Escalation of the US trade battle with China may draw the US dollar higher than the strong US employment data

If investors couldn't figure out how to trade the trade war factor in early 2018, then now, they clearly see how trade tensions affect the USD rate. The experience of the 1990s and the 2000s showed that the import tariffs and trade tensions between the USA and Japan were drawing the USD down. However, nowadays, mush has changed. First, the USA conflicts with China. Second, China’s economy is not the same as it used to be. Since the Asian crisis, its share in global GDP has been up to 155, from 3%; and the share in global economy expansion is about 30%. But the most important is that China is a kind of a driver for emerging economies. If Chinese economy slows down, it can be followed by a slower growth of global GDP and the wider gap with the US indicator. It is the right way to the stronger greenback.

Dynamics and structure of global GDP, imports and equity market

Source: Bloomberg

Therefore, the stronger the US protectionism is the more problems it will face, like unwanted dollar revaluation. It is remarkable that according to the gap between the costs of call and put options (risk reversals), emerging-market currencies have further to fall. Even after their sliding down for 155 days, the longest slump since the global crisis in 2008.

Dynamics of risk reversals for emerging-market currencies

Source: Bloomberg

In my opinion, Donald Trump’s policy strengthens the US dollar more than the increases of the federal funds rate. This factor is mostly included into dollar-pairs prices in Forex, while the fading out fiscal stimulus effect may press the USD down quite deeply. 50 Reuters experts don’t believe in its bullish long-term outlook and expect EURUSD to be at 1.21 in 12 months. I don’t think the forecast includes the factor of trade wars escalation. Investors still believe that the conflict will be settled down due to negotiations.

According to Societe Generale, the US dollar is overvalued and the Fed does nothing to drive it up. At the same time, other currencies perform even worse, so the demand for the USD increases. The Euro was supported by the news from Italy, where the anti-euro leaders announced that they would present the draft budget, according to Italian obligations to the EU. It comforted the financial markets, sending 10-year Treasury yield down to 2.9%, from 3.2%. Nevertheless, Italy alone is not enough to encourage EURUSD bulls, and a decline in German industrial production became another trouble for the euro.

The greenback is rather stable ahead the report on the US employment. Strong statistics will support the idea that the US GDP is to continue growing at the same pace and the Fed is to hike the federal funds rate four times in 2018. It will be the bearish factor for EURUSD, sending it down towards the bottom borders of the range1.15-1.185. On the contrary, weak data on the US employment will get the euro more likely to go up.


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Price chart of EURUSD in real time mode

Dollar: the Farther it Goes, the Messier it Gets

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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