Richard Franulovich, Head of FX Strategy at Westpac, suggests that trade tensions have been steadily increasing all year.
Key Quotes
“Beyond some sector and regional specific underperformance (i.e. major users of imported steel, CAD and MXN), markets have mostly ignored escalating tensions, partly because the growth and inflation implications stemming from a 25% tariff on steel imports, 10% on aluminum imports and a 25% tariff on $50bn in imports from China (mostly industrial equipment rather than consumer goods) are not economically significant.”
“A perception that the Trump administration’s trade negotiation tactics fit the “North Korean model” may be another factor, i.e. unpredictable and aggressive rhetoric that significantly escalates tensions, leading to a middle ground compromise.”
“Yet at the same time, and consistent with the administration’s unpredictability, there are signs of de-escalation around Chinese tech investments.”
“But despite the appearance of a less confrontational stance fixed income, FX and equity markets are beginning to betray growing caution.”
“Arguably the key trigger is the sudden sharp weakening in CNY/CNH. RRR cuts and weaker monthly activity data would have argued for a weaker CNY in any case. But, a deliberate policy induced depreciation of CNY is arguably is underway too.”
“While a deteriorating global trade picture is unambiguously negative for EM currencies, G10 currency movements have a more lukewarm risk averse quality. Safe haven currencies that typically appreciate in this environment such as JPY, EUR and CHF are at best rangebound. The latest escalation in trade tensions has instead produced generic USD strength vs G10, a shift from developments earlier this year.”
“Against that backdrop it’s not entirely surprising that rising trade tensions are producing broad USD gains rather than clear cut “risk off” price action.”
“Fed and BoC rate hike pricing is arguably the biggest standout risk if there is material tariff driven disruption to international trade.“
“Any sudden weakening in the hitherto robust trend in US confidence gauges would suggest that the US is not necessarily the most immune economy.”
“If these risks crystalize the Fed will begin to sound less assertive, the flattening of the US curve will stall and the current trend of generic USD gains will reverse.”
“We are not at that point, yet, though in the meantime trade tension likely continue to escalate as we approach US midterm elections on multiple fronts; including US auto imports from Europe, tariffs on Chinese goods and investment restrictions, along with retaliation risk, not to mention ongoing NAFTA uncertainty.”
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