By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Three central-bank rate decisions and a long list of important data were completely overshadowed by trade tensions this past week. Nothing mattered more than the U.S.’ tariffs on Chinese imports and China’s retaliatory measures. The world’s two largest economies are officially in a trade war and they have the power to do serious damage to the each other’s economy. No one wins in a trade war but President Trump’s dangerous gamble made the U.S. dollar the least attractive currency. The greenback sold off across the board past week as investors bailed out of U.S. assets. Although the selling pressures eased on Friday as China responded with only $3 billion worth of tariffs in 2 stages (depending on negotiations with Washington) against the U.S.’ $50 billion, odds are that President Trump won’t back down and China will need to follow up with stronger measures.
In a trade war certain currencies will outperform others depending upon where tensions are the greatest. In this case, the U.S. are the ones stirring up trouble so the U.S. dollar is therefore the worst performer. This explains why despite the sharp sell-off in U.S. stocks, rather than fall, risk currencies like euro and sterling traded higher because investors are viewing this as more damaging to the greenback. Next to the U.S. dollar, the biggest loser of a U.S.–China trade war will be Australian dollar as Australia is particularly sensitive to Chinese growth. The biggest beneficiaries should be the Japanese yen and Swiss franc (because of risk aversion). The currencies of countries that not directly involved the trade war should also outperform such as the U.K. and possibly Canada if there is real progress on NAFTA negotiations. But the greatest opportunities in a trade war should be in the crosses (non-dollar pairs) as they remain the true relative growth plays. Looking ahead, trade war and political headline remain the primary focus. We could see some mild volatility from U.S. consumer confidence, GDP revision, Chicago PMI, personal income and personal spending reports but with the FOMC meeting behind us, this data will not have a material impact on Fed policy. It is also a holiday week with global markets closed on Friday and many foreign markets closed the following Monday for Easter (US markets are only closed for Good Friday). In light of trade tensions and Japan’s fiscal year end on March 31, we expect USD/JPY to remain under pressure. The next major support level for USD/JPY is 103.00.
The best-performing currency this past week was the Canadian dollar, which rose more than 1.5% against the greenback. The move was sparked by a sharp rebound in oil prices, stronger Canadian data and reports that the Trump administration dropped its demand that all vehicles made in Canada for export contain at least 50% U.S. content. Consumer price growth accelerated significantly in February with the year-over-year rate rising to 2.2% from 1.7%. Retail sales growth overall fell short of expectations but excluding autos, demand rose more than expected by 0.9%. This bodes well for next week’s January GDP report, which should show growth strengthening at the start of the year, adding fuel to the loonie’s rise. The Australian and New Zealand dollars also traded higher on Friday as China tries to avoid a head-on collision by saying it is willing to buy more from the U.S. With no major Australian economic reports scheduled for release in the coming week, the Australian dollar will take its cue from U.S.–China trade tensions. If China takes additional steps to diffuse the tensions, we could see a stronger recovery in AUD and NZD. If they go the other way, these currencies could fall.
Both euro and sterling rallied against the dollar on Friday. Some traders may be surprised by the tight consolidation in EUR/USD despite all of the big stories and important economic reports. On one hand, the euro’s gains were restrained by the European Central Bank’s dovishness and economic data – ranging from the PMIs to ZEW and the German IFO reports – showed deterioration from the previous month. On the other hand, the U.S. dollar is under pressure from trade tensions. These counteractive factors has made it difficult for EUR/USD to rally but if the trade war intensifies, EUR/USD will break higher as it settles near the top of its range. Eurozone confidence, German inflation and unemployment numbers are scheduled for release and we are looking for softer readings all around. Sterling on the other hand finally woke up to hawkish 7-2 BoE vote on Thursday and the stronger-than-expected consumer spending and wage data. Although sterling is vulnerable to profit taking because it is overextended against the euro, Swiss franc and commodity currencies, in the long run, we expect the currency to outperform as the BoE should be the next major central bank to raise interest rates.