Financial markets have been roiled by US President Donald Trump’s announcement of tariffs on key trading partners, and investors are bracing for further volatility ahead.
Here’s how they are trading Trump’s on-again, off-again trade war.
Equities: ‘impossible to avoid risk’
Wall Street has been working since before November’s presidential election on how it should position for tariffs. Investment banks have built baskets of stocks with the highest sensitivity to Trump’s plans — mostly exporters such as carmakers and consumer goods companies — which allow their clients to bet on the impact of a trade war across a range of stocks.
That happened on Monday, with companies such as General Motors and Ford in the US and Volkswagen and BMW in Europe falling on the tariff news, before rallying when they were delayed.
The UBS Trump Tariff Losers basket, which tracks the performance of US shares negatively exposed to import tariffs on trading partners and which includes stocks such as Gap and Harley-Davidson, fell 6.6 per cent over the course of Friday and Monday, wiping out its gain for the year.
“The basket got walloped on Friday and was hit again [on Monday],” said Andrew Slimmon, managing director at Morgan Stanley Investment Management. “The market underestimated the will of the president to use tariffs as a negotiating mechanism.”
Some investors appear to have been ready for the weekend’s escalation. According to a Goldman Sachs note, hedge funds have “increasingly shorted” — or bet against — its own basket of tariff-exposed names in Europe. This basket includes Mercedes-Benz and BMW, which are down 3.8 per cent and 2.9 per cent respectively since Trump revealed his tariff plans, and beverage companies such as Diageo, which is down 7.6 per cent.
The long-short ratio — the balance of bets on rising and falling prices — of names in the Stoxx Europe Automobiles and Parts index has dropped to “multiyear lows”, driven by accelerated selling by hedge funds since December, according to the bank.
Among hedge funds to be running bets against autos is London-based AKO Capital, which is short Daimler Truck, while Marshall Wace is short companies including BMW and Mercedes, data from Breakout Point shows. Marshall Wace declined to comment. AKO Capital did not respond to a request for comment.
However, fund managers are also wary of being too bearish, given the market’s rapid reversal this week, the fact that the moves were less extreme than some had expected, and the fear of missing out on the long-running bull market.
In response to the “confusing” situation, Drew Pettit, analyst at Citi, said it is better to hold a bit of “everything”: growth, cyclical and defensive stocks. “It is impossible to avoid risk [assets] now, so you just need to manage it.”
The Vix index, a measure of expected volatility known as Wall Street’s “fear gauge”, rose on Monday. But, at 16, it remains below its long-term average, in a sign that, for now, investor nerves have not given way to panic.
However, the so-called “Vvix” — which measures investor expectations of swings in the Vix — is trading above its long-term average, suggesting investors are still wary that volatility could surge.
Short-term activity in the options market, meanwhile, has been frenzied, as traders try to hedge against or profit from the rapid market reversals, or second guess Trump’s next move.
Trading in so-called zero-day options — contracts that expire the same day and which are used to bet on extremely short-term market moves — hit an all-time high of $1.4tn in notional value last Friday, according to data gathered by Rocky Fishman at Asym 500.
Currencies: ‘incredibly difficult’
The Canadian dollar fell to its lowest against the US dollar since 2003 on Monday, as investors bet on faster Bank of Canada rate cuts, with a record 386,000 futures contracts tied to the Canadian dollar being traded, according to CME Group.
But it then recovered all of the day’s losses on news of the postponement of tariffs. The Mexican peso had a similar reversal.
That has left traders in the currency market — often the first market to react to such news — similarly scratching their heads about how they should be positioned.
“The big question is whether [Trump’s] got some master plan which involves taking things to the brink, or whether he’s just making it up as he goes along,” said Paul McNamara, investment director at GAM.
“Trying to read that man’s mind is just . . . It’s just incredibly difficult. [You’re] trying to trade on something which could go either way.”
For now, McNamara said his team was “a bit underweight” emerging market currencies and slightly long the dollar — “not to a sufficient extent to really rescue us, if we get maximum tariffs, but on the other hand it’s some protection” if Trump were to back down again at the last minute. “Our low conviction view is that things get worse,” he said.
Currency options have been popular. Strategists at JPMorgan saw “sizeable demand” for dollar options against the Canadian dollar and Mexican peso on Monday, “as the risk of tariffs going into effect was too great for the market to ignore”.
However, many investors are sticking with a bet on US dollar strength, the central “Trump trade” that has reshaped markets since the electoral odds began shifting in the Republican candidate’s favour last year.
There was more demand on Monday for dollar “calls” — options giving bullish traders the right to buy the US currency at an agreed price — than “puts”, options giving traders the right to sell the dollar, according to JPMorgan.
Some say currency markets are reacting in a more volatile and uncertain way than during Trump’s first term.
“Event risk, particularly at weekends, has definitely grown,” said Gary Prince, managing director for financial markets at ING, exacerbated by uncertainty over the potential scale of tariffs. That has also fed into investors getting less attractive prices than they expected when they trade, Prince added, due to the rapid market moves.
Some investors, meanwhile, are looking for currency pairs less exposed to tariff news. “I think we have learnt to have most of our risk in trades which are not hostage to headlines,” said Mark Dowding, chief investment officer for fixed income at RBC Bluebay Asset Management, which is betting on the yen against the euro.
Bonds: ‘countervailing influences’
Fixed income managers are trying to work out whether tariffs mean higher inflation and interest rates, or weaker economic growth, which could lead to more rate cuts.
The immediate reaction on Monday was to price in more inflation and slower interest rate cuts in the US, with two-year Treasury yields rising above 4.28 per cent, although they have since fallen back.
At the same time, investors bet on lower growth and faster interest rate cuts in countries such as Canada and the UK.
“You do have countervailing influences,” said Mark Cabana, head of US rates strategy at Bank of America. “The way the rates market has initially traded that is to expect the Fed [to keep rates] on hold for longer, due to inflation risks, but then assign some increased probability of growth negative impacts” in future.
For Cabana, it makes sense to buy Treasury inflation protected securities. “They implicitly give you a hedge to inflation and they also help you guard against some of the downside growth risks.”
In emerging market debt, meanwhile, fund managers have been using sell-offs in some countries’ sovereign debt caused by tariff news as a buying opportunity.
Such news “really results in healthy moves in asset pricing, where we can take the opportunity to get involved in names that, in our assessment, are strong fundamentally or mispriced”, said Alaa Bushehri, head of emerging markets debt at BNP Paribas Asset Management, which has recently bought Mexican debt on negative tariff headlines.
Another fund manager, who asked not to be named, said they took advantage of the recent brief US tariff threats against Colombia to buy its debt at a lower price.
Risk-on or risk-off?
Some investors are turning to other assets as they search for havens. Gold this week hit a fresh record high of $2,882 per troy ounce. “In the commodity world, the only trade you can really go to right now is gold,” said Panmure Liberum analyst Tom Price.
But bitcoin, billed by some as “digital gold”, has offered less protection and is down this week, despite investors’ early expectations that Trump would prove supportive to the sector.
Beyond the short-term trades, fund managers are nervous about longer-term bets on a major downtrend in risky assets that might never happen, particularly given how strongly markets have performed in recent years.
Investors “just don’t know enough about Trump’s next move and how the Fed will react”, said Andrew Pease, chief investment strategist at Russell Investments.
“Going underweight risk assets is a big call, and you need to be very confident. It’s hard to get back to neutral if the market doesn’t correct.”
Additional reporting by Costas Mourselas