In yesterday's daily, we discussed our thoughts on the recent escalation of a global trade war and the subsequent effects, we continue to pen our views:
The dangerous consequence of the US administration’s decision to embark on this course of action is that it could easily lead to another financial collapse and world leaders will need to think quickly about how to avert this. A slowdown in consumer spending would likely go hand in hand with a slowdown in economic growth and investors are likely to respond by taking capital home. Creditor nations like Japan tend to see their currencies appreciate under those circumstances, and whilst the euro faces difficult challenges with Brexit and the huge indebtedness of the periphery, the euro is likely to gain too. As those two currencies are major components of the RMB basket then the renminbi is likely to strengthen too.
If these exchange rate adjustments happened slowly over time, then the situation could be manageable, but as we saw in 2008 that tends not to be the case. So an escalation by the Trump administration of the current trade war risks a quick exchange rate adjustment with a much weaker US dollar which conveniently would suit Donald Trump’s agenda. However, if this happens in an uncontrolled way then this could have devastating consequences for financial markets.
With that in mind, one way of controlling the situation would be for world leaders to jump straight to the end game and consider another Plaza accord, with a quick one-off adjustment down in the dollar. Whilst that would be potentially painful, the fact that it would be coordinated means that it would be less painful than another financial and economic crises.
Whilst the Europeans might not like the outcome as their large trade and current account surpluses would decline, the appreciation of the euro would help reduce the need for the ECB to raise rates which will help insulate the heavily indebted nations like Spain, Portugal & Greece. China too would benefit as the increased spending power of the stronger renminbi would help reduce the cost of imports and speed up the rebalancing of the economy towards more domestic consumption. It's not an easy decision, but such a Plaza accord type arrangement, if delivered to the world by the Europeans, Japanese and Chinese would put those countries in a leadership role. That might not sit well with Donald Trump, but if he is going to get a weaker dollar from the consequences of his actions, it might as well be driven by a decision taken by someone else.
Whatever the next steps turn out to be, the assets of choice seem to be US Treasuries, high-grade bonds, Chinese renminbi and Japanese yen; the mix of assets that we currently favour.