Trade War or Bluster? FX Waits for China Response

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Market Drivers July 11, 2018
Risk off trades recover after Trump announcement
BOC on tap
Nikkei -1.19% Dax -1.31%
Oil $74/bbl
Gold $1251/oz.
Bitcoin $6300

Europe and Asia:
No Data
North America:
USD PPI 8:30
CAD 10:00 BOC

The Trump Administration once again rocked the FX markets at the start of Asian session trade today by proposing another set of tariffs on $200 Billion worth of goods from China.

Initially, the news bomb sent risk FX reeling with USDJPY dropping to a low of 110.78 as traders worried that the escalation in trade tensions could lead to a global trade war that would dampen growth, but after a few hours of selling risk sentiment stabilized with most of the high beta currencies recovering their losses while USDJPY inched back above 111.00 figure.

Part of the reason for the relative calm in the markets is that the latest announcement is simply a proposal rather than policy with final decisions on action not to be taken until mid-August. Markets are hoping that Trump’s characteristic “bluster and back-off” negotiating style may result in less damage than initially thought. The Chinese officials while noting that they will respond in kind, have been careful not to escalate the situation by holding off on specific retaliatory measures just yet.

Ultimately, Trump’s anti-free trade stance is damaging to global capital markets and if he insists on additional tariffs the risk off flows will resume. Many analysts have pointed out that the amount of tariffs is a small portion of the overall trade that US and China engage in, but that assumption misses the much larger point that trade wars will have a chilling effect on business investment that could ultimately lead to global recession. Therefore the risk in the market remains unless Trump begins to feel pressure from his base as the new frictions that he has introduced into the market begin to weigh on profits.

For now, the Aussie remains the most vulnerable pair in the market, as it is essentially a proxy for the trade conflict between US and China. The unit has not been able to rise much off the session lows but remains above the .7400 figure for now. A break below .7300 would suggest that the Trade War is real and the market will begin to price in the risk of global recession.

In North America today the focus turns to the Bank of Canada as it announces its interest rate policy. The market anticipates a hike of 25bp to 1.50% making the BOC along with the Fed one the only G-7 central banks to tighten policy. On the face of it, the hike by the BOC should be bullish for the loonie, but USDCAD has not declined much ahead of the event, as traders fear that the action by Governor Poloz could be “one and done” for the rest of the year. Canada is facing pressure from the US on the trade front, so if Mr. Poloz coaches the policy action in a guarded tone USDCAD could rise rather than fall as traders will assume no more hikes for the foreseeable future,.

Boris Schlossberg
Managing Director

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