The US Treasury’s semi-annual report on ‘Foreign Exchange Policies of Major Trading Partners of the United States’ is due to be released mid-April and carries a broad range of scenarios impacting asset classes across the board. Markets will focus on the tone of the report and whether any country is labelled a ‘currency manipulator’. The tone will reveal the Administrations intentions with future trade policies and give investors insight in to whether President Trump’s protectionist rhetoric he possessed during his campaign will come to fruition. Markets will need to interpret the report and determine whether the US Treasury are posing a credible threat to their major trade partners.
We expect the Administration to maintain their view on making bilateral trade agreements to address the trade deficit. The US Treasury report is an opportunity to make credible threats against some of the US major trading partners giving them an advantage going into trade negotiations. We have identified 4 scenarios with accompanying trade ideas but first look into the details of the report and the current criteria that needs to be met to label a country a ‘currency manipulator’ or to put a country on the US ‘monitoring list’.
When is the report released?
The report is due mid-April but as table 1 shows the deadline date and the release date do not always coincide.
Table 1 Release Vs Deadline Date
|Release Date||Deadline Date|
|29 April 2016||15 April 2016|
|9 April 2015||15 April 2015|
|15 April 2014||15 April 2014|
|12 April 2013||15 April 2013|
|25 May 2012||13 April 2012|
|27 May 2011||15 April 2011|
The US Treasury have flexibility when implementing their ‘enhanced analysis’ but there is currently 3 criteria that needs to be met in order for a country to be labelled a ‘currency manipulator’. There is a possibility that these criteria could change as the US Treasury ‘move the goal posts’ which we cater for in our scenarios. The current criteria are:
- A significant bilateral trade surplus with the United States
- A material current account surplus
- Engaged in persistent one-sided intervention in the foreign exchange market
What is interesting is that table 2 identifies that no country currently meets the ‘currency manipulator’ criteria but five are list’ on the ‘monitoring as they scored 2/3. Importantly China only meets 1/3 requirements.If the US Treasury do wish to single out China (which we address in scenario 1), they will need to adjust the criteria in order to avoid applying the label to other countries in the process.
|Bilateral Goods Deficit > $20bn||Current Account Suplus> 3% of GDP||Net Purchases of Foreign Currency > 2% of GDP over the year||Total out of 3|
Scenarios- From greatest to least expected market impact
- US Treasury single out China as a currency manipulator
If there were a formal accusation made markets would begin to price in the risk of import tariffs. Risk appetite would deteriorate weighing on equity and commodity markets. Our view is that Asian excluding Japan (AxJ) currencies would weaken against the USD initially especially KRWas it will also have to deal with their high exposure to equity flows. The risk off outcome would weigh on AUD, NZD, CAD, NOK, KRW and TWD while JPY would strengthen initially due to the markets risk off nature.
We do not view this scenario as likely to pan out. It is in the best interest of both China and the US to avoid a trade war. Labelling China a currency manipulator could provide the impetus for China to retaliate with their own protectionist policies. The Administration has spoken out against USD strength, which would be another unfavourable outcome from this scenario.
Trade ideas: Long USDKRW, long USDCNY, long XAUAUD and short AUDJPY.
- Small country labelled as an currency manipulator
The intent behind this scenario is the US flexing their muscle warning other larger trade partners against currency manipulation. Similar to scenario 1 risk appetite would deteriorate leading to a risk off environment and the USD being supported.
Trade ideas: Long USDKRW, Long USDCNY, Long XAUAUD and short AUDJPY.
- Hawkish rhetoric from US Treasury
We view this scenario to have the highest probability as the US Treasury adopt a hawkish tone. A hawkish tone can be achieved by: 1) lowering the thresholds for criteria 1/2, 2) extending the time horizon for criteria 3 and/or 3) citing countries for ‘currency misalignment’. AxJ currencies have outperformed since the initially Trump fuelled USD rally. We would expect to see this trend continue after the report was released although we hold a medium-term bearish bias on AxJ currencies.
Trade ideas:Short USDSGD.
- No significant changed- All talk no action
Our view is investors will see this as Trump not following through with his campaign rhetoric. This outcome on top of the failed health care bill would put more pressure on the ‘Trump trade’ but is not outright negative for risk appetite.
Trade ideas: Long EURUSD and Short USDJPY