Bank of America Corp. sees the Japanese yen strengthening as investors flee risky assets, and has recommended an associated euro-yen trade. Goldman Sachs Group Inc. warns that currencies from the euro to South Africa’s rand and Chile’s peso could be in the firing line. And Westpac Banking Corp. sees bonds as a safe bet.
“It’s probably one of the most underappreciated things in this market — this FX question” about the impact of trade tensions, said Thomas Costerg, an economist at Pictet Wealth Management in Geneva.
…“Taiwan and South Korea have the most to lose if things intensify,” said Richard Franulovich, Westpac’s head of FX strategy in New York. The won and Chinese yuan, along with the Taiwan, Australian and Canadian dollars, “are all exposed,” and the euro “would fall pretty dramatically,” he said. For downside protection, he advised shorting these currencies or owning the bonds in their markets.
This is right. European exports will get hammered as the Chinese supply chain emigrates and it struggles to revive domestic demand. China will also have to cut interest rates and sink the yuan. In turn making the trade war worse. It would also intensify its efforts to prevent CNY from falling too far, meaning more pain for those on the end of Chinese capital outflows like tourism and students.
At the same time, higher tariffs lift US inflation and the USD.
This is a real nightmare for emerging markets (EM), similar to the meltdown of 2015, when EM’s were pincered as competitiveness was crushed by a falling CNY, and capital outflows repatriated to the rising USD.
Commodity prices are road kill in this scenario. As are commodity currencies like the Australian dollar.
It would run until the Federal Reserve was forced to cut aggressively into an end-of-cycle shock.
David Llewellyn-Smith is Chief Strategist at the Macrobusiness Fund and MacroBusines Super, which is long international stocks to benefit from a falling AUD, so he definitely talking his book.