A pedestrian passes a foreign exchange sign advertising currency rates against the forint in Budapest, Hungary. (Photographer: Akos Stiller/Bloomberg)

A Trade-War Road Map for FX Markets: Take Cover, Find Your Niche

(Bloomberg) -- In foreign-exchange markets, investors aren’t waiting to find out if all the tariff threats being thrown around lead to a full-blown trade war.

Some money managers have begun piling into traditional havens like the yen; others are trimming currency exposure altogether; and even those who’re betting not much will come from the row are hedging just in case.

The concern is that President Donald Trump’s plan to impose steel and aluminum tariffs will trigger a wave of retaliatory levies that derail the worldwide economic expansion. The European Union has already responded, preparing punitive steps on iconic U.S. goods should Trump go through with his threats. Gary Cohn’s resignation drove home investors’ skittishness: The yen surged, while the peso and Canadian dollar sank.

“Currencies can be very small but sharp objects, where a little exposure can have a large impact,” said Gene Tannuzzo, a portfolio manager at Columbia Threadneedle Investments. “So you could see more and more managers just not really stick their neck out as it relates to FX exposure.”

Traders’ initial reaction has been to boost the yen and to a lesser extent the Swiss franc, the foreign-exchange market’s time-honored oases. Japan’s currency reached the strongest level last week since 2016 following Trump’s tariffs announcement. The dollar is proving vulnerable, extending last year’s tumble, while Treasuries advanced as markets gravitated toward less risky assets.

Pull Back

For Tannuzzo, the answer to the looming trade skirmishes has been to pare currency risk.

He acted on that concern last year, anticipating that North America Free Trade Agreement negotiations could turn acrimonious. He cut exposure to the Mexican peso and Canadian dollar in the $4.2 billion Columbia Strategic Income Fund. The fund had roughly 4 percent of currency exposure divided between the two currencies before he sold his peso positions in mid-2017 and reduced the loonie late last year.

“It’s probably the first time in a while that we haven’t had Canadian dollar or Mexican peso exposure at all, and one of the reasons at the top of the list is negotiations on the trade side,” he said.

The move proved prescient. Trump has used tariffs as a bargaining chip in Nafta talks, saying the U.S. won’t lower levies on Mexican and Canadian steel and aluminum unless the countries agreed to a Nafta revamp. The Canadian dollar slumped to its weakest since July this week.

The administration is also considering tariffs on a broad range of Chinese imports, according to people familiar with the matter. For some investors, U.S. action versus China would signal a mounting danger of tit-for-tat measures.

Look Micro

Some investors see a way to bet the global economic expansion survives the trade row.

Adrian Owens, a money manager at GAM (U.K.) Ltd., isn’t ignoring the rhetoric on trade. For him, the best way to navigate it is through currencies that have strong country-specific drivers that will endure what he sees as temporary volatility. He’s focusing on Norway and Sweden, the former because it looks cheap and data point to economic strength.

“We like the sort of more idiosyncratic plays,” said Owens, whose firm manages about $170 billion. “We acknowledge that one of the risks is if things deteriorate with Trump in terms of a trade war.”

To protect against the risk of krone declines should spiraling trade tensions undermine global growth and demand for Norway’s oil, he’s hedging through positions such as those that profit on yen gains, he said.

Losers Loom

Reduced global output and diminished risk appetite would also threaten currencies of emerging nations, said Mike Moran, head of economic research for the Americas at Standard Chartered.

“These kind of trade wars haven’t provided a positive environment for emerging markets, ever,” Moran said. These countries are “more sensitive to global trade, so anything that hurts that has had an adverse impact on them.”

Against that backdrop, Richard Benson, head of portfolio investments at Millennium Global Investments, which manages $14 billion, is wagering against China’s currency as part of positioning for rising trade tensions.

Dollar Dilemma

And what does it all mean for the dollar?

A global trade war could spell trouble. Barclays Plc analysts have predicted that U.S. growth would cool as much as 0.2 percentage point in the wake of steel and aluminum tariffs, a trend that could be magnified depending on how America’s trading partners respond.

That would be a worrisome development for the U.S., with swelling trade and budget shortfalls leaving it more dependent than ever on international demand for its debt.

“It’s a bit of a double-edged sword,” said Tannuzzo at Columbia Threadneedle. “The dollar should ultimately strengthen in the short-term against the currencies affected by the tariffs; in the long-run, it could stay under pressure overall because it has to fund large and growing current-account deficits.”

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