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 »

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 »

Central Banks and Governments Act To Combat COVID-19. Will It Be Enough?

March 22, 2020 — Mitul Kotecha

In just a few weeks the world has changed dramatically.  What was initially seen as a virus localised in Asia has spread throughout the world with frightening speed.  The shocking destruction that COVID-19 has wrought globally in both health and economic terms will not fade quickly.  The virus is destroying complacency in all areas.  Total and complete lock down is becoming key to arrest the virus’ ascent, but many have yet to change their ways, believing that they will be ok.  How naïve is that!

Governments and central banks are finally coming to grips with the economic and health costs, but also the realisation that even in many developed countries, they are woefully unequipped to deal with the health crisis that is unfolding.  Global policy makers and the public at large has gone from a phase of denial, to outright panic and increasingly into fear, which then brings forth the most aggressive responses.

Unfortunately, the lack of global cohesion amongst policy makers has meant that responses have largely been piecemeal and uncoordinated.  Two of the biggest super powers, the US and China, have despite a now forgotten about Phase 1 trade deal, become increasingly acrimonious in their dealings with each other.  This, at a time when the world is looking for leadership, is proving to be major impediment to dealing with the effects of the virus.

It is not all bad news in term of co-ordination.  Central banks globally appear to be acting in unison, even if accidently, in terms of slashing interest rates, aggressively increasing quantitative easing, flushing the financial system with US dollar liquidity and easing some of the regulatory burden on banks.  This has helped to improve market functioning, which increasingly appeared to be breaking down over recent weeks.  It may not however, prevent further pressure on asset markets given the destruction in economic  activity globally.

Unprecedented times call for unprecedented measures.  Governments are now stepping up to the plate.  Massive fiscal stimulus plans are being ramped up around the world.  G7 economies have pledged to do “whatever is necessary” and to co-ordinate actions though much has been un coordinated.  US lawmakers are currently deliberating on a stimulus package worth over a $1tn though this could rise significantly in the weeks ahead, Germany is planning to create a EUR 500bn bailout fund, and the UK has announced an “unprecedented” multi billion pound package of measures.  These are but a few of the various stimulus measures being undertaken globally.

China has yet to announce a major stimulus package, but has instead opted for more incremental measures as its economy begins to recover following a major lockdown.  However, just as China’s supply constraints are easing, demand is weakening sharply as economies globally shut down.  The implication is that China’s recovery will not be a quick one either.  More stimulus is likely.  Recent reports suggest China will step up special bond issuance for infrastructure spending, but more is likely.

Overall, the economic shock is just beginning as the health shock is intensifying.  We will need to brace for more pain in the weeks and months ahead.  We can only hope that the measures announced so far and yet to be announced alongside with strict adherence to health recommendations will be sufficient to prevent deeper and longer lasting damage.  The jury is still out.

Posted in Asia, Bank of England, Bank of Japan, central banks, China, coronavirus, COVID-19, ECB, Economics, Europe, eurozone, Federal Reserve, Fiscal/Budget, Germany, Interest rates, Monetary Policy, Trade, Trump, UK, US, US administration. Tags: , , , , , , , , . Leave a Comment »

Waiting For The Fed To Come To The Rescue

March 2, 2020 — Mitul Kotecha

COVID-2019 has in the mind of the market shifted from being a localized China and by extension Asia virus to a global phenomenon.  Asia went through fear and panic are few weeks ago while the world watched but did not react greatly as equities continued to rally to new highs outside Asia.  All this has changed dramatically over the last week or so, with markets initially spooked by the sharp rise in cases in Italy and Korea, and as the days have progressed, a sharp increase in the number of countries recording cases of infection.

The sell off in markets has been dramatic, even compared to previous routs in global equity markets.  It is unclear whether fading the declines is a good move given that the headline news flow continues to worsen, but investors are likely to try to look for opportunity in the malaise.   The fact that investors had become increasingly leveraged, positioning had increased significantly and valuations had become stretched, probably added more weight to the sell-off in equity markets and risk assets globally.  Conversely, G10 government bonds have rallied hard, especially US Treasuries as investors jump into safe havens.

