Whilst the US and China trade war has featured daily in headlines across the globe, a looming red blooded trade war has been flying under the radar. We’re talking about the US and Europe. With the likelihood of tariffs being imposed on imports by both parties, the threat of a major impact on market prices is a very real possibility.
Here’s a rundown of the potential outcome.
Initially the impact would likely be minimal, thus the effect on market prices would be limited. Earlier this year, Trump imposed tariffs on steel and aluminium imports from the EU, Mexico and Canada, with little to no market reaction. But as we’ve witnessed with the US and China situation is that these tariffs often turn into a game of ‘one-up-man-ship’ as both sides react to the other’s behaviour, escalating things along the way.
If history is anything to go by, a few renowned items are the next to be impacted by tariffs such as luxury cars (German of course), American motorcycles (Harleys, etc) and French produce (cheeses, etc). Now, this still doesn’t sound like the doom and gloom that it’s painted to be, but as things continually escalate in a tit-for-tat fashion we’ll see tariffs imposed on more and more critical items as pressure slowly builds. Economic growth in the affected countries can soon slow and this is where we see the real knock-on effect through the prices of currencies, stocks, commodities and government bonds.
But it doesn’t stop there. Consumer confidence starts to wane which leads to businesses and companies investing less in marketing and supply, while shoppers buying slows to a trickle.
This is where the pressure cooking really gets under way. With business and consumer confidence rapidly reducing we see the economic growth impacted strongly. Retailers and other businesses slash their prices in an attempt to lure consumer spending, but it’s all futile. Next, commodities take a hit, with widely used industry products such as copper and crude oil suffering as demand evaporates.
What does it mean for Financial Markets?
With the fall of commodity prices comes the fall of the stock prices of the companies that have anything to do with those commodities. So, raw-material companies start to suffer, manufacturing and construction companies more specifically.
As economic growth continues to plummet, so does inflation. Typically, the Forex market is the next to follow and we’ll see currencies affected, in this instance predominantly the Euro.
How to Trade Tariffs and Trade Wars
The typical first move is to avoid buying the stocks that are most affected, in fact you can begin to short the stocks within the affected sectors.
But, don’t fall into the trap of thinking that gold is the safe haven. I mean, with everything that’s going on, there’s not exactly a lot of demand for jewellery.
As fear and panic begins to infest the consumer and investor world, we see the effects of all the above exaggerated.
With the US being the EU’s most significant trading partner, even larger than China, the Euro continues to suffer and we see an enormous flow of European funds leaving the US, which means, short the Euro.
Is Anything Safe?
So you ask yourself, what can I buy? With the EU and US strongly affected, countries with more dominant service sectors would start to look quite attractive by comparison. We’d likely see the UK and Switzerland outperform their ‘peers’, which opens the door to buying GBP and CHF against the Euro.
One of the even better ways to go, would be to check out government bonds in some of the economically safest countries, such as the US, UK and Germany. As stocks fall, the bonds and bunds tend to rise.
Now, none of this necessarily will happen, and while a trade war would be devastating for the global economy as a whole, it can still be a profitable opportunity for the agile, savvy traders and investors.
Source: Vantage FX Blog