just a way of getting people to the negotiating table and haven’t translated into an actual policy being enacted.”

Warnings Against Complacency

However, others are warning that this approach could leave some agreement-expecting investors “stumped.”

“I do believe these tariffs will ultimately be implemented, and I don’t think the EU will give in as easily as Trump might hope, this scenario is likely to cause a slowdown in global GDP growth, and it’s happening in a period when many of the EU's largest economies are burdened with historically high levels of sovereign debt,” said Anthony Esposito, founder and CEO of Australian investment advisory firm AscalonVI Capital.

European officials have expressed optimism that Washington and Brussels are increasingly close to a framework for a trade agreement, but have also made it clear that the EU is prepared to take countermeasures if its economic interests are harmed by tariffs.

Kevin Yin, vice president of investment at Asterozoa Capital in Phoenix, Arizona, believes that this time, Trump has more incentive to follow through on his tariff threats.

“The ‘TACO’ narrative has worked so far, but now that U.S. equities are near all-time highs, and are largely complacent to continued tariff threats, Trump has extra leverage to continue his push, which increases the likelihood of the 30% tariff rate coming to fruition,” Yin said in an email. “On the other hand, Trump and Basset have shown more sensitivity to the performance of the bond market, and the recent increase in yields might put pressure on the president and his team to back down.”

Risks Facing European Equities

European equities have been in a bull market this year, spurred by widespread investor diversification away from U.S. assets and promises of significant fiscal stimulus in the region. The Stoxx 600 is up more than 7% year-to-date, while Germany’s DAX is up about 21%, and Italy’s FTSE MIB has soared 17%.

Market observers believe the 30% tariff scenario has the potential to “derail” the rally in the region.

“Will tariffs kill the European bull market? It really depends on the specific level,” Morningstar’s Field said. “A 10% tariff, as with the U.K., would be a modest impediment — but a 30% tariff could severely weaken European GDP growth in the coming years. It may not be enough to fully quell the money flowing into the European equity market, but it would certainly weaken Europe’s current momentum.”

AJ Bell investment analyst Dan Coatsworth agreed that Trump’s latest threat, if enacted, could stymie further growth in European valuations.

“Europe has been performing so strongly this year thanks to investors looking for cheaper valuations than the U.S., and the prospect of the German government increasing spending on areas such as defense and construction,” he said. “High tariffs have the potential to spoil this party and could trigger a round of profit-taking by investors.”

Columbia Threadneedle senior economist Anthony Willis, on the other hand, took a more sanguine view. “It is worth remembering that EU exports to the U.S. account for about 18% to 20% of their total exports — leaving a lot of trade that wouldn’t be affected by the actions of the Trump administration,” he said. “In fact, the consequence of the U.S. levying tariffs on everyone seems to be that many countries are looking for other trade opportunities.”

Trading Strategies Amidst Uncertainty

When it comes to trading amidst uncertainty, AscalonVI’s Esposito warned that a 30% tariff scenario would leave “most asset classes in the region… feeling the pressure.”

“However, if defense spending continues to rise, the ECB continues to keep interest rates around 2%, and precious metals continue to rally, we could see relative outperformance from the defense, financials, and mining sectors,” he said. “From a trading perspective, I would be long precious metals, and cautious on European and U.S. equities.”

Asterozoa's Yin added that if Trump's proposed tariffs are fully implemented, he expects to see a sell-off in U.S. Treasuries, while gold and U.S. industrial stocks would rise. “European exporters, such as auto (equipment manufacturers), could be hurt.”