US President Donald Trump’s trade war rhetoric was the likely trigger for the declines but the roots as usual go deeper than at first sight. Adversity in the form of global financial crisis 2008 got the world’s major central banks (Federal Reserve of US, European Central Bank and Bank of Japan) together with massive monetary stimulus to support global growth. At one point we had about $20 trillion invested in assets with negative yields. Prosperity might not be here yet, but having apparently averted the worst, the paths of the major central banks started diverging in 2013 when Federal Reserve started preparing markets for the eventual withdrawal of the monetary stimulus. And it started raising interest rates in late 2015. Meanwhile ECB and BoJ have continued with their injections of monetary heroin into the financial system.
This had the effect of driving up US dollar with the Dollar Index (DXY) rising from around 80 in 2013 to 95 today. Cheaper currencies made other countries more competitive in the global trade and the party kept grooving on till recently when Donald Trump started blowing the trumpet to announce the close of the party. Unable to really take away the punch bowl from the hands of ECB and BoJ and not yet wanting to directly influence the Fed to slowdown its monetary tightening, he used trade tariffs to seemingly stop the abuse of US in global trade and level the playing field.
China, which was the primary target of these trade tariffs responded by devaluing its currency sharply. If one country imposes tariff of 10% and the other country responds by devaluing its currency by 10%, the net effect of tariffs is effectively neutralised. And this is exactly what has happened. However, other emerging markets being at a different stage of economic development and more susceptible to macro-economic volatility, got caught in the crossfire as well.
I also believe that Trump’s announcement that on his request Saudi Arabia agreed to boost crude oil supply by 200,000 barrels per day if needed was also part of the multi-pronged attack towards leveling the playing field. A falling crude oil prices would lower the inflation expectations which can be used to get Fed to slowdown on its rate hike trajectory.
Further on Friday (July 20, 2018) I felt the tide turn. Trump directly attacked Fed by targeting its monetary tightening path. Is this the first time that a president has voiced his unhappiness with his central bank? No. So should we ignore it entirely? No. Also on the same day BoJ announced a review of its monetary policy, first since 2016. May be just co-incidental or might just be part of Donald Trump’s multi-pronged attack considering Japan is one of US’ closest allies in matters both economic and geo-political. Next I expect either ECB to sound more hawkish or Fed to be more dovish than expected.
I believe the tide has started turning and the next big move in the US Dollar index is on the downside. From here till either ECB starts sounding hawkish or Fed dovish, it might just be the best time in 2018 to initiate/increase exposure to assets like emerging markets and base metals.
