Trump tariffs and what they mean for basis trades

A tariff is a tax on imported goods which gets applied at the border when a good is bought from aboard. Find out their impact on basis trading.

Trump tariffs and what they mean for basis trades
Photo by Jezael Melgoza / Unsplash

This is not a political article, the purpose is to discuss the issues that exist in international trade, the impact that tariffs or other government actions may have on employment, inflation and specifically, on basis trades and funding rates.

The Tariff Man

President-elect Donald Trump has called himself "a Tariff Man," and said the word "tariff" is "the most beautiful word in the dictionary."

Trump announced on X/Twitter that he would sign an executive order for a 25% tariff on goods coming from Canada and Mexico and that those tariffs would remain until the flow of drugs and immigrants from these countries into the United States stop. After the announcement, the Canadian dollar traded at its lowest rate to the US dollar in 15 years, and the Mexican peso fell 2%.

As for China, Trump has already promised to impose a 60% tariff and even discussed a 200% tax on some car imports, saying that goods coming from China will be hit with an additional 10% tariff if China doesn't do something to halt fentanyl smuggling into the U.S.

Tariffs, a controversial subject among economists, are core to Trump's economic vision. He sees them as a way of protecting American jobs, raising tax renevue and growing the U.S. economy. On his campaign, he told voters that his tariffs would not cost American consumers anything, that they are instead a tax on the country being taxed, which economists have described as misleading, or at least, an incomplete explanation.

TikTok in the way

On January 19, TikTok will be banned in the U.S. unless ByteDance, its Chinese parent company sells to a U.S. company.

Ok, isn't this about tariffs? What does TikTok got to do with it? Bear (no pun) it with us and it'll become clearer.

Donald Trump in his 2024 presidental campaign said he would save TikTok, but likely as a way to get votes from younger people. It wouldn't be the first time a politician says one thing and does the opposite.

Altough China doesn't want to partake with TikTok, the social network could could be used as leverage in trade negotiations. Being the consumate dealmaker, Trump may say "give us TikTok, and we'll ease on the tariffs". It could be a middle-of-the-road compromise that isn't particularly good for anyone, but not bad for them either. China sells something it wouldn't like to, but gets fewer tariffs, Trump gets to throw less tariffs around, but making him the President who saved TikTok.

In any case, it's highly likely there will be plenty of tariffs to go around.

What is a tariff?

A tariff is a tax on imported goods which gets applied at the border when a good is bought from aboard. It's basically a fee imposed by governments to import goods, that serves as an economic strategy that a sovereign country can use to push its citizens into buying domestically.

It works well when the countries in question both produce a common good, such as wheat. If a country like China manufactures a television or motherboard that an American citizen can't buy from an American manufacturer, that buyer has no choice but to pay the tariff.

Here's how a tariff works

A tariff is a fee imposed at the point of entry into a country. If a retailer wants to import Chinese-made headphones, that retailer will buy it for X amount of dollars — let's say it's $100.

At U.S. customs, the tariff is imposed: if the retailer wants to import the headphones, it must pay $60, which is 60% of the original price of $100. The retailer plans to resell the headphones for a markup, because they have to make a profit. Let's assume it's 30% of those $100. If there was no tariff, the buyer would pay $100 + 30 %, or $130, for those headphones he would buy at any of the retailer's stores.

With the tariff, the retailer needs to make a choice: does it absorb the cost of the tariff, selling the headphones at or near the price of $130, or pass along the tariff's costs to the consumer?

As the goal of a company is to make money, the common belief is that the retailer would choose to make the consumer pay for the extra cost. This means our headphones costs $100 + 60% from tariffs ($160) + 30% from retailer markup, for a total of $208. That's a difference of $78 from the pre-tariff price to the post-tariff price.

What's the point of tariffs?

The idea with these proposed tariffs is that they're too large for U.S. retailers to absorb, choosing to have consumers bear that cost, which would result in prices higher than many consumers would be willing, or able to pay. Some people would stop buying the items and demand would fall.

That's the idea anyway.

Whether we look at tariffs as an effective tax, or as inflationary, the result is that the Trump tariffs will likely raise prices across different sectors, some which may be hit hardest, such as technology — tablets, phones, PCs, etc, and agriculture, having repercussions in the markets and financial products.

Can tariffs be avoided?

They can, because Donald Trump likes to think himself as a negotiator and deal-maker.

Think back at the earlier example in this article. TikTok can still be banned and Trump unable to avoid that, but there is the probable scenario that plays out in which China agrees to sell TikTok to a U.S. company to avoid the ban, thus avoiding further tariffs. TikTok doesn't get banned, Trump gets to look good, and China loses a valuable asset but doesn't get hit with (more) tariffs.

There's also Apple CEO Tim Cook, who managed to talk Apple out of the first Trump tariffs by meeting with Donald Trump personally. Then there are the other big shots who have already met with Trump (example of Jeff Bezos dinner at Trump's Mar-a-Lago house), Meta CEO Mark Zuckerberg and OpenAI CEO Sam Altman who both donated $1 million to Trump's inaugural presidential campaign. But that strategy may only work when individual company executives meet with Trump one-on-one.

