The Trade War Trade
Featuring Jens Nordvig
Published on: June 10th, 2019 • Duration: 15 minutesJens Nordvig, founder and CEO of Exante Data, returns to Real Vision to break down the multiple trade wars on the horizon, and to explain how investors should position themselves in the current environment. He examines the economic impact of the U.S. fighting two trade wars at once, suggests potential outcomes for the trade tiff with Mexico, and highlights the Japanese yen as a vehicle to play a potentially weaker U.S. dollar, in this interview with Justine Underhill. Filmed on June 7, 2019.
JUSTINE UNDERHILL: Welcome to Real Vision's Trade Ideas. Today, we're sitting down with the Jens Nordvig of Exante Data. Great to have you back.
JENS NORDVIG: Thanks for inviting me.
JUSTINE UNDERHILL: So, there's been a lot going on in the markets, especially with the trade war, and there's been a lot of confusion in this area, can you break down your analysis of what's going on in the trade war?
JENS NORDVIG: I can try. Just get quite a few things to keep track of because we have essentially multiple wars going on now. So, we have the US-China trade war that's escalating in a pretty dramatic way and might become like a full blown trade war after the G20 meeting at the end of June. So, that's one thing. That's in itself serious. But if you then have a dramatic escalation towards Mexico at the same time, then it really is something that becomes potentially quite dramatic for the US economy overall.
And I would argue that it's not just adding them together, it's really a multiplicative effect, a nonlinear effect, if you will. Because we can go into the specifics, but there are- it just becomes harder to source imports that are cheap if you have multiple wars going on at the same time. And on top of that, the confidence effects will be, I think, much, much bigger if you have uncertainty about all the different supply chains, rather than just those pertaining to China.
JUSTINE UNDERHILL: So, having both trade wars going on at the same time, does that give the US less leverage overall in both of them?
JENS NORDVIG: Well, so there's certainly that aspect of it. So, if you think about it from China's perspective, and they can see, okay, maybe the US has started to escalate not only versus China, but we have the Mexico situation, we also have the auto tariffs that have been delayed, but also something that could happen later in the year. That is something that can then hit the US economy on many fronts. And if you look at that from China's perspective, that actually means that the US is weaker, and that gives the Chinese strength in their negotiation.
So, in a way, if you think about the probability of a deal with China, it probably lowers the probability of a deal because the Chinese are not going to be so easy to persuade into giving big concessions if they can see that the US' stances are a little bit on the back foot from having all these different issues at the same time. So, our central case is that there will be an escalation versus China, we think will come after G20 meeting. And the Mexico situation actually pushes that probability even further in a negative direction. So, that's the path we're looking at in relation to China.
JUSTINE UNDERHILL: So, with Mexico, today is Friday, and there are still negotiations going on, there's a lot could change. But could you break down what you see happening? Or what are some scenarios happening in terms of the Mexico negotiations?
JENS NORDVIG: Yes. So, I think the problem is that what is being demanded at least, that the headline level from Mexico is essentially that they want to declare their country a safe harbor and therefore assume a much bigger portion of all immigrants or all of them. And that I think, is a no go topic for Mexico. I don't think that can happen. So, that's how the situation breaks down. And we don't have any agreement.
They were supposed to come to an agreement on Wednesday, they are trying again on Thursday, they're trying again on Friday. I think the problem is that we are creating a lot of uncertainty. So, even if there's a delay in this process, we're going to have uncertainty about whether there's something that could come back in the future. If you're thinking about a corporate executive CEO, CFO who have to make big investment decisions, they might have been close to a point where they say, okay, there's a trouble situation around China, let's reallocate our supply chains towards Mexico. I think you're probably going to wait a little bit now until you make that final decision, right? Even if it looks like there's a temporary deal, the uncertainty is still there.
There's also uncertainty around what's going to happen to NAFTA 2. Is that going to be approved? That's definitely going to be harder. So, we have a lot of uncertainty, it's bound to have an impact on investment. But I think also, if you start to analyze this scenario where we go down the tariff route, it's just a really large number of US imports that are potentially impacted like you can easily get to 800 billion worth of imports if you add all of the imports from China and the imports from Mexico, so a huge proportion of overall imports.
And I think more and more of the research that's being done in this area, including own research suggests that there's a really big pass through. So, when you hit these goods with tariffs, prices rise, you as consumers have to pay more. And it's essentially like you just lost some income, right? Because you have to spend more of your income on those specific goods, you have less left for anything else. And that's going to then feed into growth.
So, I think that's what you can see in the trade data that import prices are rising. Some importers are trying to source product from cheaper countries like Vietnam, and so forth. But that diversion effect as the academics call it, it's not that big, right? So, the main cost is just borne by US consumers. So, if you have multiple trade wars at the same time, that really starts to add up. And then on top of that, there's a confidence effect that really kicks in if you have uncertainty here and there at the same time.
So, I think that's also scenario that the Fed's, FMC members are worrying about. And we're in a very unusual situation. The data has started to deteriorate including payrolls today. But it's an early deterioration of data. But the Fed is looking at this shock. If this shock is really becoming a two-trade war type shock, they're going to be very concerned about the impact, even before it shows up in the data.
JUSTINE UNDERHILL: How big of an impact you think it could be for US GDP?
JENS NORDVIG: If you think about in very simplistic terms, 25% tax, and that's the number, that's the end destination of the Mexican process, and also the end destination to some degree for the Chinese process that could happen already in July. If you do 25% times 800 billion, that's a big number that's getting you close to 1% of GDP. So, doesn't mean you can map that directly into growth, but it gives you a ballpark. Okay, what is the magnitude of the hit to the economy if there is no diversion?? If you can't get these imports from anywhere else, if there's not many US producers who can step in, that's the magnitude and that doesn't take into account any of the confidence effects, right?
