PDQFX Menu

// EUR

Thursday 1st January 1970

Trade or No Trade

As US and global equities enjoyed their best trading day in more than two years during yesterday’s European session, the Dollar caught an impressive bid too. The volatility within the Dollar saw it rally through multiple cents against the Pound, the trade at 1.4060 (down from market open of 1.4240) against the Pound and 1.2375 (down from a market open of 1.2475) against the Euro by midday.

 

The rally divided investors, who were unable to unanimously settle on a cause: trade or coincidence! Whilst the former’s argument surrounding the reduction in global risk from the lightening of a trade war between the United States and China sounds more plausible, it does lack considerable evidence.

 

Certainly, the escalation in tension between the two global economic behemoths has worried the US Dollar, inciting risk off strategies to the considerable detriment of the Dollar. The risk has been so great that many analysts have commented that, when considered in conjunction with the proven and expected propensity of the Trump administration to create immense uncertainty, the Dollar could be at risk from gradually losing its status as the world’s foremost reserve currency.

 

Particularly when one considers the significance and composition of international foreign exchange reserves, the story gains plausibility. The victim of Trump’s assault, China, is the world’s single largest holder of foreign exchange reserves. In fact, its reserves, thought to be disproportionately held in US Dollars, are more than two times larger than the second largest holder of currency reserve, Japan.

 

When Trump announced the imposition of $60bn of tariffs on Chinese imports and Steel, the Dollar, along with equity markets, struggled. Moreover, the escalation of tension concomitant with the retaliation of the States’ Asian counterpart and the threat of a full-blown trade war in a fragile global economy only developed the Dollar’s woes.

 

Whilst dumping exchange reserves could perceivably damage a domestic economy, it is highly likely that in the case of China, the move would be positive for the domestic economy and currency. Dumping the Dollar en masse would demonstrate China’s developing commitment to economic openness and a floating exchange rate. Therefore, the threat of China to the Dollar is considerable and credible.

 

A weak Dollar may not be bad for the US economy; this fact was even admitted by the administration’s own Secretary of the Treasury, Steven Mnuchin. However, the plausibility of the move forced investors not to carry too much risk by holding the Dollar and equities, hence their sell off.

 

So far, therefore, I think you’ll agree that the case for Tuesday’s remarkably bullish Dollar could be explained well by a decrease in the risk of a global trade war involving the United States. However, there remains one critical problem: the absolute lack of evidence regarding a warming of sentiment between the US and China ahead of European market open this morning!

 

In fact, laughably, the claim of Mnuchin over the weekend that he is ‘hopeful’ for a trade deal between the US and China has been praised for a rally that showed no signs of occurring for 36 hours! Instead, the month end balancing of portfolios and movement of trillions of Dollars ahead of the Easter weekend could be to blame, making the rally highly unremarkable.

 

The true cause is likely to become apparent by the reaction of markets in the event (or non-event) of a tangible reduction in the trading tension between the US and China. If a deal is announced between the two global trading superpowers and only a modest rally takes place, it will suggest that today’s rally represented the pricing in of much of this progress into the Dollar. Understanding this dynamic will be important to accurately forecasting the medium-term path of the Dollar.

Sign up to receive our daily currency updates

PDQFX

Sign up to receive our daily currency updates