EU Trade Commissioner Sefcovic is scheduled to discuss with US Commerce Secretary Lutnick. The EU reports active technical and political communication with the US, prioritising a negotiated solution. While striving for a resolution through talks, the EU is also preparing other options, which may involve further countermeasures.
Trade Solution Strategies
To implement these countermeasures, the EU proposes combining two lists into a single list. These measures could include tariffs and regulations like the Anti-Coercion Instrument (ACI). Both sides aim for a compromise, and recent developments from a US-Japan deal provide optimism to the markets. Despite this, it’s essential to recognise that Japan’s circumstances differ, with Prime Minister Ishiba under pressure to maintain political relevance.
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Given the binary nature of the upcoming talks between Sefcovic and Lutnick, we believe the most direct strategy involves using options to trade the expected volatility. The preparation for countermeasures suggests a significant market move is possible in either direction, making long straddles or strangles on key European indices an attractive position. This allows traders to profit from a sharp price swing, regardless of whether the news is positive or negative.
We note that market volatility appears underpriced relative to the political risk. Europe’s primary volatility index, the VSTOXX, has recently hovered near the 15 level, which is low by historical standards during periods of trade uncertainty. This suggests complacency and presents an opportunity to buy call options on the VSTOXX, which would appreciate significantly if negotiations sour and countermeasures are announced.
Sectoral Impact and Precautions
The sectors most exposed to new tariffs, such as European automakers, should be watched closely. In 2023, Germany alone exported vehicles worth over €38 billion to the United States, highlighting the immense financial stakes. Traders could consider buying put options on a German stock index or a European automotive sector ETF as a hedge or a speculative bet against a favourable outcome.
This situation is reminiscent of the 2018 trade disputes, which caused immediate spikes in market volatility and sharp, short-term downturns upon the announcement of tariffs. While markets seem encouraged by the recent US-Japan deal, we see the pressure on Ishiba as a unique circumstance not applicable here. The EU’s new Anti-Coercion Instrument, which just entered into force in late 2023, also adds a powerful and untested retaliatory tool that markets may not be fully pricing in.
