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Exponential Jump in Trade Wars; Move into Currency Wars; Will ECB and US GDP Register - DFX Key Themes

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JohnDFX

Just When You Think Trade Wars Can’t Grow More Extreme…

The last we left global trade wars heading into the close Friday July 13th (the week before last), the situation was already firmly planted in worrying escalation with little sign of relief in the sidelines of diplomacy and political cheerleading. The United States was still applying its metals tariffs against competitors and colleagues alike, the $34 billion intellectual property oriented tariffs were in place against China (not to mention China’s retaliation upon the US), and threats of a massive escalation by the Trump administration to the tune of $200 billion in import duties on China and a 20 percent tax on all imported European autos was still hanging in the air. It would seem near-impossible to inflame the situation further than that.

And yet, they have found a way. Looking to truly turn the screws in the face of retaliatory threats by China and WTO complaints, the US President warned Friday (and his Treasury Secretary echoed Saturday at the G20 meeting) that they could introduce tax on all of China’s imports – amounting to more than $500 billion. Normally, we would assume these are mere threats meant to prompt compromise out of shock, but this has been a threat issued and executed upon too frequently. While this just seems a self-defeating game of chicken where all participants suffer economically, there is certainly a strategy to this effort.

There are hints of Eco Adviser Kudlow and National Security Adviser Bolton in this effort; but it should be said that regardless of what their intent may be, the outcome is likely to hasten an inevitable turn in the global economy and financial markets – whether they relent last minute or not. Ahead, there are two important meetings scheduled for trade talks: President Trump is due to meet the EU’s Juncker and Malmstrom Wednesday while the US Trade Representative is set to talk trade with the Mexican Economy Minister on Thursday. Good luck to us all. Watch my weekend Trade Video to see more in this topic. 

Is President Trump’s Dollar, Euro and Yuan Comments Pretense to a Currency War?

This past Thursday, President Trump sent the Dollar reeling after he weighed in on the path of higher rates and the level of the Dollar. With a background in real estate (and thereby debt financing), he lamented the Fed’s gradual pace of monetary policy tightening amid the trade wars his administration had pressed and the growing debt financing the country was facing – again increased with the recent tax cuts. He said the rates and currency rise that followed made other efforts the government was pursuing more difficult and ultimately made the US uncompetitive. The White House later moved to clarify that the President was not questioning the Fed’s independence or competence, but he would take to Twitter to double down on his remarks Friday.

A perception that the Dollar is low and claims that the Yuan and Euro are being lowered by their respective policy authorities looks suspiciously like pretext for starting a currency war. When it comes to the Chinese currency, there is little doubt that policy officials have a hand in its performance; but that is more and more likely a measure to dampen volatility rather than wholesale steer. Officials pointed to the rapid drop in the Yuan these past few months as evidence, but wouldn’t such a move arise if the trade war were having the intended effect? In fact China has shown over the past few years that too sharp a decline in the local currency was reason enough to step in and bid the CNH so as to curb fear of a capital flight.

As for the Euro, there is little ground in their claims of manipulation now as monetary policy efforts have disconnected from exchange rate movement – though had they made this accusation back in 2014, I would have agreed. Whether this claim is just rising out of the blue or indicates a strategy, it should truly concern us. Currency wars do not end well for anyone, they are more likely to trigger a fast-tracked financial crisis and it can be yet another systemic risk that sees the Dollar permanently lose status as the world’s dominant currency long term. 

Evaluating How the ECB Rate Decision and US GDP Will Hit the Markets

It is clear that the week ahead will find its market winds determined by themes (trade wars, currency wars and perhaps even systemic risk trends). However, there are high profile events scheduled that will certainly carry important fundamental weight for the big picture evaluation – even if they don’t trigger the same definitive direction and short-term volatility that have in the past. That said, fundamentals must be evaluated as a hierarchy: the most pressing theme to the largest swath of the market will more decisively define the market’s bearings (whether higher, lower or sideways).

This in mind, two particular events should be watched closely whether they overcome the gravity of trade wars or not. Thursday’s ECB rate decision is very important. Over the previous meetings, there has been heavy speculation that the central bank is heading into an eventual and inevitable turn from its extremely dovish policy path with rhetoric clearly setting the stage. Speculation around this eventual hike has led to remarkable lift for the Euro even when the anticipation for the first move was 12 to 18 months ahead (as was the case throughout 2017). Yet, recent developments will make this policy gathering even more important. Will the central bank take into consideration the accusations by President Trump that it is fostering exchange rate manipulation? Will concern over trade wars’ curbing economic and financial health show through?

As for the US GDP reading on Friday, we will see the general health of the world’s largest economy as trade wars started to go into effect and the tax cuts hit full stride. A weak showing here could add considerable fear to the already existing concern that retaliations to tariffs could tip the US economy into correction and reinforce reports that the tax cuts had little effect on US consumption through the middle and lower class American households. Context will definitely paint these events, but that doesn’t diminish their relevance at all. 

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