Europe Awaits Trump Tariff Clash With Its Own New Trade Powers

(Bloomberg) --

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Europe’s worst-case scenario for the future of transatlantic economic relations rose to the surface this week when President-elect Donald Trump gave a clear signal that he’ll use American trade might as a means to exert foreign policy leverage.

His threat to hit Canada, China and Mexico with tariffs because of the flow of illegal drugs and migrants into the US sent European stocks lower, particularly shares of companies like Stellantis NV and Volkswagen AG whose vehicles would be vulnerable in a trade war with Washington.

Trump’s warning served as a blueprint for the European Union on how he’s likely to approach his many grievances with the bloc: to impose — or threaten to impose — tariffs using norm-breaking justifications on policy issues that don’t necessarily relate to the protection of domestic industries. When it comes to trade, Trump has argued that the EU treats the US worse than China does.

“Europe needs to be prepared,” Penny Naas, a global public policy expert at the German Marshall Fund in Washington, said in an interview. “This to me seems like the starting gun of what they should expect is coming their way sometime in the not too distant future.”

The euro initially inched higher versus the US dollar on Tuesday after Trump’s remarks on social media, rebounding from a two-year low amid relief that he made no mention of European trade tariffs. But the gain was quickly erased. European stocks slumped, while the region’s bonds outperformed global peers.

Europe was largely caught off-guard in 2017 when Trump, citing national security concerns in his previous term as president, levied tariffs on European steel and aluminum. The 27-nation bloc had to scramble to defend its companies and to impose retaliatory measures.

Since then, the EU has reinvented its trade doctrine, making it more assertive and expanding its economic toolbox to counter coercive practices.

“We are well-prepared for the possibility that things will become different with a new US administration,” German Foreign Minister Annalena Baerbock said after a Group of Seven meeting in Italy Tuesday. “If the new US administration pursues an ‘America first’ policy in the sectors of climate or trade, then our response will be ‘Europe united.’”

What Bloomberg Economics Says...

“President-elect Donald Trump has criticized the European Union for treating the US ‘so badly.’ To avoid a full-blown transatlantic trade war, the bloc will have to find ways to placate him — and all the potential concessions carry serious trade-offs at home.”

—Antonio Barroso and Maeva Cousin. for full insight, click here

The Brussels-based European Commission, the EU’s executive arm, adopted a new economic security strategy earlier this year aimed at leveraging its massive single market to rebuff coercive measures from geopolitical adversaries such as Beijing and Moscow as well as from allies like Washington.

The beefed-up approach sought to identify risks “emerging as a result of increasing geopolitical tensions, geo-economic fragmentation and profound technological shifts,” and to create tools for the bloc and member states to address those risks.

EU member states agreed to a new set of trade powers that will let the EU strike back at third countries that use economic restrictions for political retribution. The EU’s new anti-coercion instrument strengthens trade defenses and enables the commission to impose tariffs or other punitive measures in response to such politically motivated restrictions.

The EU also adopted a so-called foreign subsidies regulation, which allows the commission to prevent foreign companies that receive unfair state handouts from participating in public tenders or merger-and-acquisition deals in the bloc, among other measures.

The threat of a new trade war has unnerved markets, with the expectation that the EU is headed for a period of instability and uncertainty.

Complex supply chains mean that companies in the bloc will continue to be impacted by tariffs imposed on the likes of Mexico, according to George Saravelos, global head of FX research at Deutsche Bank AG. That’s even before considering what Trump may have in store for Europe, and the latest tariff threats are a sign they will be a key tool in policy negotiations, Saravelos warned.

“Tariffs are clearly at the top of the Trump agenda,” he said. “We see an implicit signal that they are likely to be used as a broad-based economic and geopolitical tool in this administration.”

Europe’s equity and currency markets have been under pressure since the US election, with investors fearful the region will be particularly vulnerable to Trump’s policy agenda. Many strategists are forecasting the euro to slide toward parity versus the dollar and see European stocks extending their underperformance versus US peers.

‘More Cautious’

Some investors are staying on the sidelines until there’s more clarity about Trump’s policies and their impact on Europe.

“I’m being a bit more cautious, and I’m not making major macro bets on Europe whether it’s in equities or bonds,” said Julius Bendikas, European head of macro and dynamic asset allocation at Mercer, which oversees a total of $548 billion in assets, who has dialed down risk over the last few weeks. “Right now there’s still a lot of uncertainty, and we have to take a few pages from the 2016 playbook — at that point being a little cautious was the right thing to do.”

Trump has multiple grievances against the EU and has criticized Europe for not spending enough on defense and for the US-EU trade deficit. He once referred to Brussels, the seat of the EU institutions, as a hellhole, and more recently he said he’d once told a NATO member that he’d let Russia do “whatever the hell they want” to it if it didn’t hit defense spending targets.

Europe has more tools at its disposal to react to a trade war with the US, said Naas of the German Marshall Fund, but it remains an open question whether the 27 member states can remain united.

“Indeed, Europe has more tools,” Naas said. “But I think the question has always been: Is Europe prepared to go on offense as opposed to defense?”

--With assistance from Arne Delfs.

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