Morning Commentary: Darkest before the Dawn

Foreign Exchange - Morning Commentary
Darkest before the Dawn
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Last Friday, trade tensions between the U.S. and China ramped up another notch with the U.S. more than doubling the tariffs it is imposing on $200 billion of Chinese goods.  While there will be costs incurred to both economies, the ramifications will not be limited to just these two countries. 
Given the large exposure that the European economy has to global trade, renewed trade friction puts the expected recovery in Eurozone GDP at risk.  But, the immediate concern revolves around the possibility of automotive tariffs on EU auto exports. 
Part of the reason that the markets were discounting the possibility of trade escalation was the belief that President Trump would be more strategic with the stock market ahead of the 2020 presidential election.  As a reminder, it was expected that any trade deal would be an executive agreement that would bypass the need for congressional approval. 
With that assumption disproven, it warrants a reassessment of U.S. trade policy with the EU.  The Section 232 investigation, which evaluated the security threat posed by European auto imports and provides cover for Trump to impose automotive tariffs, requires a decision by May 18.  In light of past actions and Trump’s own comments, the probability that these tariffs go into place has risen materially.
This renewed threat comes at an inopportune time for Europe.  While there have been positive economic surprises out of Europe, German data continues to lag with manufacturing data declining for eight consecutive months.  As the largest automotive manufacturer in Europe, Germany stands to be the most negatively impacted European economy at a time when its economy remains in a precarious state. 
While U.S. negotiators have been invited to China to continue talks, markets appear to be more focused on the G20 meeting in Japan at the end of next month.  At the G20 meeting in Argentina last year, a meeting between President Trump and Xi resulted in a de-escalation of tensions.  Ultimately, trade remains a very fluid conversation with a lack of clarity surrounding a variety of variables behooving market participants to pay more attention than implied volatility from just two weeks ago would suggest.    
  • China has raised tariffs in retaliation to the U.S. actions last week.  According to a statement from China’s Ministry of Finance, the country will raise tariffs on part of a list of $60 billion of U.S. goods.  Additionally, it has been reported that China is investigating other non-tariff measures. 
  • In the U.K., polling shows that the probability of the Conservatives forming a government after the next election is lower than it has been at any point of this parliamentary session.  However, this GBP negative news was blunted by a falling probability of early elections.
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