Far-right leader Marine Le Pen looks set to win in the first round of France’s presidential election in April (the top two candidates will go through), but then lose in the run-off to centrist Emmanuel Macron. Francois Fillon, a conservative who was favourite to win the election only two weeks ago, has seen his campaign damaged by scandal.

Running on a pledge to take France out of the single currency, during her campaign launch speech last weekend, Le Pen pledged to promote French businesses while protecting them from foreign competitors, introduce a tax on French companies that hire foreign workers, reduce immigration, cut income taxes, simplify tax rules and fight tax evasion.

The issue for investors, if Le Pen wins, is that Europe may turn in on itself threatening cooperation across member states and undermining the future of the Euro in its current form.

China Reserves

China’s foreign exchange reserves fell below the closely watched $3tn level in January for the first time in five years. However, the $12.3bn decline was the lowest in seven months as tighter capital controls and a stronger renminbi (currency) discouraged outflows. China’s reserves peaked at $3.99tn in June 2014 but since then the central bank has sold dollars aggressively to curb renminbi depreciation. To put these figures into context, China’s foreign exchange reserves are the largest in the world with the UK and US in 10th and 12th place with their foreign exchange reserves valued at $143bn and $117bn, respectively.

It has long been speculated that China buys US treasuries (i.e. dollars) in order to facilitate a low US rate which, in turn, encourages US consumption. In effect aiding the purchase of cheap Chinese imports into the US. If China’s reserves fall this relationship will be undermined and is one of the possible consequences of Trump enforcing an import tax on Chinese goods.

In January, the renminbi recovered by 1%, mirroring a downward correction in the dollar following the US currency’s surge after the election of Donald Trump and the Federal Reserve’s interest rate rise in December.

The People’s Bank of China has continued to guide money-market rates higher in recent weeks by raising rates on loans made to commercial banks through market operations and other monetary policy tools. This rise in interest rates should have increased the appeal of keeping money in the country.

China Foreign Exchange Reserves ($m)

Source: Bloomberg, 2017

US Tax Plans

It has been just three weeks since the inauguration of Donald Trump and he has already signed 22 executive orders. Trump’s pace to push through his campaign initiatives does not seem to be diminishing and one of his many pledges is to transform corporate income tax into a destination-based cash flow tax (DBCFT), which would include border adjustments to import taxes but would keep exports exempt.

A border tax placed on certain imports would attempt to remove the incentive for firms to relocate profits or move profitable manufacturing operations outside the US. The danger is that this measure could push up inflation which could mean one of two things, either that:

  • interest rates might have to be raised sooner than they would otherwise, pushing the dollar higher which could have a negative impact on America’s exports or
  • The Federal Reserve delays raising interest rates making real yields unattractive, undermining the dollar and making nominal growth higher but meaning real GDP wouldn’t improve.

The effects that any border tax may have are still very much up for debate but given the complexities involved, the initiative has the potential for confusion and uncertainty and, as ever, all eyes will be on Trump and the US Federal Reserve.

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