Impact of trade war risk in FX market seen ‘marginal’
Positive performance in safe haven currencies could continue
Trade war was the dominating theme last week as the Italian political crisis took a back seat after the populist government was formed. The US had given temporary exemptions for the EU, Canada and Mexico, which expired at the end of last week. Afterwards, the US imposed tariffs of 25% on steel and 10% on aluminum. This elevates the stake considerably in global trade tensions and will be unquestionably followed by measures being publicized by these three important trading partners of the US. Canada has already confirmed that USD 12.8bn worth of tariffs on US steel, aluminum and other imports will take effect on July 1st. Moreover, Mexico has promised action and EU Commission President vowed imminent response.
However, the impact in the currencies market has been marginal so far. It seems from the initial reaction that there is a strong consensus that this may not result in any large scale trade war. The likely reason for such a lack of volatility in the FX market is that the US may not respond to actions imposed by other trading partners. Other nations that were hit by the initial placement of these tariffs in April did retaliate with no action followed from the US, so there is some logic in this assumption for now. Still, the risks of a more damaging escalation in trade conflict is now higher than before and that may potentially extend the period of recent positive performance in safe haven currencies. The recent surge in the two and ten year dated Treasury yields took a U-turn and have fallen in five of the last six sessions, reversing an uptrend that has been in place for the last couple of months. Demand for safe haven assets such as US government bonds, CHF and JPY are on the rise.
The American economy added 223K jobs last month and the unemployment rate edged to an 18-year low to 3.8%. The data indicates that the US labor market continues to tighten further and may cause inflation to increase even more as labor supply diminishes. As for wages, the average pay rose 0.3% after edging up by 0.1% in April. That lifted the annual increase in average hourly earnings to 2.7% from 2.6% in April. All of the above three indicators beat forecasts and this gives room for the FOMC to hike a further two times this year.
In the private sector, the US economy is experiencing more difficulty in attaining new employees in an era of record number of open positions. It seems that the labor market tightness and an unemployment rate that is considerably low is part of the story. Moreover, the below trend numbers for the past two months may have been impacted by worries of trade wars with America’s trade partners and a shortage of qualified workers. In details, the private segment added 178K jobs in May, below the expected forecast of 190K and the number for April was revised downward from 204K to just 163K.
As for the US dollar, the buck began its weekly session on a strong footing and appreciated to the highest level since November 2017. The Dollar received support from risk aversion and a weaker EUR/USD. However, the greenback’s upward momentum failed to uphold as the Italian crisis faded out of the picture and the euro recovered due to positive economic data. At the last trading day of the week, the USD dollar index gained ground after the strong labor report data. The DXY closed slightly higher by 0.22% over the past week.
The second preliminary estimate of Q1 2018 GDP was slightly revised lower by 0.1% to 2.2%. The latest growth figure is substantially lower than the final three months of 2017, when the economy expanded at a 2.9% annual pace. The two main factors for the moderate downward reassessment were a sharp slowdown in consumer spending from 4% in Q4 2017 to 1% in Q1 2018 and the value of newly added inventories was slashed to $20.2 billion from an original $33.1 billion. Moreover, exports increased slower at 4.2% vs the first estimate of 4.8%, while imports remained unchanged.
Nevertheless, the outlook for the US economy remains resilient, when other economies like the EU, UK and to some extent China are experiencing a slowdown in economic momentum. The broader indicators suggest the US economy remains on a firm footing so far in 2018, and the recent figures haven’t negatively altered the FED’s monetary strategy of increasing interest rates and slowly shrinking the money supply in the economy. Several economists still anticipate that the $1.5 trillion income tax cut package, which came into effect in January, will spur faster economic growth this year and lift annual GDP growth close to the Trump administration’s 3% target.
The Federal Reserve’s preferred measure on price growth rose 0.2% on a monthly basis in April. In annual terms, the core personal consumption expenditures index, rose 1.8%, holding steady from a downwardly revised 1.8% in March (previously 1.9%), according to the US Department of Commerce.
As for the headline PCE, the index also remained unchanged at 2% on an annual basis. Overall, inflation in the US has been improving on several fronts from CPI to wages and on the PCE index too. This indicates inflation momentum is not one off, is also becoming more consistent and broadbased. The probability of an interest rate hike from the FED on June the 13th currently stands around 85%. Treasury yields ticked higher after the data reached the market. The yield on the two-year Treasury regarded as most sensitive to Fed policy expectations, was up 1.2 basis points to 2.4234%.
US consumer sentiment recovered in May after a modest decline in the previous figure. The confidence level came in as expected at 128 from 125.6 recorded in April. Looking at the inner components, consumers’ valuation of current conditions increased to a 17year high, while their prospects for future conditions rose less robustly. May’s robust data is correlated to a healthy labor market and higher aftertax paychecks.