Looking at the graph of how currencies moved over the week, it follows a clear “risk off” pattern:  JPY and CHF gained while the commodity currencies fell. Then late Thursday, the mood improved and the laggards gained while the gainers lagged. There were few ways to make money trading on one’s view on individual currencies.

The driving force behind the moves was a “risk off” trade motivated by the fall in stock markets globally, which was due to the Trump administration’s sudden warning that the trade talks with China are on the verge of collapsing and the US would hike tariffs on Chinese imports. There is one small catch though:  the tariffs won’t apply to goods that are currently in transit. That means there’s a breathing space of two to four weeks in which the two sides can reach an agreement. Perhaps that’s why stocks in Asia recovered on Friday despite no progress yet, and why the “risk off” trade reversed somewhat.

We’ll see if Trump’s move was just a way to ratchet up the pressure, or if the talks really are headed for collapse. It may be that both sides miscalculated the other’s position and the talks are indeed headed for disaster as a result. If so, that could be a disaster for the global economy too.

China can not only raise tariffs on US goods, it can take a number of non-tariff measures that would severely disrupt global supply chains (remember back in 2010 when the country surreptitiously banned exporting rare earth metals to Japan in retaliation for Japan arresting a fishing boat captain whose trawler collided with two Japanese patrol vessels?) It can also allow the CNY to depreciate further, which would probably cause other EM currencies to decline in sympathy. Coming at a time when the global manufacturing business is already barely expanding, the moves have the potential to throw the global business cycle back into recession.

Furthermore, the global economy is already disappointing expectations, which have improved notably in the past few months. The move increases the risk of a more lasting change in sentiment. Back in January the markets expected the worst – that suddenly changed and we had one of the best starts to the year in the US stock market in decades – but now we’re risking having it all go into reverse again. That raises the possibility of a continued appreciation in JPY and CHF and further declines in AUD and NZD.

The risk-off mood could also get a boost from the heightened tensions between the US and both North Korea and Iran, plus the disillusionment of what may have been PM May’s last gasp on Brexit (see below).

A weak AUD and NZD are the natural counterparts to a strong JPY in a risk-off environment. Usually though AUD would be affected more than NZD. This time however NZD fell for reasons particular to that currency, namely that the Reserve Bank of New Zealand (RBNZ) cut interest rates. Although the Bank also stated that the cut provides “a more balanced outlook for interest rates,” the market doesn’t think so – it attributes a 46% chance to another cut this year vs zero for a hike.

The Reserve Bank of Australia (RBA) also hinted at a possible change in rates, although it was vague about which direction that might be. It just said that “…the Board will be paying close attention to developments in the labour market at its upcoming meetings.” That suggests a cut if you think the labor market is going to weaken, or a hike if you think it’s likely to strengthen. In any case, even though they changed the last paragraph of the statement for the first time since March 2018, the AUD was little changed. The market sees an 84% chance of a rate cut this year, little changed from 89% before the RBA meeting.

It’s notable that USD was down in this risk-off environment. It seems to me that this is because the market assumes a US-China trade war is bad for the US, too. After all, no matter what Trump claims, the tariffs are paid for by US consumers, not China. (Although Chinese firms may hold down their selling prices in order to keep their goods competitive.) Furthermore, China is imposing retaliatory tariffs of its own, although of course there are more Chinese exports to the US to be taxed than there are US exports to China. 

GBP was down only slightly during much of the week, but fell more sharply on Thursday. An agreement between the Conservatives and Labour on Brexit has started to look a lot less likely, while the early departure of PM May has started to look a lot more likely. If (or when, it seems) she goes, her replacement will probably be someone who is only interested in getting the UK out of the EU ASAP and doesn’t much care how. That raises the odds of crashing out without an agreement, which would be terrible for sterling. Terrible, but entirely possible and increasingly probable, in my view. 


The coming week:  US retail sales, UK employment data, China IP & retail sales

There are few highlights on the schedule for the coming week. No major central bank meetings or speeches and few crucial indicators.

For the US, the most important indicator will the retail sales figure on Wednesday. Last month was a blow-out figure; this month, analysts are expecting it to revert to trend. The figure has been extremely volatile of late though and so I wonder just how likely that is. Still, another rise coming right after such a big jump would tend to confirm that the US consumer is alive & well & out shopping as always. That would be positive for the dollar.

Other important US indicators coming out during the week include industrial production and the Empire State manufacturing index on Wednesday, housing starts and building permits as well as the Philadelphia Fed survey on Thursday, and the University of Michigan consumer sentiment survey on Friday.

In Europe, the first estimate of Q1 German GDP will be released on Wednesday, but that will be followed a few hours later by the second estimate of EU-wide GDP for the same period, so it’s likely to have only limited impact.

The ZEW survey comes out on Tuesday, but to me this is only of importance as an indicator of market sentiment, not of economic activity, since it’s a poll of analysts and not people who really do something.

For GBP, the market will be watching the employment data on Tuesday. It’s expected to show yet another healthy rise in the number of people working, albeit not as large an increase as in the last three months. At the same time, the pace of growth in wages is expected to slow by one notch. The combination of somewhat slower job growth and somewhat slower wage growth could be taken as slightly negative for the economy and the pound, although probably the difference isn’t enough to have much impact on the currency.

In any case, Brexit and PM May’s political future are likely to be more important factors for the pound.

China will release its usual mid-month trio of indicators on Wednesday, namely retail sales, industrial production and fixed asset investment. No big change is expected in retail sales and FIA. Industrial production, which surged in the previous month, is expected to fall back to trend. The surge in March may have been due to companies trying to produce products for the US before the tariffs come into force, as it coincided with a surge in exports (+14.2% yoy). It may also have been caused by the  surprisingly expansionary fiscal and monetary policies in Q1, which resulted in a steady GDP growth rate of 6.4% yoy.

Regardless of why the surge occurred, the market doesn’t expect it to last and sees production falling back. Even so, the expected rate of 6.5% would be quite healthy, seeing as the six month before last surge averaged 5.7%. The news would probably confirm in people’s minds that the stimulus in China is working. It would therefore tend to be positive for countries that export a lot to China, such as AUD and NZD.


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Marshall Gittler

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