United States: How Trade Wars, Tariffs & Thin Liquidity Could Tip the Scales

Crisis emergence in financial markets is frequently gradual and cumulative rather than abrupt. The third quarter of 2025 has been defined by a relative absence of immediate shocks. However, for those familiar with the market disruptions of previous Augusts, this calm has not been interpreted as durable. Deutsche Bank has identified three interrelated vulnerabilities: escalation in trade conflict, a marked increase in sovereign yields, and deterioration in market depth and liquidity. These dynamics have the potential to produce significant volatility within a compressed timeframe.

Central to the risk landscape is the expiration of a temporary suspension on U.S. tariffs. A 90-day deferral period, implemented earlier in the year, is scheduled to conclude on August 1. Absent a new multilateral agreement, the United States is expected to impose tariffs ranging between 30 percent and 50 percent on selected imports from the European Union, Canada, and Brazil. Communications from the U.S. Trade Representative to 14 foreign ministries have confirmed that no extensions will be granted. The application of trade barriers at a time when liquidity is seasonally constrained has created concern regarding the potential for price dislocations across equity and credit markets.

The consequences of the earlier tariff announcement were already visible in April, when the S&P 500 declined by over $2.3 trillion in market capitalization within five trading sessions following a leak of preliminary policy language. Although this decline was temporarily halted by the postponement, the Chicago Board Options Exchange Volatility Index rose by 42 percent during the same period. Deutsche Bank analysts have indicated that this episode represented a limited test of market response rather than a comprehensive repricing. In their view, current valuations do not adequately reflect the probability or severity of renewed tariffs.

Recent modeling from the Centre for Economic Policy Research and Cornell University’s Dyson School provides a quantitative assessment of the macroeconomic implications. Under a full-scale global tariff regime, the United States is projected to incur a welfare loss of $85.4 billion and a reduction in gross domestic product of 0.48 percent. Canada would experience a 1.9 percent contraction in GDP, while China, facing retaliatory duties of up to 145 percent, could absorb welfare losses in excess of $94 billion. The inflationary effects of existing tariffs are already evident in key sectors: consumer fuel prices have increased by 6.46 percent, leather goods by 15.95 percent, and apparel by 14.02 percent.

Liquidity conditions are expected to amplify the effect of these shocks. In August 2015, a shift in China’s currency policy triggered a global equity drawdown of approximately $5 trillion in one week. Current liquidity indicators are consistent with similar vulnerabilities. Trading volume on the New York Stock Exchange has declined by 38 percent relative to first-quarter levels, and participation by institutional market-makers falls significantly during August. Deutsche Bank has documented that third-quarter volatility events exhibit higher severity than those in other quarters when measured across multiple historical cycles.

These concerns are exacerbated by ongoing deterioration in bond market structure. Tradeweb’s July 2025 report identified a sharp reduction in corporate bond market depth, with dealer inventories at multi-year lows. Bid-ask spreads on 10-year Treasury securities have widened by 35 basis points on a year-over-year basis. The report concluded that tariff-related uncertainty is exerting systemic pressure on fixed income infrastructure, particularly in areas linked to non-bank financial institutions. This pressure could lead to disorderly market behavior in the presence of further policy shocks.

Fiscal and debt dynamics have also shifted. In July, the 30-year U.S. Treasury yield exceeded 4.95 percent, a level not reached since 2011. This increase has been attributed to the effects of the administration’s midyear fiscal stimulus, which included corporate tax reductions alongside expanded defense and infrastructure outlays. The Congressional Budget Office now projects a federal deficit of over $2.1 trillion in fiscal year 2025, with gross national debt nearing $37 trillion. Foreign demand for U.S. debt has declined, as indicated by year-over-year reductions in Treasury holdings by Japan (15 percent) and China (22 percent).

Of particular concern is the rising cost trajectory of public and private borrowing. Higher yields increase the expense of refinancing government debt, corporate liabilities, and residential mortgages. Sectors with high leverage exposure, including commercial real estate, consumer finance, and private equity, are particularly sensitive to these changes. Commercial mortgage-backed security delinquency rates in the U.S. urban office market reached 6.7 percent in the second quarter, the highest level observed since 2013. A sustained increase in borrowing costs could result in liquidity withdrawal or credit rationing.

International indicators reflect a concurrent slowdown. In the second quarter, China’s GDP growth rate fell to 4.2 percent, falling short of consensus estimates. The Chinese manufacturing purchasing managers’ index has remained below expansionary thresholds for five consecutive months. In the euro area, German export orders declined by 3.1 percent in May, and global trade growth projections have been revised downward by the World Bank from 3.4 percent to 2.0 percent. These adjustments have been linked to elevated tariffs and delays in trade negotiation outcomes.

Geopolitical variables continue to influence risk assessments. Ongoing conflict in the Red Sea has constrained shipping access and increased insurance costs by 140 percent compared to the previous year. Rising tensions in East Asia, particularly involving U.S.–Taiwan defense coordination, have provoked warnings of economic retaliation from Beijing. Crude oil prices have approached $100 per barrel, prompting upward revisions in inflation expectations. According to JPMorgan, instability in any of these regions could trigger global contagion under current financial conditions.

Despite these pressures, U.S. equity valuations remain elevated. The S&P 500, as of July 10, trades at a forward price-to-earnings ratio of 21.7. This level significantly exceeds the 25-year average of 16.2. Margin debt has increased by 12 percent on a year-over-year basis, and initial public offerings have reemerged despite deteriorating fundamentals. Analysts have indicated that current valuations are driven by sentiment-based momentum rather than by underlying earnings strength. Historically, such periods of elevated valuation combined with low volatility have preceded rapid downward adjustments.

Multiple catalysts are scheduled for the final week of July. These include the expiration of the tariff suspension, a monetary policy decision by the Federal Reserve, the release of second-quarter GDP data, and the U.S. Treasury’s updated borrowing schedule. In a recent market note, Deutsche Bank described the confluence of these events as statistically exceptional. The firm emphasized that both monetary and fiscal policy tools are constrained. Inflation, particularly in core categories, remains persistent at 3.4 percent, limiting the feasibility of rate reductions. At the same time, further fiscal intervention may place additional pressure on sovereign debt markets.

Institutional investors have been advised to reduce leverage, prioritize capital preservation, and expand hedging strategies. Policymakers have been urged to provide advanced guidance regarding liquidity support mechanisms. Trade authorities are under pressure to minimize escalation and avoid policies that could destabilize market conditions further.

While many of the risk signals are familiar from prior episodes, the ability of the system to absorb new shocks appears diminished. The interaction of policy, liquidity, and macroeconomic fundamentals suggests that markets are operating under reduced margins of error. Should the identified risks materialize, the transmission could be nonlinear, immediate, and difficult to reverse under prevailing constraints.