It is almost impossible to cut the US foreign trade deficit in the context of the massive fiscal stimulus.
Don't oppose the Fed. This truth is as old as time; but, to avoid stepping on the central bank’s way, one should clearly understand where exactly it is heading for. What objectives it has at a certain phase of economic development. Currently, the Fed must by any means prevent the economy from overheating and sliding into recession. In this respect, the key issues are inversion of the yield curve and the influence of trade wars on the US GDP. Exactly these matters will be carefully followed by investors during Jerome Powell’s speech on Capitol Hill on July 17-18.
The Fed’s chairman has already clarified his position on trade conflicts a few days ahead his speech before the Congress. If Donald Trump seeks to cancel the tariffs all over the world, it is positive for the US economy. If the tariffs, on the contrary, are more numerous and extended, it will result in nothing good. Free trading is getting the main slogan of the US president’s supporters, as most of them understand that the combination of the tax reform and protectionism won’t settle the matter of the US trade deficit. To reduce it, they need to cut imports, that is make the Americans spend less. And is it possible in the context of the huge fiscal stimulus? However, there is another way: to increase exports. But can they do it, if the opponents are introducing tariffs all the time?
Finally, the current account deficit is not that bad. It can be afforded by even those who live beyond their means and can, at the same time, raise money to fund their huge appetites. The USA also belongs to the exclusive ones. The financial markets believe that trade wars will decline the US GDP far less than the competing economies. As a result, the US stock indexes are rising, and their foreign counterparts are decreasing. First of all it affects China, whose economy, according to Wall Street Journal, is likely to slow down by 0.2 bps -0.5 bps in the next 12 months.
Dynamics of stock indexes
Source: Wall Street Journal
Because of different paces of the GDP growth, investors see the US market as a kind of safe heaven; and as long as it continues, the US dollar will be strong. Does Washington really need it?
In theory, trade wars, due to the import prices rise, will increase the inflation rate and get the Fed to act aggressively. The matter is that, at the same time, the real GDP is going to enter the red zone. It is indicated by the yield curve; and the derivative market doesn’t believe that the monetary normalization will go on in 2020. It is most likely to end in 2019, which limits the USD growth potential.
At the same time EUR/USD bears are stepping back as they fear that Jerome Powell will try to comfort the financial markets, driving the stock indexes up all over the world. So, euro can test the resistance at 1.172 and 1.176
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Real-time price chart of EURUSD
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