In what feels like a case of “much ado about nothing,” the tariffs announced on February 1 against Canada, Mexico, and China have been significantly softened. After speaking with the Canadian Prime Minister and the Mexican President on Monday, Trump decided to delay tariffs on both countries by a month. As a result, only the 10% U.S. tariff on Chinese imports officially took effect on Tuesday.       

Following this news, the U.S. dollar index surged at the start of the trading week, gaining 2%. This shift sent ripples through the forex market, shaking major currencies: the EUR/USD dropped by 1.1%, USD/JPY jumped 0.6%, and GBP/USD gapped lower to $1.2250.         

In response, China quickly hit back with a 15% tariff on coal and liquefied natural gas and a 10% tariff on crude oil and agricultural machinery. It also launched an antitrust investigation into Google (ironically, a company already banned in China for over 15 years). Finally, Beijing imposed export restrictions on five critical metals essential to the defense industry, clean energy sector, and other strategic areas.       

Hopes rest on Trump's statement that he plans to talk soon with his Chinese counterpart, which could lead to another delay in trade restrictions. And judging by the rise in the Hang Seng index on Tuesday, investors remain optimistic about the possibility of a deal similar to those reached with Mexico and Canada. The problem, however, is that the circumstances are different.      

Unlike Canada and Mexico, China is neither a close strategic neighbor nor a long-standing economic ally like Europe. Instead, it is a direct political and economic rival, so Trump is unlikely to soften his stance on Chinese imports. The only way for tensions to ease is for China to make significant economic concessions, but whether the government is willing to make them is unknown.     

What happens if common ground is not found?     

Both economies will suffer consequences. A January 2022 U.S. Department of Agriculture study estimated that direct export losses due to retaliatory tariffs amounted to $27 billion from 2018 to the end of 2019. Another study, commissioned by the U.S.-China Business Council in January 2021, concluded that Trump's trade policies had cost the United States 245,000 jobs.       

This time, the ongoing trade war could shave 0.8 to 1.0 percentage points off U.S. GDP growth in 2025, compared to a more modest 0.4-point impact on China. Since 2018, China has successfully diversified its trade partnerships, helping to cushion some of the fallout. It’s also worth noting that imports and exports comprise only about 37% of China’s GDP.         

When it comes to market impact, tariffs are generally negative for the S&P 500, as they directly cut into the profit margins of U.S. companies that import goods + hit domestic consumers with higher prices. The only positive is that the new tariffs are expected to be a one-time shock. Back in 2018, the S&P 500 experienced a significant drop due to tariffs, but the market quickly began the recovery.