USD crosses: Currency wars and border taxes - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, notes, "For much of last year the topic of currency wars was mostly designated to the back burner. In recent weeks, however, it has made a come-back with its new persona bloated by associated fears of protectionism and trade wars." 

Key Quotes

"By the start of last year several US corporates had complained about the impact of USD strength on their overseas earnings. After the February 2016 G20 meeting, there was plenty of speculation that the US Treasury had given a stern warning behind closed doors about participation in currency wars."

"In April 2016 Treasury Secretary Lew stated that “when the values of currencies are allowed to move according to market forces, the global economy can better adapt to changes in relative economic performance among countries. What is unacceptable, however, is intervention in foreign exchange markets in order to gain a competitive advantage in trade or impede adjustments in the balance of payments.” 

"It is difficult to consider how Trump may propose to control manipulation and devaluation without fearing that currency wars and trade spates may be the inevitable result. That said, it is very possible that Trump’s strong language is an effort to position himself strongly ahead of any negotiations on trade with countries such as China, Japan and Germany." 

"Abe remains one of the world’s flag bearers of free trade. The desire to export is no doubt made more urgent in Japan by the fact that its rapidly shrinking population means that increasing domestic demand is clearly going to remain hugely challenging." 

"In terms of the valuation of its currency Japan, like Germany is currently working with an advantage. Both these countries are benefitting from soft effective exchange rates. On many measures of Purchasing Power Parity the USD is overvalued vs. both the JPY and the EUR putting US exporters at a disadvantage. In other words, Trump does have a point in expressing concerns about the value of the USD." 

"The major push back against a border tax in the US is the assessment that in a system of flexible exchange rates the USD would, in theory, rise by the amount of any export subsidy. In practice offsetting measures by other countries could limit the amount the USD would rise, but some appreciation of the USD would likely be inevitable."

"Given its flexible exchange rate regime the US government doesn’t have the ability to manipulate its fiscal policy in the way that countries such as Germany and France can to create an incentive for exporters. That said, the enormity of the US market will ensure that Trump has a strong hand in forthcoming trade negotiations. On the assumption that the US Administration will not attempt a border tax, we are not expecting a USD rally this year."

Is Trump keeping his powder dry for the true trade-and-currency war to come?