Commentary: A summer respite

From fearing a series of dislocations in the global geoeconomic landscape to breathing a collective sigh of relief over tactical pauses, there has been a welcome swing in market sentiments over the weekend. On Russia-Ukraine, the two sides appear more amenable toward a ceasefire and talks. India-Pakistan went through serious escalation of tensions last week, yet during the weekend appeared to step back from the brink. Any de-escalation of military conflict risks is welcome. Neither cases will be resolved soon, we are aware, but we appreciate that at least the latest developments are moves in the right direction.

On US-China, the talks out of Switzerland produced some quick results on early Monday morning, with some slashing of tariffs for the next 90-days. Compared to sky-high figures announced during early April’s tit-for-tat phase, the de-escalation is impressive. However, it needs to be noted that even this 90-day pause leaves tariffs at historically high levels.

By our preliminary estimates, given the baseline 10% tariff on the whole world and the various sectoral tariffs in place, US effective tariff on imports would be about 13% from today onward, a rate not seen since the early 1940s. Compare this with the less than 3% effective rate that prevailed as President trump took over this January.

As for China, when we add up the tariffs of Trump 1.0, Biden, and Trump 2.0, even after today’s pause, the effective rate on Chinese imports would be about 40%. Meanwhile, China’s retaliatory duties would fall to 10%, along with suspension of a variety of non-tariff countermeasures. 

We will gladly take the return of the resulting risk-on mood, but would remain wary of the fragility of the various détentes. Starting with US-China, the spike in fear caused since April may have abated, but the uncertainty about which sector will settle with which tariff will linger on. Indeed, given the proclivity of the US administration to scale back tariffs so readily, investors thinking about moving investments to the US would now have second thoughts.

Furthermore, the purported rationales for sky-high tariffs, that they would generate high-paying manufacturing jobs, that they would deepen the industrial supply chain in the US, and that they would create a revenue base to pay for generous tax cuts while still achieving fiscal consolidation, would remain. We would not put it past President Trump to revisit these objectives at the end of the 90-day pause. A sharp cutting of tariffs will not help these ostensible goals.     

On the two armed conflicts that are reaching a modicum of détente presently, the deep roots of antagonism won’t fade, and the risk of flaring up will remain substantial, we fear. Both conflicts transcend issues between just state-level actors, and there is a long road ahead for mutual trust to be re-established. A number of actors have incentives to re-escalate and undermine any truce. We don’t see a decisive turning of the tide in the near term.

For the summer months in the Northern Hemisphere, this weekend’s developments may well provide a much-needed breather. We have now seen that that even committed antagonists need occasional respite. We will hope for the pauses to outlast a few months, but prepare for only temporary relief.

FX market volatility

Last week was marked by headline-grabbing currency volatility in some markets. The Taiwan dollar had two intra-day downward (appreciation) moves against the USD of magnitudes never seen before. The Korean won displayed less drama, but even its intra-day moves were akin to the magnitude only seen during major financial or political events. After a stupor of few years, global currency markets have woken up with a start.

This year’s 10% or so move of the DXY has been the key story in the currency complex this year. The ripple effects of the world’s reserve currency going through a correction of such magnitude are many. For starters, currency vols have picked up across EM and DM as traders look at trade war implications, direct and indirect. The latest bout of volatility spike has been linked with growing concerns about some parties’ (e.g. Taiwanese insurers) unhedged exposure to the USD. As market participants see the need to hedge against dollar depreciation, that very act of hedging makes USD depreciation a self-fulfilling prophecy.

With trade war détente in place for the time being, the one-way path of dollar depreciation may have run its course. But the US administration will not give up on weaponising the dollar readily, in our view. Dollar volatility is here to stay, just like trade war will outlast the various pauses in place right now. 


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