Dollar, Growth Bets Likely Losers in Any Trade War

November 11, 2003
By Burton Frierson

LONDON (Reuters) - Global trade tensions from a U.S. steel tariff dispute could undermine the dollar and high growth currencies from the Australian dollar to the Swedish crown if investors grow defensive on the world economy, analysts say.

Analysts say the issue could increasingly weigh on markets in the approach to December, when the European Union says it could start imposing sanctions on $2.2 billion of U.S. goods if Washington does not scrap controversial duties on steel imports.

The World Trade Organization's highest court ruled on Monday the duties violated global trade agreements, piling pressure on Washington to remove them.

Some analysts expect the U.S. to back down but say the dollar would suffer from signs of escalation if investors who have bought into the U.S. recovery story believe trade tensions would harm growth.

"If we start to see a looming trade war then we could see investors looking to unwind some positions and the dollar could take a little bit of a hit," said Jeremy Stretch, senior currency strategist at Royal Bank of Canada Capital Markets.

"We've seen good gains in the dollar bloc currencies -- Australian and New Zealand dollars, the Canadian dollar -- they may well start to unwind a little bit. Also currencies like the Swedish crown might also lose a bit of ground."

On Tuesday dollar was a cent off seven-week highs against the euro after rallying close to five cents in recent weeks on the back of an improving U.S. growth outlook.

Meanwhile, the Australian and New Zealand dollars have hit a succession of six year highs on the greenback and the Canadian dollar was not far from recent 10-year highs, as investors have sought out the high yielding currencies as leveraged plays on a U.S. recovery.

The Swedish crown, seen as a pro-cyclical currency, is also considered a good bet as Sweden's economy is geared into the current global economic recovery.

BROAD THREAT TO DOLLAR

The actual sanctions on the table do not amount to much of a threat to the dollar or global trade volumes. But the broad nature of the steel row indicates a potentially wider threat if tensions were to rise to the point where markets start to factor in a trade war as a likely outcome.

The steel dispute threatens more than just U.S. trade ties with the EU, which was among countries including Japan, Brazil, South Korea and Switzerland to file a complaint with the WTO.

Beijing added its voice on Tuesday to those welcoming the WTO ruling, saying the duties also affect China's steel exports to the U.S.

"Given that in the case of Japan it is very much official money that is buying U.S. Treasuries, clearly a political dispute could have repercussions here," said Michael Klawitter, senior currency strategist at West LB.

"The risk is that on the political front you would see official institutions such as central banks thinking twice about whether to buy U.S. Treasuries or whether they should invest their foreign currency reserves in other reserve currencies."

As of November 5, foreign central bank holdings of U.S. Treasury and agency debt totaled $1.003 trillion -- the equivalent of around 10 percent of U.S. gross domestic product.

This figure was a record high and a rise from $807.60 billion a year ago, suggesting the official flows were playing an increasingly important role in helping the U.S. finance its billion dollar a day trade deficit with the rest of the world and in maintaining the dollar's value.

Private foreign investors could also turn cautious about sending their savings to the U.S. if they feel a trade dispute could choke off the global economic recovery in its early stages.

Ironically this could cause further rises in the yen, even though the Japanese currency is traditionally bolstered by the country's heavyweight export sector.

"There is a double-edged sword as far as the yen is concerned. You can argue a global recovery story should be positive for the yen," said Stretch.

"On the flip-side, if there were any signs of a trade dispute picking up, it could be that Japanese investors are no longer quite so happy to channel such significant levels of fund flows into the U.S."

NOT SO LIKELY

But some analysts say the U.S. will most likely capitulate, since its massive trade deficit means it probably has more to lose from a trade war than anyone else.

Also, while some see increased trade tensions threatening the global recovery, recent signs of an improving U.S. economy -- including news of robust third quarter growth -- may leave Washington more inclined to compromise than to take a hard line.

"Obviously the situation is escalating but chances are the U.S. will back off at the last minute under the threat of trade sanctions," said Alex Patelis, senior currency strategist at Merrill Lynch.

"If this turned into a trade war and escalated into other areas, which I doubt, then the loser has to be the U.S. for the reason that it is the one that needs imports more than anyone else, has a very large share of world trade and from also an intellectual standpoint it stands for free trade."

http://www.forbes.com/markets/newswire/2003/11/11/rtr1143389.html