Revoking Hong Kong’s Special Status – Data/Events This Week.

May 31, 2020 — Mitul Kotecha

In a further escalation of US-China tensions, President Trump revoked Hong Kong’s (HK) “Special Status” as revealed in a speech on Friday.  What does this mean? At this stage there is scant detail to go on.  Trump also promised to implement sanctions against individuals in China and HK who he deems responsible for eroding HK’s autonomy, but no names were given. Markets reacted with relief, with US equities closing higher on Friday, perhaps in relief that that the measures outlined by Trump were not more severe, or that the lack of detail meant that there could be various exemptions.

On the face of it, removing Hong Kong’s “Special Status” would deal a heavy blow to Hong Kong’s economy and to US companies there, while hurting China’s economy too.  However, while still an important financial centre, Hong Kong’s economy relative to China is far smaller than it was at the time of the handover in 1997, at around 3%.   As such, removing Hong Kong’s “Special Status” could be less painful on China than it would have been in the past.  This may explain why the US administration is focusing on other measures such as student visa restrictions, sanctioning individuals, restricting investment etc.  Even so, tensions will continue to cast a shadow over markets for some time to come and will likely heat up ahead of US elections in November.

Data wise, the week began with the release of China’s May manufacturing and non-manufacturing purchasing manager’s indices (PMIs) today.  The data revealed a slight softening in the manufacturing PMI to 50.6 in May from 50.8 in April, indicating that manufacturing activity continues to remain in expansion.  However, the trade related components were weak, suggesting that China’s exports and imports outlook is likely to come under growing pressure, weighing on overall recovery.  China’s currency, the renminbi, has been weakening lately against the US dollar and against its peers, though it rallied against the dollar on Friday.  Further gradual weakness in the renminbi looks likely over coming weeks.

This week there will be attention on various data releases and events including US May jobs data, ISM manufacturing, European Central Bank (ECB) and Reserve Bank of Australia (RBA) policy decisions and UK-EU Brexit discussions.  Of course markets will remain tuned into Covid-19 developments as economies around the world continue to open up.   While the US jobs and ISM data will likely remain very weak, the silver lining is that the extent of weakness is likely to lessen in the months ahead.  Consensus forecasts predict a massive 8 million drop in US non-farm payrolls and the unemployment rate to increase to close to 20%.  The RBA is likely to leave policy unchanged at 0.25% while the ECB is expected to step up its asset purchases. Meanwhile UK-EU Brexit discussions are likely to continue to be fraught with difficulty.

 

 

 

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Tensions Take A Turn For The Worse

May 25, 2020 — Mitul Kotecha

As highlighted in my post last week markets face “Risks of a body blow” amid an intensification of tensions between the US and China.  Such tensions have worsened over recent days in the wake of the decision announced at the start of China’s National People’s Congress (NPC) to draft national security legislation for Hong Kong, which would reportedly bypass the territory’s Legislative Council.

The news prompted a slide in Hong Kong equities, demonstrations in Hong Kong and a strong reaction from the US Secretary of State. Attention will also turn to whether China’s decision will push the US administration into imposing sanctions based on the Hong Kong Human Rights and Democracy Act passed last year by Congress as well as remove the special trading status that Hong Kong enjoys with the US.

Unrelated to the above, but in line with the strengthening in non tariff measures being applied to China, the US Senate passed a bill that would effectively result in a de-listing any companies from the US stock exchange if they did not comply with US regulatory audits. In particular, Chinese company listings will be at risk given that many Chinese companies would fall into this category.  This follows hot on the heels of tougher restrictions on the sale of US technology, and the ordering of the main US federal government pension fund not to invest in Chinese equities.

Markets are right to be nervous, with tensions only likely to intensify ahead of elections, but as noted in my previous post, it seems highly unlikely that the US administration would want to tear up the “Phase 1” trade deal at this stage given the impact on domestic producers and consumers.  Instead expect more non trade measures, export controls, visa restrictions, etc, to move into place.  If the US economy/asset markets rebound more strongly, the risk of a breakdown in the trade deal will likely grow as the administration may have more confidence at that point.   Either way, the November 2020 presidential election will have a large bearing on policy towards China.

