EU’s chief trade negotiator, Maros Sefcovic, remarked on the trade discussions, acknowledging that the final phase is challenging. He plans to update EU ambassadors on the progress, with a deal deadline set for August 1st.
Analysts suggest the U.S. might introduce tariffs of about 10%, while the EU aims to obtain concessions in crucial areas. If no agreement is reached by the deadline, it’s probable there will be another extension. This would let the EU keep paying the existing 10% tariff, in place since April 9th.
Market Uncertainty and Volatility
Given the commentary from the chief negotiator, we believe the coming weeks will be defined by rising uncertainty. This market environment is ideal for strategies that benefit from increased price swings, otherwise known as volatility. We should anticipate sharp movements in European equities and currency markets as the August 1st deadline approaches.
We see an opportunity in the options market, as current pricing may not fully reflect the potential for a breakdown in talks. The Euro Stoxx 50 Volatility Index (VSTOXX), a key measure of European market fear, has been hovering around a relatively low level of 15, making it cheaper to buy options now. We are considering purchasing straddles on major indices, which would profit from a significant price move in either direction, regardless of whether a deal is made or fails.
History provides a useful guide for this type of political deadline. During the peak of the U.S.-China trade war in May 2019, the VIX index, which measures U.S. market volatility, surged over 45% in a matter of weeks as tariff threats escalated. We expect a similar, albeit smaller, reaction in European markets if the current talks falter.
Sector and Currency Impact
Specific sectors are more exposed than others, particularly the European auto industry, which exported over €40 billion worth of vehicles to the U.S. last year. A 10% tariff would directly impact the earnings of major German and Italian carmakers. Therefore, we are looking at buying put options on these specific companies as a targeted way to hedge against, or profit from, a negative outcome.
The currency market also presents a clear opportunity, as the outcome will directly impact the EUR/USD exchange rate. A failure to secure a deal would almost certainly weaken the Euro. We can position for this by acquiring EUR/USD put options, which will increase in value as the shared currency depreciates.
Should an extension be announced, as the original analysis speculates, implied volatility would likely fall as the immediate risk is postponed. In this scenario, we would look to sell the volatility we have accumulated and take profits. This allows us to reset and re-evaluate our positions ahead of the next critical date.
