Donald Trump’s new trade war with Europe has disappeared before it had even begun.

The World Economic Forum (WEF) in Davos this week has been dominated by the US president’s attempts to acquire Greenland from Denmark, and his threat to hit the UK and seven other European countries with 10pc tariffs from Feb 1 if they stood in his way.

Speaking at the forum on Wednesday, Trump proclaimed that Greenland was “our territory” and demanded immediate negotiations for the US to take it over.

But by the evening, the standoff had ended.

“I will not be imposing the Tariffs that were scheduled to go into effect on February 1st,” Trump wrote on Truth Social, after a meeting with Nato secretary general Mark Rutte.

Trump hailed “the framework of a future deal with respect to Greenland.” Details are still scant but it is clear that whatever is on the table falls well short of Trump’s stated aim of a “complete and total purchase” of the island.

Traders are likely to hail the return of an acronym that dominated much of 2025: TACO. The theory that “Trump always chickens out”.

Trump’s U-turn followed two days of market jitters as investors baulked at the prospect of trade turmoil and US aggression.

US stocks and the dollar dropped while government borrowing costs had begun to soar. Yields on 10-year US government bonds – known as Treasuries – had jumped by 14 basis points to hit a five-month high of 4.29pc, a clear sign that investors were demanding higher returns on US government debt that they viewed as increasingly risky.

And Trump will have known that this was just the beginning. Europe holds far more cards than the president would like to acknowledge.

European leaders had agreed to suspend the ratification of the EU-US trade deal in response, and the EU had resurrected the prospect of retaliatory tariffs, which would hit €93bn of US imports. But Deutsche Bank had warned that “by far” the biggest weapon the EU could have used was its ability to weaponise capital markets against the president.

European Union leaders were discussing activating the bloc’s so-called trade “bazooka”, its economic equivalent of a nuclear deterrent.

This anti-coercion instrument (ACI) is a unilateral trade defence tool that enables muscular retaliation against economic intimidation. Under the ACI, the bloc can unleash punitive measures including export controls, blocking access to the EU’s annual $2.5tn (£1.8tn) in public procurement spending and imposing restrictions on intellectual property rights, financial services and access to EU capital markets.

The Continent is also America’s largest lender and foreign investor. The US is more dependent on international money than at any point in its history and more than any other country in the world. Interdependence between EU and US financial markets has never been higher.

European countries (including the UK) hold twice as many US government bonds and equities as the rest of the world combined.

A large-scale revival of the “sell America” trade that emerged in the wake of Trump’s “liberation day” tariffs last year would trigger all-out turmoil.

There were signs this was already starting to happen. A Danish pension fund on Tuesday announced plans to sell off $100m in US Treasuries.

Europe has an economic super weapon in its potential to leverage all of these financial pressures. Though the problem for Brussels was always finding a way to do so that would avoid mutually assured destruction.

Emmanuel Macron used his WEF speech on Tuesday to warn of “imperial ambitions” that are resurfacing across the world, after Trump reiterated his Greenland threats overnight.

He said: “It’s a shift towards a world without rules, where international law is trampled underfoot and where the only law that seems to matter is that of the strongest.”

The French president spent the weekend lobbying European leaders to activate the ACI.

“He will be in contact all day with his European counterparts and will ask, in the name of France, the activation of the Anti-Coercion Instrument,” his office said on Sunday.

The idea was gaining traction.

Lars Klingbeil, the German finance minister, said on Monday: “There is a legally established European toolbox for responding to economic blackmail with very sensitive measures. And we should now consider using these measures.”

Jérémie Gallon, senior managing director at McLarty Associates and a former advisor to the EU ambassador to the US, had added: “If there is a moment when there is a chance to activate it, then it’s now.

“If you don’t activate it when your territorial sovereignty is basically threatened, then the instrument becomes, by definition, completely irrelevant.

“We are at a turning point in the transatlantic relationship that has no precedent. This is why the threat of activating the ACI is credible for the first time.”

As Trump’s threats grew more real, so did the alarm in Brussels.

Cecilia Malmström, a former member of the European Commission and European Parliament who is now at the Peterson Institute for International Economics (PIIE), said on Monday: “We do have a lot of cards and I think [Trump] is underestimating Europe’s determination.

“There is a common feeling that now he has really crossed a line.”

The EU’s first major lever would have been retaliatory tariffs. The Commission has a list of goods – covering 28pc of US exports to the EU – that it can hit following prior agreement during negotiations before the US-EU trade deal.

