FX traders must consider consequences of a trade war
Nov 6 (Reuters) -FX traders must consider the consequences of a trade war should the likely new U.S. president follow through on his promise to impose tariffs on China and other nations including allies in Europe.
While traders have prepared for the inflation that seems logical if tariffs are applied, they should consider the probability that the goods being protected don't sell so well, if at all.
Rather than consumers buying what could become relatively cheaper domestic goods - as Trump hopes will be the case, there could be a plunge in consumption that has a seriously bad impact on the economy.
Instead of fuelling inflation as feared, a trade war could herald a slowdown, or perhaps a slump in demand that forces central banks to lower interest rates much further than expected.
For those trading currencies the threat of a trade war may be cause to take a more defensive stance that might initially favour any assets deemed to be safe, but would more strongly support the world reserve currency should a trade war lead to crisis.
Like any asset though, the more who own it, the less safe it becomes which was starkly apparent when overcrowded investments in the dollar led to sharp falls in 2022. This also makes gold less attractive now, and could help Japan's currency or the Swiss franc which few own now and speculators have sold.
The euro is the natural buffer to the dollar and while it is a distant second in terms of the allocation of central bank reserves, the deeper it drops in reaction to the possibility of tariffs on the eurozone's auto industry, the more attractive it could become.
The pound in which many have invested this year has never been considered safe and probably never will be. It could be one the bigger losers as many of pounds purchased this year were bought as carry trades which are risky investments that could suffer greatly in the more volatile conditions emanating from any trade dispute.
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(Jeremy Boulton is a Reuters market analyst. The views expressed are his own)
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