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.
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