Trade Wars Shake Global Financial Markets

For decades, the United States attracted global capital through robust economic growth, market liquidity, and high returns. However, this trend is reversing as financial capital shifts toward Europeeven as Germany, the continent's economic engine, has experienced two consecutive years of contraction.

President Donald Trump's recent declaration of "liberation day" tariffs has caused turbulence in global financial markets. While U.S. equities have largely rebounded from the initial shock, they remain in negative territory for 2025.

The U.S. dollar has depreciated over 7% since the beginning of the year, indicating a capital flight from the U.S.

The U.S.'s retreat from its role as Europe's security guarantor has led to historic developments: Germany has decided to significantly increase its defense spending, marking a substantial policy shift.

The uncertainty stemming from tariffs, combined with geopolitical developments, has resulted in shocks across financial markets, influencing monetary policies accordingly.

Germany's increased defense expenditures and Europe's relatively undervalued equity markets have made the continent more attractive to investors. Germany's decision to boost defense spending also signals potential economic revitalization for Europe.

A March survey by Bank of America revealed that investors have executed the largest withdrawal from U.S. equities in history, marking the fastest shift toward Europe since 1999. 

According to Morningstar Direct, European-based ETFs investing in U.S. debt and equities saw outflows of €2.5 billion in April alone.

If European pension funds reduce their U.S. asset holdings to 2015 levels, approximately €300 billion worth of dollar-denominated assets could be sold, indicating a potential long-term decline in capital inflows to U.S. assets.

Germany's accelerated defense spending could widen budget deficits and trigger inflationary pressures, potentially prompting the European Central Bank (ECB) to halt interest rate cuts. Since June 2024, the ECB has reduced its policy rate from 4% to 2.25% over seven steps. 

Some analysts suggest that Trump's tariffs might lower consumer prices in Europe instead of increasing them. In such a scenario, the ECB might consider further monetary easing to prevent inflation from falling below its target. However, increased public spending and disrupted supply chains due to tariffs continue to pose upward inflation risks.

Understanding the inflationary effects of tariffs in Europe requires detailed sector-specific data on global supply chains, insights into the outcomes of the ongoing U.S.-China negotiations in Geneva, and clarity on the decisions expected by July 9. Currently, these elements remain uncertain.

European Commission President Ursula von der Leyen has stated that all EU exports to the U.S. face a potential 20% tariff threat. This week, she announced that the EU is "preparing for all possibilities," indicating that the trade war could escalate beyond financial implications into the political realm.

Capital movements across the Atlantic have also impacted Asia. The Taiwanese dollar appreciated nearly 10% against the U.S. dollar within two days. In response, the Hong Kong Monetary Authority executed its most aggressive currency intervention since 2020 to prevent excessive appreciation.

The dollar's depreciation and Europe's appeal have raised concerns among Asian countries regarding their dollar-denominated assets. Taiwanese life insurance companies, holding approximately $700 billion in dollar positions, have about one-third of these exposures unhedged against currency risk, leading to significant losses. Post-pandemic, Asian export-driven nations have accumulated around $2.5 trillion in reserves, and the devaluation of these reserves threatens global financial stability.

Despite this complex landscape, President Trump remains active on the international trade stage. This week's agreement with the United Kingdom demonstrates his ongoing ambition to reshape global economic arrangements, effectively bringing the world to his negotiating table.