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- EUR seen biased lower in coming months over U.S. car tariff threat.
- Stronger-for-longer USD, weaker EUR to result from U.S.-EU spat.
- U.S. demands and EU politics mean any deal will be difficult to do.
The Euro is in danger of seeing fresh weakness against the Dollar during the coming weeks as markets wait to hear whether the White House will go ahead and impose tariffs on European exports of cars to the U.S., analysts say.
President Dondal Trump now has on his desk an eagerly-awaited "section 232" report from the Commerce Department, which sets out whether European exports of cars to the U.S. are a national security threat, after a year-long investigation was wrapped up last week.
The Japan Times reported last week that the report finds European car exports are in fact a threat to national security and that it contains a recommendation to impose a tariff of 25% on all fully assembled vehicles and component parts imported into the country.
"While the EUR has clawed back some ground vs. the USD this morning after having dipped towards the EUR/USD1.1234 area at the end of last week, we continue to view the single currency as vulnerable," says Jane Foley, a strategist at Rabobank. "Faced with this level of uncertainty we see scope for EUR/USD to dip towards 1.12 on a 3 month view."
A "section 232" national security threat was the pretext used to impose tariffs on imports of aluminium and steel into the U.S. last year, which saw the European Union, Canada, Mexico and a range of other countries clobbered with new tariffs on their metals exports to the U.S.
Fears are that President Trump will now use the imposition of double-digit tariffs on cars as leverage in future trade negotiations with the EU, which means already-struggling European economies could soon have another headwind to contend with.
"This leaves Donald Trump with a three-month window to call an executive order that imposes a 25% tariff on car imports. The risk of auto tariffs was part of fuelling the setback in EUR/USD and European auto-stoxx roughly a year ago in March-2018," says Andreas Steno Larsen, a strategist at Nordea Markets. "We are therefore currently far from peak auto-tariff fears, judged from the story-count index that we track on auto-tariffs."
Above: Euro-to-Dollar rate shown at daily intervals.
Larsen says the Euro-to-Dollar rate's steep fall back in 2018 was aided by a steady escalation of concerns over White House trade policies and what they could mean for not only China, but the EU as well.
May 2018 saw the launch of the section 232 investigation although a July agreement between the White House and EU established a de facto cease fire on tariffs while both parties entered talks aimed at preventing a fight over trade.
"From March to June 2018, the setback in EUR/USD coincided with a massive pickup in stories on potential auto-tariffs. What if the talk of auto-tariffs re-emerges over the next three months on the heels of the report released this weekend? Then the USD could prove stronger for longer (maybe in particular against EUR, Asian FX and SEK)," Larsen says.
Eurozone growth has already slowed markedly in the last six months, with the German economy at the heart of the deceleration, due to economic weakness in China, uncertainy over the Brexit process and a range of temporary factors.
Weakness has so-far been mainly concentrated in the car-producing industrial sector, although surveys have shown services industries across some of Europe's major economies also experiencing a slowdown at the beginning of the New Year.
"This would hit EU GDP growth and the single currency, because auto-related trade accounts for 10% of US–EU transactions," says Vincent Freideiric Mivelaz, an analyst at Swissquote, about the 232 report. "Germany has the most at stake; the EU economy as a whole remains highly exposed."
Any tariff fight between the EU and U.S. would even further undermine the outlook for economic growth on the continent, keeping the European Central Bank (ECB) on the sidelines for even longer, or potentially forcing it to reverse the small baby steps toward policy normalisation that it's taken so far.
The ECB's interest rate is still at 0% and its deposit rate is at -0.4%, meaning it costs banks to deposit money at the ECB rather than paying them. But the ECB ended its multi-year quantitative easing programme in December and previously stopped the targeted-long-term-refinancing-operations (TLTRO) that provided cheap cash to banks.
The ECB has acknowledged risks to the outlook are now tilted to the downside and hinted strongly in January that it may be 2020 before the bank is able to lift its interest rate from current record low levels.
Above: Euro-to-Pound rate shown at daily intervals.
"The EU wants to strike tariff-cutting deals on industrial goods (“we abolish our car tariffs, you abolish your SUV tariffs.”). However, the US is also seeking enhanced access to the EU agricultural market. On this issue, the political room for the EU to yield to US demands is very limited," says Holger Schmeiding, an economist at Berenberg. "President Emmanuel Macron will not accept significant changes to EU agricultural policies that could further nurture unrest in rural regions. Similarly, lowering EU standards for foodstuffs would be so unpopular in major parts of the EU that it could put governments at risk, including German chancellor Merkel’s."
The danger for the Euro is that if President Trump does impose tariffs on the European car sector in order to have leverage over the European Commission during forthcoming negotiations, the fractious nature of European politics and litany of competing interests on trade could see talks drag on for years while the economy remains uncer pressure from the levies.
That could easily see the ECB forced to sit on the sidelines for the 2020 year too, which might then weigh on the Euro because as much as markets have recently given up any hope of seeing an interest rate rise in 2019, they're still hopeful about next year. The overnight-index-swap implied ECB deposit rate for July 2020 is -0.25%, suggesting investors anticipate at least a 15 basis point rate hike will have been announced by then.
"There would be very little to report on the EUR positive side if this conflict were to escalate. The smallest economic disruptions would no doubt be damaging for the EUR in the light of the fragile state of the euro zone economy," says Ulrich Leuchtmann, head of currency strategy at Commerzbank. "I think that positive signs on the US-Chinese trade front hardly serve as an indication as to how things are going in the US-European trade conflict. I would consider any EUR strength based on this assumption to be unjustified."
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