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FX risk: Trump hikes Chinese tariffs, is Europe next?

Posted on: 13 May 2019 , by: Boris & Kathy , category: Market Review

FX Weekly with Boris and Kathy

The trade war is back on. After four months of relative peace, Trump is getting tough on trade again. Last week, he stayed true to word to raise tariffs on virtually all Chinese imports from 10% to 25%. This should be a nightmare for Chinese exporters, the Chinese government, domestic, foreign central banks, and investors from all corners of the world. However, initial losses in currencies and equities faded as the Dow rebounded nearly 400 points from its lows to end the day in positive territory. 

Why the muted reaction?

There are at least 4 reasons why fresh Chinese tariffs did not trigger a broad-based sell-off in risk currencies. As the clock ticked towards Trump’s deadline, the announcement was priced in. There was no immediate Chinese retaliation. China stepped in with state fund buying of Chinese stocks. Some investors hope that by turning up the heat, China will be forced to deal. Unfortunately, we fear that this misplaced optimism will make investors complacent about the true risks to China and global economy. Central bankers won’t be happy with this decision: the tariffs will force the Reserve Bank of Australia to lower interest rates; Europe could be the next target for Trump’s trade tantrum; and while China is taking its time, sooner or later they will respond with retaliatory tariffs. This won’t end well as the risk is to the downside for global growth, equities, and currencies. The Japanese Yen and Swiss Franc were the best performers last week and their strength is consistent with the decline in stocks. Sterling fell the most despite an uptick in GDP growth last quarter.

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US DOLLAR

Data Review

  • PPI Final Demand 0.2% vs. 0.3% Expected
  • PPI Ex Food and Energy 0.1% vs. 0.2% Expected
  • PPI Final Demand 2.3% vs. 2.2% Expected
  • Trade Balance -$50B vs. -$50.1B Expected
  • Jobless Claims 228K vs. 220K Expected
  • CPI 0.3% vs. 0.4% Expected
  • CPI Ex Food and Energy 0.1% vs. 0.2% Expected
  • CPI YoY 2% vs. 2.1% Expected

Data Preview

  • Retail Sales – Potential upside surprise because gas prices increased and average hourly earnings growth was steady
  • Empire State & Industrial Production – Potential upside surprise given uptick in manufacturing activity
  • Housing Starts & Building Permits – Should benefit from halt in rate hikes and stronger stocks
  • University of Michigan Sentiment Index – Potential downside surprise as pullback in stocks could weigh on sentiment

Key Levels

  • Support 109.50
  • Resistance 111.00

Trump tariff hikes – good or bad for the dollar?

After President Trump announced higher tariffs for China, the US dollar sold off across the board. Investors bailed out of all US assets in what appeared to be a negative outlook for the US dollar. Typically, broad based sell-offs in US stocks are accompanied by a flight to quality into the greenback, but not this time because the announcement was accompanied by softer data. Inflation is rising less than expected and the trade deficit has increased. The fear is that Fed Chairman Powell’s optimism will fade as a result of slower inflation, weaker data, and heightened trade tensions. This will probably be necessary, but it is important to remember that the Fed is one of the least dovish central banks. Others have and will resort to easing but for the US central bank, the next move will still be a rate hike.

When President Trump introduced a 10% tariff on $200B worth of Chinese goods on the 17th of September last year, the reaction was very similar. EUR and AUD rallied against the US dollar and extended their gains in the days to follow despite retaliation from China. USDJPY fell the day that the tariffs were announced but also rose from 112 to 114.50 over the next few weeks. There was one big difference: Trump was waffling between 10% or 25% tariffs and investors bid currencies and equities higher in relief when he opted for the smaller penalty. When the steel and aluminium tariffs were announced in March, currencies and equities also traded higher but the rallies fizzled a few days later. Ultimately, Trump’s tariffs are bad for US markets but worse for the rest of the world. As the weeks progress, central bankers will express their frustrations and data will soften, led by lower demand in China.  

In the near term, the question around tariffs has been answered so we could see a further relief rally in currencies and equities. US retail sales, the Empire State, Philadelphia Fed surveys, and housing market reports are scheduled for release. Given Fed Chair Powell’s optimism and the diminished prospect of a further rate hike this year, most of these reports should improve helping risk appetite and the US dollar.


