Trump vs. the World: Trade the Trade War

Another Trump tantrum? Take profit

US President Trump promised to make America great again, but is he moving in the right direction with his protectionism measures?

It seems so, if you take a look at the latest GDP figures, as annualized growth hit a whopping 4.1% in the second quarter of the year, with mounting speculation that Q3 reading will start with a 5. Employment levels in the US are near record highs, and beyond the normal monthly fluctuation, macroeconomic readings indicate that the US economy is growing at a solid pace.

But at what cost?  Trump unwind a trade war that is expected to have consequences all over the world, with different fronts opened. How it will end is something that nobody dares to anticipate, although it adds uncertainty on a daily basis to the financial world. What is certain at this point is that the data are not yet reflecting mounting tensions and the tit-for-tat tariffs announcements. Anywhere.

Breaking international agreements in order to get new, better ones seems something not many dare to do. Trump did, and his trade war spreads to neighboring countries, with the US administration renegotiating the NAFTA deal with Mexico and to a lesser scale with Canada, fighting an extra battle with the latter. It also reached the EU with duties on steel and aluminum imports, although Trump met EU the European Commission president, Jean-Claude Junker, a couple of weeks ago, and they gladly announced a deal to work towards "zero" tariffs and barriers, but the joint statement lacked any further detail. That battle is for now in pause.

These days, attention centered in Turkey, as not only the Turkish Lira plunged to record lows spurring concerns of contagion, but also because the country accused the US of the devaluation of its local currency, announcing retaliation tariffs on US goods of up to 140%.

The toughest battle

The biggest fight, however, is taking place with China. The trigger behind Trump's decision of imposing tariffs to Chinese goods was the US trade deficit with the Asian country, roughly at $375 billion in 2017 and, according to official estimates, such a deficit grew by 2.8% in the first half of this year. Also in June, the US total trade deficit widened by 7.35 to $46.3 billion, up from a revised $43.2B in the previous month. 

Why is then, the trade deficit with China is so high? There are multiple reasons, but pretty much, it's because the US sends raw materials to China, where the workforce cost is much cheaper, and receives final products, in the form of imports.

The United States imports consumer electronics, clothing, and machinery from China. A lot of the imports are from U.S. manufacturers that send raw materials to China for low-cost assembly. Once shipped back to the United States, they are considered imports. Trump's detractors have seized on the fact that, many of his merchandise has the "Made in China" label, including his ties.

With US policymakers hoping for wage growth to keep boosting economic growth, competing with China seems an unlikely and unachievable scenario. Trump's solution has been imposing tariffs on Chinese products.

What happened so far?

The first move was US President Trump announcing tariffs on all imports of steel and aluminum. Then, in March, the US administration announced a 25% tariffs on 34 billion worth of Chinese imports, which came into effect early July, then announcing another round of 25% tariffs on $16 billion worth of Chinese goods, starting later this month. In response, the Chinese government announced a similar measure, 25% tariffs on $16 billion worth of US goods.  Trump responded by threatening to hit another $200 billion worth of Chinese goods, and China responded with the promise of levy $60 billion worth of US goods.  

What will happen?

But, who will pay such cost? Not companies and that is certain. At least, not at the beginning. Consumers will be the first affected by such levies, leading to contracting spending. Decreasing consumption will mean lesser inflationary pressures, and hence, a less aggressive Fed. It also means economic growth will start decelerating, as businesses will be hurt in time. So, while the US GDP could actually hit 5% in the third quarter, escalating tit-for-tat tariffs may see a sudden slump afterward, and all hell could break loose for the greenback.

Trading the Trade War

Understanding and anticipating USD reaction against major rivals

These days, market participants price in everything way in advance. The key is always the potential effects of a certain headline, and how much of a surprise such headline is. The trade war, however, is not the only factor, and if other factors change, then, market reaction will also do. The main factor that keeps dominating the FX board, despite hidden behind political woes, are central banks.

 A good example is what happened these days in the market. The dollar was up as safe-haven, but relief news signaling that trade talks were resuming, send it down. A new escalation of trade concerns should have put it back in bullish mode, yet such headlines were accompanied by concerns about the Fed decision. The Fed is three steps ahead of every other central bank, and the dollar’s charm as a safe-haven will prevail, as long as the US Central Bank remains on that path.

Therefore, if Powell & Co. maintain their course of action, the USD should strengthen when fear rules, even against other safe-haven assets, except for the JPY. 

In the case of the JPY, it will undoubtedly strengthen against the greenback on risk-averse scenarios, while a major factor driving the pair are US Treasury yields. Should yields rise, then so will the  USD/JPY. The Yen gains on a run to safety will be moderate. 

Safe-haven gold has lost such status once the Fed started to hike. If the central bank holds on to its hawkish stance, gold prices will tend to fall or at least consolidate near the lows. It is worth mentioning that on average, gold's production cost is $1,050.00, so the closer the price gets to this last price, the higher the chances are of a bounce.

If further rate hikes in the US are at doubt, then safe-havens JPY, gold, and even CHF will tend to appreciate against the greenback.

High yielding currencies, particularly European ones, have the added seasoning of self-political jitters. The Pound won't be able to rally beyond logical corrective movements, as long as Brexit is poised for a hard landing.  As for the EUR, chances of sustained gains are quite limited on the back of ECB's dovish cut of QE, at least until the upcoming ECB's meeting, on September 13.

Pullbacks and profit-taking in the way are new opportunities to add to the dominant trend, once the dust settles.  Look for relevant, long-term resistance/support levels and the price to struggle with them before resuming its previous trend.

Last but not least, keep an eye on Trump's tweets.  ;)

Read also: Strong Dollar: 4 things that could halt the Fed hikes and send the Dollar down