Everything seemed to be going right. Economic growth was well underway and the US stock market had hit new highs, even oil had rebounded from its lows in recent years. Inevitably, also geopolitical tensions to which a new element was eventually added: American protectionism. Below we analyze the good, the bad and the ugly of protectionism and its consequences in terms of currencies.
THE GOOD
Although exempted from aluminum and steel tariffs, the Canadian dollar is the worst performing G-10 currency year-to-date due to fears over the renegotiation of NAFTA agreements, even as oil prices are holding well above the breakeven price Canada. Given that a good 20% of Canada's GDP comes from exports to the US, it is no surprise that bearish sentiment on Canada drove USD/CAD higher to 1.3130 (a ten-month high). However, the road is not all downhill.
Canada has extended its trade agreements with theXNUMX-XNUMX business days under the EU-Canada Comprehensive Economic and Trade Agreement (CETA 2017). Given that the Canadian central bank is likely to make two rate hikes in 2018, relying on a stable macroeconomic environment, the Canadian dollar could soon recover as trade concerns have already been embedded in the price. At best, the storm of US protectionism could ease and disappear over time.
THE UGLY
The new tariffs should help companies operating in the steel and aluminum sector in the short term, but in the medium term they could negatively impact the levels of the US dollar. China, the European Union and Japan account for two-thirds of the entire US trade deficit, and retaliatory measures don't seem that far off. Although a scenario in which history repeats itself is by no means imminent (think of the Smoot-Hawley Act of 1930 which led to a 60% reduction in global trade), a negative fallout from the raising of trade barriers could translate into bearish sentiment on the US dollar and discourage international investors from funding the already inflated US debt.
With the China which holds the largest share of US debt (1,25 trillion dollars), they could implement a retaliatory policy by allowing the yuan to depreciate further against the dollar, further increasing trade tensions (remember the accusation made by Trump to China to manipulate its currency in 2017). We are all waiting to hear what US Section 301 investigations will reveal in the coming months about Chinese policies and practices and how they affect US trade. In any case, it was fair to expect some retaliation from China, as it did.
THE BAD
The hypothesis of the most catastrophic scenario, ie that of a real trade war, seems highly unlikely, even if there are some points to consider. A global disaffection with risk could lead investors to safer financial assets: Yen, Swiss franc and gold, so far nothing new. The trade war could also translate into a currency war, with central banks engaging in a “race to the bottom” (in order to boost exports through currency devaluation). Companies with complex supply chains could then see margins shrinking and be subject to increased volatility and profit-taking on the equity markets – a situation that could favor the USD in the long run. In this case, the waltz into risk-free financial assets could make a comeback, with gold trumping all other alternatives.
