At a Glance
- Market-sensitive currencies like euro and pound sterling tend to perform better when stock markets rally
- The U.S. dollar could be the ultimate winner if trade war news sends stocks lower
Stocks hit record highs in April, but for the past few weeks, it has been a rocky ride. The S&P 500 turned south after Sino-U.S. trade relations boiled over and the United States slapped China with new tariffs. They retaliated in kind with duties on U.S. imports and the battle is now spilling over to the corporate sector with President Trump adding Chinese telecommunciations giant Huawei to a trade blacklist.
This is a big deal because it prompted a decision by Google to stop supporting Huawei devices. While the Commerce Department eased restrictions after Google’s announcement to give U.S. telecom providers 90 days to come up with long-term solutions, it is a temporary reprieve to help US businesses and not the rest of the world.
No Panic Yet
With that in mind, investors are worried but not panicking over the trade war. The slide in U.S. stocks has been limited by the resilience of US data and the Federal Reserve Chairman’s upbeat outlook. As recently as late May, Jay Powell said he sees continued growth in the economy and strong job creation. This confidence explains why the U.S. dollar was one of the best performing currencies in the second quarter. The trade war may hurt the U.S., but it is far more damaging to the rest of the world.
Even if stocks go cold as slower growth abroad spills onto U.S. borders, investors could continue to buy dollars. The timing for a stock market correction could not be more well timed as we’ve all heard the saying “Sell in May and go away.
When Stocks Are Strong
There’s always been strong correlation between equities and currencies. Traditionally, when stocks perform well and risk appetite is strong euro, sterling, Australian, New Zealand and Canadian dollars will perform the best. These countries are the most vulnerable to global growth so an improved outlook gives investors the confidence to invest in their riskier and more market sensitive currencies. There’s less of a need to park cash in safe haven currencies like the U.S. dollar, Japanese Yen and Swiss Franc.
When Stocks Fall
In contrast, when stocks crash, the U.S. dollar and Japanese Yen perform the best because they attract the most influx of safe haven flows. But if stocks go cold because of the trade war, the U.S. dollar could be the ultimate winner. We’ve already seen evidence of that as currencies such as the euro, sterling, Australian and New Zealand dollars fall to multi-month lows. As a direct result of growing trade tensions, the Reserve Bank of New Zealand lowered interest rates and the Reserve Bank of Australia is widely expected to follow. The European Central Bank could also resort to more accommodation. The Fed on the other hand is still focused on tightening monetary policy and has no plans to raise interest rates.
The Japanese Yen rises when stocks fall for a very different reason than the U.S. dollar. When markets are rallying, global macro investors love to borrow in the low-yielding Japanese Yen to fund purchases of higher yielding instruments. When volatility rises and markets collapse, they reverse their flows and the Japanese Yen is bought back after riskier positions are liquidated. So if the rest of the world suffers more from a trade war than the U.S., the Japanese yen and U.S. dollar should be the best performers. Even if stocks rise, as long as the trade war rages on, the dollar will be king as long as the U.S. economy DOESN’T fall into recession.