Currencies Dumped As Trump Takes On China

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

Currencies and equities extended their losses Thursday as the U.S. prepares to take on China in what could spiral into a very dangerous trade war. The U.S. announced $50 billion worth of tariffs on Chinese imports aimed at penalizing the Asian giant for intellectual property theft. It also wants to limit Chinese acquisitions in the U.S. The spokesperson for China’s Ministry of Foreign Affairs said Wednesday, “The Chinese side never wants to fight a trade war with anybody, but if we are forced to, we will not hide from it.” Adding that China would “definitely take firm and necessary countermeasures.” On Thursday, China’s ambassador confirmed that it “will hit back at U.S. tariffs.” The fears of a trade war are legitimate and have overshadowed central-bank policy, causing weakness for almost every major currency pair. John Dowd, Trump’s top lawyer for the special-counsel investigation also resigned on Thursday after the president’s complete disregard for his legal advice. The president’s actions have cost him the confidence of foreign and domestic investors who expressed their frustration by bailing out of U.S. stocks and risk assets. The sell-off in USD/JPY has been slow because of demand near 105 but the yen crosses have taken the brunt of the selling.

The Bank of England’s monetary policy announcement was supposed to be the day’s most market-moving event risk and while sterling experienced significant volatility, risk appetite had a larger impact on the currency. The Bank England voted 7-2 to keep interest rates unchanged with the 2 dissenters (Saunders and McCafferty) voting for an immediate rate hike. Sterling jumped above 1.4220 on the back of the announcement but instead of extending its gains, it u-turned in a move that eventually took it below 1.41. Part of the reversal can be attributed to the lack of major changes in the monetary-policy statement – the BoE wants limited, gradual hikes as inflation and growth remain in line with February forecasts. They also felt that protectionism and Brexit remain serious risks for the U.K. economy. They expect to make a fuller reassessment in May, which means they may or may not be raising interest rates at that time. Before Thursday’s rate decision, the market was pricing in a 66% chance of a hike at the next meeting – those odds have now increased to 72%. Nonetheless, the BoE’s concerns and risk aversion led to profit taking on long pound positions. While a further correction is likely, buyers could swoop in between 1.3950 and 1.40 as the BoE should be the next major central bank to raise interest rates. U.K. retail sales was also strong, reinforcing the underlying health of the economy.

EUR/USD on the other hand continued to consolidate. The latest economic reports confirmed that economic activity slowed in March. Both Germany and France reported lower manufacturing and service sector PMI readings that led to weakness in the Eurozone composite PMI index. Although the German IFO business climate index beat expectations, both the current and expectations component of the report fell from the previous month. These softer economic reports and the ECB’s caution could keep the euro on its back foot.

The Australian dollar was hit the hardest by risk aversion but having fallen over 1% intraday, it ended the NY trading session well off its lows. Not only is Australia particularly vulnerable to trouble for China but Wednesday night’s Australian employment report also fell short of expectations. Although full-time job growth was very strong, the unemployment rate rose to 5.6% from 5.5% and the overall employment change came in at 17.5K against expectations for 20K rise. These numbers aren’t terrible since part of the increase in the unemployment rate can be attributed to a higher participation rate. Full-time work also saw the largest one-month rise in nearly a year. However, concerns about China-U.S. trade tensions weighed on the currency throughout the European and U.S. session. AUD/USD could slip down to 76 before any support is found.

Meanwhile, the Canadian and New Zealand dollars ended the day virtually unchanged. USD/CAD, which had fallen to 1.2830 during the European session, rallied on the back of lower oil prices and risk aversion. Whether it continues to move higher from here hinges on Friday’s economic reports. Canada’s inflation and retail sales reports are scheduled for release on Friday, putting the loonie in focus. If they beat, USD/CAD will resume its slide but if they fall short of expectations, the pair could find its way back toward 1.30. The New Zealand dollar on the other hand found support from a relatively benign RBNZ statement and AUD/NZD selling. NZD/USD itself appears vulnerable to a deeper correction toward .7150.