Sunday 18th Nov, 2018

CURRENCIES, GEO-POLITICS & TRADE: Markets in the age of Trump

Image: Shutterstock
Image: Shutterstock

The G7 and the trade wars
Financial markets have been mesmerised by geo-political events enveloping the globe. The G7 is always a fantastic event for leaders to prance around the world stage and bask in the media spotlight. The talk-fest has always ended with an agreed-upon communiqué, signed by all participants in a show of world solidarity. The build-up was enormous, with verbal jousting surrounding the emerging “global trade war”. The US, under President Donald Trump, has been threatening all its major trading partners with a reality check on tariffs. Trump has looked at the massive trade imbalances suffered by the US and concluded the multi-lateral trade agreements are neither fair nor free. The EU, China and Canada (under NAFTA) have all seemingly taken advantage of unfair trade practices, employing many protectionist measures and penalising US exports. Meanwhile, the unfettered access to the biggest market in the world (the US), has been virtually unimpeded. Trump is advocating reciprocal, bi-lateral agreements, so all trading partners operate under the same rules. This has been vociferously rejected by the EU and Canada, framing it as an attack on the concept of free trade, while playing the victim card. Trump has responded with tariffs and dire warnings linking trade to defence. The G7 seemed to accept this, until his departure from the meeting, when Canadian PM Trudeau launched a scathing attack on the president (in his absence). Result: a car crash, which will cost the Canadians and Europeans $$$.

The Singapore Summit
This G7 was a tumultuous event but would soon be forgotten in the brave new world of Trump. The speed and regularity of momentous events occurring in the world have increased in frequency since the inauguration of the current administration in the White House. Trump flew directly from Canada to the Singapore Summit, where he spent the day negotiating with the North Korean Communist Chairman Kim. This was a historical occasion, resulting in a signed agreement between the two leaders, aimed at denuclearising the Korean Peninsula. The G7 was way in the rear-view mirror. Trump and Kim cavorted for most of the day in a world-first, addressing the climacteric position the region and the world find themselves in. The results were, it seems, surprisingly positive and look to be a great first step in solving one of the world’s great dilemmas. An agreement was signed and the process is underway.

Global trade wars
Trade remains a key issue in global markets and a resolution may take some time. The Europeans will have to sign an amended trade agreement, balancing tariffs and trade sanctions, or suffer the consequences. Trump did offer a proposal, namely to abandon all tariffs between the G7 nations, but this was summarily rejected. Trade is a major factor globally and particularly impacts trade-dependent, commodity nations, such as Australia. The ebb and flow of these developments therefore affect the associated currency. The AUD has suffered severe recent setbacks, although looks to have stabilised, with recent positive fiscal developments. The real fluctuations are found in relation to the reserve currency. The AUD experiences more volatility measured against the USD, rather than the EUR, which tends to move in conjunction with the AUD.

Therefore, recent currency fluctuations are rather exaggerated when measured against the USD, as opposed to the EUR. e.g. the trading range of the AUD/USD this year has been 0.7430-0.8130 (700 points or a 9.5% fluctuation) while the AUD/EUR has moved from 0.6200-0.6550 (350 points or a 5.5% fluctuation). This continues to hold true as the EUR moves more in line with the AUD, versus the reserve USD (N.B. their respective central banks occupy a similar space in dramatic contrast to the Federal Reserve). It is therefore even more important for businesses to address foreign currency risk and ensure it is managed effectively. The risk factors and protection against exchange rate movements are essential. Foreign exchange cover should, therefore, be even more comprehensive for the USD as fluctuations are more likely to be even greater. Take the risk out of foreign exchange exposure.

Central bank influence on the markets
Central bank influence has been more dominant in markets since the GFC. The GFC encouraged record-breaking, expansive monetary policy to combat massive debt levels and stimulate depressed global growth. This has continued for 10 years in the ECB, Bank of Japan, RBA and RBNZ. As their economies continue to struggle to get on top of deficit/debt levels and stunted growth they have maintained extremely accommodating monetary policies. The US, in contrast, has boomed recently and is rapidly returning to a normalised monetary policy. This has been reflected in inflation, growth and employment leading to rising interest rates. The Fed has been raising rates over the last two years and look set to continue to do so. They operate on an island. US growth has pushed interest rates up, as demand surges, while a reasonable return on money promotes competition for the investment dollar. Normalised monetary policy is a place where all economies wish to be, but indebtedness, sluggish growth and instability remain a curse to other western economies. Rising interest rates support a stronger currency so expect the US dollar to appreciate over most currencies in the coming year.

Markets operate on confidence and removing geo-political obstacles provides a conducive environment in which to operate. The focus then shifts to global economic data and the health of the individual countries economy and fiscal/monetary policy. Monetary policy has dominated interest rates, thus currencies, forcing effective management of foreign exchange risk. Financial tools can remove this risk and allow the orderly function of a business in an international environment. Risks in the near future, remain the trade wars and unforeseen geo-political events while global economies improve. 

This article appeared in the July edition of DCN Magazine

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