Macro Freestyle: Trade wars, currencies and central banks
The desk believes that the US dollar will remain under pressure due to ongoing trade tensions and shifting central bank policies, as outlined in the recent commentary by Standard Chartered. Per the full note, the interplay between inflation dynamics and global trade flows is critical, particularly as emerging market (EM) central banks adjust their strategies in response to these pressures. The desk highlights that the dollar index may face challenges, especially if inflation data continues to surprise to the upside, which could lead to a more aggressive stance from the Federal Reserve. Current positioning suggests a cautious outlook for the dollar against major currencies, particularly in light of potential shifts in EM FX policies.
What the desk is arguing
The desk argues that the US dollar is likely to weaken amid escalating trade tensions and evolving central bank policies. Per the full note, Standard Chartered's analysis indicates that inflationary pressures could lead to a recalibration of monetary policy, particularly in the US and emerging markets.
Supporting this view, the commentary notes that the dollar index is sensitive to shifts in global trade flows, with the potential for increased volatility as central banks navigate these challenges. For instance, if inflation continues to rise, the Fed may be compelled to adopt a more hawkish stance, impacting dollar dynamics.
Where it sits in our coverage
Our consensus target for the USD is 1.075, with a range of 1.04 to 1.12. Notable firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view aligns closely with jpmorgan, which anticipates a stronger dollar, while diverging from bofa, which holds a more bearish outlook. The desk's call is positioned at the upper end of the consensus range, suggesting a cautious optimism about the dollar's resilience.
How other firms see it
Firms like jpmorgan and citi are aligned with the desk's perspective, anticipating that the dollar will face headwinds due to trade uncertainties and inflationary pressures. Conversely, bofa and deutsche maintain a contrary stance, expecting further dollar weakness as trade tensions escalate.
Key currency pairs to monitor include EUR/USD and USD/JPY, as their trajectories will be influenced by central bank actions and trade developments. The outlook for the Fed's policy adjustments will also play a significant role in shaping these dynamics.
What the calendar says
(omit this section entirely if no upcoming events)
Key takeaways
01The US dollar is expected to weaken amid trade tensions and inflationary pressures.
02Emerging market central banks are adjusting policies in response to global dynamics.
03The Fed's potential hawkish shift could impact dollar dynamics significantly.
04Positioning suggests caution for dollar strength against major currencies.
Market implications
Traders should watch for key inflation data releases, as these could prompt a shift in Fed policy and impact the dollar's trajectory. A break below 1.07 in the dollar index could signal further weakness.
stanchart
Hello, I'm Eric Robertson, Global Head of Research and Chief Strategist at Standard Chartered. And I'm Madhur Jha, Global Economist and Head of Thematic Research also here at Standard Chartered. Welcome to Macro Freestyle, our monthly podcast series where Madhur and I will identify and explore topics that are likely to be most impactful and relevant for financial markets and the global economy.
Hi Eric, super excited to be back on the podcast with you. We are recording this podcast on May the 23rd. And wow, so much has changed since our last podcast that I cannot wait to discuss all the latest developments and the implications of that for financial markets as well as the global economy.
We will broadly be discussing the trade war, currencies and central bank moves. But before we get into that, Eric, I wanted to kick off by focusing on something rather unusual, given the heightened uncertainty, which is the weakness in the US dollar. Is the trade war damaging faith in the US dollar?
Is this a signal of a more structural decline in the US dollar? What do you think? Look, it's an important question because I think the decline in the dollar since the start of the year, which is getting close to about 10 percent, really flies in the face of historical precedent and historical correlations.
Normally, when you have periods of uncertainty, risk aversion, equity, volatility, etc., you get a flight to the dollar, this sort of flight to quality trade. And we've had the opposite this time around. So as you correctly point out, there's some questions around, is there a loss of faith in the US dollar itself?
Is there a loss of faith in US policy transparency? I think there's some truth to that, but I think it's very important not to overstate it. And I say that because if we go back even five months, the dollar was sitting in a position where global investors were significantly overweight.
The US dollar itself, as well as US dollar denominated assets. And that historical overweight has been built up effectively over the last 10 years. I think what we've seen is a catalyst, tariff uncertainty, policy uncertainty, etc., which has sparked people to say, you know what, I don't need that overweight anymore.
