Trade war is slowly fought
Market focus remains on trade policy, as markets are still concerned about a full-blown trade war. Yesterday, Trump announced he will impose tariffs on USD60bn of imports from China, targeting 10 strategic sectors (e.g. robotics and electric vehicles) laid out by China in its 'Made in China 2025' plan and restricting Chinese investments in US companies. As the plan is not finished yet, it supports our view this is going to be a very slowly fought trade war and the theme will pop up every now and then ahead of the US mid-term election in November. Until we get more information about what Trump is actually going to do, China will stick to its moderate retaliation to Trump's tariffs on steel and aluminium for now. However, officials have said China will take further steps if necessary, most likely targeting imports of US aircrafts and soybeans and possibly other goods. See Flash Comment: Moderate Chinese retaliation - but keeping the powder dry , 23 March 2018. While important on a political level, the direct effect on Chinese GDP should not be overestimated. Trump is targeting approximately USD50bn of Chinese goods, corresponding to 10% of Chinese exports to the US, or 0.4% of Chinese GDP .
Only slightly steeper Fed rate path due to Trumponomics
Despite trade war concerns, the Fed hiked rates at its meeting this week and lifted its rate hike signal for next year by nearly one full 25bp hike , now signalling a total of five hikes from now until year-end 2019, as the Fed thinks it is appropriate to tighten a bit more due to more expansionary fiscal policy. See FOMC review: Only slightly steeper rate path due to Trumponomics , 21 March. We still believe the overall policy mix is going to be more expansionary, posing upside risk to the US inflation outlook . See Part 1: Global Inflation 6 US stimulus and closing output gaps pose upside risk , 26 February.
Despite the Fed continuing its gradual hiking cycle, we stress that short-term rates are not a key driver of EUR/USD at present. The Fed needs to change its course on policy more dramatically for it to impact USD crosses and we still see EUR/USD in the 1.21-1.26 range near term with markets being more focused on trade policy . Our medium-term story remains unchanged, as capital flow reversal and valuation should support EUR/USD on a 6-12M horizon. We target 1.28 in 12M.
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