The Next Market Shock...

...And how to play it.

It’s good to know that someone had a worse weekend than I did. After President Trump called off trade talks with Canada, Ottawa was forced into an agonizing reassessment of the trade gun pointed at the side of the Great White Head and… blinked.

The rub was a digital services tax that was set to go into effect on Monday that would mainly hit American Big Tech. Canada’s Prime Minister Mark Carney had said that the tax wasn’t up for discussion, and it a way he was right: There wasn’t much discussion. Trump announced the tax was “a blatant attack on America” - which is a bit thick, but the United States accounts for more that a quarter of Canada’s GDP and three quarters of its exports. Moral points tend to get smothered under the weight of reality. Unless Canada scrapped the tax, the country’s economy was more or less doomed.

Canada’s market isn’t large enough to really scare Mark Zuckerberg’s accountant and storming out of the talks on Friday wasn’t for Canada’s benefit so much as the EU. So if you’re wondering where the next market shock, or spasm, will come from, there you are.

Over the last decade, the bloc has appointed itself the regulatory watch-dog over global digital services, and gadfly to American Big Tech, in order to punch above its economic weight. So far the play has worked. Unlike Canada, the EU does scare Silicon Valley. As does the tendency of developing markets to follow Brussels’s lead on tech regulation. With all due respect to the world’s poly-sci majors and their abstract political winds theories, regulation is the reason Big Tech came out to line up behind Trump 2.0. The president’s slap-fight with Elon Musk notwithstanding, he still owes an industry that, he suspects, can take him out if they want to. In short, the administration is perfectly willing to blow EU trade talks up over digital services. With all due respect to Canada, they were just a shot across the bow.

European leaders are looking across the ocean in horror, and that’s precisely the point. It’s a king-hell of a political pickle: privacy and digital regulation is very popular with European voters. To capitulate on Trump’s demands will likely cost them their jobs at election time. On the other hand, standing up to the White House risks a blow up with the bloc’s largest trading partner – which buys about a fifth of EU exports. That’s not the size of the gun pointed at Canada, granted, but it would still wreck the Eurozone economies. It won’t do the US economy any favors either, but it a question of scale.

The smart bet – if you’ve got the stomach for it – is that the EU will go through the motions of standing up to the US. If nothing else it will play well at home and test Trump’s admittedly patchy resolve. Assuming that the White House storms out of talks, there will be some market panic. Which is what the EU will be banking on. Then it becomes a matter of who blinks first.

The TACO trade isn’t the indicator to watch. While Trump does tend to blink in a showdown, Brussels shouldn’t count on it. The White House does get spooked by market spasms but it’s the bonds, not the stocks, that give him the yips. And why not? He’s riding high on the fact that, after the S&P drive-heaves pass, the numbers land higher than before. The man is feeling expansive and, since Canada capitulated on the digital services tax over the weekend, we can assume he is emboldened. Trump has the advantage.

After a short, performative stand-off, it will probably be the EU that blinks - at least in the short term. That will salve spooked markets, but it wont help the dollar much. What the White House isn’t seeing is that all this weaponization of trade and the dollar that started under President Biden has been causing rivals and allies alike to start the slow process of rewiring their financial systems away from the dollar dominance through diversification of central bank assets.

But that’s a long-game bet.