Is Economic War Waiting in the Wings?

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Includes: AUNZ, CNY, EU, FXA, FXCB, FXE, FXY, GBB, UDN, UUP
by: FXedu

By Mike Conlon

Just yesterday I was thinking about what to write about this morning and decided that I would address the potential for “economic war” to materialize. This could be a trade war, a currency war, or a tug-o-war. Heck, this could actually lead to a military war.

What am I speaking of? I’m talking about the Bill that passed the lower house of Congress here in the US which seeks to impose trade sanctions on China and other countries who manipulate their currency. Coincidentally, Treasury Secretary Geithner came out and said there is no threat of a trade war with China or a world currency conflict. Where there is smoke there is fire.

Meanwhile, Chinese PMI figures came in better than expected as manufacturing is still expanding, sending the market into risk taking mode as once again the Dollar is weaker across the board.

The Euro is also higher this morning despite worse than expected retail sales figures in Germany and a slightly higher unemployment rate. This is not a big deal as Germany gets by on its exports, and anti-Dollar sentiment is driving the Euro.

Speaking of the greenback, all eyes will be on the consumer confidence and ISM manufacturing figures sue out later this morning, as this could provide insight into the possibility of “QE2”.

In the forex market:

Aussie: The Aussie is higher despite declining manufacturing figures as the currency is bid because of Chinese PMI figures. In addition, the RBA will meet next week at their policy meeting, where the odds of a rate hike are close to 50/50. (Click chart to enlarge)

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Kiwi: The Kiwi is also higher on increased risk appetite thanks to China.

Loonie: The Loonie is higher as well as oil prices have gone back above $80, though yesterday BOC Governor Carney said that he may keep rates steady if the US embarks on QE2. In addition, Canada is experiencing slower economic growth.

Euro: The Euro is higher because the Dollar is lower. Negative economic data has been brushed aside as the market waits for the US ISM manufacturing number, which will indicate whether or not the US is likely to recover. (Click chart to enlarge)

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Pound: The Pound is also higher for the same reasons as the Euro, sans the negative economic data, which gives it a slight advantage this morning. PMI figures in the UK came in lower than expected.

Dollar: The fear of further quantitative easing “QE2” has been weighing the markets heavily and has pushed money flows to just about everywhere else. This has encouraged currency manipulation around the globe as the US is winning the race to the bottom. While consumer confidence is not expected to be good, a much worse than expected ISM number could increase bets that the Fed will act sooner than later.

Yen: The Yen is lower against all but (surprise) the Dollar as it is getting closer to that 15-year high that inspired the first round of Yentervention. PM Kan said he is prepared to intervene further, but those words may ring hollow with the market. CPI figures came in negative again showing deflation, but were in line with expectations.

So what initially started out as a race to the bottom has now escalated into a full-on threat of a trade war. Any sanctions or tariffs placed on Chinese goods are likely to cause retaliation, which could in turn hurt US exports.

Meanwhile other regions around the globe are starting to complain about higher currency values, including Brazil, Switzerland, and of course Japan. While some regions have taken steps to attempt to prevent appreciation, it may be fruitless as money makes its way to better performing economies.

This has basically exported US inflation to some of the developing countries and hot money seeks yield and runs from the Dollar.

How this plays out is anyone’s guess, but at this point US is still the big dog on the block and all other currencies will still play second fiddle to the Dollar. If the Chinese do not take action with the Yuan then expect the war of words to continue.

Meanwhile, Bernanke and the Fed’s debasement of the Dollar will continue to drive money to other currencies and gold, which is likely to be met with opposition. It is a sad commentary when the US Treasury secretary doesn’t see a potential problem, or is just playing dumb as the truth is too hard to handle.

Either way, expect things to heat up and remain volatile!