Markets are underestimating the risks of a prolonged US-China trade war, which would drive dollar strength against the currencies of developing nations, according to some money managers.
Uncertainty over how the dispute would be resolved in the one-month deadline set by Washington will reinvigorate a hunt for haven assets in a world already hampered by slowing growth. An easy bet will be to short the expected losers: risk-sensitive currencies from Asia to South America, they say.
“To be honest, I thought the dollar would be rising at a much faster pace than this - markets were pricing in a Goldilocks environment and they were clearly wrong,” said Stephen Miller, an adviser at asset manager GSFM and a former head of fixed income at BlackRock Inc’s Australian business. “Right now I’d be long US dollar versus EM currencies, the likes of Argentina and Turkey.”
There’s a 60% chance that China and US won’t reach a deal in the coming weeks, according to analysts at Australia and New Zealand Banking Group Ltd, after last week’s talks laid bare divisions including the removal of existing tariffs and a breakdown in trust. While both nations plan to continue negotiations, traders are waiting for Beijing’s retaliation measures after Washington slapped more duties.
The Bloomberg Dollar Spot Index has strengthened in the past month - with the greenback rising against all Group-of-10 currencies except for the Japanese yen, which is a fellow haven asset. It has also climbed against a basket of developing-nation currencies, with bellwether or trade-sensitive forex such as Indonesia’s rupiah and Korean won slipping at least 1% in the past week.
“I’d be long USD against a basket of EM Asia currencies as I think this trade war will continue,” says Raymond Lee, money manager at Kapstream in Sydney. “You can’t solve a lot of these trade issues overnight – we’ve also gone long rates in general and it’s worked well for us.”
Offshore yuan fell past 6.9 against the dollar, erasing all its gains this year, after the People’s Daily, the flagship newspaper of China’s Communist Party, said yesterday that unreasonable US demands severely disrupted the talks.
The uncertainty has shown up in the JPMorgan Global FX Volatility Index, which rose as much as 16% last week from its close on May 3, before two tweets from US President Donald Trump changed the narrative on the talks from optimism for a deal to an escalation of tariffs imposed.
“We are increasingly sceptical that any meaningful agreement or even progress will be made in the near future,” said Todd Schubert, head of fixed-income research at Bank of Singapore Ltd, which reduced its investments in emerging-market credit as tensions rose. “Bonds have not really priced-in the complete collapse of US-Sino trade talks.”
Not everyone is convinced the dollar is a sure bet.
The greenback is in the process of peaking as the Federal Reserve becomes more balanced in its monetary policy, according to Manpreet Gill, head of fixed income, currency and commodities strategy at Standard Chartered Bank in Singapore.
But count among the dollar bulls Mary Nicola, a Singapore-based G-10 FX and Asian fixed-income strategist at Eastspring Investments, which oversees $193bn. The asset management arm of Prudential Plc is taking a long dollar position versus the euro and other G-10 currencies, partly on yield differentials that are in favour of the US.
“We’ve always had a high conviction in US dollars,” she said on Bloomberg Television. “Now it’s just a little bit harder to be long emerging-market foreign exchange because they’re going to be dealing with a lot of volatility.”
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