AUD, NZD, CAD

Data Review

Australia

  • RBA Leaves Rates Unchanged at 1.5%, Cites Uncertainty and Weakness in Economy
  • Melbourne Inflation 0.2% vs. 0.4% Previous
  • PMI Construction 42.6 vs. 45.6 Previous
  • Trade Balance A$4.9B vs. A$4.4B Expected
  • Retail Sales 0.3% vs. 0.2% Expected
  • Q1 Retail Sales ex Inflation -0.1% vs. 0.3% Expected
  • China Trade Balance $13.8B vs. $34.5B Expected
  • China Exports -2.7% vs. 3% Expected

New Zealand

  • RBNZ Cuts Interest Rates by 25bp to 1.5%, More Easing Possible

Canada

  • IVEY PMI 55.9 vs. 54.3 Expected
  • Trade Balance -3.21B vs. -2.4B Expected
  • Building Permits 2.1% vs. 2.4% Expected
  • Net Change in Employment 106.5K vs. 11.6K Expected
  • Unemployment Rate 5.7% vs. 5.8% Expected
  • Full Time employment 73K vs. -6.5K Previous

Data Preview

Australia

  • Employment Report – Potential downside surprise given major deterioration in employment component of manufacturing, services & construction PMIs

New Zealand

  • PMI Manufacturing Index – Potential downside surprise given dovish RBNZ
  • PPI – Likely to be lower given drop in CPI

Canada

  • CPI – Potential downside surprise given lower price pressures globally and only small rise in price component of IVEY PMI

Key Levels

  • Support AUD .6900 CAD 1.3400 NZD .6500
  • Resistance AUD .7100 CAD 1.3500 NZD .6700

RBNZ cuts rates, is the RBA next?

The Reserve Bank of New Zealand cut interest rates by 25 basis points and Australia’s central bank will be the next to follow. In last week’s note, we said it would be smarter for the RBA to wait and see if President Trump follows through with his threat of more Chinese tariffs – we got our answer last week. China will be hit with tariffs that could shave GDP by more than 1% and reduce annualised growth to 5% in 2020. Australia’s fortunes are linked to China’s, so if China slows, Australia slows. When the RBA left interest rates unchanged last week, they had nothing good to say about the economy. They felt that inflation in the March quarter was noticeably lower than expected, spare capacity was an issue with household spending being the main domestic uncertainty. They also cut their GDP forecast for the year through 2019 and mused about the economic implications of a low CPI. Rate cuts are on their minds and unless Trump suddenly rolls back the tariffs, they will ease in June. Improvements were seen in the latest retail sales and trade reports, but they took a backseat to RBA and trade. In the week ahead, all eyes will be on China’s response. If they opt for more measured retaliatory tariffs, AUD could rally. Labour market numbers are also scheduled for release this week and the risk is to the downside with a major slowdown in job growth reported by the PMIs. Even if AUDUSD rallies this week, fundamentals and technicals favor weakness not strength.


The New Zealand dollar hit a six-month low versus the greenback after the Reserve Bank of New Zealand cut interest rates by 25 basis points to 1.5%. This drop didn’t last: the central bank guided to a “one and done” policy stance rather the start of new easing regime. The RBNZ noted that “A key downside risk relating to the growth projections was a larger than anticipated slowdown in global economic growth, particularly in China and Australia, New Zealand’s largest trading partners. The Committee agreed that the projections adequately captured the observed global slowdown and its impact on domestic employment and inflation. The Committee noted that additional stimulus from central banks had underpinned growth and reduced the likelihood of a more pronounced slowdown. With some indicators of global growth improving in recent months, a faster recovery in global growth was possible. However, on balance, the Committee was more concerned about a continued slowdown rather than a faster recovery.” Still, despite the easing move, the market took the action as more preventative in nature given the tensions in global trade. One of the reasons why RBNZ may not want to cut rates further would be because it would create a serious imbalance in the AUDNZD cross rate. That could change though if the RBA eases next month. Business PMI and Q1 PPI are scheduled for release – both reports should validate the central bank’s decision to ease.


