Trade battles are developing into currency wars

People tend to blame someone else if something goes wrong. Donald Trump is, first of all, a human, and nothing human is foreign to him. The US president’s criticism of the Fed, China and the EU is an echo of weakness. The US president is disappointed that the increase of the federal funds rate results in US dollar strengthening, and expresses his hope that the central bank would suspend the monetary normalization. President Donald Trump charges China with manipulating the exchange rates and threatens with $500-bn import tariffs. US trade war with China develops into the currency war, though the US Treasury Secretary Steven Mnuchin denies it flatly.

The key growth drivers for the US dollar in April-June were the divergence in the economic expansion and monetary policies. The first can’t be affected by Donald Trump, but he can make the Fed pause. It is clear that the central bank must hike the interest rate to avoid the US economy’s overheating and uncontrollable inflation rate; however, I, personally, won’t be surprised if the media start to draw an analogy to August, 2015. At that time, the Fed had to move monetary normalization from September till December due to the turmoil in China’s financial markets. At present, Shanghai Composite is trading down, and yuan is going to drop to its yearly lows. The situation is worsened by the fact that for the last twenty years the volatility in the US equity market is the most likely to increase in August than in any other month.

Seasonality of VIX volatility index

Source: Bloomberg

Investors are seriously concerned about a possible slowdown in the Fed’s monetary normalization and prefer to take the profits for EUR/USD shorts, which results in euro growth above the base of figure 17. Even if Steve Mnuchin dines the factor of currency wars, the market believes the US administration to be interested in dollar devaluation. The Treasury Secretary said the yuan weakening creates unfair competitive advantage for China. It is nothing else but a verbal intervention, isn’t it?

According to IMF, 10-percent decline in the real effective exchange rate result an increase in net export by about 1.5% of GDP on average. Even if yuan drop is caused by economic factors and its rate, according to Bloomberg, is still overvalued by 6.6%, the fact that PBOC doesn’t interfere annoys the US administration.

Does it suggest that the way up for EUR/USD bulls is open? I have strong doubts. First, the ECB has clearly indicated its commitment to the ultra-easy monetary policy through at least September, 2019. Until the core inflation isn’t rising steadily and the Euro-area economy isn’t improving, they won’t end QE. Second, the spread between US and German bond yields is till at its widest level since the 1990s, which opens the way for the capital flow from Europe to the USA. And, finally, the rumors about ItalianEconomy Minister Giovanni Tria resignation increase political risks. These factors prove that EUR/USD will further consolidate in the range of 1.15-1.2. 

 

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Real-time price chart of EURUSD

Dollar is Scared by Currency Wars

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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