Written by Luca Martina
We don’t know whether the trade war triggered by President Donald Trump stems from his ignorance of the potential consequences, it is a poorly conceived strategy of “conquering” global markets, or simply a botched attempt to impose his negotiation rules on other countries. Certainly, acts of commercial hostility are multiplying, and the possibility of a significant contraction in international trade (one of the greatest drivers of global growth) has become real. What about financial markets?
Investors are typically averse to uncertain environments, as it complicates the process of valuing a company. Stock markets rely on predictions of future performance and it is hard to make informed guesses if you cannot predict future profits and at what interest rate future cash flows should be discounted (the value of a sum received must be brought to the present, discounted by an interest rate).
What is happening now undoubtedly represents the highest level of uncertainty we have ever witnessed, and it makes the Russian and Asian crises of the early 1990s, the dot-com bubble of 2000, the great recession of 2007-8, and even the explosion of the COVID-19 pandemic pale in comparison. We are talking about what will probably be remembered as the first consciously (?) self-inflicted recession. How should one react in the face of such a leap into the unknown?
The only weapon investors have is to sell what they hold, thus causing heavy declines in stock prices. The drop in prices, in turn, has devastating effects on the psychology of savers and this triggers new waves of panic and further price declines. The mechanism is bound to run its course when uncertainty reduces their portfolios. In fact, history, logic and common sense tend to be ignored when one believes that uncertainty governs the markets (and the world). So, who is right? Those who sell to avoid even harder landings, or those who stay put? In the short term, selling is a reasonable way out, as it helps lighten the psychological burden caused by the news that disrupts mood and portfolios. Selling is also logical: if investors avoid selling at the lowest prices, they feel they have abandoned the sinking boat in time. In the medium and long term, however, negative periods have been brilliantly overcome: the economy eventually improves, along with corporate profits, and technological progress continues its course without looking back.
At this moment, the markets are clearly indicating that they would like to see moderation. Unfortunately, the “Trade Act of 1974,” a law passed by Congress during Gerald Ford’s presidency, grants the US president the authority to impose tariffs to protect domestic industries from imports (Safeguard Measures: steel and solar panels have been subjected to tariffs for this reason), to respond to unfair trade practices or to protect national security. Yet, the unity of the Republican majority has begun to crack. In November 2026, the Midterm elections will renew the entire House of Representatives and one-third of the Senate, as well as a significant number of governors. Under the current circumstances, those elections would result in a severe defeat for the president’s party (which has promised to eliminate inflation and trigger an economic boom), turning him into a clumsy and impotent “lame duck” for the rest of his term. Fine modulo
This could create a stalemate in the economy (with a dangerous return to stagflation) or, in the more favorable scenario, encourage a return to the negotiating table.
The president’s actions are once again a demonstration that trying to force the mechanisms of free markets leads to instability, uncertainty, economic and financial. Indeed, the disorderly impact of the latest measures has already affected stock prices, interest rates, exchange rates and commodity prices.
The prospect of a full-blown trade war with China puts at risk the mass subscription of U.S. bond issuances (this was clearly seen in the jump in yields on longer maturities). This, along with the possibility that Chinese reserves may decide to start selling off part of their holdings in U.S. government bonds, makes debt more costly and thus risks having a recessionary effect.
The dollar, caught in the crosshairs of fears about its future centrality in international trade, also appears on a path toward further weakening, making it less attractive to investors.
Finally, commodities are affected by the worsening economic outlook and, in the case of oil and natural gas, by the possibility of oversupply (“Drill, baby, drill”).
The United States built its greatness on free markets and the idea it could be made “great again” by reviving protectionist practices was bad idea from the start. Doing so in the manner advocated in these first months of the presidency risks having very severe consequences for the global economy. One hopes that markets encourage Trump to think again.
Source: https://en.irefeurope.org/publications/online-articles/article/terra-incognita/
