Trump fires the starting gun on the trade war

Trump fires the starting gun on the trade war

Initial fears over AI were overtaken by fears of a trade war, with markets fearing a growth slowdown more than inflation risk. Its early days to assess the impact ahead, but the US seems to be in the driver’s seat…for now. Our Chief Investment Office explains.

We started 2025 similarly to how we ended last year, with intra month volatility once again signalling a cautious market as investors waited for Trumps inauguration, still uncertain as to the speed and extent to which his policy positions would be implemented once he held the keys to the oval office. Despite the volatility, with some markets moving around a 5% range in January, equities once again finished in the black, generating strong returns for investors, and continuing the positive run from 2024.

With markets hovering near all-time highs, ongoing concentration in the rally (thanks to the Magnificent 7), and the potential for an unprecedented trade war ahead – it’s no surprise that investors were looking for any reason to sell, and sell they did with the announcements around DeepSeek AI. DeepSeek is a Chinese backed large language model (LLM) that spooked the market by showing investors that the Chinese may not be as far behind in AI development as previously thought, while potentially doing so at a lower price. This was initially interpreted as a major negative for all technology stocks, which resulted in steep sell offs across the board. By the end of the month, the fear around AI had dissipated somewhat, with stocks either finding a new trading range, or in many cases bouncing back.

Post month end, we are dealing with a more serious risk, with Trump having made good on his threats to start a trade war by announcing tariffs on major trading partners, Canada, Mexico and China. Although this poses a threat of slowing economic activity, at present, we continue to be constructive and await more information before reassessing our portfolio positions. Indeed, it was subsequently announced that Trump is pausing tariffs on Mexican and Canadian goods following conversations with each country’s respective leader, where they committed to assist in securing their border with the US against the flow of illegal drugs and migrants. We currently hold a mild overweight to equities in our portfolio, balanced against defensive assets should Trump choose to re-escalate trade tensions.

Valuation in developed equity markets (particularly the US) continues to look expensive from a historical perspective. Although the trade war may now be under way, the US’s lower reliance on global trade as a proportion of GDP compared relatively to many other nations, and with Trump still in control of how and when policy is rolled out, US equity markets may continue to look better positioned than its trade partners. However, such a view can change rapidly. We are very much in new territory, with little precedent for comparable scenarios, and uncertainty as to how other nations will react with either retaliatory actions or concessions to Trump’s demands.

The world is very different today compared to prior periods when nations could rely on tariff revenue as a sustainable source of income. Supply chains can be easily restructured within months rather than years, as witnessed by the actions of China and Ukraine in recent years. Both nations rapidly restructured export supply chains, limiting disruptions. Although this can be seen as a positive, the concern is that Trump may have to go much wider in his trade war to achieve his policy aims. This is well known, so we currently see two possible scenarios ahead. The US may continue to seek some small concessions from its targets – as evidenced with Canada and Mexico this week - then look to reverse policy. We view this as a relatively good outcome for markets. The negative scenario is that Trump pushes ahead with proposed tariffs and includes a wider set of countries to limit the impact of supply chain restructure, leading to a more challenging economic scenario globally. This is not our base case, a potential slowdown in economic activity is a reason we see to maintain a healthy position within portfolios to defensive assets.

In addition to growth concerns, the risk of near-term inflationary pressures has increased. We have previously highlighted that we saw inflation as second half of 2025 issue, however, the tariff announcements could see this be brought into the first half of 2025 (although markets have not yet priced any material changes to expected rate cut trajectories). Inflation prints both globally and locally have continued to suggest that inflation pressure is slowing, with the global easing cycle expected to continue. Central banks globally will likely look to reassess their stance in the weeks or months ahead, as any potential action and retaliatory action around tariffs are announced. It should be noted that even with any ongoing announcement of tariffs, there will be a point at which central banks will look through the immediate impact on prices and see through to the growth impact (as the market is currently doing) and may well maintain an easing bias.

