- The US Dollar is the most heavily used currency in the world by a very wide margin, but this position isn’t permanent
- Trade wars provoked and escalated by the United States could readily alter the flow of capital away from the US system
- Given the aggressive US actions against its peers and a collective response, the Dollar risks a systemic reduction in its use
See how retail traders are positioning in EUR/USD and other key Dollar pairs. Retail traders are much shorter-term focused in their positions, giving important contrast to long-term risks. See the evolution of positioning using the DailyFX speculative positioning data on the sentiment page.
The US Dollar Isn’t Infallible, but It Is Robust
There is little doubt that the US Dollar is robust. The currency has grown to be an undisputed benchmark of the currency world and is anchor for the global financial system in its own right. There are a number of factors supporting this elevated status including economic girth, global integration and even habit. On the economic side, the United States represents the largest economy in the world by a large margin. This factor’s influence is rather straight forward in that its scale can prove a significant boon or subsequent burden to trade partners through its remarkable consumption of exports. However, there is also a financial side to that aspect as economic depth creates a more robust buffer to market disruption. That characteristic is best observed during periods of intense risk aversion where global investors flee to US Treasuries and Money Market assets. For global integration, the use of the Greenback as a base currency in exchanges or direct purchase of commodities is without equal. That in turn leads central banks to expand its reserves of the USD. Even the habits of global investors contribute to reinforce the currency’s status. As fear rises across the globe, capital flees to the safety of the US markets as it has in the past ostensibly for liquidity.
Trade Wars Represent a Systemic Risk for the Dollar
There are many things that could theoretically challenge the position and use of the US currency in the global system. A global war that arises from a diplomatic blunder, an internal political crisis that sends capital rushing for the exits or debt crisis emerging from unchecked liabilities are all technically possible but improbable. Previously, I would have considered the United States withdrawing from its position at the center of global trade and commerce equally as unlikely, but that has clearly changed over the past months. The pursuit of tariffs against China represents a considerable risk for the US as the second largest economy and largest foreign holder of Treasuries can exert considerable influence. However, far more troubling is the country’s pressure on close allies. Following through on the steel and aluminum tariffs against the European Union, Canada and Mexico represents a remarkably belligerent stance on trade relations. What is strategically problematic for the US with this push is the likelihood that a greater segment of the world market will work together to circumvent and perhaps even penalize the instigator for this unwanted pressure.
What Does a Loss of Reserve Status Mean?
Whether the intention is to simply compensate for the economic damage done to their country or to retaliate, the net effect will of a response by the United States peers and competitors will be a reduction in the purchase of Dollars. That is natural byproduct of a reduction in consumption of US goods that require the local currency. Yet, a more troubling side effect will be the establishment of direct connections to other global economies that can provide necessary substitutes and are seen as easier and more stable to deal with. China is already a great example of this opportunism as it continues to expand connection to global economies as it diversifies away from the US. As these various connections are made through natural trade of goods and services, financing and investment naturally follows. That changes the mix of needs for currency reserves and in any combination is a diversification away from the US Dollar. It is unlikely that the Greenback will relinquish its top status as it has considerable premium to burn, the government could steer out of its policies should they deliver too much pain and the agenda will naturally shift through political cycles. However, losing ground on this front carries serious ramifications for a currency too often considered incontrovertible.
US Sanctions Against Iran May Spark 1970s-Style Oil Crisis Fears
TALKING POINTS – Iran, Sanctions, CRUDE Oil, Trump, Emerging markets
- US oil export sanctions against Iran will be enforced on November 4th
- Net-importers in emerging markets likely to suffer from higher prices
- 1970’s oil crisis, embargo may haunt markets as Trump buckles down
The Trump administration’s trade wars and economic nationalism have caused severe volatility for most of 2018. The White House also withdrew from the 2015 multilateral Iran nuclear deal – known as the Joint Comprehensive Plan of Action – in May, and has re-imposed sanctions. The most devastating will be an oil embargo that is scheduled to be take effect on November 4th.
In the 1970’s, the US imposed an oil embargo against Iran that led to a surge in prices. The jump in energy costs radically affected markets. The US – which at the time was coming on the heels of massive public spending programs– had its inflationary pressure skyrocket.
The administration’s public spending agenda, coupled with the sanctions against Iran, echo a dangerously similar narrative the world saw 39 years ago.
1979 OIL CRISIS
In 1979 – amid the turmoil of the Iranian Revolution – political radicals stormed the US Embassy and took 52 Americans hostage. In response, US President Jimmy Carter froze billions of dollars’ worth of Iranian assets in the United States and enforced an oil embargo.
The decrease in oil exports – adding to growing fears of further disruptions – caused prices to climb. Adjusted for inflation, the price per barrel stood at around $55 in 1978. In 1979, the cost skyrocketed to $97 and peaked at $122 in 1980. In 1981, the hostages were released and the price began to fall.
See our full interactive history of trade wars here.
Some economists and historians argue that “precautionary demand” was an influential contributing factor to the increased cost of oil. This same fear may be rearing its ugly ahead again today.
