US Dollar rebounds on trade as US, China restart negotiations

KUWAIT: The US dollar rebounded this week on hopes that the United States and China are returning to the negotiating table to resolve their tariff dispute. US President Trump spoke to Beijing saying “this is the first time I’ve seen them where they really do want to make a deal, and I think it’s a positive step”. It followed comments from Chinese vice Premier Liu He who spoke with a conciliatory tone by stating that “China resolutely opposes the escalation of the trade war. An escalation of the trade war is not good for China, it’s not good for the US, and it’s also not good for the interests of the people across the world.” The Chinese commerce ministry confirmed that China and the US are scheduled to discuss the next round of face-to-face trade talks sometime in September.

Despite reopening negotiations, the latest new tariffs announced by Trump in August are still set to be implemented. The imposition of 15% tariffs on $300 billion worth of new Chinese imports would be split between two dates, September 1st and December 15th. In a sign of good will towards the planned meeting between Washington and Beijing, China pledged that it would not immediately retaliate against the latest US tariffs, emphasizing the need to discuss ways to deescalate the trade war between the world’s two largest economies. “China has ample means for retaliation, but thinks the question that should be discussed now is about removing the new tariffs to prevent escalation of the trade war,” stated a Chinese spokesman.

The strengthening dollar and the ongoing US-China trade tensions pose downside risks for the US economy and increasing pressure on the Federal Reserve to deliver further rate cuts. At Jackson Hole, Chair Powell clearly emphasized that slowing global growth, trade policy uncertainty and muted inflation have all played a role in encouraging the Fed to begin lowering rates. Since their Fed’s last meeting risks to the global growth outlook from global trade have clearly increased.

The latest GDP figures estimates the US economy grew 2.0% in the second quarter down from 3.1% in the first. The last consumer price index reading on August 13th shows the figure below the Fed’s 2% target at 1.8%. When looking at the Fed’s preferred inflation indicator, the personal consumption expenditures (PCE) price index released Friday, it too was well below the 2.0% target at 1.6%. It is therefore, not surprising that markets have been pricing in two to three rate cuts by the Fed this year. Expectations for a 25bps in September are now at 96% while the remaining 4% are betting on a deeper 50bps cut.

US Consumer Confidence
Consumer confidence was slightly lower in August at 135.1, following July’s increase. Consumers’ assessment of current conditions improved further, and the Present Situation Index is now at its highest level in nearly 19 years. The Expectations Index – based on consumers’ short-term outlook for income, business and labor market conditions, cooled moderately, but overall remained strong. While other parts of the economy may show some weakening, consumers have remained confident and willing to spend. However, if trade tensions persist, it could potentially dampen consumers’ optimism regarding the short-term economic outlook.

The sterling pound was pressured this week due to new developments in the Brexit crisis. The prospects of a no-deal Brexit increased this week after UK Prime Minister Boris Johnson asked the Queen, and had been given her approval, to suspend Parliament until October 14. Returning again on October 14 would leave just over two weeks until Britain is due to quit the EU on October 31.

A no-deal exit, which is currently the default option on October 31, would represent a significant shock to both the demand and supply side of the economy. The near-term effect on supply will depend on the extent of disruption at the border with the EU while demand in the UK economy would be affected in several ways. Dimmer prospects for Britain outside the EU and ongoing uncertainty about the future relationship would spell further weakness in business investment.

Meanwhile, the combination of a sharp increase in inflation, due to a drop in sterling and an increase in tariffs, and a modest rise in unemployment is likely to mean consumption growth slows or turns negative. Economists believe the Bank of England will likely cut interest rates immediately to support the economy. Over the week, the UK 10yr government bond plunged 19% as investors rushed to safety while the GBP/USD on the other hand only fell 1%. The limited fall in the sterling is likely due to traders having already reduced their exposures to the currency throughout the year.

Euro Pressured
The euro has also been pressured this week over geopolitical issues stemming from not only Brexit, but Italian politics as well. Italian President Sergio Mattarella has to decide whether to appoint a new premier, after Prime Minister Giuseppe Conte resigned August 20, or dissolve parliament and trigger new elections. The prospect of having a more pro-EU government would hopefully avoid another confrontation with the European Commission on Italy’s budget. The result would support Italian assets and to some extent the euro as well.

The euro was also weighed down by a sluggish euro zone economy and likely monetary easing from the European Central Bank next month. Future ECB President Christine Lagarde spoke on Thursday saying the Central Bank still has room to cut interest rates if needed. “The ECB has a broad tool kit at its disposal and must stand ready to act,” Lagarde continued to the European Parliament’s committee on economic affairs. With growth slowing and inflation persistently undershooting the ECB’s target, the bank has all but promised fresh stimulus when policymakers meet on September 12. The EUR/USD fell a similar 1% throughout the week.

Global stock markets rebounded higher this week over cautions hopes of a trade resolution between China and the US. US markets the Dow Jones, S&P 500, and NASDAQ all grew over 2% while the European STOXX 500 went over 3%. Japan’s Nikkei 225 was up around 2%. A resolution between China and the US would also ease global trade tensions increasing the demand for oil. Oil prices were also supported by a decline in US inventories. However, a looming hurricane in Florida capped the increase. International benchmark Brent Crude rose 2.4% to close the week at $59.25.


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