» Despite the diplomatic train wreck at the G7 Summit, no significant reactions have been witnessed to date on foreign-exchange markets;
» In the markets, the perception predominates that the US dollar would be in the strongest position in the event of a further escalation (GDP growth differentials, Fed rate moves…);
» Market actors are currently not taking on board the fact that an undesired side-effect of Trump’s policy could be counterproductive dollar strength.
Where public opinion about the events at the G7 summit is still vacillating between dismay, disillusionment and tacit admiration, there has not yet been any conspicuous reaction on the financial markets. Neither the risk of an escalation in the trade war nor the global economic outlook are being assessed markedly differently to the way they were being looked at last Friday.
It may or may not be the case that Trump’s notions regarding free trade are implementable and that the remainder of the world is indeed enriching itself unfairly at the USA’s expense. What is incontrovertible is that the US president is intent on improving the situation of “his” exporters and on scaling back the US trade deficit (which he regards as a symptom of the unfair treatment allegedly being meted out to the US). As well as more or less apocalyptic verbal threats, import duties are his favourite way of trying to redress the balance. Such a “declaration of war“ could have an unsuspected – and, as yet, largely ignored – side-effect via the exchange-rate channel, promoting a bout of dollar appreciation counterproductive from the point of view of Trump’s ulterior designs. At the present juncture, the greenback is benefiting from the positive US economic outlook, and the perception is currently predominating in the market that the US economy may well gain from the new trade-policy stimuli – or, at least, that the rest of the world would be more adversely affected than the USA by shrinking foreign-trade volumes. By contrast, the prospect of the purchasing power of US consumers deteriorating in the absence of cheap imports from abroad is not en vogue at the moment.
What is more, if the punitive tariffs imposed by the USA feed through into higher prices, this would tend to imply more leeway than at present for the Federal Reserve to raise rates – that, at any rate, is the market’s interpretation. (Rising prices could result from higher import prices because there are no US substitutes for certain imported goods, meaning that import duties would have the effect of a tax on US consumers buying such imports. Should there be sufficient comparable US products, by contrast, their prices would likewise come under upside pressure on account of the higher demand, the reason being that capacity-utilisation rates are already high in many segments of the US economy). Whichever way you look at it, the dollar looks to be the winner at the present time. Yet a significant upward movement in the US currency would threaten to nullify Trump’s endeavours on the trade-policy front and to erode the competitive situation of US exporters. The argument that Trump could ultimately aid and abet a strong-dollar policy with his aggressive stance on trade and security has not yet done the rounds, but it might well confront the US president with new, unforeseen problems.