There is no guarantee that businesses will keep prices down, even if they're not subject to tariffs. Fed economist Aaron Flaaen and others found that the tariffs on both the cost of washing machines and dryers increased, even though it were the washing machines the subject of tariffs, not dryers. But dryer prices went up anyway.

We don't know for sure what will happen. Some analysts think this is another Trump bluff, as a bargain chip for negotations, while others think Trump will follow through with them. But hopefully advisors in the Trump administration will be wise enough to know how to deal with them and advise the President with the best way forward.

The impact of tariffs on market conditions

The Trump tariffs can have some implications for basis trading and funding rates, the type of trades our users make with the Basis Trade eXecutioners (BTX), our delta-neutral crypto trading platform.

Here's how these tariffs may impact the market and opportunities for basis trades.

Economic uncertainty

Tariffs often lead to economic uncertainty as they disrupt global trade, increase costs for businesses reliants on important, and potentially trigger retaliatory measures from those trading partners, such as China, Canada and Mexico, countries mentioned by Trump. This uncertainty can heighten volatility in financial and crypto markets, creating more opportunities for arbitrage and basis trading.

Inflationary pressure

Tariffs raise the cost of imported goods, which can lead to higher consumer prices and inflation. In response, central banks (like the Federal Reserve in the US or the European Central Bank) may raise interest rates to combat inflation. Higher rates could reduce liquidity in financial markets, potentially impacting funding rates in perpetual futures contracts.

Currency volatility

Countries affected by tariffs may devalue their currencies (e.g., China's potential devaluation of the renminbi). This could create fluctuations in exchange rates that ripple into crypto markets, increasing volatility and funding rate disparities.

Domestic markets

Tariffs may encourage domestic production and consumption, potentially reducing global trade volumes. This could limit arbitrage opportunities between spot and futures markets if liquidity decreases on international exchanges. In traditional finance, this is more obvious in sectors like tech and agriculture, and it will have similar effects in crypto.

How will this affect Basis Trading

The goal of basis trades is to profit from funding rates, determined by the difference between the spot price of an asset and the perpetual future of the same asset. Tariffs have the potential to shake markets, and thus, affect the meat and potatos of basis trading: the funding rates.

Volatility creates opportunity

Higher volatility caused by economic uncertainty and currency fluctuations is favorable for basis trading. This is because disparities between spot and futures prices tend to widen during volatile periods, creating more profitable opportunities for delta-neutral strategies.

Funding rate dynamics

If tariffs lead to inflation and higher interest rates, funding rates on perpetual futures contracts could become more volatile. Positive funding rates (where longs pay shorts) may persist longer in bullish or inflation-driven markets, benefiting BTX users who short perpetuals while holding spot positions.

Hedging market risks

Basis trades are delta-neutral, meaning they are less exposed to directional market risks. As such, they can serve as a safer strategy during times of economic or geopolitical uncertainty caused by tariffs.

Scenarios favourable to BTX users

The purpose of the BTX is to be the ultimate product for delta-neutral trades, allowing it to be a safe heaven under different market conditions. As a BTX user, you want to be in that position, to allow you to profit regardless of price direction. Tariffs may bring some uncertainty, but these tips will help you use the BTX to take advantage of them.

Periods of high funding rates

If funding rates on perpetual futures remain consistently positive (e.g., due to bullish sentiment or reduced liquidity), BTX users can profit by shorting perpetuals while holding spot positions.

Market Volatility around tariff announcements

Announcements or implementation of tariffs often lead to short-term market turbulence. BTX users can capitalize on temporary mispricings between spot and futures markets during these periods.

Inflation-driven bull markets

If tariffs contribute to inflationary pressures that drive investors toward alternative assets like crypto, the resulting market activity could increase funding rate opportunities for basis trades.

Risks and considerations

A significant risk of basis trading is leverage, which is using borrowing capital to fund your positions. Although leverage is useful as it allows you to increase the potential return from an investment, it can also work against you, especially if considering a variable like tariffs, which can bring added risk.

Liquidity risks

If tariffs reduce global trade volumes or liquidity on international exchanges, it could narrow spreads betweeen spot and futures prices, reducing profitability for basis trades, as it impacts the funding rates.

Regulatory uncertainty

Tariffs often come with broader geopolitical tensions that may influence crypto regulations (positively or negatively), affecting marketing dynamics. Governments of countries being tariffed often fight back with tariffs of their own, perpetuating (no pun intended) the cycle.

Interest rate sensitivity

Rising interest rates due to inflation could shift investor sentiment away from risk-on assets like crypto towards safer investments (e.g., bonds), potentially reducing overall market activity. Less liquidity in the markets may also mean less atractive opportunities.

Conclusion

The upcoming Trump tariffs could create a favourable environment for basis trading due to increased volatility, funding rate disparities, and economic uncertainty. However, those of you using the BTX should be on your toes about potential risks such as reduced liquidity in the markets or regulatory changes.

To max out opportunities during this period:

  • monitor funding rates closely across BTX's supported exchanges;
  • stay up to date with macro indicators such as inflation and interest rate changes;
  • leverage BTX's delta-neutral approach to hedge against directional risks while capitalizing on market inefficiencies created by tariff-induced volatility.

Basis Markets is a trade analysis engine and execution plaftorm that supports your delta-neutral strategies across several exchanges. Learn more on our official website and join our Discord.