Risk aversion spreads amid renewed trade tension

Asian equities fell across the board on Wednesday after Donald Trump announced tariffs on a further $200bn in imports from China. The Nikkei 225 gave up 1.19% to 21,932 points, while Chinese stocks bore the brunt of the sell-off. The Shanghai Composite fell 1.76%, while the tech-heavy Shenzhen Composite slid 1.96%. European equities followed the lead and moved in negative territory. The German DAX already gave up more than 1%, the Eurostoxx 50 fell 0.85% while the SMI erased 1%.

The Trump administration unveiled a new list – which includes a broad range of products ranging from electric vehicle batteries to air conditioning machines – of Chinese products that will be hit with a 10% tariff. The list is not definitive yet and is expected to come into effect in September. China already declared the new tariff were “totally unacceptable” and promised it will retaliate dollar-for-dollar.

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In the FX market, the announcement triggered a risk-off reaction, which translated into a sell-off in emerging market currencies, and a broad US dollar appreciation. Safe-haven currencies such as the Swiss franc and the Japanese saw limited but were at least able to hold ground. In the EM complex, the Russian ruble and the Turkish lira suffered the most as they both fell 0.50%. The Chinese yuan slid 0.48% with USD/CNH rising to 6.6815. Finally, the currencies of export-oriented countries also felt the pain. The Australian dollar fell the most within the G10 complex as it erased 0.65% to $0.7410.

Canadian conundrum

The Canadian economy is in good shape. Governor of the Bank of Canada (BoC), Stephen Poloz, is therefore in a difficult situation. With favourable economic data on one side and a potential trade war with its largest commercial partner on the other, economic policy lies in the grey zone. With inflation above BoC’s 2% target, wage growth largely exceeding consumer price indices, unemployment at a decade low and, most importantly, an economic expansion above the 2.2% projections from the Canadian monetary authority, the odds would most certainly support further monetary policy tightening.

However, uncertainties regarding further trade sanctions from the US remain. The North American Free Trade Agreement (NAFTA) renegotiations, started nearly a year ago, keep dragging and tariffs are looming on lumber, steel, aluminium and possibly autos and automotive parts. Since Canadian interest rates remain among the lowest and the loonie continues to weaken, we see no reason not to hike. Now at 1.25%, the BoC’s policy interest rate will be increasing by a quarter percent to 1.50%. USD/CAD is up 4.7% in 2018: we would therefore expect the pair to head to 1.3170 after the BoC’s announcement.

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