Saturday 17th Nov, 2018

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

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The global economy has been excited by a super-charged global geo-political environment, which inevitably impacts foreign currency markets. Tariffs have dominated global markets as the US pursues its trade war and expands it on several fronts. The major target has been China, who has the biggest trade surplus with the US, but the EU and NAFTA have not escaped notice. Central bank activity has been influential on currency markets and the hawkish Fed has driven a powerful dollar bull market.

Geopolitical developments
Trump imposed US$34bn in trade sanctions as an opening salvo and the Chinese returned fire. Trump has once again upped the ante in this dangerous game of poker, but is committed to holding the line. The Chinese will fold and agree to a more “free and fair” trading relationship because they have little choice and Trump will allow a face-saving, off-ramp deal.

NAFTA co-signees Canada and Mexico have both pledged to fight fire with fire but have a weak bargaining position. Trump is the alpha male type and likes to see himself as the king in the “Art of the Deal”. If the EU thought it might slip under the radar, it was mistaken. It has been confronted with the fallout from the migration crises, which has threatened the EU leadership.

Adding to this conundrum, the US president has opened a trade war and made NATO and defence part of the conversation. While Europe is suffering a political identity crisis, Trump has taken the opportunity to strike, advocating reciprocal and free trade and pressuring massive increases in European defence spending via NATO. Once again, he has positioned the US in an extremely strong bargaining position.

Trump has used the NATO platform to castigate Germany and other members who rely on the US to defend their eastern borders but sign large energy agreements with Russia. He will use this issue to force increased defence spending from wealthy members such as Germany, balancing defence commitments and allowing the US more traction.

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Britain and Russia
Trump moved on to a tour of the UK, which provided considerable political entertainment. Trump commented on the political turmoil enveloping Britain. The ruling Tory party has been torn asunder over the Brexit negotiations, with Brexiteer cabinet ministers led by Boris Johnson resigning from cabinet. A showdown looms and may cost Prime Minister May her job. Trump then moved on to the Russian summit held in the Finnish capital Helsinki.

Impact on currencies

Escalating trade wars spook equity markets and lend to a certain volatility in the foreign exchange markets. Markets hate risk and yearn for settled trading environments. The turmoil on the global geo-political level is offset by strong global growth numbers. Economic data have been positive. The European market has been beset with challenges and the euro remains vulnerable, trading around 1.1650, while the pound sterling holds 1.3200. The Brexit crisis has torn the Tory government apart and the outcome will have a big impact on the currency. The soft Brexit strategy of the government would arguably lead to “death by a thoUSnd cuts”. Hard Brexit, as advocated by the rebel Brexiteers, would ultimately lead to a massive appreciation of the pound sterling.

Trade-exposed nations such as Australia and New Zealand are in a terrible situation. These countries are thoroughly dependent on trade for their prosperity and threats to the status quo are damaging their associated currencies. The Australian dollar has fallen all the way back below 0.7400 with little technical support, or much from the central bank. The RBA was dovish in its last monetary statement and resisted rate rises for the foreseeable future. This places further downward pressure on the currency, already under extreme pressure. Careful risk management tools must be employed to mitigate the currency impact on FX exposures.

Conclusions
The global political situation is seeing a new world order with the rise of populism and nationalism. This directly impacts the way countries interact and trade, thus influencing global financial markets. Central banks have maintained loose monetary policies since the GFC, but the explosion of the US economy is changing dynamics. The Federal Reserve has tightened monetary policy and is normalising interest rates, challenging other economies and central banks. The problem with the ECB, RBA and RBNZ is that they are fighting massive fiscal challenges, which restrict growth and normal monetary markets.

The new era of the strong dollar is upon us and that means importers must have serious and effective risk strategies. Carefully projected foreign currency cash flows are necessary, making it essential to take remedial action employing forward contracts and other financial tools.

* Paul Bettany is a foreign exchange partner at Collinson & Co
paul@collinsonfx.com

This article appeared in the August edition of DCN Magazine



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