One Trader Warns “A Hot Trade War Is Not Priced-In”

It appears the rhetoric coming out of Davos is slowly but surely catching up to markets – after initially just impacting the dollar – as former fund manager and FX trader Richard Breslow details below, the market is not priced at all for a “hot trade war” and Ross/Mnuchin’s rhetoric suggests we are closer to that that not.

Via Bloomberg,

Reading the comments made this morning in Davos by the U.S. Secretaries of Treasury and Commerce, I found myself humming the song “You Did It” from the musical My Fair Lady. And just couldn’t figure out why. Then I realized there were actually two very logical reasons. First of all, it was sung by two self-congratulatory individuals who were celebrating that they had pulled off a terribly clever deception without being aware of the responsibilities attached from having done so. Secondly, I realized that I was subconsciously changing part of the lyrics in my head to now read, “He was born a vulgarian.”

Without even getting into the implications of the policy threats promised, the zero sum understanding of global commerce, let alone the choice of words (“A trade war has been in place for quite a little while, the difference is the U.S. troops are now coming to the rampart”) I was struck by how various asset prices responded. Or didn’t.

But if they carry through on these statements, it’s worth re-evaluating which current winning positions should stay good and which are open to question.

  • The dollar under pressure story versus the majors seems like a difficult (read potentially volatile) but sensible trade to try to stick with. There will be pushback, and yes, it could make their central banks more dovish at the margins on inflation concerns. But consider what long-term effects such go-it-alone unpredictability will have on reserve allocations.
  • There’s a belief that the size and depth of the Treasury market makes it too alluring to be shunned. Secretary Mnuchin seems to think so. It’s a big risk to take. Any sort of buyers’ strike would be felt quickly and definitively. The Treasury Secretary said, “Treasuries not an issue in talks with China.” Merely proving the point that some things shouldn’t, or don’t need to be said.
  • Which makes me very interested in watching what the yield curve decides to do. Flatteners have been a marvelous trade. I’m not sure the lack of term premia will be as justifiable going forward. And it’s unlikely that the short end can keep up in that scenario despite any inflation effects from a secular dollar downtrend. We could get to that elusive 3% level in tens for all the wrong reasons.
  • Asia seems unfazed so far. Investing in emerging markets from the Pacific Rim is a widely popular expression of risk. But actions so far this week, have put the growth outperformance story for that region squarely in the trade war cross-hairs. Keep a close eye on where the promised “further measures” are aimed. They sell a lot of things into the U.S. market. And also consider what this all means for Chinese hegemony in that part of the world and the standing of the U.S.
  • Gold feels like it will only get more popular as an essential in a well-balanced portfolio. But I’m torn about other commodities. It’s a mixed bag, with the Bloomberg commodity index looking impulsive to the upside but hard commodities like iron ore and copper looking decidedly wobbly. This may be a case where the components speak louder than the sum. Put that together with a potential Chinese import slowdown and you have to wonder just how high the Australian dollar will want to run.
  • I hate to say it, but the equity story hasn’t changed and they may continue to look like the best game in town. But I do know that if the other trades that have worked so well this year begin to falter, global macro funds will need to adjust their positions and risk. Your cabbie will be explaining risk-parity to you.
  • It’s hard to a priori separate bluster from the real thing, but it’s well worth the time to at least revalidate in your mind those trades that have been so consistently compelling to models and risk-takers alike. Investors, and analysts alike, have been perhaps too unconcerned about the real threats to global trade and what it could mean.

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Update: US Equities finally stumbled as the rhetoric stoked…

After earlier, dismissing concerns of a “gigantic” trade war, saying Washington simply wanted a level playing field and was still open to trade talks with the European Union.  

U.S. trade authorities are investigating whether there is a case for taking action over China’s infringements of intellectual property, Commerce Secretary Wilbur Ross said on Wednesday, calling Beijing’s 2025 technology strategy a “direct threat”.

Action on intellectual property would open a new front in global trade battles involving the United States. Washington on Tuesday slapped steep import tariffs on washing machines and solar panels in moves billed as a way to protect American jobs by President Donald Trump. They sparked condemnations from China and South Korea.


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