I'm going to move back to a more neutral weight. And perhaps there are some alternatives to the dollar which have started to appear, which people are saying, OK, this is an opportunity to diversify. So I'm not a huge advocate of the idea of de-dollarization.
I prefer to call it diversification. And I think we are seeing evidence of that diversification. Sure.
Eric, and actually maybe relate to that. We've had a lot of talk recently of maybe currency being part of the negotiations between the US and its trade partners. Do you see this as a key element of negotiations?
And more importantly, what probability do you attach to a Mar-a-Lago accord on exchange rates? I do think currency will be a part of the discussions. Do I think it's a key part?
No. And again, we go back to the idea that because the market has been so overweight dollars, even the suggestion that currency could be a part of the discussion, I think will prompt people to reduce that overweight dollar position. And by the way, it's not just investors that have been overweight.
Global corporates, global exporters have maintained a large overweight dollar position in terms of their receivables. So I think there's some catalysts going on. But in terms of sort of a more concrete agreement that involves currency moves, I think we have to be careful there because I think different countries will have very different priorities and very different objectives for how much currency strength they're willing to tolerate, how much of a shift in currency flows they're willing to encourage.
Currency movements are a function of a lot of different factors. There's rate differentials, there's the current account, there's the trade account. And I think it would be very difficult to over-engineer a currency move on a multilateral basis.
So I don't see it as being a part of a Mar-a-Lago accord or any of the other types of accords that we've heard discussed. Madhur, one of the things that is increasingly on my mind and I know our clients' minds is since we spoke last, we've seen a dramatic shift in the tariff stance of the U.S., a 90-day pause. It seems like there's been a major softening in the stance towards China.
But I wanted to get your take on do you think the worst is behind us or is this just a temporary calm before another storm? I'm definitely more aligned with you in terms of worrying that maybe people are over-optimistic about how this trade war has evolved. This is only the starting point of negotiations between the U.S. and China.
Nothing has really been agreed. All they have agreed to do is lower tariffs to a more reasonable, if you want to call it that, level. But just for reference, the last time that they had the phase one deal, that negotiation process took 21 months.
And it was very limited agreement. It did not cover thornier issues like industrial policies, technology transfers, non-tariff barriers. All of these issues remain and these things are going to take a long time to negotiate.
So I think that we are in for a very extended period of negotiations and there will be repeated periods of volatility for the markets because markets will not be very sure about how the negotiations are going. I'm also actually looking a little bit more closely at whether this U.S. trade war morphs into a slightly broader trade war with other countries also because recently we've had some news from other countries suggesting that they were also thinking of raising tariffs or raising trade barriers, especially towards China and fearing the influx of cheap imports from China. So I don't think that we're completely in the clear.
I think it's going to be still many bouts of volatility before we get to any sort of a negotiated deal between the U.S. and China. And I guess that leads me to a follow up question. There was an assumption that once tariffs were announced and once they were announced as being much more aggressive than initially expected, that we would see this across the board decline in global trade flows.
Now, the reality is that it's been much more nuanced. And I wondered if you would highlight some of those themes that we've seen in the data over the last couple of weeks to a month. There has been clearly an impact on global trade flows even before the tariffs were announced.
In Q1, we saw a lot of frontloading of exports from various countries into the U.S. The U.S. saw its widest trade deficit on record. And a lot of frontloading happened because people were scared about the possibility of tariffs being imposed.
We don't really have a lot of data for April trade for a number of countries. But what we do know is that trade between the U.S. and China did significantly decline once the tariffs were imposed. But this did not really reduce trade overall for either the U.S. or for China.
China was able to find other partners for its exports. The U.S. has been able to find other partners for its imports. And what we are seeing is that there has been an increase in market share of other countries that are being able to export to the U.S.
India, for example, increased its exports to the U.S. significantly in April. But there's also an increase in transshipments most probably because when you look at data for countries like Vietnam, Cambodia, for April, you see a massive increase in imports from China, but also a significant increase in exports to the U.S. So the U.S. concerns about transshipments is likely to continue.
As you know, Trump recently announced that he's going to send letters to trade partners telling them what are the new tariff levels that they will have to pay over the coming few weeks. Now, my view is that these countries that are viewed by the U.S. as transshipment hubs are more likely to be targeted with slightly higher tariffs. And the other region which is likely to face higher tariffs is the EU.
