This post is taken from our March 6th weekly report.

Once again, trade wars are a potential risk, with Donald Trump threatening to impose tariffs on steel and aluminium imports, and other countries responding that they may impose retaliatory taxes on US goods. The knee-jerk reaction was for a weaker dollar, but all other things equal, an import tax should reduce demand for imports and thus for foreign currencies, causing the dollar to rise. In the first instance, lower imports in the US leads to a smaller US trade deficit, which means lower trade balances outside of the US. As we can see in the top chart, falls in global trade tend to go hand in hand with rises in the USD.

Trying to gauge what happens with currencies necessitates not thinking in terms of single causes. The dollar is just one side of a currency pair, so we must also consider what happens in the rest of the world if global trade falls. The bottom-left chart shows that global growth and global trade are closely related, so a fall in global trade is likely to be bad for global growth. But this is likely to be more problematic for the rest of the world than the US – the bottom-right chart shows the ups and downs of global ex-US growth are more extreme than the ups and downs of US growth, ie the beta is more than one. So we would expect any slowdown in global growth to disproportionately affect the rest of the world, leading to weaker foreign currencies, ie a stronger USD.

(Click on image to enlarge.)

Source: Bloomberg, Macrobond and Variant Perception