4 Reasons Why FX & Stocks Rallied on China Tariffs

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4 Reasons Why FX & Stocks Rallied on China Tariffs

Daily FX Market Roundup May 10, 2019

The trade war is back on and despite the FX market’s muted reaction to President Trump’s Chinese tariff hike they pose a serious risk to currencies and equities going forward. After four months of relative peace, Trump is getting tough on trade again. On Thursday he stayed true to word to raise tariffs on virtually all of their Chinese imports from 10% to 25%. This should be a nightmare for Chinese exporters, the Chinese government, domestic, foreign central banks and investors from all corners of the world. However initial losses in currencies and equities faded as the Dow rebounded nearly 400 points from its lows to end the day in positive territory.

We can identify at least 4 reasons why fresh Chinese tariffs did not trigger a broad based sell-off in risk currencies:

1. Chinese support for stocks
2. Tariffs were priced in
3. No immediate Chinese retaliation
4. Hope that more pressure on China will lead to a deal

As the clock ticked towards Trump’s deadline, the announcement was largely priced in. The chance of an agreement within such a short period was slim. There was also no immediate Chinese retaliation and some investors hope that by turning up the heat, China will be forced to deal. To stem the slide in stocks, China stepped in with state fund buying of Chinese stocks.

When President Trump introduced a 10% tariff on $200B worth of Chinese goods September 17 of last year, the market reaction was very similar. EUR and AUD rallied against the US dollar and extended their gains in the days to follow despite retaliation from China. USD/JPY fell the day that the tariffs were announced but also rose from 112 to 114.50 over the next few weeks. However there was one big difference – Trump was waffling between 10% or 25% tariffs and investors bid currencies and equities higher in relief when he opted for the smaller penalty. When the steel and aluminum tariffs were announced in March, currencies and equities also traded higher but the rallies fizzled a few days later. Ultimately Trump’s tariffs are bad for US markets but worse for the rest of the world and in the weeks ahead, central bankers will express their frustrations as data softens.

In the near term, the question of yes or no tariffs is answered so we could see a further relief rally in currencies and equities. US retail sales, the Empire State, Philadelphia Fed surveys and housing market reports are scheduled for release next week. Given Fed Chair Powell’s optimism and the diminished prospect of a further rate hike this year, most of these reports should improve helping risk appetite and the US dollar.

Meanwhile according to the latest reports, Canada’s economy is on fire Manufacturing activity is up and most importantly Canada reported the largest one month job growth ever. Canada added 106.5k jobs in April, which was nearly 10x times more than expected. A nice combination of full and part time work helped drive the unemployment rate down to 5.7%. Jobs are the foundation for the economy and this solid report extends the year of solid job growth. Wages and consumer spending should benefit from these improvements, easing any concerns for the central bank. USD/CAD fell sharply after the report and we believe that further losses are likely, even if next week’s CPI report shows price pressures easing slightly.

Kathy Lien
Managing Director

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