The U.S. dollar extended its slide on Friday when Canada, the European Union and China blasted President Trump's decision to impose tariffs on steel and aluminum imports. Canada called the tariffs unacceptable, but it was the EU and China that threatened to take their own protective measures if the U.S. proceeds with their plans. The European Union has already called a meeting next week to discuss a response. The first step would be to appeal to the WTO - this happened under President George W Bush but it took a year and half before the tariffs were lifted. The WTO declared the steel tariffs under Bush as a violation of America's WTO tariff-rate commitments and threatened $2B in penalty sanctions. Bush ignored the threat, preserved the tariffs until the EU countered with tariffs on oranges and cars and finally he backed down. Foreign leaders may not be as patient with President Trump and could respond more quickly with specific tariff threats and actions. Either way, trade tensions will intensify before they improve which means further losses for USD/JPY.
The threat of a trade war should overshadow U.S. data including the upcoming non-farm payrolls report because regardless of whether payrolls are strong or weak, there's no question that Fed Chair Jerome Powell will raise interest rates later this month. With FOMC voter Dudley calling four rate hikes gradual, the dot plot forecast will also be revised upwards. Based on data, USD/JPY should appreciate into the jobs report but politics easily overshadows economics. If China starts talking about their own tariffs or expresses less desire to buy U.S. Treasuries (again), USD/JPY will break 105 quickly and aggressively. Aside from the NFP report, non-manufacturing ISM, the trade balance and Beige book are also scheduled for release in the week ahead.
Right out of the gate, the euro will be in focus with elections in Italy and the results of Germany's Social Democrats' ballot vote due over the weekend. All of the SPD votes will be in by Friday and the results will be announced shortly after. There are 2 outcomes - SPD members vote yes and Merkel forms a coalition government. If the SPD votes no, there will either be new elections or Merkel may try to form a minority government. The former is positive for the euro and the latter is negative. In Italy, polls open on Sunday and the results are expected by Monday. The 5 Star Movement is in the lead and a victory by this anti-euro party would be dangerous for the currency. A coalition government where no single party has majority would be less negative for EUR/USD whereas the only unambiguously positive outcome would be a victory by the current government. In addition to these political risks, the European Central Bank also holds its March meeting and investors will be eager to see if they change their forward guidance. Despite hawkish comments, there are reports that they will wait until the summer which is not surprising given trade tensions, equity market volatility and widespread slowdown in economic activity.
Cautiousness is also expected from the Reserve Bank of Australia and the Bank of Canada. The Australian dollar ended the week near its lows on the back risk aversion and softer Australian data. Unlike the Eurozone, which is seeing data pull back from multi-month or multi-year highs, there hasn't been any meaningful traction in the Australian economy over the past few months. Since the last meeting in March, retail sales declined, consumer confidence fell, job growth slowed, consumer inflation expectations eased, housing activity slowed and the trade deficit doubled. The only good news is that the weaker U.S. dollar is driving commodity prices higher and for the time being, service and construction activity remains healthy keeping business confidence stable. The RBA has very little reason to change their neutral policy bias so the reaction in the Australian dollar should be limited. Instead the more recent economic reports such as service sector PMI, retail sales, Q4 GDP and China's trade balance could have a bigger impact on how the currency trades but ultimately we think AUD and NZD will take its cue from the market's appetite for U.S. dollars.
USD/CAD traded higher every day this past week with the latest move taking the pair within 5 pips of its 7-month high. Weaker data, NAFTA uncertainty, risk aversion and lower oil prices made the Canadian dollar the worst performing currency. As the number one supplier of both steel and aluminum to the U.S, Canada is a huge victim of the tariffs and all of this could be a step towards the U.S.' NAFTA withdrawal. Prime Minister Trudeau is hoping for an exception but we are not optimistic. The possibility of greater trade troubles for Canada means USD/CAD could break 1.30. The Bank of Canada may not say much about this issue at their upcoming meeting but its certainly going to be a cause for a concern. Canadian data has taken a turn for the worse since their last policy meeting with retail sales, employment, GDP, the trade balance and manufacturing activity weakening. Consumer prices and building permits are one of the few economic indices that are up. Job growth could rebound after last month's soft numbers but the Bank of Canada's outlook and trade war developments should have a greater impact on USD/CAD.
Last but certainly not least, it should be no surprise that Prime Minister May's Brexit speech failed to instill confidence among sterling traders and U.K. investors. Brexit negotiations are not going well with the European Union proposing terms that the PM finds unacceptable. She insisted that the UK would be leaving the customs union but seemed willing to consider a "customs partnership" in which the UK would offer the same requirements as the EU on imports and a "highly streamlined customs agreement" to facilitate border activity. On the Northern Ireland border issue, her speech failed to provide any meaningful solution. Instead she reiterated that they did not want a hard border and threw the ball back into the EU's court by saying they can't find a solution on their own, "it is for all of us to work together." In a nutshell, after all of this week's developments, the U.K. is no closer to a Brexit deal. In the week ahead, the PMI composite index and trade balance are the main reports on the U.K. calendar. This is likely to take a back seat to all of the rate decisions and political events happening in other parts of the world.
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