Trading the unknown unknowns amid tariff shocks and India-Pak faceoff

Regardless of the outcomes of the US tariffs and India-Pakistan faceoff, change is coming for global value chains and the subcontinent

Traders find a template of “known unknowns” useful for analysing some situations. Take the annual Budget, for instance, or the Reserve Bank of India’s (RBI’s) monetary policy reviews. You know when the event will occur, and you know it will have financial implications. But you don’t know what the implications will be. You gather resources, build scenarios, and take positions accordingly, based on the known timing.

 

Two events currently on the anvil contain large components of “unknowns” with economic implications. One is the global tariff war, and the other is the Indo-Pak faceoff after Pahalgam.

 

The tariff war falls into the category of “known unknowns”. There’s a 90-day moratorium and that “pause” runs out in July. Donald Trump is unpredictable and he’s backed himself into a corner, but he has only a few alternatives.

 

He can impose tariffs at the last proposed levels, probably with a rethink on China-specific tariffs. He can propose some other tariff structure, and go through another round of bargaining for “deals”. Or, he can revert to the structure prior to April 2025 and pretend none of this ever happened.

 

Each outcome has different financial implications. Traders will be prepared for excessive volatility as the 90-day period ends. Every hedge fund will be garnering resources with that timeline in mind. Traders may gamble on the currently proposed structure being imposed, or they may bet on a restructuring of tariffs followed by further bargaining.

 

The imposition of the proposed structure may send the market into a steeper downtrend. A complete withdrawal would lead to a relief rally, which may last for some time. A scaling back of tariffs may also lead to a relief rally, or markets moving sideways, while trade “deals”, as Trump refers to them, are negotiated.

 

Even if there’s a complete withdrawal, the global economy will have endured three months of disruption, which will lead to lower revenues and lower earnings, net-net. That would push markets down over the medium term and may even trigger a long-term bear market if inflation spikes and the United States Federal Reserve refuses to cut the funds rate. In the longer term, regardless of what happens in July, this imbroglio has sparked reviews of supply chains and trade relationships and it may trigger a move away from the US dollar when it comes to pricing cross-border trading.

 

India’s trade account aggregates to roughly $700 billion in goods imports and $400 billion in goods exports. That’s almost one-third of gross domestic product (GDP). Exposures are, therefore, substantial. India could be a beneficiary of a “China Plus” effect, as in iPhones. If manufacturers are seeking “Made Outside China” labels, they may import knocked-down components and assemble and ship the products from India.  The value addition would be minimal, but there would be some boost to employment, which in turn may lift consumption. Weaker global economic activity could also result in lower energy prices, which would be a blessing, given India’s unavoidable energy imports.

 

If the US stays with punitive tariffs, China may also dump an inventory of dirt-cheap commodities and goods into global markets. This could destroy the profitability of entire Indian sectors and enhance the profitability of some select players. For example, cheap steel would reduce costs for infrastructure projects while killing Indian steel manufacturers. India’s policymakers may also be provoked into setting up an anti-dumping tariff structure.

 

The other situation involves multiple “unknown-unknowns”. The one thing that’s predictable about the Indo-Pak faceoff is that the political establishments of both nations will proclaim “victory” to their respective citizens, regardless of what actually happens.  

 

India and Pakistan may indulge in continued posturing, without actual hostilities. There may be limited hostilities with Special Forces raids, missile strikes and counter-strikes, or perhaps a “Reverse Kargil” scenario where India occupies heights along the Line of Control. Or there could be a full-scale war. India may leverage its control of upstream Indus waters to cut off Pakistan’s freshwater. China may retaliate in the Northeast by cutting off Brahmaputra waters. A water war could have knock-on effects for decades in a very water-stressed subcontinent.

 

The financial implications are hard to predict for this “unknown-unknown”. India does have a large, growing military–industrial and aerospace sector. Defence contracts tend to be very lumpy, and projects are often delayed by decades. A war could lead to an acceleration of defence-related activity and higher budget allocations. That could be a focus area for investors.