Trade Clash Hits Markets Everywhere But Where It Really Counts

(Bloomberg) -- Even as the world’s two largest economies clash over international commerce, the asset class that directly influences the terms of trade between nations isn’t sounding any alarms.

Foreign exchange volatility measures remain subdued and have barely budged this week, while other asset classes were thrust into whipsaw trading after the U.S. ordered tariffs on Chinese goods and China retaliated. Price swings for stocks are elevated amid concerns that a trade war may erupt and choke global growth. But the JPMorgan Global FX Volatility Index is down on the week, and the only one of the three asset classes whose current gauge of market unease is below its 252-session average.

Mark McCormick, North American head of FX strategy at Toronto-Dominion Bank, attributed sluggish volatility to a lack of conviction among investors, a dynamic that’s left them reluctant to put risk to work.

“There is a mix of dollar bulls and bears with varying views but most don’t have the ability to trade a theme,” McCormick said. “Trends are sparse so I think that is sapping activity and vol to some degree."

Even so, the imposition of tariffs amid a relatively solid U.S. growth backdrop has TD growing slightly more upbeat on the greenback’s prospects, he added.

Muted price swings in currency markets underscores the synchronized nature of global output and a still-stable monetary trajectory -- offsetting, for now, trade tensions.

Traders may simply be complacent. Protectionist measures are sure to disrupt the real economy, with currency markets yet to price in the full extent of damage likely to occur, warns Jane Foley, head of FX strategy at London-based Rabobank.

“The dim reality, that the market is probably going to take on board over the next few days and weeks, is that a trade war between the U.S. and China will reach the global economy,” she said. “As the market begins to work out the real impact of this on global growth, I think it’s quite likely that currency volatility will pick up.”

Take the impact, or lack thereof, on the currencies of export-heavy economies this week. Though emerging market equities tumbled 1.7 percent yesterday, the MSCI Emerging Markets Currency Index was essentially unchanged, as the gauge’s two-week realized volatility tumbled to the lowest in five months.

One would expect emerging markets to exhibit some of the greatest weakening, said Kit Juckes, global foreign-exchange strategist at Societe Generale AG.

“Trade wars are bad for equities, for sure, and can be bad for growth,” Juckes said. “They are bad for smaller, open, trade-dependent economies more than big developed, services-centric ones.”

However, traders seem convinced that any Chinese retaliation will not play out through the currency channel. Across a variety of tenors, the implied volatility of the U.S. dollar relative to the offshore yuan barely moved on Thursday.

And that’s perhaps for good reason: George Magnus, associate at Oxford University’s China Centre, tweeted that the "surest way to reignite capital flight" would be for Beijing to devalue its currency.

To contact the reporters on this story: Dani Burger in London at dburger7@bloomberg.net, Luke Kawa in New York at lkawa@bloomberg.net.

To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Cecile Gutscher, Sid Verma

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