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Future trade fears take their toll on US Dollar

Published: Monday 10 September 2018

  • ​​Markets watch US activity closely as trade trauma bites
  • Pound pushing up but remains on a knife edge
  • Guidance for USD buyers and seller
Role reversal?

The US Dollar has seen a reversal of fortunes recently, after having soared above its currency counterparts for some time. Trade war fears, China’s strong economic performance and, dare I say it, that twit on Twitter have finally taken their toll on US Dollar strength. The USD has fallen against all its major currency pairings.

Markets watch US activity closely as trade trauma bites

A number of key economic announcements are expected for the US in the weeks ahead, including the all-important Beige Book, which is tipped to highlight the effects of ongoing trade uncertainty on the US economy, particularly the China-US trading relationship. The US economy is the world’s largest, importing approximately $500 billion of goods from China each year. In contrast, China imports far fewer American products; tending instead to import raw materials and export more valuable finished goods. Trade fears are being felt as ripples worldwide, as companies err on the side of caution and, in some cases even delay investment decisions based on the impending trade tariffs. This could have very severe supply chain implications across the globe; so many finished products produced in the US, EU and elsewhere, rely on components made in China. This, for all the same reasons, is also giving the currency markets, which loathe uncertainty, further jitters.

Commodity linked currencies, such as the New Zealand and Australian Dollars, are likely to be among the most directly  affected, particularly given their close import-export ties to China. The Canadian Dollar will also feel the pressure of US-China trade tariffs, but the North American Free Trade Agreement (NAFTA) resolution could soften the blow if it ever reaches a conclusion. Asian currencies and markets will also be affected.

A cloud on the horizon…

Trade trauma is also starting to affect consumer confidence in the USA, despite impressive employment levels, as the outlook for wage growth and stock prices have dropped. Alongside all the trade drama, some of the recent US economic results have been lacklustre, combining with the ongoing geopolitical uncertainties to chip away at US economic confidence.

There is an overwhelming feeling of trouble on the horizon, although the US Dollar often strengthens in times of trouble, as, like the Japanese Yen, it is considered a safe haven currency. In the event of a truce, some agreement between the US and China, positive news on Brexit etc., the US Dollar and Japanese Yen are likely to weaken somewhat, as investors shift into riskier but more lucrative assets. This could provide some impetus for the Pound and Euro to make gains against the US Dollar.

Members of the US Federal Reserve will also make several speeches in the days to come, which can often provide an insight into the overall economic situation and sense of direction for monetary policy. The markets watch and wait.
GBPUSD notes on white background
Pound pushing up but remains on a knife edge

The Pound, meanwhile, has had help from better Brexit talks, as the chief negotiator for the EU, Michel Barnier, offered a glimmer of hope for a deal by hinting that there could be a trade deal reached in line with the £39 billion “divorce” payment from the UK to the EU.

Some surprisingly strong economic data surfaced in the Service Sector Purchasing Managers’ Index (PMI), also fuelling Sterling strength, although the Pound still remains at the mercy of ongoing Brexit chatter. Any hint of a Brexit deal being reached helps to boost the beleaguered Pound, just as any negative reports will most likely have exactly the opposite effect.

Mixed signals for UK economy

While manufacturing figures at the start of the month were disappointing (yet still showing growth for the sector), the latest UK industrial and manufacturing production data from the Office for National Statistics (ONS) was an even greater disappointment, posting -0.2% versus the 0.2% forecast and 0.4% figure for July 2018.

Industrial output also fell short of expectations, coming in at 0.9% growth compared to the predicted 1.1%.

At the same time, monthly Gross Domestic Product (GDP) exceeded expectations at 0.3% growth, as opposed to forecasts of 0.2%; and a marked improvement on the previous month’s result of 0.1%, so the combination of positive and negative economic results have served to balance each other out and lessened the effect on Sterling strength.

The markets will be watching the forthcoming Bank of England (BoE) monetary policy decision and any rhetoric before and after the announcement closely for clues, and this could also have the power to move the Pound.

Guidance for USD buyers

GBPUSD has been gaining steadily, climbing up from below 1.2900, where it sat for some time, to a high of 1.3020 on Barnier’s suggestions of flexibility. Resistance around the 1.2980 mark is being tested as I write. $1.30 is a key psychological level and any further progress on Brexit will see that level brushed aside as traders eye $1.3250. Beware if $1.30 is not breached and be very wary if the Pound drops through $1.28. A target of around $1.25 is the most likely target rate if that happens.

Guidance for USD sellers

Any continued stay below the 1.3000 level could lead to a drop toward 1.2800, the next important level for this currency pairing. At the moment though, $1.30 looks vulnerable and further gains towards $1.3250 seem the most likely path. A stop loss order above there is a very solid backstop in the short term unless a full agreement on Brexit is announced. Then Sterling will rally and your risk increases significantly.

GBPUSD - Research Report - September 2018
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