Tariff escalation brings back trade uncertainties sooner than expected

USD: US dollar vulnerable as Trump turmoil escalates

The European Stoxx future is down 1.3% and the S&P future is 0.9% lower as market participants respond to the announcement by President Trump of a 10% US import tariff being implemented against Denmark, Norway, Sweden, France, Germany, the UK, the Netherlands, and Finland. The tariff is effective 1^st February and will rise to 25% on 1^st June. The tariff will remain until a deal has been reached on the “complete and total purchase of Greenland” by the US. Initially the currencies impacted by this announcement opened weaker but through the Asian trading session the view that there could be a return of the “sell America” trade and the dollar has seen some renewed weakness. This tariff escalation needs to be viewed in the context of other developments, in particular the upcoming decision on the new Fed Chair and the possible imminent Supreme Court decision on the legality of using IEEPA to implement reciprocal tariffs globally.

There is a plausible scenario in which those additional factors undermine the dollar as well and hence reinforce the view that global investors will either sell US assets or look to reduce US dollar exposures via increased hedging. Given the countries impacted are all European, it is not surprising that the Swiss franc is seeing the greatest outperformance on safe-haven flows. It remains the most reliable currency for safe-haven flows. Even the yen has strengthened today which may reflect in part the increased risk of intervention after last week’s rhetoric that signalled the potential for yen-selling intervention. A sharp sell-off of JGBs today hasn’t resulted in yen selling although we are sceptical the yen can hold up in circumstances of JGB selling.

What will likely contain the sell-off for the dollar (DXY just -0.3%) is the fact that this tariff is only effective 1^st February and investors will be aware of the potential for Trump to back down on some form of “deal” being done. However, that scenario becomes less likely if there is retaliation in Europe. The EU is considering imposing tariffs on EUR 93bn worth of goods if Trump follows through on the threat. This relates to a previous plan that was suspended and therefore could be activated quickly. President Macron wants to go further with the EU’s anti-coercion instrument, giving the EU scope to act beyond trade tariffs. Uncertainties have just increased further and we believe Trump’s actions will further encourage reduced exposures to the US dollar although we assume moves will remain modest on the assumption of a major escalation being avoided.

BIG REDUCTION IN EUR LONGS LAST WEEK

Source: Bloomberg, Macrobond & MUFG GMR

G4 FX: Positioning data reveals some big shifts

The IMM data for the week to 13^th January was released on Friday evening and was notable in revealing some big shifts in positioning amongst Leveraged Funds. At the start of the year it looks like we are seeing some increased conviction in direction amongst speculative market participants.

We had highlighted the fact in previous FX Weeklies that EUR positioning was beginning to look stretched and that could trigger some reversal and liquidation. The Leveraged Funds’ long position in EUR hit over 56k at the end of last year, which was the highest total since February 2018, after which FX momentum shifted during Trump’s first term in office. A 10% drop in 2017 turned out to be a one-off and Trump’s aggressive trade policy and Fed rate hikes helped see a sustained turnaround in EUR and by May 2018 Leveraged Funds were running net shorts.

We don’t think that will happen on this occasion. The US macro backdrop is different and while there has been economic resilience, this year is more likely to see further rate cuts and certainly not rate hikes. So we see this EUR liquidation as more a lightening of positioning rather than anything more sustained.

The change in JPY positioning is also interesting. The Leveraged Fund market was already short JPY but there was huge yen selling with shorts increasing by over 35k contracts – a very sizeable one-week change. The last yen-selling related shift in positioning of that size in one week was back in 2011. There was a more recent big shift the other way – JPY-buying – following the intervention by the MoF in July 2024.

What this very big yen selling indicates is that market participants don’t appear particularly concerned over the risk of intervention – we had already had rhetoric from Japanese authorities although that rhetoric has intensified since last Tuesday that covers the positioning data. But the rebound of the yen has been relatively modest despite the notable increase. Yen shorts now total 99k amongst Leveraged Funds, the biggest short since the week before that July 2024 intervention. So from a measure of speculation being behind the JPY weakness rather than fundamentals, the MoF could certainly cite this data. The MoF specifically cited 9^th January as a day of excessive moves which this data implies was possibly fuelled by speculative moves. We still remain sceptical of intervention being successful on a sustained basis and would need fundamental supportive JPY factors to play out as well.  Moves in JPY today are certainly more contained. The JGB market has seen heavy selling with yields surging but the yen remains modestly stronger, perhaps reflecting Trump trade uncertainties that has put downward pressure on the dollar today. We would still argue though that the JGB sell-off is a negative for the yen.

JPY SHORTS JUMP NOTABLY AND BACK TO INTERVENTION LEVELS FROM 2024

Source: Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com