Canada’s economy on the other hand is on fire according to the latest economic reports. Manufacturing activity is up and most importantly Canada reported the largest one-month job growth ever. Canada added 106.5k jobs in April, which was nearly 10x times more than expected. A nice combination of full and part-time work helped drive the unemployment rate down to 5.7%. Jobs are the foundation for the economy and this solid report extends the year of solid job growth. Wages and consumer spending should benefit from these improvements, easing any concerns for the central bank. USDCAD fell sharply after the report and we believe that further losses are likely, even if this week’s CPI report shows price pressures easing slightly. 


BRITISH POUND

    Data Review

    • Halifax House Prices 1.1% vs. 0.1%Expected
    • Q1 GDP 0.5% vs. 0.0% Expected
    • Q1 GDP YoY 1.8% vs. 1.8% Expected
    • Industrial Production 0.7% vs. 0.1% Expected
    • Manufacturing Production 0.9% vs. 0% Expected

    Data Preview

    • Jobless Claims and Employment Report – Strong risk to the downside as PMIs report widespread hiring slowdown in manufacturing, services and construction sectors

    Key Levels

    • Support 1.2900
    • Resistance 1.3100

    GBP shrugs off good data, hit hard by risk aversion

    The worst performing currency last week was sterling. Despite broad-based improvements in the UK economy, the British pound broke below 1.30 on the back of risk aversion and unsuccessful cross-party talks. Very little progress was made between the UK government and Labour last week, increasing the calls for Prime Minister May’s resignation. She’s promised to resign once a Brexit deal is approved but Tories are pushing for an earlier exit. May could appear before committee this week to discuss her future, which could be interesting but not exceptionally market moving. Instead, we continue to watch UK data. House prices, GDP, industrial, and manufacturing production numbers were better than expected last week but Tuesday’s labour market report may not be as kind to GBP.  According to the PMIs, employment growth slowed in the manufacturing and service sectors. 


    EURO

    Data Review

    • German PMI Services revised up to 55.7 from 55.6
    • German PMI Composite revised up to 52.2 from 52.1
    • EZ PMI Services revised up to 52.8 from 52.5
    • EZ PMI Composite revised up to 51.5 from 51.3
    • EZ Retail Sales 0% vs. -0.1% Expected
    • GE Factory Orders 0.6% vs. 1.4% Expected
    • GE Industrial Production 0.5% vs. -0.5% Expected
    • GE Trade Balance 22.7 vs. 20B Expected
    • GE Current Account 30.2 vs. 26B Expected

    Data Preview

    • EZ Industrial Production – Potential upside surprise given stronger German industrial production
    • German ZEW Survey – Stabilization in EZ data could bolster investor sentiment
    • EZ Q1 GDP – Potential upside surprise as retail sales and trade activity improve in the first quarter
    • EZ Trade Balance – Should be a bit stronger given uptick in French trade balance 
    • Revisions to EZ CPI – Revisions are hard to predict but any changes will be market moving

    Key Levels

    • Support 1.1100
    • Resistance 1.1300

    The battle turns to Europe

    Slowly but surely, we are beginning to see gradual improvements in the Eurozone economy. Factory orders, industrial production, and trade activity are up in Germany as retail sales in the Eurozone stabilize. These improvements helped to drive EURUSD above 1.12 but investors are reluctant to take the currency pair much higher as President Trump turns his focus to Europe. After announcing fresh tariffs on China, Trump said he would make a decision on auto tariffs by May 18th. Europe’s $50B car industry is at risk if Trump decides to impose new duties. Three months ago, Trump was handed a report by the Commerce Department that would justify tariffs on the grounds of national security. That triggered a 90-day deadline for Trump to make a decision. He could extend the deadline, which is what Europeans hope and investors expect but he could also slap Europe with tariffs of up to 25% on imported cars and parts. A decision probably won’t be made until the end of the week or even the weekend so the euro could still see cautious gains on data.  Most of this week’s economic reports including Eurozone industrial production, the German ZEW survey, and first quarter GDP numbers should be positive for the currency. If auto tariffs are delayed, EURUSD could squeeze up to 1.1350 but if they are imposed, the pair could sink to fresh year-to-date lows.


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