So, what's the trend in the US economy right now? Okay, it depends on which quarter you're looking at. But I would say if you take out the fiscal stimulus that's also coming out of the equation, maybe the trend is close to two, right? So, 1% hit is a big deal. And then you wristed those confidence on top of that, then you can get to very low numbers, like less than one. And that is something we've not seen for a while, and certainly something that the Fed will be very, very worried about.
JUSTINE UNDERHILL: So, as an investor, how would you go about positioning yourself in this environment?
JENS NORDVIG: I'm a bit biased, because I'm very focused on currencies. But I think actually, this news around Mexico really has been very important for the currency market. The dollar has generally had a pretty strong trading dynamic this entire year, up until the point where Mexico came on the agenda again. So, we've started to see a turn in dollar-yen that way. We started to see a turn in euro-dollar that way. So, the dollar is turning, I think that makes sense for the economic reasons we have discussed.
And then we've obviously had a big move in rates, which you can argue also make sense. And then the equity market is split in the sense that okay, there's a negative growth effect. But the equity market loves the Fed potentially easing. So, we're in a torn in different directions on the equity market front. So, I think that it makes sense to look at, okay, financials that are typically impacted by lower yields. Are they really starting to turn? So, that would be my expectation.
But I think overall, we've had an essentially a strong dollar since 2014. If that really is a question mark that we have to take seriously around, okay, is the Fed changing the cycle? Is there really a big growth hit to the US? We're seeing that hit at a point in time where actually, the positioning picture and the currency market is quite vulnerable. So, I think it's a very important inflection point here.
JUSTINE UNDERHILL: Do you see the Chinese Central Bank potentially weakening the yuan in response to the trade wars?
JENS NORDVIG: That's the big, big wildcard here, right? Because, again, if we analyze the US-China trade war separately, you can come up with a scenario where, okay, this is something that's negative for global growth, that actually tends to support the dollar, even though it's also going to hurt the US economy. But if you have weak global growth, and then China allows their currency to weaken substantially, because the Chinese economy and the Chinese currency is so important, it actually drags a lot of other currencies with it. And then you actually have a strong dollar effect.
So, when you look at the scenario for the next couple of months, it is absolutely crucial whether we have the escalation or in relation to Mexico also and then how China's managing their currency. If they keep the currency close to 6.90 like they've done in recent weeks, then you have a degree of stability. And it becomes more driven by this incremental shocks from the US, if we have a break of seven and we have a big move in the currency that's going to counter that effect. So, this is really a quite binary situation where Chinese currency policies really play a crucial role in this equation here.
JUSTINE UNDERHILL: So, when investing in the current environment, how would you go about expressing that in currencies?
JENS NORDVIG: So, I think if we have the escalation versus Mexico, I think safe currencies, meaning the euro and the yen, low-yielding currencies that typically trade very well in a risk averse environment, or the one that can benefit the most against the dollar. So, in the short term, there's an interesting situation around the euro, because what we call CTA is trend following accounts, funds have actually been very short the euro up until very recently. And we're getting just to two levels around 113, where they can really get squeezed out of those positions. So, if we have bad news for the dollar and we have that dynamic around positioning just about to flip, that can accelerate the move and we're going to have potentially a gap high of two, 3% very quickly.
So, that's very short term dynamic, but something that can be very important because we're not used to seeing big moves in the euro. We've had incredibly low volatility environment for many months. From a little bit longer term perspective and bringing in dollar-yen, the yen on most valuation models, certainly the ones we use is still a very cheap currency. It's very difficult for the Japanese authorities to intervene in the currency market like they've done historically. Because intervention is very much on the focus within the US administration now. So, politically, it's close to impossible, I would say.
So, if there is a big shift in Fed policy that starts to generate a move down in dollar-yen, there's all kinds of dynamics that could kick in motion. And then if you, on top of that, have the equity market turning, again, it's super sensitive to what's going on in the equity market, that could really cause a meaningful breakdown there. So, there, you're going to have a much bigger move. We've been trading close to 108 in recent days, then you have to think about okay, can we actually break 100 in that scenario over a couple months? So, I think that's one to really focus on now.
JUSTINE UNDERHILL: Okay. So, watch the euro, watch the yen in this trade war environment. Can you summarize what you see going on in the trade war in 30 seconds?
JENS NORDVIG: So, I think we're moving from a situation where it's highly likely that the Chinese part of the trade war will escalate and we're watching whether we're also going to get the Mexican leg into the equation. If that happens, I think the dollar dynamic really is highly likely to turn after multiyear strong dollar trends. And this is what investors should focus on. It matters not just for those currency we just discussed. It matters for emerging markets. It matters for commodity prices, it matters for a lot of different things at the same time.
JUSTINE UNDERHILL: Well, Jens, we'll have to have you back on in a few months to see how this all shakes out. Thank you so much.
JENS NORDVIG: Thank you. Thank you.
JUSTINE UNDERHILL: So, Jens would be bearish on the dollar if the US tries to fight two trade wars at once. In this scenario, he sees short term strength in the euro and thinks the Japanese yen could hit 100 against the dollar over the next few months.
Just remember this is a trade idea and not investment advice. You should do your own research, consider your risk tolerance and invest accordingly. For Real Vision, I'm Justine Underhill.