Geopolitics A Ticking Bomb?
Summary: Asia equities broadly higher and sweeping aside the mounting tensions between the US and China, instead focusing on the perceived positives which have driven risk assets in recent weeks. Namely reopening economies, slowing COVID-19 case growth and expanding central bank balance sheets.
We still maintain, the failure of the S&P 500 to sustain above the bear market retracement zone, bears watching into tomorrow’s cash session (US markets closed for Memorial Day tonight) particularly as sentiment continues to flip flop and upside momentum looks to be stalling. However, as we have previously noted, risk assets are not being driven by pervasive uncertainties and reopening realities. The hope trade is firmly rooted in abundant liquidity and the promise of more if necessary, along with the speculative flows of retail traders driven up the risk spectrum via the lack of alternative (TINA) and the expectation that rates will remain low for an extended period. The rise of zero commission trading and ease of online account opening has fuelled the retail flows, which in the long run may serve to democratise financial markets. However, there is also the continued expectations that central banks will fix all ills and are equipped to backstop asset prices against a fundamental backdrop that has arguably never been so uncertain. The sharp rebound of March lows in turn drives continued speculative behaviour, as the fear of missing out (FOMO) becomes a driver and in this paradigm markets remain biased to the upside.
Fundamentally, it seems markets have run ahead of reality in pricing the recovery, particularly given a wide range of consumer, economic, and pandemic (vaccine/2nd wave) probabilities exist. For that reason, we remain on high alert for the “trading on hope” narrative reversing and remain cautious on the short-term risk reward across equities at present levels.
Are rising US/China trade tensions enough to snap the positive bias? Markets have typically traded on the hope that the rhetoric is worse than reality when it comes to the US/China disentanglement. Now it seems that each day brings fresh evidence that the relationship has permanently changed and the global geopolitical architectures, which have long been fraying, are moving closer to breaking point. The ideological differences and political fragmentations that drove the original US/SINO confrontations are on full display and the tectonic shifts like, the East/West divide, Splinternet, and supply chain relocations we talked about when trade tensions first emerged are now coming to fruition. Beijing revealed plans on Friday to impose laws on Hong Kong that would ban subversion, secession, foreign interference and any acts that threaten national security. With China’s strike on Hong Kong comes the ultimate test of whether this US administration’s hawkish position on China “bark” is worse than the “bite”. Particularly as the tough stance on china plays into the election strategy and diverts attention from the handling of the health crisis, whilst shifting blame to China.
The rebuttal from the US will be closely watched, to date White House economic adviser Kevin Hassett has stated that the US government is “absolutely not going to give China a pass” and is threatening punitive actions. Revoking Hong Kong’s special trading status, along with sanctioning individuals and entities involved in enforcing the proposed new security law in Hong Kong have been floated, but talk is cheap and we await the US response.
Although the CNY fix today was stronger than estimated, illustrating the PBOC acted to slow the CNY decline, the fix was the weakest since 2008. USDCNY bears watching closely as a barometer of China’s intent and proxy for the state of US/Sino relations, the PBOC has previously made it very clear the Yuan is not a one-way bet and do not want a disorderly panicked move. However, the slow and steady depreciation is in play. The yuan will weaken to offset renewed tariff risk but also remains under fundamental market pressures. As the $CNY exchange rate approaches 7.20, no doubt angst will be on the rise but the manner of the depreciation will determine the resultant risk asset response. The more disorderly, the greater the fallout.
As the US and China go head to head in the battle for hegemony, Australia is caught in the middle of the two superpowers. With the mounting US/China tensions comes an increasingly difficult trajectory for Australia to navigate.
Balancing the ideological and national security allegiance with the US and the trade relationship with China leaves Australia in a difficult position. Although the Australian government have asserted that Australia is not under pressure to pick sides. Recent actions and commentary from both China and the US appears to the contrary. China’s dominant purchasing position for Australian goods potentially comes with a price Australia is not willing to pay, as recent support of the independent investigation into the origins of COVID-19 have prompted retaliatory reactions from China motivated by economic coercion and resulted in tariffs on Barley imports to China and the banning of some beef imports. By this token, the pandemic outbreak could prove a pivotal moment for the long run relationship between China and Australia. Whilst the present industry attacks are no doubt harmful at the individual level, in terms of the broad GDP impact they are minimal. However, China accounts for more than 30% of goods and services exports and a more serious reduction in Chinese demand like a consumer boycott of Australian goods and services exports (education/tourism), targeting iron ore, or coal exports would pose a far greater and more damaging impact.