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Trump's Trade Wars: Fighting On 3 Fronts Cannot Keep Markets Calm For Too Long And It Could Turn Ugly

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This article originally appeared on FXStreet.

  • The Trump Administration is fighting trade wars on three fronts.
  • Stock markets continue rising, and currency movements move into risk.
  • The atmosphere may change quickly, and it may turn ugly.

Things seemed to calm down on the trade front when US Secretary of the Treasury Steven Mnuchin said that China and the US decided to put trade wars on hold as negotiations between the world's economic superpowers were going on.

But things went downhill from there, and it happened on three fronts. Egged on by anti-trade advisers and the right-wing media, Trump when all-in on trade.

1) Trans-Pacific trade war with China

While negotiations continue in the background, the US is thinking out loud about imposing tariffs on tech products coming out of China, which is now seen as a competitor not only in low-tech but also in high-tech. The details are still in works.

The move comes in addition to the steel and aluminum tariffs that the US had already imposed on China and the retaliatory Chinese tariffs. Another retaliation is on the cards.

2) Trans-Atlantic trade war with the EU

The European Union, which still includes the UK, initially received an exemption on steel and aluminum tariffs and trans-Atlantic negotiations continued. Diplomacy ended on May 31st when the US lifted the exception, implementing duties on its closest allies. 

The European Union vowed to respond in early July with countermeasures aimed at politically sensitive constituencies in the American heartland. 

Moreover, the Administration is also considering slapping tariffs on imports of automobiles or automobile parts. This is due to a grievance related to European tariffs on cars.

3) Inter North American trade war with Canada and Mexico

The metals and vehicle issues are also seen in America's negotiations with its two neighbors: Canada and Mexico. Defining North American content in the production of cars is a key sticking point in the talks. Similar to the EU, the US hit its NAFTA partners with steel and aluminum tariffs on May 31st. 

Yet contrary to the slow-motion response of the EU, Canadian Prime Minister Justin Trudeau reacted angrily by denouncing the usage of security concerns to the tariffs. Mexico went one step further by slapping tariffs on American pork and other imports. 

Another deterioration on NAFTA happened when the Top Economic Adviser at the White House Larry Kudlow said that Trump is seriously considering reaching separate bilateral agreements with the North American partners. The move was rejected by both countries but the outgoing Mexican government is pressured by the clock: Mexicans go to the polls on July 1st to elect a new President. The leading candidate Andrés Manuel López Obrador is not very keen on warm relations with the US and the current President Enrique Peña Nieto may be inclined to clinch whatever deal he can grab. 

Why are markets sanguine?

Making trade more expensive lowers the overall amount of trade. This, in turn, slows down global economic growth. In such scenarios we usually see stocks fall, bonds rise, and safe-haven currencies such as the Japanese Yen gain ground.

This is not happening. At least not yet.

Markets did react to some of the news described above. We have seen the Canadian and Mexican currencies suffer from time to time and relevant stocks were hit. 

However, the NASDAQ set new record highs while other stock markets are looking good as well. US bonds are sold off (with yields rising). And in currency markets, it is risk on. There can be explanations for only some of the single moves, but not the full picture.

The Euro is gaining on the calm in Italy and a few OK euro-zone figures. The Pound enjoys a few upbeat economic numbers but ignores Brexit concerns. The Australian Dollar rises on good GDP data.

Upward moves in the Euro, Pound, and A$ go hand in hand with the rise in stocks and also with a sell-off of the safe-haven Japanese yen, which is precisely what is happening. There are no other immediate reasons to see the Japanese currency sliding.

So, it is risk-on instead of risk-off, which is the normal reaction to fears of a global slowdown related to trade.

Are markets assuming that Trump will eventually back down? Is fighting a trade war on three fronts just a move intended to boost his approval with his base ahead of the November mid-term elections? 

External politics are often driven by internal ones. Nevertheless, as time passes by and the policy remains confrontational, there is a growing risk to global growth. The mere threats already cause second thoughts on investments. Fears can become a self-fulfilling prophecy that hurts the world economy even if no tariffs are imposed. And they are already imposed. 

At some point, markets may wake up with a cold sweat and realize that these trade wars take their tolls. It could then turn ugly.

What happens if this realization occurs? Stocks may turn south, bonds turn north, and in forex, the Yen may return to a top position, followed by the Swiss franc and then the US Dollar. What about the rest? The Euro, Pound, Australian Dollar, and especially the Canadian Dollar, may drop sharply.

Posted-In: FXStreetNews Forex Treasuries Markets

 

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