2018 OIL EMBARGO ON IRAN
After unilaterally pulling out of the nuclear deal – due to allegations that Iran was not cooperating with the International Atomic Agency – the Trump administration hit Tehran with two waves of sanctions. The first included a ban on any transactions involving the US Dollar, gold, precious metals, aluminum, steel, commercial passenger aircraft and coal. The White House has also banned imports of Iranian carpets and foodstuffs.
The second wave will be the oil embargo. Trump warned that anybody who conducted business in the Iranian market would face “severe consequences”. The ban requires that all importers have to immediately cut off their supply from Iran by November 4th. Any countries that violate the ban face the possibility of sanctions. The EU responded by pledging to protect European firms by activating a blocking statute established in 1996. It allows European businesses to operate under US sanctions without incurring any penalties.
The EU’s defiance to the US adds to the growing tension between allies amid the escalating trade wars. The sanctions also empower hardliners in the Iranian government. This makes the possibility of repairing relations and easing international tension much more difficult.
EFFECT ON MARKETS
If the US imposes sanctions or tariffs against the EU for conducting business with Iran, they will almost certainly retaliate. In that event, sentiment-linked assets are likely to suffer and anti-risk currencies like the Japanese Yen or Swiss Franc will probably rise.
Euro Falling on Trump’s Iran Sanctions Announcement
Crude oil has reached a four-year high, with the Brent benchmark trading at around $84/barrel. Rising prices are damaging for net importers in emerging markets. If Trump digs his heels in and commits to limiting Iran’s oil exports, emerging markets are likely to suffer.
Indonesian Rupiah and South African Rand vs the Dollar and Rising Oil Prices
— Written by Dimitri Zabelin, Jr Currency Analyst for DailyFX.com
To contact Dimitri, use the comments section below or @ZabelinDimitrion Twitter
GBP/USD Gaps Lower on Brexit Stall, Eyes CPI and Carney Speech
- GBP gapped lower versus USD, responding to Theresa May’s rejecting of an exit deal
- GBP/USD’s downside momentum continues dominant downtrend for majority of 2018
- Key economic data and BOE Gov. Carney’s speech may further influence the British Pound
Find out what retail traders’ British Pound buy and sell decisions say about the coming price trend!
The British Pound fell against the US Dollar during weekend trading as Brexit negotiations between the United Kingdom and the European Union hit an impasse. UK Prime Minister Theresa May’s Brexit Secretary Dominic Raab and EU Chief Negotiation Michael Barnier were unable to reach an agreement on a draft treaty, leading PM May to label the deal a “non-starter”. Barnier later mentioned that some key issues remain open, including the Irish backstop.
GBP/USD 1-Hour Chart
This is the latest in ongoing Brexit turmoil, and could possibly bode ill for the Sterling’s recent upside momentum. If a deal is not reached, the United Kingdom would exit the EU and be subject to World Trade Organization rules, potentially causing declines in GBP. Furthermore, longstanding political uncertainty and tensions regarding Brexit have caused the GBP to weaken for the majority of this year. Furthermore, an increasingly hawkish Federal Reserve and haven demand amidst EM contagion fears and trade wars have caused the greenback to strengthen, intensifying the currency pair’s bearish action since April 2018.
GBP/USD Daily Chart
Looking ahead, this is a week of high economic activity for the British Pound. On Wednesday, the UK Statistics Office will release consumer inflation data for the month of September. In addition, Bank of England Governor Mark Carney is set to give a speech on Thursday, with forward guidance possibly dictating next moves for the Pound. However, ongoing Brexit negotiations will continue to take center stage and overshadow economic data’s influence on the Sterling. Developments upcoming summit of European Union leaders focusing on Brexit could cause volatility shocks to the currency pair.
GBP/USD Trading Resources
— Written by Megha Torpunuri, DailyFX Research Team
Unsteady Risk Trends Increase Scrutiny on China, Italy and Brexit
Market participants will return with caution this week. Following the rout in speculative assets from shares to emerging markets to Yen crosses, there is an understandable tension amongst investors. In this environment troubling news in trade wars, Chinese growth, Euro-area stability or any number of key themes can readily find traction.
Fresh developments coming out of the U.S. economy may curb the recent selloff in USD/JPY as Federal Reserve officials see a risk for above-neutral interest rates.
After trading to four year highs to open the month, Crude has come off the highs along with risk sentiment, but you crude appears to have fundamental support that could keep bulls confident.
It may be uncomfortable but sitting on the fence is the best place to be ahead of next week’s Brexit updates and EU Summit
Gold was the beneficiary of safe haven demand this week after the Dow lost over 1,300 points in just two days.
The Australian Dollar held up quite well to the intensification of one or two factors which have stymied it this year. Don’t rely on that continuing
China’s weak economic growth could add more bearish momentum to the Yuan; at the same time, Chinese regulators may try to avoid extreme volatility.
See what live coverage is scheduled to cover key event risk for the FX and capital markets on the DailyFX Webinar Calendar.
See how retail traders are positioning in the majors using the IG Client Sentiment readings on the sentiment page.
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