Enough Threats of a Currency War and You Find Yourself In One
It has been a common theme in the negotiations between the United States and the countries they have targeted for trade inequities that aggressive language has preceded tangible action. While both sides (the US versus the ‘World’) have been clearly willing to dole out the warnings, it has been the White House that has advanced both action and intimidation far more willingly. At this stage, we have seen the trade war level out somewhat. US President Trump and Chinese President Xi agreed to some measure of armistice at the G-20 meeting, heading off a standing threat by the US to expand is onerous 25 percent tariff against Chinese imports to encompass the remaining $300 billion or so in goods that were not already being taxed. Yet, that is about as far as the agreement has stretched – with the caveat that US firms would be allowed to sell their manufactured goods to Chinese telecom. As far as the scorecard goes, this hardly qualifies as de-escalation; but negotiations are ‘ongoing’.
In the meantime, US policymakers seem to be anxious to avoid any impression that they are letting off the pressure on the rest of the world to ‘right their wrongs’ against the country. The US Trade Representative’s office this past week proposed tariffs on an additional $4 billion worth of EU goods to add to the $21 billion list offered up back in April. This is ostensibly a response to the ongoing spat between the US and Europe on what they each deem is unfair subsidizing of each other’s’ largest airplane manufacturer (Boeing and Airbus respectively). Thus far, the two principal Western economies have not engaged in an all-out trade war – like the US and China have – but all the ingredients of escalation are in place. I maintain that if these two economies engage in this growth-destructive behavior, it will inevitably stall the developed world (and like global) – GDP.
As it happens, President Trump has taken the standoff to a different venue altogether: exchange rates. He revived his criticisms this past week that other key economies are targeting devalued currencies as a means to artificially amplify their own growth. Of course, a government that is conducting an aggressive trade war that looks to leverage taxes to change trade partners ways would hope for a steady – or cheaper – currency to ensure those levies have their maximum impact and the local reciprocal pain is minimized. While Trump’s threats have thus far have been kept to criticism over the Federal Reserve’s policies while his own administration say he is not seeking a ‘weak dollar policy’, if the central bank doesn’t acquiesce to his critiques, he may very well pursue other avenues to make a more comprehensive impact. That said, if the US were to forge twin trade and currency wars, a financial crisis is likely and a systemic downgrade in the use of the US Dollar as top reserve currency would be inevitable.
Fed Monetary Policy Finds Itself In a Position to Steer the Broad Markets
We have gotten to a point where there is so much reliance on monetary policy for the well being of the entire financial system that the markets are gauging their day-to-day sentiment against significant shifts in monetary policy expectations. While external support for the markets is a function of all the majors central banks’ collective efforts, the world’s largest authority holds greater pull owing to its symbolic status as captain to the world’s largest economy and as the paradigm of what a ‘hawkish’ policy is this unusual economic cycle. The interest is so sharp that the markets are reading into key pieces of event risk not for their economic consequences, but rather for the support or opposition it represents to a faster reversal in Fed Reserve policy. Point-in-case was this past week’s US employment report.
The June nonfarm payrolls (NFPs) beat expectations soundly with a 224,000 net addition (versus 160,000 forecasted) with the jobless rate barely ticking up from its multi-decade low (3.7 percent) and wage growth holding steady at a 3.1 percent annual pace. All-in-all, this was a robust print to contribute to a remarkably strong series. And yet, the markets responded as if it was a bad omen of what was ahead as the major US indices (Dow, S&P 500, Nasdaq) all gapped lower on the open Friday. Why would run of important data that supported the outlook for growth provoke a slump in capital markets? Because, the market is not intending to profit through a long-term picture of strong economic expansion and steadily rising rates of return but rather through the tried and true strategy of front running deep pocketed and relentless central banks. This puts us in an economically-unusual but relatively familiar situation from this past decade whereby the speculative rank covets data that disappoints just enough to warrant monetary policy accommodation without tipping an overwhelming wave of deleveraging. That is a difficult balance to maintain.
Nevertheless, Fed intent will remain a driving force for this equilibrium which places greater emphasis on top-line US data and central banker speak when gauging global market moving potential. That said, the week ahead holds a few particularly important milestones. On the economic calendar side, the market’s favorite inflation figure – the US CPI – is due for release on Thursday. For the more qualitative influences, there is a range of Fed speak scheduled with Chairman Jerome Powell’s Congressional testimony Wednesday and Thursday.
The Curious Case of an Unrelenting Sterling Slide
The British Pound cannot seem to catch a break. Where many of the key Sterling crosses have come to levels of meaningful support recently, we have seen the boundaries bow under the pressure while some pairs haven’t even broken stride. GBPUSD and GBPCHF are good examples of crosses that show little deference towards boundaries while both GBPCAD and EURGBP have extended incredible pace - 9 week slides for the GBP for both marking the worst performance in 12 years and on record respectively. Against the backdrop of Brexit, this may not seem that unusual a fate. However, it is not so straightforward a scenario when we consider we are not dealing with a relentlessly deteriorating situation – at least not yet. At present, we are in a holding pattern in the UK-EU divorce proceedings as the Britain works out who the next leader of the Conservative Party – and therefore the country – will be.
Normally, in this situation, we would find markets either trading without much progress either bullish or bearish while in some situations in the past there is a measurable unwinding of a stretched speculative exposure. The difference for the Pound is the practical recognition of probabilities for the difference scenarios. While possible that the leadership change will happen quickly and the two sides hash out a fruitful agreement that satisfies all, it is very unlikely. Instead, the front-runner for the next PM, Boris Johnson, continues to make clear his comfort with a no-deal outcome should European negotiators not relent. And, despite his suggestions that the country will be totally prepared for such an outcome, three years of uncertainty has led to a deeply-rooted skepticism.
In the event that the controversial figure takes over the Tories and the country finds itself heading towards General Election, it will only extend the uncertainty and make a solution by the designated cutoff date (October 31st) virtually impossible. That deadline marches relentlessly closer. With a clear mandate for negotiation on the UK’s side still weeks away at least, the probability of a more disruptive outcome grows. And, against this backdrop, it is worth reiterating that uncertainty is risk. Be mindful when trading the Sterling.