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Ahead of the 2 April deadline for the US Trade Representative (USTR) to report on the justification for tariffs on the US's trade partners, and the disruptions that might ensue, the USD has enjoyed a rebound. The USD index (DXY) has climbed 1.1% since 18 March, while the EURUSD fell 1.3% during that time. On the flip side, during this time, the VIX also fell from 21.7 to 17.5 and the S&P 500 rose 2.7%, suggesting an improvement i n risk appetite. Markets seem to have partially鈥攂ut not fully鈥攑riced in the incoming tariff turbulence. Should investors take cover in the run-up to April's likely trade war escalation?
Investors should be mindful of risks, but at the same time also take the opportunities that such volatility will likely present themselves. One way to position is to use the FX market to play the differing levels of tariff damage that is likely to be placed on various US trade partners. We suggest some options below.
Sell EURGBP upside. The pair has climbed on the back of optimism over an expansionary German fiscal budget. However, coalition talks in Germany remain incomplete and could still cause policy uncertainty. As a result, we expect some profit-taking in the EURUSD. The likely upcoming tranche of reciprocal tariffs though will probably target Europe in particular鈥攁t the very least more severely than the United Kingdom (UK), which has a more balanced trade relationship with the US. From the current elevated levels, we like strategies that sell the upside in the pair above 0.8490 over one month.
Sell AUDUSD downside. The pair weakened recently, partly thanks to the strength of Australia鈥檚 labor market in February being somewhat obscured by seasonal factors. However, the pair's longer-term drivers of the terms of trade (particularly commodity prices), the continuation of Chinese policy accommodation, and Australia-US interest rate spreads all signal a fair value of around 0.68. Moreover, the market鈥檚 net-short positioning in the AUD is stretched. We believe the pair will rise over the next 12 months toward the fair value target, and so we like selling downside in the pair at or below 0.62.
Go long AUDCHF. The optimism over potential German fiscal spending had boosted most European currencies in the recent weeks. But we think the improving European fundamentals are not sufficient to justify the strength of European exchange rates relative to the AUD. A big part of this stems from the impending imposition of import tariffs by the US on European exports. We think that the CHF is the best proxy to channel the negative impact of US tariffs on Europe as it is likely to benefit the least from both positive German fiscal news and a resolution in Ukraine. Moreover, the yield differential between the AUD and CHF鈥攁t nearly 4%鈥攊s currently the widest compared to other European currencies. We therefore like going long AUDCHF at 0.556, targeting 0.580, and we see a stop-loss at 0.545 as a prudent safeguard.