Markets are attempting a tentative rally in risk assets today in the hope that major central banks and governments can come to the rescue.  The US Federal Reserve on Friday gave a strong signal that it is prepared to loosen policy if needed and markets have increasingly priced in easing , beginning with at least a 25bps rate cut this month (19 March).  The question is now not whether the Fed cuts, but will the cut be 25bp or 50bp.  Similarly, the Bank of Japan today indicated its readiness to support the economy if needed as have other central banks.

As the number of new infections outside of China is now increasing compared to new infections in China, and Chinese officials are promising both fiscal and monetary stimulus, China is no longer the main point of concern.  That said, there is no doubt that China’s economy is likely to tank this quarter; an early indication came from the sharp decline in China’s official manufacturing purchasing managers’ index, which fell to a record low of 35.7 in February, deep into contraction territory.  The imponderable is how quickly the Chinese economy will get back on its feet.  The potential for “V” shape recovery is looking increasingly slim.

Volatility has also risen across markets, though it is notable that FX volatility has risen by far less than equity or interest rate volatility, suggesting scope for catch up.  Heightened expectations of Fed rate cuts, and sharp decline in yields, alongside fears that the number of virus cases in the US will accelerate, have combined to weigh on the US dollar, helping many currencies including the euro and emerging market currencies to make up some lost ground.  This is likely to continue in the short term, especially if overall market risk appetite shows some improvement.

Markets will likely struggle this week to find their feet.  As we’re seeing today there are attempts to buy into the fall at least in Asia.  Buyers will continue to run into bad news in terms of headlines, suggesting that it will not be an easy rise. Aside from watching coronavirus headlines there will be plenty of attention on the race to be the Democrat Party presidential candidate in the US, with the Super Tuesday primaries in focus.  UK/Europe trade talks will also garner attention as both sides try to hammer out a deal, while OPEC will meet to deliberate whether to implement output cuts to arrest the slide in oil prices.  On the data front, US ISM manufacturing and jobs data will be in focus.

Posted in Asia, Asian currencies, Bank of Japan, Bond markets, Brexit, central banks, China, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Interest rates, Japan, Monetary Policy, South Korea, Trade, UK, US, US administration. Tags: , , , , , , , , , , , . Leave a Comment »

US-China Phase 1, Now What?

January 16, 2020 — Mitul Kotecha

Now that the long awaited Phase 1 deal has been signed between the US and China (significantly taking place in the White House) and details finally released (in a 94 page document) it’s worth asking whether much has actually changed.  After all, China still faces (high) tariffs on around two-thirds of its exports to the US while the deal does little to end Chinese state subsidies.  In return the US offers little aside from removing tariff increases.  Intellectual property transfer commitments agreed in the deal are mostly not new as China had already addressed most of these. 

Ironically the magnitude of Chinese purchases, ($77.7bn in manufactured goods, $32bn in agricultural goods, $52.4bn in energy and $37.9bn in services to Dec 2021) means that the Chinese State will have to be even more active in influencing its economy.  The reality is that to achieve this is going to be extremely difficult if not highly unlikely though this may ultimately not matter if China is seen to significantly increase its US purchases.

Looking ahead don’t expect China to be as agreeable on a Phase 2 deal; any such deal would touch on far more sensitive issues.  The likelihood of this being agreed and signed ahead of US elections or maybe at all, is low.  However, in the near term, the deal keeps the risk taps open and avoids any near-term escalation while President Trump walks away with another notch on his belt.  What it doesn’t do is stop any of the US non-tariff barriers, export controls etc, that will still hurt Chinese companies and push China to develop its own technology. Chinese growth will not get much of an uplift from the deal while markets have already largely priced it in.

The commitment from China on the Chinese yuan (CNY) looks vague (achieve market determined FX rate, strengthen underlying fundamentals, refrain from competitive devaluations, avoid large scale, persistent, one-sided intervention), but China will at least avoid any sharp devaluations (of the type experienced in mid-2015, Jan 16), not that they would want to do that again given the negative consequences on its markets/economy.  And as it is China has not been intervening significantly in FX markets for a long while so this should not be difficult either.

Posted in China, Currencies, Economics, Economy, equity markets, Trade, Trump, US, US administration. Tags: , , , . 1 Comment »
« Older posts
Newer posts »