Trump’s Tariff Talks Wobble Forex Market, Close Neighbors Suffer Most

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Marc Chandler
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Overview: As some market pundits were debating about a possible grand deal between the US and China. In exchange for a lighter tariff regime, Beijing would accept yuan appreciation. As far-fetched as such scenario may be, it was predicated on ideas that people like the Bessent, the Treasury Secretary-nominee, was pragmatic. Trump's comments hit in early Asia Pacific turnover specifically cited a 25% tariff on all product from Canada and Mexico and 10% more on China starting on January 20. Even currencies not explicitly cited, suffered but have mostly recovered. Among the G10 currencies, only the Australian dollar, Norwegian krone, and Canadian dollar are lower. The former two are off 0.20%-0.25%, while the Canadian dollar is about 0.75% lower. Emerging market currencies are mostly weaker, except a few central European currencies and the South Korea won. The Mexican peso is off a little more than 1%. 

Equities are under pressure. In Asia Pacific, all the large markets but Hong Kong fell. Europe's Stoxx 600 is snapping a three-day rally and is off more than 0.5%. US index futures have recouped most of the earlier declines and are nursing minor losses now. Asia Pacific bonds played catch-up after the strong rally in the US yesterday. However, European yields are edging higher, and the 10-year US Treasury yields is a couple of basis points higher to almost 4.30%. Gold extended yesterday's dramatic 3.35% drop and neared $2605 today before recovering through $2630. January WTI also extended yesterday's drop marginally to almost $68.55. It is a little more than a dollar higher in the Europe. 

Asia Pacific

The 2.9% year-over-year rise in Japan's producer service prices in October shed little light on the two key considerations for the exchange rate. First, the US 10-year premium over Japan reached a five-month high near 345 bp a day after the US election. It has trended lower, and yesterday fell below 330 bp for the first time this month. The rolling 30-day correlation between the changes in the exchange rate and changes in the US 10-year yields remains slightly more robust that the correlation with changes in the 10-year interest rate differential. Second, between the weakness of the yen, and recent comments by BOJ Governor Ueda, the market is warming to the idea of a rate hike next month. The swaps market has 15 bp discounted. At the end of October, less than nine basis points were discounted. By the middle of next year, the swaps market has 40 bp of tightening discounted. The focus shifts to the Antipodeans tomorrow. The Reserve Bank of New Zealand is widely expected to deliver its second consecutive half-point cut, which will bring the cash rate target to 4.25%. For its part, Australia reports October CPI. The four-month decline that saw the monthly measure tumble from 4.0% to 2.1% likely ended with a small rise to 2.3%. The RBNZ is among the most dovish G10 central banks while the RBA is among the most hawkish. Since mid-year, the New Zealand dollar is the weakest G10 currency, dropping by nearly 4%. The Australia dollar is off about 2.3%.

The dollar dipped below the 20-day moving average (~JPY153.95) yesterday but recovered to slightly above JPY154.70 before the end of the local session. It consolidated within that range in Europe and North America. A 10-bp pullback in the US 10-year yield seemed exaggerated. The yen has been largely sidelined from the Trump's tariff talk and dramatic foreign exchange action. It is trading inside yesterday's range that saw the dollar confined to about JPY153.55 to JPY154.40. The Australian dollar traded to a nine-session high near $0.6550 in the euphoric response to the US Treasury appointment and traded briefly above the 20-day moving average (~$0.6545). But that was it. Sellers took the whip hand and sent the Aussie to new session low near $0.6490 before the end of the European session. It dropped to $0.6435 earlier today amid the initial reaction to Trump's tariff threat, its lowest level since the early August low (~$0.6350). The Aussie recovered to about $0.6500 before consolidating, during which time it found support near $0.6475. The dollar remained soft against the yuan, but activity was choppy yesterday. The session high in late Asia Pacific turnover was near CNH7.2580, and the low was recorded in North America around CNH7.2360. Trump's comments threatening to add 10% more to all Chinese tariffs saw the dollar rise toward CNH7.2725, a new four-month high. Ironically, it follows on the heels of speculation of some broad deal that exchanges a stronger yuan for a less robust tariff regime. The PBOC continues to lean against market forces and keeps the dollar's reference rate weaker than the market suggests. In doing so, officials are limited the pace of the dollar's appreciation. Claims of "manipulation" are louder when officials push the yuan lower rather than higher. The PBOC set the dollar's reference rate at CNY7.1910 (CNY7.1918 yesterday). The average in Bloomberg's survey was CNY7.2394. 

