DB FX Daily: Trade Policy Drag on USD, FX Managers Shift from USD

[RTFX-Trading]

FX Daily: Trade Policy Drag on USD, FX Managers Shift from USD

Trade Policy Another Potential Drag on USD

The US Department of Commerce announcing countervailing duties on imports of coated free sheet paper from China last Friday is a fairly narrow tariff provision by itself. But it marks a potentially important change in trade policy as this is the first time countervailing duties are to be imposed on a "non-market" economy as China is currently defined. This shift in policy by itself could open new trade cases in other sectors where countervailing duties could now be employed should anti-subsidy or anti-dumping be found in China or other "non-market" economies. Relative to currency markets, trade policy can have longer time horizons meaning future decisions on trade policy actions could be months rather than weeks away. But the now credible threat of further trade actions may increase the time pressure on policymakers to address global imbalances. For the US, the recent history of the FX markets points to USD weakness around moments where tariffs and trade policy have become significant issues perhaps as the market sees a priority placed on competitiveness through policy changes which could also point to currency depreciation. One key example would be the steel tariffs imposed in March 2002 at the beginning of the USD's multiyear decline. Trade policy may not be enough to prompt USD weakness by itself but can add to a cyclically driven USD drop.

Looking forward there are some key dates on the US political calendar over the next two months which could keep trade policy a key USD issue. We would highlight the next US-China Economic Dialogue in May, the due date for the next semiannual US Treasury report to Congress on exchange rate policy on May 15 (though recent reports have sometimes come some weeks later) as well as the debate over the extension of trade promotion authority for the President which expires on June 30th. These domestic events combined with the G7/IMF meetings in mid-April make for a period of heightened political risk on trade and currency issues over Q2.

FX Reserve Managers Shift from USD to EUR, GBP and JPY

The latest release of the IMF COFER data is summarized in the two charts below where reserve managers appear to be reducing the USD share of reserves and have shifted into EUR, GBP and (for the first time in a while) JPY. Though the data only captures the currency composition of about two thirds of global FX reserves the acceleration in the shift out of USD since the beginning of 2006 still appears quite strong.