Dollar Falls as Trade Tensions Reignite

The new month started off on a positive footing for the euro (EURUSD) and pound (GBPUSD) on the back of a weaker dollar (DXY) on Monday, 2 June. Soft economic data in the US and rising uncertainty surrounding trade tariffs took markets by surprise after US President Donald Trump criticised China for violating their recent trade agreement following his announcement to double steel and aluminium import levies.

Now, some analysts warn not only of potential tariffs on new items, such as copper (HG), but also fear that the US’s protectionist agenda will lead to retaliatory tariffs. Following China’s accusatory response, the EU also stated that it may accelerate the imposition of retaliatory measures if the US proceeds with doubling the steel and aluminium (ALI) import levies. 

However, as the Trump Administration faces headwinds on multiple fronts, one of the most sentiment-setting battles appears to be at home.  (Source: Bloomberg)

China, EU Prepare Retaliatory Measures

Following a recent 90-day truce between the US and China, Trump lashed out at China last Friday for failing to uphold the agreement signed in Geneva on 12 May. In response to the accusations, Chinese officials pointed the finger at the US on Monday, 2 June, saying that it was the US that violated the trade agreement by introducing new “discriminatory restrictive measures” since signing. The Chinese also threatened to take retaliatory measures, with the tit-for-tat starting to take its toll on investor sentiment ahead of the August expiration of the truce deal.

Meanwhile, Trump’s announcement to double levies on steel and aluminium imports has sent shockwaves in the EU at a time when Trump faces headwinds not only with China but also back at home as federal judges seem to take a hit at the legality of Trump’s tariffs. On top of that, the US President urged all nations to come back with their “best offer” by Wednesday, 5 June. The European Commission expressed disappointment at the announcement, claiming that an increase in levies undermines any progress in resolving trade issues. US and EU representatives are scheduled to meet in Washington on Wednesday. (Source: Bloomberg)

Dollar Slides as Trade Uncertainty Fuels Haven Flows

Recent optimism emerging from trade deals has started to fade as the deals appear more fragile with time, with investors brushing aside any positivity stemming from the federal court ruling or the fact that high-stakes meetings are scheduled for this week. The flare-up disappointed markets, with the US dollar sliding against the six-basket currencies and gold (XAUUSD) rising by 2%. The sell-off accelerated further following the release of poor ISM Manufacturing PMI and Construction data in the US, despite an upward revision in Q2 GDP to 4.6% from 3.8%. Chicago Fed President Tustan Goolsbee also said that tariffs had little to no impact on inflation so far, but he warned that this might change soon.

With safe-haven US bond prices and, by extension, the US dollar impacted by trade escalation, the antipodean currencies, the Japanese yen, the euro, and the pound all ended the session in the green, with the antipodean currencies specifically receiving extra support from the tariff announcement. Notably, the pound surged past 1.35, a 3-year high, as the UK benefits from a flight to safety given its current trade agreement with the US. As for the euro, the region is set to report its flash CPI inflation data today, Tuesday, with the ECB meeting commencing on Wednesday and a likely 25-basis-point interest rate cut expected to be announced on Thursday. (Source: NewsQuack)

Temporary Tariff Relief or Prolonged Uncertainty

While the Administration fights several battles, the one back at home is taking an interesting turn that may remove trade pressures for some time. The court that brought the legal issue of tariffs to life now appeals a decision to keep tariffs effective during the appellate process, which may take months.  The court even favours a longer pause, with all involved parties filing briefs by 9 June.

If history is any guide, pausing tariffs in the interim could help alleviate selling pressure in the dollar and limit the upside on EURUSD and other currency pairs. However, even if the ruling halted tariffs in the short term or remained in place for the longer term, the Administration will likely make use of national security grounds to expand the use of tariffs to other instruments. This would be a similar step taken by the Administration in the case of steel and aluminium, which essentially limits the scope of negotiations between the EU and the US, regardless, suggesting the prevalence of the current tariff tit-for-tat. As a result, how markets perform is likely to continue to depend on potential deals. (Source: Think.ing)

Conclusion

The escalating trade rhetoric since the end of last week has supported a lower dollar at the start of June, with EURUSD and GBPUSD testing upbeat levels, as dollar weakness hangs on the shape of tensions. With Wednesday's EU-US trade talks and Thursday's ECB decision this week, traders may prefer to keep a close eye on these two events for clues into the pair’s direction.

As far as trade negotiations go, despite legal challenges to tariffs potentially providing temporary relief, the Administration is likely to pivot to national security grounds, which suggests continued volatility ahead. While market performance will ultimately depend on the outcomes of high-stakes trade negotiations, the UK could continue to benefit from its current US trade agreement. 

*Past performance does not guarantee future results