Tariff confusion and elusive trade deals: is another market crash inevitable?

• Tariff uncertainty remains elevated despite trade truce
• The wait for new trade deals seems to be getting longer
• Risk of complacency but no panic yet
• Is a new market selloff looming around the corner?

Trump’s trade fight is in full swing

It’s been four months since President Donald Trump began his campaign to reshape America’s trading relations with the rest of the world, and it’s fair to say that things have changed irrevocably. Having initially targeted Mexico, Canada and China, Trump has taken his trade war to all corners of the earth, introducing 10% universal tariffs on most imports into the United States, and sectoral tariffs on steel, aluminium and cars. Some restrictions have also been announced for the chips and pharmaceutical sectors.

But primarily, the sky-high tariffs that threatened to raise US inflation through the roof and plunge the world economy into recession are on pause. These so-called reciprocal tariffs will be revisited on July 9, with those on China suspended until August 12. In the meantime, new levies are still being imposed. Trump just announced the doubling of the tariffs on steel and aluminium to a staggering 50%.

From gloom to optimism

Yet, by and large, investors have maintained the optimism that returned to the markets when Trump delayed the reciprocal tariffs just days after ‘Liberation Day’, and whilst there have been several escalations since then, such as with China and the European Union, it’s looking increasingly likely that trade tensions have peaked. Much of the calm is to do with the assumption that the White House is not willing to oversee another market meltdown like the one in early April under its watch. Trump has even toned down his personal attacks on Fed Chair Jerome Powell, which was adding to the panic.

Investors seem content to put up with Trump’s erratic nature as long as he continues to demonstrate the tendency to back down from his tariff threats. However, this thinking comes with risks. It is clear that the Trump administration is serious about rebalancing trade and it’s unlikely to give up doing so very easily. Trade negotiations can be a very lengthy process and Trump’s scare tactics are just a way of injecting urgency into the talks and add pressure on his opponents.

Trade deals are becoming elusive

However, the stakes are high for all parties, and although Britain seems to have caved in to Trump’s demands quite quickly, winning very few concessions, other countries do not appear to be ready to put pen to paper without a much stronger fight. That’s not to say that trade deals aren’t possible before the summer deadlines, but apart from the UK, there’s so far been no agreement with any of the countries that were supposedly at the top of the list.

A deal with Japan and India could be near, but even if there’s some announcement soon, it doesn’t bode well for other countries that it’s taken this long for fast-track agreements to be reached. The most likely outcome is that the current 90-day extensions will be extended further, at least for the big countries/blocs such as the EU where negotiations can be quite complex.

This not only delays any real resolution of the trade conflict, but it also generates yet more uncertainty for businesses, as well as for policymakers. For the Fed, where officials have been in wait-and-see mode for much of the year to assess the impact of Trump’s policies on inflation and the labour market, failure to obtain fresh clarity on the tariff outlook could keep it on pause for the remainder of the year.

US equities rebound despite ongoing uncertainty

Even worse, if the prolonged uncertainty begins to severely curtail consumer and business spending and the Fed is forced to cut rates into a recession, this would hardly be the rate-cut scenario that markets are hoping for.

Some of the complacency is understandable. It’s only natural that investors would become de-sensitised to the never-ending tariff headlines and focus only on the final outcome. The problem with this is that not even Trump probably knows what the endgame is.

When the S&P 500 nosedived by about 10% in the aftermath of ‘Liberation Day’, the VIX volatility index jumped to 60.0 – a level synonymous with crises. It’s since climbed down to around 20.0, which although is somewhat higher from the more stable region of 10.0-15.0, it doesn’t indicate anything too concerning troubling the markets.

Sinking dollar tells a different story

The warning signs are bigger, however, in the FX market, as well as in gold prices. The US dollar has fallen by about 9% against a basket of currencies in the year-to-date, making it the worst performing currency. In comparison, the S&P 500 bounced back strongly after the reciprocal tariffs were postponed, recouping its yearly losses in the process. It now stands just 3.5% below its February all-time high.

But the dollar’s underperformance shouldn’t be ignored. Yes, it’s true that the dollar’s slide reflects a wider loss of faith in American assets, marking the end of US exceptionalism, and there is also speculation that the Trump administration favours a weaker currency. But the ‘Sell America’ trade can come back to haunt Wall Street at any point, even if it’s not a major worry right now.

Moreover, one-month implied volatility rates for EUR/USD and USD/JPY have not declined as much as the VIX has since the April spike, underlining the nervousness in the broader markets about the tariff impact. The same is also true for the popular safe-haven gold, which has rallied by more than 25% so far in 2025 and it’s approaching its record high from April.

China may hold all the cards

Ultimately, a successful outcome of the trade war hinges on a US-China pact, specifically, whether Washington and Beijing will be able to sort out their differences and hash out a permanent deal. Talks between the two sides appear to have stalled, although there’s reports that Trump and Chinese President Xi Jinping are planning on holding a phone call as early as this week.

Realistically, however, positive talks between the two leaders would only go as far as securing a very basic agreement at best by August 12. And this is what doesn’t seem to be priced in by Wall Street traders – that markets are potentially staring at protracted negotiations that last well beyond the summer, with the risk of stretching into 2026.

Until the trade dispute between China and the US is fully resolved, there’s always going the be the danger of higher tariffs hanging over the markets. Investors can probably ignore this risk if China is the only big trade deal that’s pending and the US economy continues to grow.

A recession is still a possibility

But it’s only a matter of time that the uncertainty becomes too heavy a drag on the economy, pushing it into a full-blown recession. This then brings into the spotlight the other question mark that’s being treated as a given by the markets. Would the Fed cut rates if the economy is in recession but both actual inflation and inflation expectations remain elevated? The answer is probably yes, but only modestly.

The view from some Fed officials seems to be that if the average tariff rate doesn’t exceed 10%, then the impact on inflation will be limited and temporary. But that’s not factoring in the potential increase in costs through the restructuring of global supply chains sparked by Trump’s desire for all manufactured goods sold in the US to be made in the US. The President’s threat to tax Apple if the company doesn’t shift production of all its US-bound iPhones to America is an example of how far he is willing to go to achieve his objectives.

To sum up, there are still too many unknowns at this stage of the trade war to conclude that the worst is over and that Trump will either get what he wants or back down on his demands. The risk of re-escalation remains too high, and there’s also Congress’s budget reconciliation bill to consider that could raise the national debt to unsustainable levels. All this leaves US stocks, and risk assets, in general, vulnerable to another sharp selloff.