“They don’t need to go through the whole procedure again. The Commission can impose it tomorrow,” said Malmström before Trump’s climbdown emerged.

But if the retaliatory tariffs were not enough to make Trump back down, the ACI could have been the next port of call.

“The impact can be massive. Once you activate it, you can impose the restrictions you want on capital markets, financial services and tech, in terms of access to procurement markets in Europe, et cetera,” says Gallon.

“The tool itself is incredibly powerful. Basically you can just cut the access to the market. At a maximum level, you could prevent US financial institutions from trading in the eurozone market.”

The measure could not be used quickly, however. It would require an investigation and agreement from a majority of member states and would take a minimum of six months to implement.

But perhaps the biggest impediment would have been just how big the fallout could be.

Many measures available under the ACI would have involved self-harm to the EU if deployed against the US.

Mark Zandi, the chief economist at Moody’s Analytics, warned that excluding American financial institutions would be too explosive.

He said: “That’s the kind of thing that could set off a complete financial meltdown.”

US institutions hold 4.6pc of all EU banking assets and nearly a quarter of EU derivatives, a market that is essential for companies to hedge risks. They also provide a large amount of credit to European companies.

A more obvious target would have been America’s tech sector, which is closely affiliated with the Trump administration, a key symbol of US dominance and essential to both the strength of the US stock market and economic growth.

The ACI could have been used to impose emergency tariffs or taxes on US tech giants or to prevent them from having access to government procurement markets, said Gallon.

Sky-high stock market valuations of America’s artificial intelligence companies and investor jitters over a potential bubble mean the sector is particularly vulnerable to a shock.

“That market is very, very highly valued. There’s nothing but positive expectations for those companies and that depends on their ability to sell what they produce all around the world,” says Zandi.

“If they can’t do that without facing taxes in Europe, I think that would be hard for investors in those AI stocks to digest and that could mean a sell-off.”

Of course, Europe does not have its own alternatives to US tech giants. 80pc of Europe’s software expenditures go to US companies and America provides Europe with two thirds of its cloud services.

The ACI includes provisions that ask the commission to minimise the effect on EU households and businesses – but there is no guarantee that tech companies wouldn’t pull their services completely in protest.

A more promising avenue may have been export controls.

Dutch company ASML is the only company in the world that makes the extreme ultraviolet (EUV) lithography technology that is essential for the manufacture of the world’s most advanced artificial intelligence microchips.

“Given the importance of the chips industry in the US, that’s a potential strategic asset that the EU has,” says Erik Brattberg, managing partner of Brzezinski Global Strategies.

Europe is also a key supplier of pharmaceuticals to the US. Restrictions on exports of either of these goods would have been problematic for the US, because they would not only drive up prices but could mean shortages.

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“For a president who has run on cheaper drugs, this would be politically damaging,” says Ben Harris, a former chief economist at the Treasury.

Ultimately, Gallon argues that it is the threat of the big stick rather than its use that matters most when it comes to dealing with Trump.

“All you need is one or two days of turmoil for there to be a response. I suspect you wouldn’t have to go very far down that path before you see some change in the negotiation,” says Zandi.

On Wednesday night, it seems that has come to pass with Trump’s about-turn.

With negotiations over Greenland still fraught, Europe’s biggest source of leverage could have been something that politicians do not have much power over.

The US is more heavily dependent on foreign cash than any other time in its history and more than any other country in the world.

Its net international investment position – the difference between America’s holdings of foreign assets, and foreign holdings of US assets – is $27tn, close to 100pc of its GDP.

The US is dependent on trillions of dollars of investment from overseas to prop up its economy.

Plus, America’s deficit is getting wider. And Europe is by far its biggest lender.

Discussion of bond market leverage over the US has typically focused on China, which is the third-largest individual foreign holder of US Treasuries after Japan and the UK.

As of November 2025, China held $682bn in US government debt, down from $768bn a year earlier. But Europe as a whole is theoretically far more influential.

European countries own $8tn in US Treasuries and equities, according to calculations by George Saravelos at Deutsche Bank. This includes nearly $2tn held by the UK.

The total is nearly twice what is held by the rest of the world combined.

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“In an environment where the geo-economic stability of the Western alliance is being disrupted existentially, it is not clear why Europeans would be as willing to play this part [as lender],” Saravelos warned in a client note over the weekend.

If Europe sold off its Treasuries en masse, it would drive up US government borrowing costs at a time when its national debt is at a record $38tn.

