US President Donald Trump has warned that Mexico might face a 5% tariff if it does not supply enough water to US farmers. This warning stems from a potential violation of a 1944 treaty that guarantees US access to water from the Rio Grande. Trump claims that Mexico owes the US 800,000 acre-feet of water under this treaty. Currently, the USD/MXN exchange rate has risen slightly by 0.07%, reaching 18.27. Tariffs are fees on certain imports, aimed at making domestic products cheaper compared to foreign goods. Tariffs differ from taxes in that they are paid when goods enter the country, while taxes are paid at the time of purchase. Tariffs affect importers, while taxes apply to individuals and businesses. Economists have different views on tariffs. Some believe they protect local industries, while others argue they can lead to higher prices and trade conflicts. As the 2024 presidential election approaches, Trump plans to use tariffs to strengthen the US economy. In 2024, Mexico, China, and Canada made up 42% of total US imports, with Mexico being the largest at $466.6 billion. Revenue from tariffs might be used to lower personal income taxes. With the potential 5% tariff on Mexico, currency markets are reacting. If this situation continues, the peso may weaken further. We should think about buying call options on the USD/MXN to benefit from a possible rise above 18.50 or even 19.00 in the coming weeks. We’ve seen similar situations before, particularly during the trade disputes of 2018-2019. Those events showed us that tariff announcements or even threats create significant market fluctuations. Therefore, buying call options on the VIX index could be a smart move to profit from increased market uncertainty. The automotive sector is particularly at risk due to interconnected supply chains. Recent data from the Commerce Department indicates that automotive parts trade between the two countries is set to exceed $150 billion this year. We should consider buying put options on US automakers and parts suppliers with major production operations in Mexico, as their costs are likely to rise. This situation also threatens the larger Mexican economy, as the US is its biggest export market. By purchasing put options on a broad Mexico-focused ETF like EWW, we can express a bearish outlook on the Mexican market. A larger trade dispute could lead to a 5-10% drop in the Mexican stock index in the short run. Finally, we need to be alert for possible retaliation from Mexico, which could involve targeting US agricultural exports. In 2018, Mexico enacted retaliatory tariffs on products such as pork and bourbon, causing prices to plummet. It would be wise to monitor futures contracts for agricultural commodities heavily exported to Mexico and be prepared to take short positions if retaliation seems imminent.

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