The US-China trade war reached new heights on Friday. Currencies and equities ended the week with major losses after China hit the US with tariffs on $75B worth of US goods. Almost immediately, President Trump ordered US companies to start looking for an alternative to China and promised a more painful response. Many believe that he will raise Chinese tariffs to 25% but we can’t rule out a more distressing countermeasure. The US dollar was hit the hardest by the escalation of trade tensions with USD/JPY and USD/CHF falling nearly 1%. More losses are likely in the coming week as investors and central banks grow more concerned about recessions.

Federal Reserve Chairman Jerome Powell’s Jackson Hole speech was a big disappointment. He refrained from mentioning the possibility of easing next month (or the near future) and simply said they are watching carefully to see how the US is impacted by the events since July. But the market didn’t care – they were satisfied to hear Powell admit that the economy faces “significant risks” and the central bank “will act as appropriate to sustain the expansion.” Around the same time, China announced tariffs on the US and nothing else mattered. The Dow crashed and the US dollar sold off aggressively against all of the major currencies. As usual, the market interpreted the trade war headlines as negative for the greenback first but next week we should see weakness in AUD and NZD

China and the US have made it clear that they won’t back down easily and the rest of the world will be victims of this intensifying trade war. Even if the Fed is reluctant to ease, they could be pushed into action especially as Fed fund futures price in 2.5 rate cuts before the end of the year. With that said, Fed officials are going out of their way to downplay the need for easing. Powell described the economy as being in a favorable place. Harker doesn’t think they should act right now and instead stay the course and see how things unfold. Vice-Chair Clarida admitted that the global outlook has worsened but the US economy is in a good place and the consumer is strong. Earlier this week, Rosengren said the US is in a good spot right now and there is no need to take action if their outlook stays on track. He stressed that the Fed doesn’t have to ease simply because other countries are weak. On Tuesday, Fed President Daly said she supported the July cut but sees the labor market as strong and consumer spending healthy. Fed President George seems to agree – she said she’s not ready to provide more policy accommodation without seeing evidence of a slowdown. Like Rosengren, she said the economy as in a good place. So while President Trump is doing everything in his power to shame the Federal Reserve to act, US policymakers aren’t sold on the need for easing.

Meanwhile, the Canadian dollar received very little support from retail sales. Although consumer spending beat expectations with retail sales excluding autos rising 0.9% against a forecast of 0% (headline numbers were 0% vs. -0.3%), USD/CAD remained stuck in its 1.3250-1.3350 trading range. With inflation and spending rising more than expected, USD/CAD should be trading closer to 1.32 but concerns about the ripple effect of weakness in the US economy coupled with lower oil prices makes it difficult for the Canadian dollar to rally.