By Arthur Idiatulin Tickmill Market Expert
By Arthur Idiatulin Tickmill Market Expert

Trade spats make the dollar bulls sit on a powder keg

The Federal Reserve hiked interest rates in June and signalled that two more rate hikes are ahead. This information was somewhat surprising or investors, although market players treated the update with caution, building moderate bets on the dollar. 

First Published: e-Forex Magazine 81 / Currency Clips / July 2018

Trade spats make the dollar bulls sit on a powder keg

The Federal Reserve hiked interest rates in June and signalled that two more rate hikes are ahead. This information was somewhat surprising or investors, although market players treated the update with caution, building moderate bets on the dollar. 

One of the most pressing concerns for the Fed remains the employment overshoot, which dictates picking up the pace for policy tightening. Considerable improvements in the labour market front suggest wage growth, which could translate into faster consumer inflation. By removing the wording about the need to keep the rates at a low level, the Fed finally acknowledged that the post-crisis era measures have finally ended. Market players demonstrated a rather wary stance, which is likely to have been a result of Trump’s tariffs and expected tit-for-tat measures from the US trading partners, which could potentially thwart economic pickup in the US through the cost-push inflation primarily on imported goods and decreased company profits. 

From the angle of yield-driven sentiment, the dollar remains at a premium against the European currency and other major peers due to the widening gap in borrowing costs. The ECB June meeting caused a mix of disappointment and relief, as the policymakers signalled the end of asset purchases in December which was a widely expected decision and, despite the initial concern, shifted the outlook for interest rate hikes to late 2019, leaving the hawks somewhat unsated. 
The historical summit of US and DRPK leaders, which resulted in a pledge of complete denuclearisation of the Korean Peninsula, allowed Trump to gain an edge in trade talks with his Chinese peers. The summit wouldn’t have been possible without China’s help, but it seems that by helping Trump to strike a deal with Kim, China voluntarily gave away their leverage on the US. Trump’s achievements in foreign policy could allow him to renew tariff pressure on China. The threat of global trade disruption is likely to hit emerging markets, while the US will be less impacted due to its maturing investment cycle, which is likely to smooth the impact of external shocks. 
 
The retaliatory measures against the US tariffs are likely to be the main theme of trading in July and US partners are likely to start applying the adage ‘the best defense is a good offense’ to their practices. Aside from the trade spats, the sustainable path of US economic recovery shapes a solid ground for the dollar appreciation.