By Deepta Bolaky

Probably, the first step following the announcement of the new US-China trade tariffs will be to monitor the reaction of the US dollar. There is a change in the dynamics driving the markets compared to last week. Whether the momentum will be maintained ahead of the FOMC meeting is perhaps a “wait and see” situation.

Trade tensions and the central bank policy have been the main drivers that put the US dollar in the spotlight.

Investors went bull on the greenback as they were betting on a stronger US economy which helped the currency to emerge as a safe-haven. Reuters recently revealed that all the 70 economists that participated in a survey said that “The trade war between the world’s two biggest economies poses downside risks to the near-term upbeat US economic outlook”. The survey revealed a few key points showing economists are concerned about the future long-term growth in the US despite the current robust pace:

• Economic growth is expected to moderate…risks from trade tensions and uncertainty around the path of fiscal policy clouds the outlook farther out on the horizon.
• When asked what could bring the next recession closer, about three-fifths of 68 respondents said faster Fed rates hikes than what is currently expected was the top worry.
• Over 20 per cent of respondents listed the trade war as the top reason why the next U.S. economic downturn might be brought closer.
• Remaining responses were varied, including a significant correction in stock markets and a further dollar rise.

Even though a lesser trade tariff percentage brought some relief to the markets amid all the bad news, there is no doubt that the US and China are plunging deeper into a trade war.

Now, that the new tariffs have proved less costly than expected and that the US dollar safe-haven outlook is fading away, the markets have switched their focus back to fundamentals. The recent US CPI figures have shown some weakness in the economy and Dollar bulls are a bit reluctant to push the greenback higher. Since the announcement of the new duties, the US dollar has been under pressure against the major G10 and emerging currencies.

The US Dollar Index that measured the greenback against a basket of major currencies dropped to 7-week low.

In the equity markets, investors were also relieved that the tariffs were less severe. The stock markets are on a bull run and have a lot of potential and optimism, but a trade war is capping the gains.

The stock markets are currently wobbly because escalating tariffs could be the trigger that might potentially cause a significant correction in the equity markets.

Major equity indices have been trading mostly in the black this week. The Asian markets shrugged off the tensions and remained in the positive territory for the last five days as of writing. While the relief rally is reassuring, investors need to be cautious as the trade tariffs might be long-lasting.

If and when China runs out of options, the dynamic of the trade tensions might also change significantly.

As we progressed into the week and we see the US dollar losing its safe-haven momentum, the markets are gearing up for the upcoming FOMC meeting. The policy divergence of the Fed compared to the other central banks is a big part of the equation favouring the greenback. Fed speeches so far have been stable around “gradual pace of rate hikes” amid trade chaos.

Next week, we will most certainly see a rate hike which is mainly priced-in, but attention will be directed to the “growth” risks.

• If economic growth persists defying the odds of a slowdown, the Fed could be forced to hike more aggressively.
• On the downside, if there are concerns that trade tariffs will hinder global and domestic growth, the Fed might be less hawkish.

The FOMC meeting next week will be high on the agenda and will give traders the opportunity to gauge the decisions of the Fed.

26^th of September- Mark your Calendar!!

This article is written by a GO Markets Analyst and is based on their independent analysis. They remain fully responsible for the views expressed as well as any remaining error or omissions. Trading Forex and Derivatives carries a high level of risk.

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