China Tariff Extension & What it Could Mean for USD

Before the end of this week, US President Trump will decide if the March 1st China tariff deadline should be extended. Everything he’s said so far suggests that it will but if he changes his mind at the last minute, which is always a possibility, currencies such as the Australian and New Zealand dollars will come crashing down. They won’t be the only currencies on the move because a breakdown in trade talks and fresh tariffs on China will have global ramifications. Risk appetite will sour, stocks will fall and all high beta currencies will suffer.
However all signs point to an extension. Earlier this week, President Trump said March 1st is not a magical date and today he said there is a good chance a deal will be made and that he expects to meet with President Xi in the not too distant future. Although he also downplayed expectations by saying that they “perhaps could work out the final deal and perhaps not,” they are closer to an agreement than ever before. Trump even talked about a short term memorandum of understanding (MOU). However “there are some great hurdles left” according to US trade representative Lighthizer. Extending the March 1st deadline would not be a major concession for President Trump. An extension does not equal an agreement and given the complexity of the talks, they are going to need more time. By extending the date, Trump will also be applauded by the markets so the decision should be easy. The key question is how long the extension will be – one month, two months, October or open ended? The longer the extension, the better it will be for risk appetite. While USD/JPY could rally, the biggest beneficiaries won’t be the dollar but rather AUD, NZD and EUR.
If the deadline is extended and generously so, stocks will rise to fresh highs taking all of the major currency pairs up with it. A decision, good or bad will be a breath of fresh air for FX traders looking for volatility as we’ve just closed out a consolidative week with pairs like USD/JPY never venturing more than 50 pips from its high/low and EUR/USD fluctuating within a less than a cent range.
Last week, we talked about how the US dollar was past its prime and we saw evidence of that in the latest economic reports that showed manufacturing activity in the Philadelphia region contracting for the first time since May 2016. Orders for durable goods also fell while sales of existing homes continued to decline. None of these reports were game changers for the central bank but they reinforce the slowdown that has reduced the dollar’s luster. According to the minutes from January FOMC meeting, Federal Reserve officials are unsure what rate changes would be needed in 2019. Its clear that for the Fed, everything is data dependent and because they don’t have a strong conviction in one direction or another, investors continued to price in a greater chance of easing than tightening before the end of the year. With that in mind, the dollar is trading purely on risk on / risk off flows which will continue in the coming week. President Trump’s decision on the March 1st China tariff deadline will be the main focus because the only number that matters to the dollar is Q4 GDP.