China can also not risk a major flare up in tensions at this stage given the pressure on its economy even as it has largely opened up post the Covid-19 lockdown measures.  The magnitude of the growth shock was on show last Friday, with the NPC dropping its growth target from its work report for the first time.  This was a prudent move given that growth this year is subject to much more uncertainty than usual in the wake of the Covid-19 shock, but it also suggests that Chinese authorities do not want to commit to the type of stimulus enacted in 2008, which resulted in a sharp build up in leverage in the economy.  GDP growth fell by 6.8% y/y in Q1 and is likely to come in at best around half of last year’s 6.1 rate.

As such, the risks to markets has moved from the virus (though second round infections remains a key risk to markets) to geopolitical.   Nor have economic risks have dissipated.  A cursory glance at data globally makes this obvious.  Markets have tried to look past the data, but risks remain high that growth recovery will be far more prolonged than is being currently priced in.  At some point, maybe soon, it will be hard to keep looking past the data, when what is in view is not pleasant at all.

 

 

Posted in Asia, China, coronavirus, COVID-19, Economics, emerging markets, equity markets, Federal Reserve, Monetary Policy, Trade, Trump, US, US administration. Tags: , , , , , , . Leave a Comment »

US-China tensions – Risks of a body blow to markets

May 17, 2020 — Mitul Kotecha

Tensions between the US and China are once again escalating, resulting in growing nervousness in markets and raising concerns of a further deterioration in global trade at a time when the world is increasingly reeling from the devastating economic impact of Covid-19.   As many countries open up their economies hopes that activity can finally begin to resume, has strengthened.  However, the economic cost is still mounting and as revealed in awful economic data globally over recent weeks the picture is a horrible one.

It will be a fine balancing act for the US administration between imposing more trade tariffs and in turn hurting US importers on the one hand and punishing China for accusations of concealing information about spreading Covid-19 on the other.  President Trump recently threatened to “cut off the whole relationship” with China, which threatens the “Phase 1” trade deal reached at the beginning of this year.   Recent moves by the US administration include instructing a federal pensions fund to shift some investments in Chinese stocks and tightening export controls on Chinese telecoms company Huawei and its suppliers, which the US administrations says are contrary to US national security.

However, the White House may want to keep trade separate from other measures including tighter export controls and investment restrictions.  Indeed recent talks between senior US and Chinese officials on implementing the Phase 1 deal appeared to be cordial and constructive while Larry Kudlow, director of the National Economic Council said on Friday that the trade deal is continuing.  This is logical.  Renewed tariffs on imports from China would hurt the US consumer, while likely retaliation from China would mean any chance of China increasing its purchases of US goods as part of the Phase 1 deal would disappear, inflicting more pain on the US economy.

One other major consequence of a new round of US tariffs on China would likely be a weaker Chinese currency.  So far China has avoided weakening the yuan, which could also provoke increased capital outflows from China (as it did in Jan 2015 and mid 2016) and a drain on FX reserves at a time when Chinese growth is slowing sharply.  However, China may yet opt for a sharp depreciation/devaluation of the yuan to retaliate against fresh tariffs and to support its exporters as it did when the US first imposed tariffs on the country.  Although this comes with risks for China as noted above, if it was sold as a one off move and was well controlled, it need not fuel an increase in capital outflows from China. This is something that the US will wish to avoid.

Although the US may want to avoid trade as the primary target of any pressure on China, this does not mean that tensions will not increase.  In fact it is highly likely that the relationship between the US and China will worsen ahead of US elections in November, especially as it is one issue which garners broad support among the US electorate. As such, US measures will likely skirt trade restrictions but will most probably involve a whole host of other measures including tightening export controls, student visa restrictions, investment restrictions, and other such measures.  Markets hardly need a reason to be nervous, but after a multi week rally, this is an issue that could prove to be a major body blow to risk assets.

Posted in Asia, Asian currencies, China, coronavirus, COVID-19, Currencies, Economics, Economy, emerging markets, equity markets, Trade, Trump, US, US administration. Tags: , , , , , , , , . Leave a Comment »

Opening Up

May 10, 2020 — Mitul Kotecha

Attention is squarely going to be on efforts to open up economies in the days and weeks ahead.  Most US states are opening up to varied degrees while the same is happening across Europe.  The risk of course is that a second or even third wave of Covid-19 emerges for some countries, as is being seen in some parts of Asia, for example Korea where renewed social distancing measures have been put in place after a fresh cluster of cases in clubs and bars there.

However, governments will need to weigh up these risks against the growing economic costs of lockdown, which will by no means be easy.  Even as social distancing and lockdown measures are eased, it will likely be a gradual process, with activity likely to remain under pressure.  This is when the real test for markets will take place.  While markets have clearly been buoyed by unprecedented stimulus measures, especially from the Federal Reserve, which could continue for some time, fiscal injections will run their course over the next couple of months.