The Treasury market has proved to be Trump’s Achilles heel in the past.

Last April, it was a revolt in the bond markets and the resultant surge in US government borrowing costs that pushed Trump to pause his “liberation day” tariffs just a week after he announced them.

Credit: Reuters

But hitting Trump in the Treasuries would have generated blowback for Europe too.

Rising borrowing costs would have meant tumbling bond prices. And that would have reduced the value of the Treasuries EU countries still held.

Ultimately, it may be a price the bloc was willing to pay, says Harris at the Brookings Institution, speaking before Trump’s reversal.

“I don’t think this is all about a financial calculation. This is about sovereignty. Nations have long histories of making economic sacrifices to achieve other gains, and that could certainly be the case here.”

Technically, European leaders have little power to orchestrate a sell-off.

“Most of those US bonds and equities are privately held, so Europe can’t really ‘deploy’ them without imposing costs on itself and spooking its own investors,” says Marcello Estevão, chief economist at the Institute of International Finance (IIF).

But as tensions ramped up, a fire sale could have happened organically.

On Sunday, Saravelos noted that Danish pension funds were the first to take steps to reduce their US dollar exposure as Trump launched his trade war last spring.

By Tuesday, AkademikerPension – a Danish pension fund which manages around $25bn in savings for teachers – announced it would dump its $100m US Treasury holdings by the end of the month.

Its chief investment officer Anders Schelde told Bloomberg: “The US is basically not a good credit and long-term the US government finances are not sustainable.”

Trump’s talk of taking control of Greenland added to the fund’s motivation to shift away from America, he said.

“If we see a widespread shift in appetite for the US either to be punitive, or because the US is no longer seen as a reliable trading partner, that could have pretty severe impacts on the US economy,” says Harris.

A sharp rise in government borrowing costs would drive up mortgage rates and America’s debt interest bill – piling pain on both consumers and the public finances.

It would also put a big strain on America’s financial system. In a worst-case scenario, it could push the country to the brink of a financial crisis.

Jobs growth has slumped and affordability is becoming a bigger issue for the US president as midterm elections loom in November.

Kate Kalutkiewicz, who worked on White House trade policy during Trump’s first term, says: “I think the discussion around prices in the US will be present in almost every political decision that they’re making.”

While Macron had ramped up the rhetoric, Rachel Reeves, the Chancellor, had used her time in the Swiss Alps to do the opposite.

“We absolutely want to de-escalate,” she said on Tuesday. “I ⁠don’t think it’s in ‌anyone’s interest to escalate tensions or to allow rhetoric to be a substitute for ‍hard work and diplomacy.”

Unlike the EU, Britain’s tactics in the trade war was to avoid confrontation.

While the EU drew up a retaliation tariff package last year, Sir Keir Starmer played diplomat and focused on securing America’s first post-tariff trade deal.

Although the Prime Minister has condemned Trump’s claim over Greenland, there had been no talk of UK retaliation.

Paul Dales, of Capital Economics, says: “I think his view is that the way to get the best out of Trump is through flattery and friendship rather than retaliation and force.”

Trump had been making this diplomatic strategy increasingly difficult.

In a post on Truth Social on Monday night, the US president attacked Sir Keir’s decision to hand the Chagos Islands back to Mauritius – a decision he previously approved – and claimed the agreement was one reason why the US should take Greenland.

Trump wrote: “The UK giving away extremely important land is an act of great stupidity and is another in a very long line of national security reasons why Greenland has to be acquired.”

Stephen Millard, of the National Institute of Economic and Social Research (Niesr), says: “The more that the US president acts in this way and imposes tariffs on us actually, the more sense it makes for us to get closer with the EU.”

Whatever the UK would have decided, it would not have been able to escape the conflict.

If the EU chose to retaliate with its super weapon – the ACI – Britain’s economy would have suffered too.

Ultimately, the EU and UK would have been the biggest losers from escalation.

If the bloc had matched the US tariffs on US imports, it would have knocked 0.7 percentage points off eurozone growth and 0.5 percentage points off UK GDP growth by 2027 according to Oxford Economics.

By comparison, US growth would be only 0.2 percentage points lower.

Scott Bessent, the US treasury secretary, for one, had been wholly dismissive of the EU’s scope for a major response.

He told reporters on Monday: “I imagine they will form the dreaded European working group first, which seems to be their most forceful weapon.”

But after Trump’s Wednesday announcement, it seems perhaps the president fears the working group after all.

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