Morning Commentary: More than Meets the Eye

Foreign Exchange - Morning Commentary
More than Meets the Eye
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Equity markets were down sharply yesterday and remain under pressure today on virus headlines and renewed tariff threats from the US against the EU and Canada.  Looking specifically at the US-EU conflict, the United States Trade Representative (USTR) released a notice that they are opening a one month comment period that is required before possibly imposing tariffs on $3.1 billion of exports from Europe.  

On the surface, this move was not much of a surprise as it is part of a very long running fight on illegal aircraft subsidies involving the WTO.  Further, it could be argued that the US’s actions were relatively benign as the tariffs were authorized by a 2019 WTO ruling and are relatively small.  

However, that is not where the story ends.  The timing of the USTR’s notice is a bit conspicuous as it comes at a time when the US could potentially impose aluminum tariffs on Canada and closely after the EU announced that it would be banning American visitors.  Markets were expecting Trump to continue to talk tough on trade leading up to the election, but recent developments raise the possibility of actual follow through against multiple trading partners.  

The second complication relates to how tariffs work.  While the US’ proposed retaliation is relatively small, tariffs work through the sentiment channel which is fragile due to the COVID shock.  Adding to this is the possibility of carousel tariffs where the US rotates the industry subject to tariffs.  This approach would ensure maximum uncertainty across all the industries in the targeted economy on what would otherwise be a small nominal tariff measure.  

Finally, there is the possibility of an EU response.  The WTO is currently evaluating a similar case against US-based Boeing, which could present a proportional WTO authorized channel to respond should the WTO rule in the EU’s favor as expected. Granted the possibility of a tit-for-tat response to a WTO authorized measure is unlikely, a WTO ruling doesn’t compel the implementation of tariffs.  Should the US and/or the EU choose to impose tariffs when other avenues are available, it would be a clear negative sign for global growth prospects. 
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • Initial jobless claims disappointed for the second week in a row.  1.48 million jobless claims were filed last week against expectations for 1.32 million claims.  As touched on in past commentaries, continued high initial jobless claim prints are of particular concern because they suggest businesses remain under pressure despite the re-opening of economies.  In total, 47 million claims have been filed since mid-March.  Continuing claims came in at 19.5 million versus expectations for 20.0 print.   
  • The US saw one of its highest increase in daily cases yesterday with the country recording 34,500 new infections.  The peak daily infection number was set on April 24 at 36,188.  In California, the state reported 7,149 new virus cases, the largest daily jump so far.  Walt Disney Co. announced that it will delay the re-opening of its theme parks indefinitely.  
  • The US took further action on China via Huawei as the Pentagon placed Huawei and Hangzhou Hikvision, on a list of companies linked to China’s military.  On its own, this move is largely symbolic but could be a precursor to further sanctions.     
  • Canada was downgraded from AAA to AA+ with a stable outlook by Fitch as public debt grows and concerns rise over public finances.  This new rating puts Canada on par with Finland and Austria.  AAA countries include Germany, Netherlands, Denmark, Norway, Singapore, Sweden, Switzerland, Australia, Luxembourg and the US.
  • The ECB released an account of its June meeting where it upsized its PEPP program by 600 billion euros.  In the account, some Governing Council members expressed reservations on the size of the program but all agreed that it was the "most effective and efficient tool."  In Germany, the German constitutional court rejected a challenge to the ECB’s asset purchase program. 
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