Trump's declaration of a trade war shakes the markets.

By Tom Westbrook, Reuters - Investors bought dollars, sold stocks and worried about inflation on Monday, in a race to assess the risk of a trade war after Donald Trump imposed tariffs on the U.S.'s main trading partners.

Trump's orders for additional 25% tariffs on imports from Mexico and most Canadian goods, as well as 10% on Chinese goods, take effect on Tuesday and have already shaken markets that assumed Trump was mostly bluffing and boasting.

The sell-off extended beyond the Canadian and Mexican markets and the stocks directly in the line of fire, to cryptocurrencies, equities, and even the safe-haven Japanese yen, as investors tried to guess the next moves of the US president.

Concerns about the inflationary impact of comprehensive tariffs on growth and the uncertainty this creates for the Federal Reserve played a role, causing everything except the dollar and long-term US Treasury bonds to be sold off.

"Trump's trade war has begun," said Alvin Tan, head of Asian currency strategy at RBC Capital Markets in Singapore, noting that it was difficult to see the US dollar weakening anytime soon.

The dollar has been the main driver, gaining strength as Trump headed for and later gained power, because investors assumed that countries affected by the tariffs would weaken their currencies to offset the impact.

On Monday, the euro fell 1,3% due to fears that Europe could be next on the list of tariffs.

The Canadian dollar fell to a 20-year low, the Chinese yuan fell in offshore trading, oil jumped, metals fell, and US stock futures dropped about 2% due to risks to American corporate profits.

Trump said the tariffs could cause suffering "in the short term" for Americans, and although he will speak on Monday with the leaders of Canada and Mexico, who have announced their own retaliatory tariffs, he downplayed expectations that the Mexican and Canadian rulers would change his mind.

He said that tariffs would "definitely happen" with the European Union, but did not say when.

"Amid sweeping tariff threats that are expected to expand further, the dollar has gained strength at the expense of the currencies of the US's trading partners," wrote analysts at Mizuho.

The long-term implications for other asset classes are less clear.

Stocks fell as analysts, such as those at Barclays, expect a slowdown in US corporate profits and uncertainty about how the rest of the world will respond. Canada has already ordered retaliatory tariffs, and Mexico has signaled a retaliatory response.

Mizuho said that optimistic investors are reassessing their negotiations with Trump.

"Stock market optimists seduced by the narrative that 'Trump is good for stocks' are subject to a stark warning about the potentially shocking impact on growth/profits amid spirals of retaliatory tariffs," said Mizuho.

Stocks in Hong Kong, Tokyo, Sydney, Seoul, and Taipei fell by around 2%. European stock futures dropped 2,8%.

"I don't believe market participants have fully grasped the extent of the potential consequences yet, especially as responses from affected countries unfold," said Tareck Horchani, head of first-tier brokerage at Maybank Securities in Singapore.

He said that many investors had built positions in dollars and gold in recent weeks, but may still have been surprised by how quickly Trump's threats translated into action this time.

"It's possible that some investors underestimated Trump's resolve on tariffs, expecting more negotiations instead of immediate action."

Anxiety

The difficulty in assessing the effect of the tariffs stems from the fact that their duration and precise justification remain unknown.

Some investors still believe that some kind of deal is possible or that the tariffs will be quickly eliminated if Trump gets what he wants.

Trump linked the tariffs to the flow of migrants and drugs — particularly fentanyl — into the U.S. and demanded crackdowns on Canada, China, and Mexico.

China and Mexico have said that fentanyl is a problem for the United States, so the prospects for a breakthrough are unclear.

China, still closed on Monday for the Lunar New Year holidays, said it would challenge Trump's tariffs at the World Trade Organization and take unspecified countermeasures.

"These broad tariffs that cover a much wider range of products and are targeted at social policy generally prove to be a mistake," said Rick Meckler, a partner at Cherry Lane Investments in New Vernon, New Jersey.

"I think that's why the market has been looking at this with skepticism and anxiety all along," he said. "A full reaction won't be achieved until it's clear that this is the policy, however."

Meanwhile, debt markets appear to be caught between the negative inflationary implications of higher consumer prices and the potential for rate cuts due to the impact on growth — which should be positive for bonds.

Benchmark 10-year Treasury bonds showed a slight recovery, reducing yields by about 4,5 basis points to 4,52%.