US-China trade war may be a boon to the euro and Brazilian real

Neal Kimberley says that amid the US-China trade crossfire, holdings of the euro may gain on the dollar and the Brazilian currency may rise against America’s. As a major trading partner of China, though, Australia’s dollar may be in for a rough ride 

PUBLISHED : Tuesday, 10 April, 2018, 12:28pm
UPDATED : Tuesday, 10 April, 2018, 10:33pm

Never let a serious crisis go to waste. Rahm Emanuel, former US president Barack Obama’s first chief of staff, made that assertion back in 2008, but from a market perspective, those words could equally apply today amid deteriorating trade relations between China and the United States

The bottom line is that China-US trade tensions will offer markets trading opportunities, and as these two economic giants square off over trade issues, markets will seek to identify potential winners and losers. That’s what markets do. But where might their gaze fall? 

Soybeans is a good place to begin, following China’s decision to put tariffs on US agricultural products, as part of Beijing’s response to an initial set of levies on Chinese goods imposed by the US. 

China, with the world’s biggest livestock industry to provide for, purchases about 60 per cent of globally traded soybeans, as reported on Friday. Brazil supplied half of those imports in 2017, with the US providing around a third. 

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It’s perhaps no wonder then that, when China announced its move, the market pushed up the price for Brazilian soy, rationalising that Brazil would be the prime beneficiary of any US loss of soybean market share in China.

Taking that argument into the currency space, TS Lombard’s senior macro strategist Oliver Brennan argued last week that the Brazilian real could appreciate versus the US dollar as the foreign exchange market starts to realise that any tariff-related reduction in US soybean exports to China, as a consequence of the trade tensions between Beijing and Washington, could be to Brazil’s advantage. 

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But if the real could be a currency winner, might the Australian dollar go down under? Australia’s biggest trade partner is China.

US bank BNY Mellon will surely have been thinking of that fact when it wrote last week how the Australian dollar had in recent years “been able to shrug off a sharp decline in yield support against the [US dollar] across much of the curve, thanks to improving sentiment surrounding Australia’s major trade partners”. The US firm felt the Australian dollar could be vulnerable if there was deterioration in such sentiment.

Looking further ahead, with China the largest holder of US debt outside the US, if trade tensions get out of hand, markets will surely hypothesise about the possibility that Beijing might be minded to trim, or at least not add to, its existing pile of US paper even if, as Zhu Guangyao, its vice-finance minister reiterated last week, “China is a responsible international investor.” 

In truth, China could easily remain “responsible” while being less inclined to retain such an exposure to US paper. If the currency market was to perceive that to be a possibility, then the main beneficiary would likely be the euro, given that it is the world’s second most widely-held reserve currency behind the US dollar and also because, currently, central bank holdings of euros are historically relatively low.

As Derek Halpenny, European head of global market research at Japan’s MUFG Bank, noted last Thursday, based on recent data from the International Monetary Fund, euro holdings as a percentage of “total reserves in nominal terms have fallen from a record high of 28.0 per cent in Q3 2009 to 20.1 per cent in Q4 [2017], only a little above the most recent low of 19.1 per cent”.

The market could rationally conclude, even without any portfolio tweaks resulting from rising trade tensions, that China, and indeed central banks more generally, already have considerable room to add euros to their reserves, at the US dollar’s expense. 

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Additionally, as European Central Bank (ECB) executive board member Benoit Coeure said last Friday, in a scenario where trade barriers are erected, ECB simulations have suggested that the world trade in goods could fall by up to 3 per cent in the first year and world gross domestic product by up to 1 per cent. Further, while GDP in the euro zone would decline, it would do so “by less than in the US”, he said. 

In short, if it was in a two-horse race with the US dollar, the euro might start to look the better prospect if trade tensions between China and the US continue to escalate. 

Of course, there’s absolutely no inevitability to any of this and it’s impossible to know how the China-US trade spat will play out. But that won’t stop markets seeking to identify potential winners and losers along the way. Trade tensions offer trading opportunities. Markets don’t waste a good crisis.

Neal Kimberley is a commentator on macroeconomics and financial markets