RPT-COLUMN-FX markets still suspect Trump is bluffing: Mike Dolan

By Mike Dolan

LONDON, March 26 (Reuters) - It's been a lousy start to the year for Wall Street, but any notion that a global trade war is fully priced by investors seems fanciful. Just look at currency markets.

If you've lost track of what the U.S. administration's trade plan is currently, then rest assured that you're not alone.

President Donald Trump's strategy ebbs and flows by the day amid periodic insistence that every country is going to pay, only to revert to seemingly random exclusions or added complexity via sectoral and national caveats.

Slightly punch drunk, financial markets have reverted to behaving like a metronome: "risk on" with any suggestion that Trump is hesitating and "risk off" with every social media post calling for blanket U.S. trade retribution.

As it stands, the latest nods and winks suggest the momentous April 2 announcement will be a messier than first billed - and the pressure on stocks and bond yields has lifted a bit to reflect that. Whether the administration's more equivocal stance is a result of the market's tantrum in recent weeks is an open question.

But it's anyone's guess what measures will eventually show up and it's a pretty safe bet that whatever is announced will not be the end of it.

So is the trade war risk fully priced in? How could it be?

MODELLING THREATS

Barclays FX strategist Themos Fiotakis and team have been brave enough to attempt to build a framework showing how currency markets might react in a full trade war scenario. And they reckon very little of the outsize risk is currently priced into foreign exchange rates, either from tariffs already announced or from those coming down the pike.

The Barclays model works off the basic idea that tariffs will inflate the globally-cleared price of imports in the U.S. and that the dollar should nominally appreciate to offset the resulting real exchange rate effects.

They judge the extent to which it has done so since Trump was elected for a second term last year by the size of moves since then that cannot be explained by economic considerations embedded in interest rate differentials.

Needless to say, the matrix of what's already announced, what might be announced and what retaliatory measures are in place or expected gets pretty complicated.

Numerous "ifs" and "buts" apply. Just one of many unknown wrinkles for the Canadian dollar and Mexican peso, for example, is the extent to which some imports will be exempt due to the USMCA agreements struck during Trump's first term.

Barclays' conclusion is that of the four major currencies under the gun, the Canadian dollar CAD= is reflecting the most risk, with a 6% tariff premium already priced in. However, the strategists argue this is still less than half of the move that would be expected given the tariffs already in place, and even less based on those that might yet come.

The euro's tariff-related loss since the election of some 4% is almost half of what might be expected given potential tariffs, insulating it to some degree.

And if you take all of the worst-case scenarios, Barclays thinks the peso MXN= could be at risk for further depreciation of 38%, with a risk of a 21% decline for China's yuan CNH= from here, 19% for the Canadian dollar and 9% for the euro EUR=.

Deutsche Bank emphasises differences in relative hits to the U.S. economy and rival markets of similar-sized tariffs, pointing out that a U.S. tariff on the euro zone would impact a greater share of the U.S. economy than that of Europe, whereas the opposite was true with the impact on Mexico.

Complications aside, if you at least accept that currency markets are far from fully priced for what's coming, then it's unlikely stock or bond markets are much more prepared.

To be sure, U.S. growth forecasts have been downgraded and full-year 2025 earnings growth forecasts for S&P 500 firms have been dragged lower.

Year-end S&P 500 index .SPX targets have been cut too - even though consensus forecasts remain 15% above current levels.

But if currency markets are any guide, the full blast of what's to come has yet to be absorbed.

While it's still possible the Trump trade threats are mostly bluster - that's a nervy stance to cling on to as next Tuesday's "Liberation Day" approaches.

The opinions expressed here are those of the author, a columnist for Reuters