Europe

The eurozone has gone from the proverbial frying pan into the fire. It was barely over the Covid shock when it shocked by Russia's second invasion of Ukraine. The re-structuring of global auto industry and the transition to EV dominated by China posed a separate shock. Now the return of Trump as the US president and the tariff threat are unsettling. And if that were not enough, the German government has collapsed, and we are waiting for the last rites (confidence vote) to set the stage for a national election and new government. France has its election, but the polarized outcome means the government will likely be short-lived. In fact, Prime Minister Barnier's efforts to pass next year's budget may prove too tall of an order. The German 10-year premium over France is pushing past 80 bp to flirt with its extreme since 2012. 

The euro was squeezed up to $1.0530 in North American turnover yesterday. It had bottomed after the dismal flash PMI reading before the weekend near $1.0335. The short-squeeze met the (38.2%) retracement target of the euro's sell-off since the November 7 FOMC meeting slightly above $1.0520. However, the momentum stalled, and the euro retreated to around $1.0465. In the initial reaction to Trump's tariff talk the euro was sold to $1.0425, though no EMU member was cited. It recovered and reached $1.0520 in the Europe today. There are 1.7 bln euros in options at $1.05 that expire today and another 2.4 bln options that expire at $1.05 tomorrow. The market appears to be working through the orders. The $1.0565-80 may offer the next area of resistance. A higher EMU CPI print at the end of the week may see the swaps market continue to pare the chances of a 50 bp ECB rate cut next month. Sterling traded miserably. It made a marginal new session high in North America, slightly shy of $1.2615 but was beaten back to a new session low near $1.2540. Amid the market reaction to Trump's tariffs, sterling was slod to almost $1.2505. Like the euro, it has recovered and is now higher on the day, trading near $1.2585 in late European morning turnover. There are about GBP410 mln options at $1.26 that expire tomorrow. While the euro fell to new two-year lows last week, sterling did not. This year's low, set in April, was near $1.2300.

America

There is a flurry of US data today, but most of it is not market moving. Investors and businesses continue to consider the likely policies of the new US administration and the implications for Fed policy. Yesterday, we pushed back against ideas that nomination of a mainstream Treasury Secretary that would have fit in well into nearly any traditional Republican administration was a game changer. We suggest that it was not clear power would be delegated to the cabinet posts as opposed to be largely retained in the White House. Trump, it seems clear, will not be overshadowed by billionaire advisers or cabinet appointments. He calls the shots. Meanwhile, neither the house price data, new home sale, Conference Board's consumer confidence surge nor the regional Fed surveys pose more than headline rise. The FOMC minutes late in the session may give the markets a better sense of where Fed officials saw the bar to the December rate increase a couple of days after the election. When Trump was first elected, the Federal Reserve, including at the time Governor Powell anticipated a more accommodative fiscal policy and wanted monetary policy to be adjusted accordingly. Now, Chair Powell plays down the need to "guess," "speculate," or "assume" about the new administration's policies. Is that widely accepted? Recall too that the Federal Reserve began cutting rates in July 2019, a little more than a year-and-a-half after the tax cuts.

The US dollar fell to a marginal new nine-day low against the Canadian dollar (a little below 1.3930) yesterday, ostensibly in response to the naming of an uncontroversial Treasury Secretary. However, the greenback trended mostly higher in the North American session and resurfaced above CAD1.40 near midday. Trump's comments specifically cited a tariff on US imports from Canada and this set the greenback to nearly CAD1.4180, a new four-and-a-half-year-high. Since the high was recorded earlier in the Asia Pacific session, the greenback has eased and is trading a little below CAD1.41. The intraday momentum indicators are consistent with a further pullback. Support may be in the CAD1.4025-50 area. All but a handful of emerging market currencies appreciated yesterday. The top six were evenly divided between central Europe and Latam. The Chilean peso bested the Mexican peso to be the strongest from the region (~0.85% vs. 0.80%). The US dollar settled at a three-day low against the Mexican peso near MXN20.25, finding support ahead of the 20-day moving average (~MXN20.2380). Trump's tariff threat set the US dollar to MXN20.75, holding below the post-US election high (~MXN20.8070). Meanwhile, for the third consecutive session, the greenback settled above BRL5.80. A four-and-a-half-year high was set early August by BRL5.8550 could be tested.