As revealed in April US jobs data at the end of last week the costs in terms of increased unemployment has been severe. The US unemployment rate hit a post war high of 14.7% while 20.5 million people lost their jobs.  This news will be echoed globally. Markets were expecting bad news and therefore the reaction was limited, but the data will nonetheless put more pressure on policy makers to keep the stimulus taps open.  Discussions are already in place between US Republican and Democrats over a new package, though disagreements on various issues suggest a deal may not happen soon.

Another spanner in the works is tensions between the US and China.  The US administration has become more vocal on blaming China for the virus, over recent weeks.  This had threatened to undermine the “phase 1” trade deal agreed a few months ago.  However, there were some soothing remarks on this front, with a phone call between senior US and Chinese officials last week, highlighting “good progress” on implementing the deal.  Despite such progress, it may not calm tensions over the cause of the virus, especially ahead of US elections in November and markets are likely to remain nervous in the weeks ahead.

This week there will be more evidence on tap to reveal the economic onslaught of the virus, just as many countries are finally flattening the virus curve itself.   Q1 GDP releases will reveal weakness in several countries.  Chinese activity data including retail sales and industrial production as well as credit metrics will give further evidence of the virus impact and how quickly China is recovering.  If anything, China’s recovery path will likely show the pain ahead for many economies that are easing lockdown measures.  In the US, inflation data and retail sales will garner attention.  In terms of central banks attention will be on the Reserve Bank of New Zealand (RBNZ). While no change in policy rates is likely a step up in the RBNZ’s asset purchases may take place.

 

 

 

 

Posted in Asia, central banks, China, coronavirus, COVID-19, Currencies, Economics, Economy, equity markets, Federal Reserve, FX, Interest rates, Monetary Policy, South Korea, Trump, US, US administration. Tags: , , , , . Leave a Comment »

Covid-19 Economic Toll Worsening

May 3, 2020 — Mitul Kotecha

Unease about the economic toll of Covid-19 is starting to dent the rebound in equity markets.  The disconnect between the strength of the rally in equities and the reality on the ground has become increasingly visible following recent earnings releases including from tech heavyweights Apple and Amazon, and dismal economic data which included sharp falls in US and Eurozone Q1 GDP data.  Q2 will look even worse as most of the economic damage was inflicted in April, suggesting that the pain is just beginning.

Meanwhile geopolitical tensions between the US and China are adding another layer of pressure on markets, with US President Trump stating that he had seen strong evidence that Covid-19 originated from a laboratory in Wuhan.  Trump’s comments have raised the spectre of a renewed trade war between the two countries at a time when in any case it was looking increasingly difficult for China to live up to its end of the agreement to purchase a substantial amount of US goods in the wake of a Phase 1 deal.

Some of the economic pain emanating from the shutdowns will be on show this week, with the US April jobs report likely to reveal a sharp rise in the jobless rate and massive decline in non-farm payrolls, with markets looking for an increase to around 16% and a drop of 22 million, respectively.  Already jobless claims have risen to over 30 million, with the only silver lining being that the rate of increase in claims has declined over recent weeks.  The extremely sharp deterioration in job market conditions threatens to weigh heavily on recovery.

The US dollar fell towards the end of March due in part to month end rebalancing (given US equity and bond market outperformance over the month), but also due to a general improvement in risk sentiment, reducing any safe have demand for dollars.  If as is likely markets become increasingly nervous about the sustainability of the rally in risk assets, the USD is likely to move higher during the next few weeks. Even in an environment where global equities sell off, US assets are still better placed in terms of return potential than those elsewhere, implying US dollar outperformance.

In terms of data and events focus this will turn to the Bank of England and Reserve Bank of Australia policy meetings.  Neither are likely to cut interest rates further, but the BoE could announced a further increase in asset purchases, while conversely the RBA is likely to maintain its asset purchases tapering path.  Aside from the US jobs data noted above, the other piece of data globally that will be watched carefully is China’s April trade report.  A weak outcome is likely for sure, but the extent of deterioration in exports and imports, will have very negative global consequences.

Posted in Australia, Bank of England, central banks, China, coronavirus, COVID-19, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, FX, Interest rates, Monetary Policy, Trade, Trump, UK, US, US administration. Tags: , , , , , , , , , , . Leave a Comment »
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