We notice that important indicators for China, such as the AUD, have eliminated their risk premium amid a prevailing belief that Beijing will reach an agreement with the US, thereby avoiding a deepening of trade disputes. However, we think the markets may have reacted a bit too optimistically, especially since Trump may not be as eager to lower tariffs as he is with Canada and Mexico.
The US dollar has been declining since the agreement between the US, Mexico, and Canada was reached. Attention has shifted to China, where a muted reaction from Beijing to Trump’s tariffs keeps hopes alive for an agreement before China imposes retaliatory tariffs on January 10. The AUD/USD pair, reflecting sentiment towards China, has lost its short-term risk premium.
While a US-China agreement seems probable, we believe markets might be undervaluing the chances of a prolonged trade conflict. Trump’s tariffs on China have less impact on US consumers than those on Canada and Mexico, giving him more time. Trump also seems unhurried in discussions with President Xi Jinping. Thus, the risks for currencies like AUD and NZD, which are anticipating a deal, appear to lean towards the downside.
