By Mike Dolan
LONDON (Reuters) – Hypersensitive currency swings to this week’s “stop-go” U.S. tariff threats suggest a persistent offset to the new administration’s trade stance that may just help central banks look beyond it all.
The first salvos in President Donald Trump’s latest trade war included 25% tariffs on Mexican and Canadian imports that were almost immediately pushed off for at least a month, as well as a 10% charge on Chinese goods that is still lingering.
The dollar initially surged against the peso and Canadian dollar, only to reverse course on news of the tariff delays. The reaction of the Chinese yuan was complicated by the fact that mainland markets were closed at the time of the announcement.
In the process, the DXY index, which measures the dollar against the most traded currencies, managed a 2% round trip from last Friday’s low only to reverse by mid-week.
These shifts suggest that if any of these import taxes do hit, the market’s reaction function will be to lift the dollar, as concerns about the potential for overseas economic damage and domestic U.S. inflation irritation exaggerate the relative interest rate gaps.
That is a plus for many foreign firms because a stronger dollar can allow them to keep the dollar price of their goods stable in U.S. markets, helping them to retain market share without a lockstep hit in their home currency earnings.
Of course, a weaker local currency can affect both a country’s employment and economic activity in complex ways, as recent studies have shown, but overall the currency market can offer an instant and significant offset to rising tariffs. A prime example is the weakening of China’s yuan during Trump’s 2018/19 bilateral tariff war, which clearly softened the fallout.
READY RECKONERS
Given the myriad moving parts, it is probably impossible to make an accurate forecast of the eventual macro fallout of tariffs, even assuming one knows for certain whether they will be applied and how large they will be.
In theory, exchange rate shifts can dampen both the real impact of the tariffs and any upward pressure on U.S. inflation, though that should rein in interest rates and bond yields, setting in motion yet more changes.
And then there are the debates about whether a one-off increase in prices actually boosts the inflation rate over time or how business switching and uncertainty douse domestic activity and global confidence and growth.
In this type of environment, rules of thumb tend to dominate.
Goldman Sachs used one to suggest that sustained 25% tariffs on imports from Canada and Mexico would amount to a 7 percentage-point increase in the “effective” overall U.S. tariff rate. And that would lead to a 0.7% increase in “core” prices in the personal income expenditure (PCE) basket.
What’s curious is that the effective tariff increase roughly equates to the increase in the dollar index recorded since October, when polls suggested Trump was the clear favourite to win the election. The dollar’s appreciation against both the peso and Canadian dollar over that period was roughly 10%.
SANDING THE SHARPER EDGES
Given all of these mind-numbing complexities, it is not hard to see why central banks have avoided taking a firm stance on the tariff question.
Federal Reserve officials this week have seemed intent on signaling that plans for further easing remain intact, even if the multiple uncertainties mean there is no “hurry” right now as they assess the “totality” of Trump policies.
Meanwhile, the European Central Bank, Bank of England, Bank of Canada and Bank of Mexico all pushed ahead with interest rate cuts over the past week.
BoE boss Andrew Bailey on Thursday put it best when he said monetary policy has little impact on short-term forces influencing headline inflation, but it should also not be used to respond to factors that will fade by the time the policy actually takes effect.
It is unclear what exactly Trump’s tariffs are truly designed to achieve. Trump’s nominee for U.S. trade representative, Jamieson Greer, laid out his ideas this week, including “reciprocal” access to overseas markets.
But regardless of the intent, the rapid moves in the currency markets may sand down the sharper edges of any inflationary fallout – along with much the point of the tariffs in the first place.
The opinions expressed here are those of the author, a columnist for Reuters
(by Mike Dolan; Editing by Matthew Lewis)
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