So there's a real risk that we have another bout of higher reciprocal tariffs for a few countries where the negotiations haven't really proceeded in accordance with what the U.S. would like. And I think this is going to be a source of stress and uncertainty for the markets, as well as the fact that as China continues to find other trade partners, we'll have to see where the flows are going, Latin America, sub-Saharan Africa. There might be greater integration happening over there.
Eric, maybe coming back to the U.S. itself, there was a lot of worry initially that the tariffs would lead to higher inflation in the U.S. But now that you've had the 90-day reprieve for the broad set of countries, as well as for China now, do you still see inflation being a worry for the U.S., or do you think that that has faded? I still do.
I suppose for me it's a two-pronged concern, which is to say that I still have concerns about inflation risks to the upside for the U.S. And I have concerns about disinflation or deflation risks for a number of other economies. And I guess the combination of those two is also concerning because this inflation divergence leads to monetary policy divergence, and that creates both currency and interest rate volatility, which I'll come back to in a second.
But on the U.S. side first, look, it's been very clear from corporate communication and some of the data that we've seen quite a bit of preemptive restocking, especially in response to the 90-day pause. And certainly there is evidence of the stocking of inventories, of people trying to prepare for a more protracted tariff uncertainty. I think that is just delaying the inevitable, right?
As President Trump himself has said and as Treasury Secretary Besant has said, they won't be able to conclude negotiations with everyone in that 90 days. There is going to be some base level of tariffs that I think are still, I don't want to say punitive, but certainly problematic from a cost point of view. And I think the redirecting of supply chains is just going to increase the frictional cost of doing business, and that's going to filter through into the price level.
The other factor, and we haven't talked about this yet on this particular discussion, but is the risk of fiscal stimulus. We believe very strongly that you're going to see some form of fiscal stimulus in the U.S. We all know that it's coming in Europe as well.
I still think there's a high probability of fiscal stimulus coming out of China. And so when the three largest economic blocks in the world are all talking about fiscal stimulus in a world of tariff uncertainty, it makes me concerned that the markets are underestimating the risk of higher inflation, especially for a consuming nation like the U.S. Now, the final point on this, I think it's the opposite in China and in the other emerging economies that China is exporting to.
I think the risk of deflation or disinflation remains very high. Now, that may be good for those end user consumers in those economies. But for the corporations and the competitors of China in other emerging economies, I think this deflation risk is going to present all kinds of challenges.
And as you said earlier, and I agree, the risk of an increase in non-tariff barriers, I think, is material and something that we need to think about in the second half of the year. And just maybe staying on the topic of disinflation for the rest of the world besides the U.S., what do you think should be the response of emerging market central bankers or what do you think they're likely to do? Also, given the fact that the U.S. dollar actually has been weakening and their currencies have been strengthening to some extent.
So you just hit on exactly the right way to think about this development, which is that normally when we have periods of trade uncertainty, economic uncertainty, and as we said earlier, typically the dollar tends to rally in those environments. It puts EM central banks in a very difficult position because they would like to ease monetary policy to support growth, but they don't want to ease too much, if at all, because they worry about the impact on their currency. A weakening currency raises the risk of imported inflation, et cetera, et cetera.
This time around, I think EM central banks have much more flexibility than they were anticipating. We've already seen a few of these central banks ease monetary policy and we expect a number of them to continue to do so, especially in Asia. Their currencies are stronger against the dollar.
You're correct. And I think what we're seeing is that local currency debt in a number of these emerging economies is actually performing very, very well in this environment. And again, that provides these central banks with quite a bit of flexibility.
So I think maybe it's overstating it to call it a silver lining, but one of the new relationships in this particular saga is that EM central banks are playing from perhaps a position of strength in a way that they haven't been able to before. And again, we've seen some monetary easing already and we expect to see more of it going forward. One of the things that we've not really delved too much into, and I think when people talk about tariffs, there's an assumption that we're talking about tariffs on goods.
But this underlying story that I think is raising some concerns for people is this issue of services and how services may be subject to tariffs in different sectors and what that means for some of the different economies. And I know you have done some work on this, and I wondered if you could share some of your thoughts and where you think the real vulnerabilities lie. Thank you so much, Eric.
Actually, yes, I think the announcement by Trump that he would like to impose 100% tariffs on foreign made movies really rattled markets because this was the first time that we were hearing about any potential tariffs on purely digital services. And that was something that really was not expected by markets at all. And it raises the questions on whether the US could then broaden that to other types of services as well.
