The President announced a coercive tax on Mexican goods, which had less of a focus on any trade imbalance and more as a response to cross border migration. Mexico wasn’t the only country in line for new rules; as the trade war with China rumbles on, the US administration announced that it would remove India and Turkey from its list of developing countries, which means an end to currently preferential tax treatment. While the moves may have been part of a larger campaign to put ‘America First’, the result was to upset the financial markets; tariffs are considered by investors to exert an upward pressure on inflation and interest rates as well as having the potential to place downward pressure on the US economy.
The National Association for Business Economics reported that a consensus among economists put a 60% chance on a US recession before the end of next year. ADP's monthly employment change showed a net 27k new jobs in May and while the services sector maintained its momentum, manufacturing and industry shed jobs. The numbers point to the impact of the trade war on the US economy and the US dollar fell against the pound and the euro on the news. Manufacturing PMIs from Markit and ISM came in above 50 and better than elsewhere in the world but both fell short of forecast. Federal Reserve chairman Jerome Powell acknowledged "recent developments involving trade negotiations and other matters" promising appropriate action, although did not mention a rate cut. The end result was a difficult week for the US dollar which was volatile amid the changes and uncertainty.
Although Service Sector PMIs across much of Europe came in better than expected, France missed target at 51.5 and Italy was a neutral 50.0. In Germany, the European Elections highlighted a change in public opinion which has seen the German Greens overtake the CDU, led by Angela Merkel, in popularity. The leader of the CDU’s junior coalition partner the SDP, Andrea Nahles, resigned over their poor performance in the European Elections, adding to the uncertainty.
While the ECB considers how to address the fact that inflation remains below the 2% target, speculation about their response grows. Although a rate cut may seem like the next step, there is very little left of the rate to cut and there is growing belief that the quantitative easing programme may be restarted. Either option could leave the euro in a vulnerable position.
The Canadian dollar hit a two-week high against the US dollar on Thursday. This was in part due to the fact that the greenback weakened due to various factors, but positive trade data also suggested that the Canadian economy was improving. The trade deficit was down to $966m in April and experts also pointed to the latest GDP figures as another supportive factor for the Canadian dollar.
It is not just the US dollar that has struggled against the rise of the Loonie, which has also been making steady gains against sterling. The pound is seeing considerable volatility amidst political uncertainty due to Brexit and the search for a new Prime Minister, and the Canadian dollar has seized the opportunity to make gains on the back of more positive economic figures after a prolonged slowdown, suggesting forward momentum in the future.
While the President met with outgoing Prime Minister Theresa May in the UK this week, ongoing Brexit uncertainty is currently being compounded by the political uncertainty of the search for a new Prime Minister to put pressure on sterling. As the Conservative Party seeks a new leader for the country, the landscape has become even harder to predict, with candidates including leading proponents of Brexit as well as those with a more measured approach, including one candidate calling for a second referendum. The pound is likely to remain volatile until a clearer picture emerges. During a visit to the UK, US President Trump promised a “phenomenal” trade deal once the UK leaves the EU but there is some concern over the fate of the publicly funded healthcare system, the NHS, which suggests that any agreement will not be a simple process.
The pound benefited briefly from positive Service PMIs, which came in above forecast at 51.0 but most other sectors missed forecast. Britain's manufacturing sector purchasing managers' index fell nearly four points to 49.4 in May, and the Construction Sector PMI also came in two points short of forecast at 48.6. Sterling didn’t react initially but did trend lower and there was more bad news from the British Retail Consortium. Sales were down by 3% in May compared with the same month last year, the largest seasonally-adjusted decline since the survey began in 1995. Among other things the BRC blamed "political and economic uncertainty," which looks set to put pressure on sterling for some time.
Uncertainty elsewhere in the world, from new trade disputes initiated by the US to the ongoing Brexit uncertainty, has meant that investors are moving towards the safe haven yen. The market is certainly appearing slightly risk averse as the rapid changes elsewhere in the world against a backdrop of slowing economies elsewhere present an opportunity for the yen to make gains.
However, the yen was not alone in benefiting from weakness elsewhere; positive news from Canada and Australia, for example, stopped the yen from rising unchecked and while investors may have some caution over the US dollar, the Swiss Franc is also seen as a viable alternative safe haven.