Figure 1: Australian & US 10-year government bond yields

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Source: Macrobond, U.S. Treasury, ANZ CIO

An easing bias, coupled with fiscal support and a stable (albeit increasingly challenged) earnings environment may well provide a floor under markets for the near term. Investors may take time to digest the implications of the trade war, and any increase in liquidity stemming from the delay in the debt ceiling resolution, will only add to this support for equity markets.

Central banks to maintain an easing bias

We continue to expect the European Central Bank (ECB) to take its deposit rate to 1.5% and deliver monetary stimulus to stimulate growth and to support its inflation target over the medium term. In addition, the ECB will also be waiting to hear details of any proposed tariffs on European imports into the US, that have been threatened but not yet delivered by Trump. While European policy makers may be relieved at the cooling of tensions between the US, Canada and Mexico, Trump has sent a clear signal that he expects some form of concession before pausing any trade hostilities. Given the existing need for stimulatory policy in the region, any actions by the US will likely lead to an acceleration of ECB easing policy, should it be deemed to sufficiently increase the depth or speed of the slowdown in Europe.

At home, the ASX finished the month on another all-time high, and continues to trade on an elevated multiple of over 18x forward earnings. With global trade accounting for close to half of Australian GDP, any trade war presents a material risk to economic activity in the near term, and we remain cautious on Australia equities as a result.

The local economy continues to show mixed results, with unemployment remaining low but economic activity staying on the softer side. This has seen inflation come in under RBA expectations, with the trimmed mean falling to 2.7% (previously 3.2%), well within the 2-3% target range the RBA would need to start easing rates. As such the market has increased its probability for the easing cycle to begin at the February board meeting. ANZ Economics has also brought forward its expected timing for the first RBA rate cut to February.

Figure 2: Markets have increased rate cut expectation

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Source: RBA, ASX, Macrobond, ANZ CIO

What this means for our diversified portfolios

We have maintained our positioning within risk assets this month and will spend the period ahead assessing the medium-term impact of announcements made by the Trump Administration. Within short duration, we have looked to add domestic duration as a hedge against any further slowdown in China that might force the RBA to cut rates more aggressively. With weakness in Europe, stretched valuations in Australia and the trade war with China underway, we continue to see positions tilted towards the US as the most appropriate positioning within the Equity bucket. Although US looks more favourable in the near term, the longer-term impact of a trade war should it re-escalate will likely be felt globally, and earnings growth and margins are likely to suffer.

Though our allocations to US tech-related shares, which were increased during December came under pressure, earnings results across the sector continue to look strong against other sectors, and with fears around the impact of DeepSeek having subsided for now, we continue to favour this sector across portfolios. Although further announcements regarding China’s strengthening position in the AI race may see more volatility in this sector, the race for dominance could well see a further acceleration in AI development in general, which may further support tech related stocks.

Our exposure to broader emerging market equities was maintained, and without material fiscal stimulus by China to offset its weaker growth position, we see little reason to add to this position at present. We believe there is likely to be opportunity in the months ahead for investors to benefit tactically should China look to shore up growth through policy stimulus, but there is little benefit in pre-empting such a move.

We see the positive outlook for gold, which we have held for some time, further supported by the accelerated commencement of the trade war, and the underlying drivers for the asset including rising geopolitical turmoil, increasing fiscal deficits, and robust purchases from central banks, all likely to remain this year.

Figure 3: Gold continues to perform

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Source: Macrobond, U.S. Treasury, ICE, S&P Global, ANZ CIO

The yield environment had not materially changed by month end, but like other markets continued to face intra month volatility. Since the announcements around tariffs, rates have faced downward pressure, with markets looking through the initial inflationary impact of tariffs and reading through to the slowdown in economic growth. As we have maintained, this has been the key driver of our mild overweight to long-duration in portfolios, with duration remaining an important diversifier for a growth slowdown in a risk-off environment.