Rare earths, tariffs and a TACO reversal
Over the weekend, analysts and economists once again rushed to interpret the consequences of the latest flare-up in US–China trade relations. This latest clash began when Beijing announced new tariffs on rare earth exports, prompting a characteristically combative response from President Trump on Truth Social. His remarks sent financial markets into a tailspin, followed shortly afterwards by a public retreat on the issue that left many observers wondering what the original objective had been.
The US dollar gave back some of its earlier strength at the end of the week, as investors were caught off guard by this new phase of trade friction between Washington and Beijing. China set the ball rolling with a broad set of export restrictions on rare earth elements and certain lithium-ion batteries. These materials are essential for American technology firms, defence contractors and car manufacturers. The announcement raised the prospect of significant supply chain disruptions and drew an immediate reaction from President Trump, who threatened to double existing tariffs on Chinese imports from 1 November. It was a clear signal that Beijing is prepared to use its economic leverage, placing the Trump administration in a challenging position.
By Friday, panic had taken hold in markets. The threat of extensive new tariffs, combined with the reality of China’s restrictions, triggered a sharp sell-off. The Nasdaq Composite fell by 3.6 per cent, a drop of 820 points, while the S&P 500 endured its worst single session since April, sliding 2.7 per cent. Investors sought safety in government bonds, which pushed down 10-year Treasury yields and weakened the dollar index. The message was unmistakable: China retains the power to strike at the very companies that have driven Wall Street’s recent gains.
The tone shifted by Sunday. President Trump attempted to calm the situation with a social media post urging the public not to worry about China. Beijing’s Commerce Ministry responded with a statement saying it did not wish to enter a tariff war but would not shy away from one, calling on the US to resolve differences through dialogue and describing repeated tariff threats as the wrong way to engage with China.
Earlier this year, the administration had taken a more aggressive stance to increase pressure on Beijing. That strategy now appears to be softening. The confrontation ended with a temporary truce after fears of a sudden stop to global economic activity briefly gripped markets on Friday.
Markets are expected to rebound as the new week begins, though caution is likely to persist. China’s decision to restrict access to critical raw materials and continue its suspension of US soybean purchases will keep pressure on the Trump administration and American farmers. The President may choose to signal flexibility by proceeding with his meeting with President Xi and moderating his tariff threats. Alternatively, he could double down on the hardline approach, a move that would risk placing the burden on US industries rather than Beijing.
Complicating matters further, the US Treasury’s decision to extend a currency swap line to Argentina has attracted criticism at home. With China’s retaliatory measures already hitting US agricultural exports and global demand weakening, many farmers in the Midwest argue that the funds would have been better spent supporting domestic producers rather than stabilising Argentina’s peso.
In a broader sense, this episode highlights the race between the US and China to reduce their economic dependencies. China is investing heavily to build its own technological capacity, particularly in semiconductors, to reduce reliance on American firms. The US, on the other hand, faces a lengthy and difficult process to loosen China’s grip on rare earth processing. With no major economic data due this week, investors will shift their focus to third-quarter earnings. Thirty-six S&P 500 companies will report, starting with major financial institutions including BlackRock, Wells Fargo, JPMorgan Chase, Goldman Sachs and Citigroup on Tuesday, followed by Bank of America and Morgan Stanley on Wednesday. Attention will centre on whether profit margins across the index are beginning to erode, perhaps due to higher supply chain costs linked to tariffs, or whether productivity gains and cost control measures are offsetting these pressures.
EUR: Familiar political troubles weigh on the euro
The euro’s recent slide was largely driven by sentiment following the second collapse of the French government in less than a month. Friday’s reappointment of Sébastien Lecornu may mark the end of the most intense period of negative headlines, but the political situation remains fragile.
The move risks deepening France’s political gridlock. Lecornu faces significant criticism over his proposed cabinet and his attempt to push through the 2026 budget is likely to prove challenging. Investor sentiment is unlikely to improve in this context, reinforcing the perception of limited options within a fragmented parliament. The euro therefore has little room for a political uplift and is more likely to weaken further.
Short-term support for the euro is seen around 1.16. Traders will be listening closely to fresh central bank commentary this week, with speeches expected from Christine Lagarde and Piero Cipollone at the ECB, and Jerome Powell, Michelle Bowman and Christopher Waller at the Federal Reserve. However, most of the rhetoric is already well signposted, so the next significant shift is likely to follow the US inflation data from the Bureau of Labor Statistics. This report, delayed by the government shutdown, is expected later this month, though the date has not yet been confirmed.
Investors will also be watching the final inflation figures across eurozone member states. Since inflation is central to ECB policy, any material undershoot would increase the likelihood of another rate cut.
GBP: Employment data in focus
Sterling fell to a fresh two-month low against the US dollar last week, driven by firm demand for the dollar as political risks increased globally. Although the currency looks oversold by some measures, the momentum remains strongly negative and further weakness towards 1.3173 is possible in the short term.
With no significant domestic data last week and yield differentials between the UK and the US steady, sentiment largely determined sterling’s trajectory. Risk reversals for sterling, particularly over a two-month horizon, continued to decline, indicating rising demand for protection against further falls ahead of the UK Budget. Sterling’s weakness has also been compounded by safe-haven flows into the dollar following political developments in Japan and France.
Attention now turns to Tuesday’s UK employment figures for the three months to August. This release could play a key role in shaping expectations for Bank of England policy and sterling’s near-term direction. While some technical indicators suggest the pound is stretched, the broader trend still points towards ongoing weakness.
