FX Focus: Trade war trouble ahead

Trade wars are once again on the lips of market participants as the US stands its ground on the exemptions put in place when president Trump first indicated his policy intentions earlier this year.

At the time, the proposed tariffs on steel and aluminium were seen as growth and US dollar (USD) negative, given the potential follow through into other US imports, though risk assets managed to brush this off as they have numerous other key events deemed investor unfriendly.

So far, the targets for the US include the EU as well as their close allies and trading partners Canada and Mexico, with the latter clearly disappointed with what they see as an aggressive stance amid ongoing talks on NAFTA.

There may be more trouble ahead for Europe as the US president has also intimated tariffs on foreign cars, where Germany will be notably affected as will Japan given some of the leading car names involved.

This pressured the USD earlier in the year, though this was at a time when the greenback was already under pressure off the back of concerns over the US trade (and budget) deficits, which will likely come to the fore if global trading volumes suffer and consumers – in the US and abroad – feel the pinch.

We have to assume that at some point risk assets will suffer, but for now, hopes of resolution with all US trading partners continue to provide some support, keeping the traditional safe havens at bay.

Gold has been particularly quiet and has, hitherto, been following the USD in the same way as the rest of the metals complex, and price action at the start of the week sees the yellow metal back under $1,300 again, while the Japanese yen (JPY) remains on the back foot as the carry trade (in the same vein) holds its ground.

Swiss franc (CHF) gains have been largely off the back of the political crisis in Italy, which has rocked Europe across the board. The new coalition government is still expected to clash with EU fiscal rules with its ante establishment agenda unwavering in the current wave of populism.

Just as Euro (EUR)/CHF rallied hard on dormant cash piling into Europe on the positive growth outlook, so the reversal has taken hold given more recent developments both economically and politically.

Looking ahead, EUR/USD is still very much in a position to extend further south based on comparative growth metrics, but last week we saw a sharp upturn in EU CPI based on exchange rate weakness as well as a rise in energy costs. Based on the former factor there are further upside risks to asset price stability which will have to be measured in context by the ECB and their monetary policy response.

As we have seen in recent months, and ahead of the resurgence of the USD, the market has finally accepted that the end of QE is now priced in, but a significant part of recent EUR weakness has been down to repricing on interest rate normalisation.

There are many conflicting factors other than just responding to an inflation overshoot which could see any adjustment in the view that mid 2019 is when the governing council will choose to tighten rates.

Source: Trading View               Past performance is not a guide to future performance

EU Sentix investor confidence at the start of the week highlighted the complexity of what was a pretty emphatic view on Europe at the beginning of the year, with EUR/USD longs at record levels into February, which shows just why the lead spot rate has come off so hard.

More Euro wide data out this week with final EU GDP expected to confirm annualised Q1 growth at 2.5%, with final readings for the services PMI of secondary importance given softness seen in the manufacturing readings. Expect more of a reaction to factory order data out of Germany, and industrial production levels at the end of the week.

From the US, non-manufacturing ISM is expected to mirror the healthy results seen in the manufacturing numbers at the end of last week, which were somewhat overlooked in the wake of the strong US jobs report. The USD response was pretty mute at the time as further evidence that trade wars raise uncertainty on US growth as well as reigniting concerns over the current trade deficit.

On Wednesday, we get the April (trade) balance which is expected to remain unchanged, but the market will also be looking a little further ahead to May and June numbers, given the sharp appreciation in the USD in the last two months.

It is a big week for Australia, headlined by the Reserve Bank of Australia (RBA) meeting on Tuesday. Given detailed guidance given by the board in recent meetings, the prospect of any material change in the rhetoric is highly unlikely, and the market is pretty confident that there will no adjustment in rates until the middle of 2019.

The RBA still feel the next move is up, and based on the steady domestic data, there will be little need to change this narrative.

Indeed, at the start of the week we have seen Apr retail sales coming in better than expected to dampen fears on consumption, but wage growth is the ultimate factor which the RBA are keeping a watchful eye on. However, steady job growth keeps hopes of an eventual feed-through alive.

Q1 corporate profits were better than expected at 5.9%, and this will bolster confidence that the GDP in the first quarter of the year can match expectations of a 0.8% quarter-on-quarter gain, which would put the annualised rate at 2.7%.

Source: Trading View                   Past performance is not a guide to future performance

Fears over demand from China seem to have abated, and indeed, some will believe that any material trade spat with the US could work in Australia’s favour. Australian trade data for Apr is also due for release on Thursday.

Mixed sentiment on the Canadian dollar (CAD) at present, with the economic data also hit and miss at the present time. Q1 GDP missed on the annualised calculations despite March coming in a little higher than expected, so we may see some revisions and/or positive follow-through into Q2 with wholesale and manufacturing sales looking strong and some of the PMIs suggesting a healthy backdrop.

NAFTA, however, is a stone around the CAD’s neck, and there is no escaping this at the present time, and more so now in light of the developments last week.

PM Trudeau could not contain his disappointment with his more recent comments in the wake of the tariff imposition (as of midnight 01 June), calling the move(s) “insulting” and an “affront” to the longstanding security partnership between the US and Canada.

Canadian payrolls at the end of the week are the data highlight to watch out for here, with the Apr report somewhat mixed as the circa 30k gains in full time employment were offset by losses in part time positions.

We also have trade data to watch for, which will make for an interesting reaction in the aftermath given the timing of the release is alongside that of the US.

Source: Trading View                 Past performance is not a guide to future performance

Finally, in the UK, we are waiting for the UK services PMI number as the main economic driver of the pound.

Industrial and manufacturing production numbers on Friday will be somewhat academic given the manufacturing PMIs for May were better than expected and, if Tuesday’s (services) release also beats expectations, then we have all three metrics showing improvement which could start to the turn the screw on rate hike pricing later on this summer.

The Bank of England had the uncomfortable exercise of backtracking at their last Monetary Policy Committee (MPC) meeting and press conference, and, with a strong belief that poor weather was a major contributor to Q1 weakness, they will be hoping for a comeback in Q2.

The numbers so far are not discouraging (at the very least). Apr retail sales produced a strong rebound and a stronger one than expected, so there are early signs that there will be some improvement at the very least, but the market is holding back for now. Perhaps it will until we get more hard data, before moving back into the rate-(re)pricing trade which caught the market long and very long earlier this year.

Brexit is even more reason to take a cautious stance, and matters are coming to a head as the EU pushes the UK for more credible proposals, not least of all on the Irish border issue which has since developed into an internal squabble within parliament on the customs relationship post Brexit.

Safe to say that early year optimism has since faded – and fast. EUR/GBP sticking to a tight 0.8700-0.8850 range reflects the uncertainty and lack of conviction in the market at the present time.

Source: Trading View           Past performance is not a guide to future performance

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