Tariff Uncertainty Fuels FX Market Adaptation

tariffs Loom Large: Why the Macro Story is Dominating FX Markets

The latest tariff news suggests that the broader macroeconomic narrative is set to gain significant influence over foreign exchange (FX) markets in the coming quarter. While previous market movements might have been driven by other factors, the impending impact of higher US tariffs is poised to recalibrate expectations for monetary policy and, in turn, influence currency valuations.

US Tariffs Set to Bite: A Fed Brake on Easing?

Analysts at ING anticipate that the upward pressure on US prices, a trend hinted at by business survey data, will finally manifest. This anticipated inflationary effect is expected to reinforce the cautious stance of the majority of the Federal Open Market Committee (FOMC) members. Their inclination towards delaying any restart of the easing cycle is crucial for the dollar’s trajectory.

ING’s forecast for the Fed to hold off on rate cuts until December suggests a potential boon for the US dollar. This could lead to a reversal of the decline seen in short-dated US rates during June, which had previously weighed on the dollar. The prevailing view is that the dollar could experiance a corrective bounce of 2-3% in the third quarter as the Fed remains resilient to White House pressure to stimulate the economy through rate cuts. The graphic below illustrates the potential impact of a rise in short-term rates on the dollar:

[Insert Chart: Back-Up in Short-term Rates Could Help the Dollar – Source: ING, Refinitiv]

G10 Low-Yielders Under Scrutiny amidst Tariff Uncertainty

As the dollar perhaps finds some stability, attention may also shift to developments within other Group of 10 (G10) economies, notably those with lower yields. Japan, in this context, presents an intriguing case. The upcoming Upper House elections on July 20th and their implications for Japanese fiscal policy are beginning to impact the yen. Rather of rising Japanese Government Bond (JGB) yields supporting the yen, the current sell-off in JGBs is bearing a resemblance to events in the US back in April, proving detrimental to both asset markets and Japan’s currency. A combination of firmer short-dated US rates and potential sovereign risk in Japan could see the yen weaken towards 150 against the dollar – a development that could surprise the market this month.

Swiss Franc’s Resilience and Euro’s Expected Correction

Elsewhere, the Swiss National bank (SNB) appears to have limited options regarding the persistently strong Swiss franc. Heavy FX intervention to curb franc recognition is politically sensitive given ongoing trade discussions with the US. Moreover, the SNB’s capacity to implement further rate cuts may also be constrained. This suggests that the Swiss franc remains an attractive currency for investors seeking a hedge against the potential breakdown of current benign global economic conditions.

For the Euro, ING foresees a correction back towards the 1.15 level against the dollar within the current quarter. However, their year-end forecast has been revised upwards, anticipating a resumption of the dollar’s downtrend towards the end of the year. This outlook is predicated on the Fed enacting a 50 basis point rate cut and the subsequent availability of cheaper dollar hedging costs for buy-side investors with US exposure.

In essence, the unfolding tariff landscape and its potential impact on inflation and central bank policy are likely to be the dominant drivers in FX markets, overshadowing other factors in the near term.

Disclaimer: This publication has been prepared by ING solely for details purposes irrespective of a particular user’s means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more*

How do tariffs influence the demand for a country’s currency?

The rising Tide of Trade Protectionism & Currency Volatility

Global tariff uncertainty has become a defining characteristic of the modern economic landscape. Beyond the direct impact on international trade flows, this uncertainty is profoundly reshaping the foreign exchange (FX) market, forcing businesses and investors to adapt their strategies. The imposition of tariffs – and the threat of further escalation – creates ripples of volatility across currency pairs, impacting everything from import/export costs to investment returns.Understanding these dynamics is crucial for navigating today’s complex financial environment. Key terms like exchange rate fluctuations, currency risk management, and trade wars are now central to financial planning.

How Tariffs Directly Impact FX Rates

Tariffs don’t operate in isolation.They trigger a chain reaction that directly influences currency valuations. Here’s a breakdown of the key mechanisms:

Demand Shifts: Tariffs increase the cost of imported goods, potentially reducing demand. This decreased demand can weaken the currency of the importing country.

Retaliatory Measures: When one country imposes tariffs, others frequently enough retaliate, leading to a cycle of escalating trade tensions. These retaliatory tariffs further distort trade flows and exacerbate FX volatility.

Economic Growth Concerns: Prolonged tariff disputes can dampen economic growth prospects, leading investors to seek safer haven currencies like the US Dollar (USD), Japanese Yen (JPY), or Swiss Franc (CHF). This increased demand drives up the value of these currencies.

Supply Chain Disruptions: Tariffs force companies to re-evaluate their global supply chains, potentially relocating production.These shifts can impact capital flows and, consequently, exchange rates.

Adapting to Currency Risk: Strategies for Businesses

Businesses heavily involved in international trade are especially vulnerable to currency risk.Proactive risk management is no longer optional; it’s essential for protecting profitability. Here are several strategies:

1. Natural hedging: Matching revenues and expenses in the same currency can minimize exposure. Such as, if a US company exports to Europe, it could try to source some of its inputs from Europe, paying in Euros.
2. Financial Hedging: Utilizing financial instruments like forward contracts, currency futures, and options to lock in exchange rates for future transactions.
3. Currency Diversification: Holding assets and liabilities in multiple currencies to reduce overall portfolio risk.
4. Pricing Strategies: Adjusting pricing to account for potential exchange rate fluctuations. This might involve incorporating a buffer into prices or negotiating currency clauses in contracts.
5. Supply Chain Resilience: Diversifying suppliers and production locations to reduce reliance on any single country or region. This mitigates the impact of tariffs and geopolitical risks.

The Role of Safe Haven Currencies

During periods of heightened trade uncertainty, investors frequently enough flock to safe haven currencies. These currencies are perceived as less risky and tend to appreciate in value when global economic conditions deteriorate.

US Dollar (USD): Remains the dominant reserve currency and benefits from its status as a global safe haven.

Japanese Yen (JPY): Historically considered a safe haven due to Japan’s large current account surplus and net creditor position.

Swiss Franc (CHF): Switzerland’s political neutrality and strong financial system make its currency attractive during times of crisis.

Gold: While not a currency, gold often acts as a safe haven asset, and its price tends to rise during periods of economic and political instability.

Real-World Example: US-China Trade Tensions (2018-2020)

The trade war between the US and China provides a compelling case study of how tariff uncertainty impacts the FX market. The imposition of tariffs on billions of dollars worth of goods led to:

Chinese Yuan (CNY) Depreciation: the CNY weakened against the USD as concerns about China’s economic growth mounted.

USD Strength: The USD benefited from its safe haven status, appreciating against many currencies.

Increased Volatility: The FX market experienced notable volatility as investors reacted to each new tariff declaration and negotiation update.

Corporate Adaptation: companies scrambled to adjust their supply chains, seeking alternative sourcing locations to avoid tariffs.