Now, my own answer would be two part. First of all, I think there is a reason why people don't impose tariffs on services. It's a lot harder to do.
It's not a good that crosses borders. It's a lot harder to impose tariffs. But clearly, non-tariff barriers can be imposed.
And I think what we're likely to see more often than not in the coming months is that non-tariff barriers will be used on the services side rather than tariffs, because it's just a lot easier to do. More importantly, it might not be the US that's really imposing non-tariff barriers because the US has a very large services trade surplus with the rest of the world. It is possible that if negotiations don't go very well, say, between the US and EU, you might see the EU then starting to use non-tariff barriers on services such as digital services a little bit more effectively.
It's not something that would be used immediately. But I think clearly the fact that there has been some discussion about services makes it a little bit more now open for negotiation and makes a little bit more open to the possibility of non-tariff barriers being raised. And I think that is a key risk that we will have to continue to view.
And Eric, coming back to you about the possibility of fiscal stimulus, we've had quite a lot of volatility in the markets recently around worries about fiscal. Are there any other risks that you are keeping your eye on? I suppose there's two, and you just alluded to one of them.
One is very specific and the other is a longer term sort of big picture or structural risk that I worry about. The first is on fiscal. We have started to see some evidence over the last couple of weeks of an increase in long term bond yields, especially in the U.S., Japan, and a few other places.
I've written about this risk a handful of times over the last nine months where I've been worried about a broader shift from monetary stimulus to fiscal and what that means for debt financing, the ability of governments to issue more debt to fund this fiscal stimulus. And what I think the markets, specifically the bond markets, are starting to say is there may be a limit to how much the markets will tolerate this increase in fiscal stimulus and sovereign borrowing. And certainly some of the bond markets are saying that we're fairly close to that limit.
Now, an increase in long term borrowing costs, especially if it's what we would call a bear steepening of the yield curve, raises all kinds of questions for me. Number one, does it start to crowd out the private sector? In other words, does the surge in borrowing costs for sovereigns, whether it's U.S.
Treasury, Japan, Germany, etc., does that make it prohibitively difficult for corporates to tap capital markets? Does it also become a competitive threat to EM sovereigns and corporates who are trying to tap capital markets? So somebody might say, well, generally speaking, global interest rates are still pretty low relative to where they were 10, 15 years ago.
That might be true, but the amount of debt outstanding in the world has also increased dramatically, right? So interest expense or debt to GDP metrics are all significantly worse today than they were 10, 15 years ago. So this issue of fiscal space, I think, is highly, highly relevant to the market and economic outlook for the next six months.
So that's one concern. The second one is more broadly on trade. And there's two scenarios that I think we need to consider.
Number one is if countries start to believe that conducting trade with the U.S. is either prohibitively difficult or, from a cost point of view, prohibitively expensive, the benign response to that is they just redirect their trade to other economies. And we see a big shift in global trade flows. But the overall level of trade volumes stays constant.
Now, that's the benign scenario where we say, OK, maybe the U.S. suffers as a result of that, but you see an increase in trade everywhere else. The more troubling scenario is that because of this environment that we've been talking about, you see a general drop in trade volumes because people either retrench or the overall level of economic activity starts to decline. And for a number of the really open or trade-dependent economies that you and I focus on and our team focuses on, there's some real risks there, right?
I mean, there are certain parts of the world where trade is their lifeblood. And what I would not want to see is a broader or wholesale retrenchment from trade because the cost of doing so has gone too high. So, look, there's no way to establish whether that's happening in the short term.
It's a more medium-term, slow-moving story. But it is one that I really, really worry about because effectively what that would say is that the frictional cost of trade has become too high and it's become unprofitable for both companies and sovereign. So, to me, that's the longer-term risk that we need to think about.
Thank you, Eric. I think there's still so much to flesh out. And I could spend a lot more time discussing this with you, but we are out of time.
Thank you so much, everyone, for listening in to our podcast. And thank you, Madhur. Look, I would say to all of our audience, this is an evolving story.
As we all know, the market narrative changes, feels like every week at the moment. And so, please continue to tune in. Madhur and I will keep trying to help address a number of these questions as they come about.
Thank you for listening to Macro Freestyle, our monthly podcast series on all things macro. Please do join us again for next month's edition. This podcast is provided for informational purposes only.
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