Traders unshaken by equity volatility

5 April, 2018

“We are not in a trade war with China, that war was lost many years ago by the foolish, or incompetent, people who represented the U.S. Now we have a Trade Deficit of $500 Billion a year, with Intellectual Property Theft of another $300 Billion. We cannot let this continue!” Donald Trump

It was an ugly start to the U.S. trading session on Wednesday. The Dow Jones dropped 379 points lower at the open, and losses reached 510 points in the first minute of trading, after China threatened to impose tariffs of 25% on $50 billion of U.S. goods in response to Trump’s proposed tariffs on China. Larry Kudlow, the new National Economic Council Director, told investors to not “overreact”; he indicated that tariffs could be a negotiating tactic that might not be implemented after all. Kudlow seemed to have convinced investors, that what’s going on is a war of words and not a serious threat of trade war. At the end of the U.S. trading session the Dow Jones, S&P 500 and Nasdaq were up 0.96%, 1.16% and 1.45% respectively.

I still believe that the world’s two largest economies will find a middle ground. Although China may feel more pain if tariffs are to be applied, Trump’s political base will be severely damaged if Beijing imposed 25% tariffs on soybeans. Farmers gave Trump their votes, and he cannot pay them back by hitting their biggest importer.

Foreign exchange traders seem to be the wise guys. Despite all the tension and volatility in equities, currencies remain in a state of calm. The dollar index has been trading in a range of 89.82-90.27 for the past six days. Currency traders are focusing more on the macro picture and so far, there doesn’t seem to be any significant shifts in inflation trends, growth, jobs, and thus monetary policy. It looks like currencies are fairly priced at the moment.

If I am proved wrong, and trade tensions escalated further, the Japanese Yen will be my best bet. The safe haven currency has the potential to move 5-10% higher from current levels, if the U.S. and China delivered on the recent tariffs proposals.

Friday’s U.S. non-farms payrolls report would likely steal the spotlight from the trade tensions. Private companies added 241,000 jobs in March - 36,000 above average estimate. Meanwhile, the employment components of the ISM Manufacturing Index and service indices have also shown a slight improvement. These leading indicators assume the NFP report will likely surprise to the upside. However, for the U.S. dollar to see a significant move to the upside, wages should grow by 2.8% or more, which will lead to a repricing of interest rates hikes for 2018.

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