Home / Blog / Market Analysis / London Open: High carry currency appeal back in fashion as FX investors anticipate economic recovery – but US-China trade war clouds loom large

London Open: High carry currency appeal back in fashion as FX investors anticipate economic recovery – but US-China trade war clouds loom large

Market Analysis / 3 Min Read
Stephen Innes / 27 May 2020

The Dueling Playbooks 

More positive risk sentiment in recent days sees investors expressing this view by the S&P 500 briefly breaking through 3,000 to the topside and the broad trade-weighted US dollar falling through downside support that’s held since late March. Indeed, high carry currency appeal is back in fashion, signaling that Forex investors are anticipating a global economic recovery and are reducing US dollar hedges or hunting for yield with more purpose. However, the omnipresent US-China trade war clouds could put a brake on improving risk sentiment.

And while China threatens, it’s the "no news is good news" playbook for now. So, given the unbridled waves of optimism around economic re-opening, investors could pour back into risk assets on speculation the worst of the financial hit from the pandemic has passed, treating the US-China-Hong Kong fracas as an isolated escalation initially.

According to reports, the US is considering sanctions on Chinese businesses over plans to introduce national security legislation in Hong Kong. And while USDCNH has been trading in a relatively tight range but with a skew higher, this semblance of calm could prove short-lived. 

The Bank of Korea is widely expected to cut its policy rate by 25bp to 0.50% on Thursday. Korea is one of a few countries to emerge from the coronavirus relatively unscathed, after avoiding some of the more extreme economic lockdowns of its regional peers. However, financial challenges remain with export growth weak (20-day exports -20.3% y/y om May) and disinflationary risks looming (CPI: 0.1% y/y in April).

The Trade War Playbook 

US President Trump was asked how the White House would respond to China's proposal to introduce national security legislation for Hong Kong and implied that there would be a reaction by the end of the week (Nikkei). Note that US Secretary of State Mike Pompeo is also due to release a congressionally-mandated assessment on whether Hong Kong enjoys sufficient autonomy to justify continued special economic treatment.

USDCNY traded through the May 22 high at the open, pulling USDCNH almost 150 pips higher while USDCNH is wasting little time waiting for the wrath of Trump, making a shift to the top side 7.16 levels and is taking the rest of the ASEAN basket along for the ride. Indeed, the relative calm in the RMB space was short-lived as the omnipresent US-China trade war clouds put a brake on improving risk sentiment.

Increasingly gnarly US-China trade relations are challenging the bullish narrative around economies reopening. If China takes a more combative stance where the policy of choice is to weaponize the Yuan, the risk of higher US tariffs will loom exponentially. 

The early trade-driven risk-off lean is having an adverse effect across growth assets and the heavier bullishly subscribed oil markets are bearing the risk-off brunt again. Oil prices remain overly sensitive to any bad news, particularly around US-China tensions. Still, after the headline shock, the trade war impact on oil markets depends mostly on whether investors expect US import tariffs on a broader range of goods or higher trade taxes on existing ones.

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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