USD: Goldman Sachs On USD, Tariffs Key But Data Resilience Underpins USD
Goldman Sachs: "We see three key takeaways from a frenzied week. First, the recent back and forth headlines have not altered our view that tariffs are coming and this will materially impact exchange rates. In fact, our economists now expect a larger increase in the effective tariff rate than they had previously envisioned, though not quite as high as what was threatened a week ago. As a simple summary metric, judging by the effective tariff rate, our economists previously expected new tariff measures to be worth twice as much as the entirety of the first trade war; our new baseline is for Trade War Two to be three times the size. Importantly, we see a distinction between the tariffs being bandied about now, which seem intended mainly as leverage in negotiations to extract concessions and were never a part of our baseline, and the tariffs that seem intended to address economic issues like increasing domestic production of particular products and narrowing the trade deficit. We expect tariffs of the latter type are still on the way.
Second, it is clear that FX is responding strongly to tariff risks in both directions. This had been somewhat in question a few weeks ago, when investors were asking whether tariffs were “priced in” to FX already, and whether the Dollar could outperform rate differentials on tariff risks to the same extent as in 2018-19. We now have multiple event studies in the space of the last two weeks that provide a helpful mapping for exchange rates in response to tariff expectations ratcheting up or down. The Dollar broadly outperforms on higher tariff expectations, the Euro underperforms, and the Yen was the safe haven of choice by a slight margin.
All of that is similar to last time, even as the response in rates and equities has been somewhat more nuanced than last time. However, while there are important caveats around these particular tariffs—the ongoing negotiations, fentanyl focus, and the fact that the higher tariff rate will take a few weeks to take full effect after taking post-holiday shipping times into account—we see a somewhat higher risk of a smaller CNY response to the tariffs we expect. But we think overall moves demonstrate that the Dollar can outperform if tariffs are actually implemented, and that FX should be the preferred asset class for hedging this risk for cross-asset investors.
Third, the solid payrolls report demonstrates that economic performance is still putting a floor under the Dollar. While we remain closely focused on risks to our forecasts stemming from tariff under-delivery and more balanced global economic performance, at least for now the US continues to set a high bar, and much of the Dollar’s strength in recent months can be attributed to shifting macro outcomes rather than tariff expectations."