How To Hedge Against The Trade War
President Trump’s trade tariffs have put the global economy on edge. While China seems to be the primary target, America’s traditional allies have not been spared. The trade war could also affect the EU, Mexico, and even Canada.
Commenting on the import tariffs imposed on Canadian goods, an exasperated Justin Trudeau, Canada’s prime minister remarked, “For 150 years, Canada has been America’s most steadfast ally … From the beaches of Normandy to the mountains of Afghanistan, we have fought and died together. That Canada could be considered a national security threat to the United States is inconceivable.”
In fact, even though it does seem far-fetched, national security is the bogey that Mr Trump has raised when imposing import tariffs. He reportedly asked the U.S. Commerce Department to investigate levying duties on imported cars, trucks, and auto parts as they could threaten the country’s national security.
Investing during a trade war need not be intimidating.
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The beginning of the war
In January this year, the U.S. imposed tariffs on washing machines and solar cells. Shortly after, China started an investigation into sorghum imports from the U.S. In retaliation, President Trump raised the game by complaining to the World Trade Organization, an intergovernmental body that regulates international trade, about China’s poor record of protecting intellectual property rights.
This tit-for-tat has continued since then. In the latest salvo that was fired by the U.S. in early July, tariffs on US$34 billion worth in Chinese goods have been imposed. Beijing has responded by announcing levies on a similar amount of imports from the U.S.
What impact will the trade war have?
The objective of the U.S. government in increasing tariffs for imported goods is twofold. The first is to improve the country’s trade balance. The other goal is to protect American manufacturers from foreign competition and to retain jobs in the U.S.
However, will the trade war that President Trump has initiated help the American economy? Or will it have the opposite effect?
Consider the impact of increased tariffs on the American dollar. As the trade war escalates, investors are likely to become nervous. Fears about a slowdown in the global economy could intensify. When this happens, capital could flow out of other economies and find its way to the U.S., pushing the value of the American dollar upwards. This will make exports from the country more expensive, creating an adverse effect on companies located in the U.S.
Increased tariffs for imports may not also help to boost employment in America. In a recent analysis by the Washington Post, solar panel manufacturers have been lobbying for increased import duties. The new 30% tariff seems to be a shot in the arm for American solar companies.
In addition, there are relatively few of such companies. About 80% of solar panels sold in the U.S. are imported. A reduction in imports may help local manufacturers, but it could have the opposite effect on employment. Why is that?
It seems that manufacturing contributes only about a sixth of the employment that the solar energy sector generates. Hence, a reduction in solar panel imports will take away installation and related jobs.
Another factor that could have a negative effect on American employment is the increased tariffs for steel and aluminium. According to the Brookings Institution, a research group based in Washington, D.C, 5.1 million jobs could be at risk because of higher metal prices while the number of jobs that would gain from the new tariffs would be a mere 313,000.
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How to take advantage of such market conditions
The uncertainty caused by the trade war could have an impact on stock valuations, forex rates, and commodity prices. But this increased market volatility could also offer traders market opportunities. One way to take advantage of this situation is to trade Contracts for difference (CFDs).
Different products you can trade with using Contracts for difference:
⇨ Stock market indices – A stock market index is a basket of stocks that measures a specific segment of the stock market. For instance, the S&P 500 is a market capitalisation weighted index of the 500 largest US-listed stocks, selected based on their market value. Movements in the S&P 500 typically reflect the changes in the larger US equity market.
The market’s perception of global economic and political developments can have an immediate effect on prices. Very often, the entire stock market moves up on news that is considered to be favourable. Conversely, prices can fall if investors think that the new information will have a negative effect on the economy. A CFD allows you to benefit from these price movements when you trade to go long or short on the market.
⇨ Individual stocks – specific companies may be impacted from the new tariffs. For example, steel manufacturers in the U.S. could gain from import duties. Trade CFDs on these shares and go long or short on them.
⇨ Forex – Exchange rates are often affected by new government policies and announcements, particularly in the case of trade wars, where tariffs impact the demand for export goods and in turn affects the demand for currency.
⇨ Commodities – Commodities are the first to experience the effects of a trade war, as the imposition of tariffs directly affects trading volumes. As surplus production is unable to be sold, it leads to an oversupply in producing countries and puts a downward pressure on commodity prices. Investors may choose to trade commodity price changes with CFDs.
Understand how CFDs can be used to trade different assets, like stocks, indices, commodities, and forex.
However, you should remember that CFDs are a leveraged product. The margin that you are required to put up is usually a small percentage of the value of the underlying asset. So, for example, when you buy a particular share, you could have to put up only 10% of its value. In a forex CFD, the margin is even lower and could be about 2%.
While this allows you to boost your returns many times over, it also exposes you to a higher level risk. It is entirely possible to lose your entire investment if the trade goes wrong.
Fortunately, there is a way to mitigate your losses. You can opt to use stops and limits. These can automatically close your trade and limit your losses. It’s important to understand the difference between basic stops, guaranteed stops, and trailing stops. The judicious use of these stops can help you minimise losses while retaining the profits that your investment makes. Here’s a quick video that you can watch to learn more about guaranteed stops.
Volatility could increase
As the trade war escalates, it could lead to a higher degree of volatility in the markets. Gold prices could go up as investors seek a safe haven. Stock prices for companies that are affected by the trade tariffs may fluctuate as it becomes clearer that certain sectors will benefit while others lose out.
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