Forex: Markets are steering clear of the 60% doomsday tariff scenario

It's been quite a week in the FX markets. The week started with a bang due to President Trump's inauguration, but it has lacked real momentum. It's hard to gauge what's bluster and what's bona fide trade policy, which has left many of us in a holding pattern. Data releases haven’t been too exciting, either. As traders, we’re practically glued to our social media feeds, not wanting to miss any off-the-cuff remarks from Trump that could shake the markets.

For those who follow the bond markets closely, which every FX trader does, the real focus is next week’s core PCE data. If it hits 0.2% or better, it’ll confirm a turning point in core inflation trends—a boon for Treasury bulls. Such a result could see more dollar longs pared back, assuming the Fed or Trump doesn’t throw us any curveballs.

Despite President Trump's bluster about tariffs, the broad US dollar index (DXY) has softened to around the 108.25 mark. The markets seem to have digested the idea that any tariff hikes under Trump will be more measured and less severe than initially feared. This perception has likely prompted some unwinding of long US dollar positions.

Trump's actions so far include mandating government agencies to review trade practices with findings due to be reported by April 1st. Moreover, though significant, the prospect of a 10% tariff on Chinese imports is substantially milder than the 60% he brandished during his campaign. While it's clear Trump still aims to implement higher tariffs, the market is currently steering clear of the doomsday scenario involving a 60% tariff on Chinese goods and a blanket 10%-20% rate.

At this juncture, FX traders remain shrouded in uncertainty following the mixed signals from President Trump's initial days in office. While Trump has renewed his tariff rhetoric against China, he has, for the most part, avoided escalating the trade war with the world's second-largest economy. This has left investors parsing his statements and intentions, trying to forecast the possible impacts on currency markets.

Turning to updates from Asia, particularly China, there's an apparent push by the government to ignite a stock market rally amidst a lacklustre economic backdrop. The authorities are coaxing local institutional investors like insurers and mutual funds to ramp up their market investments. Yet, as we've seen in the past, such efforts can be likened to attempting to kindle a fire with damp wood — often proving ineffective and short-lived. This latest attempt is likely another instance where initial enthusiasm may quickly fizzle out, serving as yet another false dawn for the Chinese markets.