Author: Igor Kuchma

This Wednesday, July 9, was supposed to end the 90-day grace period Donald Trump had set for countries to reach trade agreements with the U.S., or face steep tariffs. As such, markets tightened again, especially after Trump announced 25% tariffs on Japan and South Korea, which will take effect on August 1. To top it off, he also sent a new wave of warning letters to Malaysia, Kazakhstan, Laos, and Myanmar, among others.

Subsequently, the major U.S. indices fell, including the S&P 500 and the Nasdaq. However, the situation had improved slightly by the end of the session. In a now familiar move, Trump backtracked on his tariff threats, signing an executive order postponing “reciprocal” tariffs until August 1, as opposed to the July 9 initially set. Thus, the markets breathed a sigh of relief, but the issue remains on the table, and it is big.

So far, trade agreements have only been reached with the United Kingdom, Vietnam, and China. The European Union also appears close to reaching a trade agreement with the United States. There is also progress in talks with India, and, finally, negotiations with Canada and Mexico are ongoing. In short, progress is being made slowly, and it is not yet clear how substantial the final agreements will be.

Beyond the uncertainty, the risk of this whole trade war saga is that it prevents the Fed from resuming the easing cycle. In a speech last week, Jerome Powell reemphasized that the Fed is in no rush to cut rates, in large part because of the current trade-related uncertainty. If Trump were to replace Powell with someone more accommodative, it could undermine confidence in the Fed’s independence, which would only worsen matters.

And what if no major deals are made?

That would be the worst-case scenario. A collapse in negotiations could trigger capital flight from U.S. assets, impacting not just the dollar and Treasuries, but also equities. Global investors could rotate into safer or alternative assets like the euro (EURUSD), yuan (USDJPY), or gold (XAUUSD). The U.S. stock market would not be immune and could take a significant hit. Still, the White House will likely do everything possible to avoid this cliff-edge scenario. 

In his appearance before Congress last week, Fed Chairman Jerome Powell once again reiterated the central bank’s cautious stance: it is not rushing to cut interest rates, firstly because the economic situation allows it for now and, secondly, because it is concerned that the ongoing trade war could trigger a spike in inflation.

And indeed, the data is already showing the first signs of the negative impact of higher tariffs. Although the PCE price index rose by only 0.1% month-on-month and 2.3% year-on-year in May, core inflation was slightly higher than expected at 0.2% month-on-month and 2.7% year-on-year, with goods prices leading the way.

So why are investors still pricing a 21% chance of a rate cut in July, which has supported the S&P 500? First, there is still hope for progress in trade negotiations. Second, there is a growing belief that further deterioration in the labor market could finally force the Fed to make the long-awaited move.

Market expectations for interest rates could also be shaped by Trump’s attacks on Powell and reports that he’s considering potential replacements. Trump has argued that the Fed should cut rates to 1%, claiming it would save the U.S. hundreds of billions of dollars in interest on the national debt.

For reference, the U.S. spent $1.1 trillion on debt interest in 2024, nearly double what it paid five years earlier.

The problem is that if the Fed’s independence is undermined, investors could start demanding a higher risk premium, especially for 10-year and 30-year treasuries, thus we could see higher yields. And the damage won’t be limited to just bonds. Trump’s political meddling could also hurt the dollar.

The effect already seems to be affecting the dollar index, which has slipped toward the 97-point mark. Sentiment could be further clouded by an OMFIF survey showing that many central banks plan to increase their exposure to the euro and the yuan, reducing their dependence on the dollar.

That said, it would be far better for the economy if the Fed made its decisions based on economic fundamentals rather than political pressures, which could create more problems than they solve. Ultimately, much will depend on whether real progress is made in the trade talks with key partners.

Donald Trump did not wait for the two-week deadline he had given Iran on Thursday to avoid U.S. airstrikes. Instead, just two days later, he ordered a direct attack on the Iranian nuclear facilities at Fordow, Natanz, and Isfahan, bypassing Congress altogether, prompting calls for impeachment proceedings.

Despite what appeared to be an extraordinary rally, the markets barely reacted. On Monday, the futures of the major U.S. indices — the S&P 500, the Dow Jones, and the Nasdaq — opened in positive territory, while oil prices started to decline. Even news of an attack on a U.S. base in Syria’s Hasakah province failed to unnerve investors.

The muted response reflects hope that the worst of the conflict has passed, and that Iran may have limited capacity to retaliate. As for the threat of Iran closing the Strait of Hormuz, doing so would cut off its own vital oil revenues, invite a far harsher U.S. response, and leave Tehran even more isolated in the region.

So, for now, markets do not seem to believe that the latest flare-up in the Middle East could have devastating long-term consequences for the global economy. However, should a collapse of logistics chains occur, market sentiment would deteriorate sharply, with risk assets down and defensive assets up.

The problem is that even if this particular flare-up subsides, deeper structural threats persist.

In particular, unresolved trade wars continue to drag on without significant progress, and time is running out. Meanwhile, Washington is increasing pressure on technology: the U.S. threatens to revoke exemptions that allow companies like Samsung, SK Hynix, and TSMC to run Chinese factories with U.S. technology.

Add to this the signs of a slowdown in the U.S. economy. In May, retail sales fell by 0.9% MoM, consumer enthusiasm, which had been ignited by tariffs in March and April, faded, and industrial production fell by 0.2% MoM after rising by 0.1% in April. Against this backdrop, the market’s persistent optimism seems less justified.