US Dollar's "Safe Haven" Status at Risk from "Trade War" say ING

-White House's Harley Davidson comments bode ill for global markets.

-Current account deficit means USD "safe haven" status now at risk.

-Dollar exposed to risk of Fed disappointment if tariff spat escalates.

© Robert Cicchetti, Adobe Stock

The US Dollar is at risk of losing its coveted status as a "safe haven" currency if tensions with China and the European Union boil over into a full blown "trade war", according to strategists at ING Group, who are arguing the greenback will increasingly lose ground to current account surplus currencies like the Euro and Japanese Yen.

Investors could also begin to question whether or not the Federal Reserve will be able to push ahead with three interest rate rises that markets now expect to be delivered over the next 12 months if an escalation of tit-for-tat tariffs leads to a deterioration of the US economic outlook. This would almost certainly be bad for the US Dollar, according to the ING team.

"The President’s dismissal of Harley-Davidson’s decision isn’t indicative of an administration that is overly concerned about the potential backlash from their nationalist policy agenda. Nor does it suggest that anyone (person or business) will be able to stop the White House on its current trade warpath," says Viraj Patel, an FX strategist at ING Group. "If that’s the case, then the landscape for FX markets looks set to remain murky this summer."

Patel and the ING team's call comes right after the European Union imposed tariffs on imports of Harley Davidson motorcycles into the EU in retaliation for earlier US levies against European steel and aluminium, prompting Harley Davidson to shift some of its international production into Europe and drawing an angry response from President Donald Trump.

The US is currently locked in a tit-for-tat tariff fight with China, the world's second largest economy, over alleged unfair trading practices, which has stoked fears of a so called trade war. The White House has also signalled repeatedly that it will soon lock horns with the EU, citing a large bilateral trade deficit and imbalance between tariffs charged in both directions as particular gripes with the bloc.

"It seems a little baffling to us to see consensus US GDP growth expectations for 2018 continuing to nudge higher (currently 2.90%) – despite an unprecedented degree of uncertainty over the global trading system. If the Harley Davidson anecdote is anything to go by, the US economic outlook is not immune to any trade war escalation – and small retaliatory tariffs from a large number of major trading partners will most likely surmount to something noticeable," Patel writes, in a note to clients Monday.

The so called trade war has escalated quickly, morphing from a series of simple tariffs affecting US metals imports worth less than $50 billion in total per year to something that is threatening to embroil more than $250 billion of annual US-China trade. It is also threatening the European automotive industry that generates more than half a trillion Euros of revenue and supports hundreds of thousands of jobs in Europe and elsewhere including in the US.

"In that case, it’s also difficult to see the Fed pressing ahead with another two hikes this year – and three next. At this stage, the 70-80bps of Fed tightening priced into markets over the next year looks more like a headwind for the Dollar, says Patel.

Fears are that President Trump will soon impose a 25% tariff on cars imported into the US, which could hit European companies and the North American Free Trade Agreement countries hard while drawing a more significant response from the EU.

This combined with a series of retaliatory measures from other countries impacted by some of the new tariffs, such as Canada and Mexico, would be a watershed moment that prompts currency traders to reconsider their assumptions about growth and interest rates.

"The USD’s role as a safe-haven currency should not be overstated given its large negative net international investment position. Although one should expect the $ to exhibit its typical safe-haven characteristics against risky emerging market currencies in any global trade war – as the evidence has clearly shown over the past few months – the same cannot be said for how the USD fares versus current account surplus currencies like the EUR and JPY," Patel writes.

Patel and the ING team say the Euro could even begin to exhibit safe-haven qualities over coming months, particularly if there is a sustained bout of risk aversion that sees global stock markets turn lower and volatility in currency markets pick back up, given large flows of export trade with the rest of the world can will offer natural support to the single currency.

Current account surpluses in Europe and Japan also mean both are less dependent on attracting investors from international markets for funding than the US and some other countries are. America is increasingly reliant on inflows of capital from overseas in order to compensate for a government fiscal programme that is expected to see the US budget deficit rise by as much as $1.5 trillion over the next 10 years.

"The bottom line is that being long USD isn’t necessarily a winning trade in any global trade war. In fact, taking the contrarian bet has proved to be the outperforming tact in 2018 so far. With the consensus seemingly favouring the US dollar (and the latest CFTC positioning data showing markets now net long USD across major currencies), it may well be time to ditch the dollar. Certainly the case for unfettered USD upside is not a guarantee," Patel says.

The US Dollar index was quoted 0.26% higher at 94.53 Tuesday and is up by 2.4% for the 2018 year to date. The Euro-to-Dollar rate was 0.32% lower at 1.1664 and has fallen 2.7% in 2018, while the Pound-to-Dollar rate was 0.37% lower at 1.3228 and has dropped 1.98% this year.

The greenback's current levels against its major rivals come after the currency about-turned in April, beginning a corrective rally that saw the Dollar index convert an earlier 4% loss into a 2.4% gain for 2018. This was the result of economic growth gathering pace in the US at a time when momentum in other parts of the world was beginning to wane.

 

 

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