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- HSBC says the Trump administration could shake up most of the $5 trillion currency market with clauses it's trying to insert into trade agreements.
- Global head of FX research David Bloom says the administration wants to stabilize the euro, Chinese yuan, Japanese yen, and other currencies to address the US trade deficit. That would give the US' tariffs more strength as well.
- Bloom warns that the trade deals could make the economy itself more volatile if those currencies can no longer respond to changes in fundamentals.
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The Trump administration's trade war could alter the global economy, and HSBC says it could also reshape the world's currency markets. If so, it could introduce new dangers.
An HSBC team led by David Bloom, global head of FX research, writes that the administration wants China, Japan, Europe, and other partners in trade talks to keep their currencies more stable relative to the dollar. The proposed US-Mexico-Canada Trade Agreement contains a similar clause.
"Currency clauses in these trade deals would imply an agreement among policymakers to alter how much of the currency market operates," says Bloom's team.
If it gets all of the trade deals and terms it wants, HSBC says it could affect 80% of the $5 trillion global currency market, and would reduce volatility beyond its already-low levels. Those are documented in this chart, which shows a strong trend dating back four years.
Bloomberg and HSBC
Volatility of foreign currencies compared to the US dollar has been falling, and new rules backed by the Trump administration might reduce it even further.
Less volatility might sound like a good thing, but Bloom's team says that making it a critical part of so many major trade deals is risky. They say cracking down on currency movements just means that when conditions change, the pressure that is currently released by those moves will come out somewhere else.
"Lower FX volatility might be accompanied by higher economic volatility," the team wrote. "If currencies are prevented from responding to shifting fundamentals or if the targeted rate is wrong, then the adjustment would have to happen elsewhere, most likely in the real economy."
And that reference to the "targeted rate" is significant because HSBC believes there is already evidence the dollar is trading at a higher level than it should.
If the trade deals are designed with the assumption the dollar will stay roughly where it is, that could make it harder for the administration to achieve its goal of reducing the trade deficit. Worse, it might mean that inevitable currency market moves will put some of the US's trading partners in violation of the trade deal, leading to new tariffs and bigger problems in the future.
"If trade agreements and lower tariffs are built on a promise of stable FX, they will be on very uncertain foundations," Bloom and co. wrote. "So much has to go right for such a framework to be sustainable."
Given the huge economic effects, it's not surprising that the trade dispute has already made waves in the currency market. HSBC notes that when tariffs on imports from China and Mexico were threatened, both of their currencies swiftly weakened relative to the dollar.
The moves mirrored the size of the proposed tariffs, which would have made the duties less effective. It's one reason experts have said the tariffs won't do much to reduce US trade deficits.
Trump often bashes those moves as currency manipulation. Such moves can be the result of deliberate manipulation, HSBC says, but they're also the normal behavior of currency markets. But either way, it says the administration aims to stop them.
"They want to impose limits and clauses preventing currencies from adjusting and undoing the work of tariffs," HSBC said. "The aim is to prevent currency moves being used to offset the economic obligations of any trade agreement."
And that wouldn't just change the way currencies are traded. It would change the way they respond to changing conditions and expectations. On Tuesday the euro fell after European Central Bank President Mario Draghi pledged new stimulus for Europe's struggling economy. Trump attacked that, too, as manipulation.
While Bloom's team writes that any trade deal is likely to encourage a "risk on" attitude from investors, but if the trade deals all hinge on stabilized currencies, the relief of a deal could ultimately set the stage for a big drop.
"The risk therefore is that the trade agreements could be threatened by transgressions of the currency stability clauses, prompting a return of 'risk off,'" they said.