Trump’s trade barrage rattles global markets, triggering recession fears

Open this photo in gallery:

U.S. President Donald Trump’s decision to hike tariffs to the highest level in a century has sent shock waves through the global economy, hammering financial markets, adding to inflationary concerns and raising the odds of a recession in the United States that could ripple across the border into Canada.

On Wednesday afternoon, Mr. Trump announced a baseline tariff of 10 per cent on imports, with much higher rates for dozens of trading partners, including the European Union, China and Japan. That pushed America’s average tariff rate above 20 per cent, from around 2 per cent when Mr. Trump took office – a level last seen in the 1930s when a breakdown in global trade helped fuel the Great Depression.

Mr. Trump’s move – a wholesale repudiation of the open trading system the U.S. spent decades building – stunned governments, businesses and investors around the world. The S&P 500 and Nasdaq Composite tumbled 4.8 per cent and 6 per cent on Thursday, the biggest stock market drop since the start of the COVID-19 pandemic.

Other equity markets wilted, including Canada’s TSX Composite, which fell 3.8 per cent. The U.S. dollar weakened more than 1.5 per cent against other currencies and the price of oil dropped around 7 per cent amid concerns of a global economic slowdown and a wrenching adjustment to international supply chains.

“It’s a structural break in the global trading system,” James Rossiter, head of global macro strategy at Toronto-Dominion Bank, said in an interview.

“We talked through the first season of Trump about globalization unwinding and sort of collapsing a little bit on itself. But I think what we’re seeing now is far more fundamental and far more durable and long lasting than what we saw previously.”

Canada, Mexico spared from worst of Trump’s latest tariff blitz

Mr. Rossiter said the tariff shock could increase U.S. inflation by 1.5 percentage points by the middle of next year, as import prices jump and supply chains fracture. It could also carve 0.75 percentage points off U.S. GDP growth, he said. That’s not quite recession territory, but it’s getting close.

World Trade Organization Director-General Ngozi Okonjo-Iweala released a statement on Thursday warning that the U.S. moves could lead to a 1-per-cent contraction in global goods trading volumes. That would represent a nearly four-percentage-point downward revision from the WTO’s previous projection.

“I’m deeply concerned about this decline and the potential for escalation into a tariff war with a cycle of retaliatory measures that lead to further declines in trade,” Dr. Okonjo-Iweala said.

Canada and Mexico fared comparatively well in Mr. Trump’s latest barrage. Neither country will face the baseline tariff or a higher “reciprocal” rate. Crucially, an earlier one-month tariff exemption for goods that trade in compliance with the United States-Mexico-Canada Agreement was extended indefinitely.

Canada and Mexico are still being hit by tariffs on autos, steel and aluminum and all products that don’t comply with USMCA content rules. But by avoiding the latest round of tariffs, many Canadian goods will have a competitive advantage in the U.S. market compared with products from other countries.

The Canadian dollar strengthened on Thursday, rising by about a cent to 71 cents against the U.S. dollar, although this was also due to the U.S. dollar weakening.

“Tariff rates now that are being imposed on Canada and Mexico are significantly lower than the rates on the rest of the world,” Nathan Janzen, assistant chief economist at Royal Bank of Canada, said in an interview.

That means Canadian products could win market share in the U.S. The problem, however, is that overall demand in the U.S. could take a beating if the country falls into a recession and consumer confidence, which is already fragile, crumbles.

“Potentially we can keep our share of the pie, or even maybe it gets a little bit bigger in this environment. But that’s not a whole lot of consolation if the size of the pie itself is shrinking,” Mr. Janzen said.

Stephen Brown, deputy chief North America economist at Capital Economics, said Canada is in a slightly better position today than it had been over the past month, when Mr. Trump was directing most of his protectionist attention at his two closest neighbours. Mr. Brown had previously been forecasting a recession for Canada, but now expects a period of essentially zero growth rather than an outright contraction.

But a lot will depend on how global disruptions spill into Canada.

“These tariffs are going to cause a lot of weakness in other economies, and therefore weaker commodities demand,” Mr. Brown said in an interview. “So even if demand for Canada’s exports holds up in volume terms, we’ve seen this big drop in oil prices and other commodity prices. So that feeds through to weaker earnings in Canada and can likewise weigh on investment.”

Trade wars are a difficult type of shock to navigate, because tariffs weigh on economic activity while increasing prices – something economists call “stagflation.” This puts central banks, such as the Bank of Canada and the U.S. Federal Reserve, in a tough spot. They have to choose between cutting interest rates to fend off a recession and keeping them steady or raising them to stop a one-time jump in prices from becoming an inflationary spiral.

U.S. tariffs will directly increase the price of imported goods, and may push up prices for domestically produced goods as American companies take the opportunity to raise their prices. Companies may also increase prices in response to rising costs across their supply chains.

“The U.S. and other advanced economies import a lot of intermediate goods that feed into domestic supply chains, and tariffs on those intermediate products increase the costs of domestic production as well,” said Mr. Janzen of RBC.

“That’s really where you can get spillovers into Canadian inflation. Because the North American industrial sector … is very heavily integrated, so if costs rise in the U.S. industrial sector, that means that they’re also rising in the Canadian and Mexican industrial sectors as well.”

Given potential inflationary pressures in Canada, including from Ottawa’s retaliatory tariffs, financial markets expect the Bank of Canada to hold interest rates steady at its next meeting in April, before cutting two to three more times this year, according to LSEG data. Markets expect the Fed to remain on hold for now, but to resume rate cuts in the summer.

How much Mr. Trump’s actions reverberate around the world may depend on how other countries respond. On Thursday, Prime Minister Mark Carney announced Canada’s third round of retaliatory tariffs, this time matching U.S. tariffs on automobiles.

Others have said they will hit back against Mr. Trump’s “reciprocal” tariffs, including the European Union, Japan, South Korea and China. Australian Prime Minister Anthony Albanese, by contrast, ruled out retaliation and said he wanted to avoid a “race to the bottom that leads to higher prices and slower growth.”

The last time the U.S. shocked the world economy in this manner was the infamous 1930 Smoot-Hawley Tariff Act, which sparked a tit-for-tat trade war that added to the length and depth of the Great Depression and aided the breakdown in global co-operation in the lead-up to the Second World War.

“We’re in sort of uncharted waters to some degree, or at least uncharted waters in the modern era,” said Mr. Rossiter of TD. “This is not something the world hasn’t seen before. It’s just the last time we saw it was the 1930s or the 1890s.”