Pricing the risk of another conflagration between the US and China is an inherently difficult task, so equities have decided not to bother, apparently. Best leave it to more sophisticated market participants and FX speculators, I suppose.
Wall Street tacked on more gains Wednesday despite a choppy session marred by extremely negative news on the Hong Kong situation and a threat from Donald Trump to shut down America’s social media platforms.
Small-caps really are the story right now stateside – they’re riding a five-day win streak, and have gained in eight of the last nine sessions.
Banks are on track for a stellar week.
This is mostly predicated on reopening optimism and the ongoing realization that monetary and fiscal stimulus are finally on the same page.
“There is a better chance of swift recovery from this shock than from the early 1980s or 2007-09”, Jim Bullard said Wednesday, during an online discussion. “There is much less confusion this time around than there would be in a financial crisis, as in 2007-09, or a more extensive recession, as in the early 1980s”.
But behind it all is a guaranteed fight between Washington and Beijing. This is something investors have learned to live with over the past three years, but as I’ve tried to dutifully impress upon readers, this time it’s considerably more serious.
Mike Pompeo made it clear Wednesday that the US won’t certify Hong Kong’s autonomy and revoking the city’s preferential tariff rates is reportedly on the table.
China has attempted to guard against excessive yuan depreciation, but the market isn’t playing along. USD/CNH is flirting with record highs.
Bloomberg’s Ye Xi spoke with David Loevinger, a former China specialist at Treasury about the situation on Wednesday.
“I expect the administration will come out first with a lot of tough talk and financial sanctions and visa restrictions on Chinese officials who probably weren’t dumb enough to keep funds in the US”, Loevinger said. “Then hold back some of the bigger guns like tariffs, export controls and investment restrictions until they see what the new law looks like and how it’s implemented”, he added, noting that “China’s response will likely continue to be measured, particularly against US companies that are major employers and procurers in China, but there is a risk the US overreaches and hits a nerve on Hong Kong or Taiwan”.
Asked about the trade deal, Loevinger was unequivocal. “The trade deal is toast”, he told Ye. “China’s import commitments weren’t realistic even when its economy was firing on all cylinders… there’s no way they’ll meet their commitments now”.
He did say, though, that neither side thought the targets were realistic in the first place, and the Trump administration may be keen to preserve the agreement for political reasons at least until the election.
For their part, BNP puts 30% odds on the deal coming unglued. “In our view, [Trump] will probably be reluctant to back away from the agricultural, manufacturing and energy purchase targets, which were insisted upon by American negotiators and which the president sees as his most direct way of rewarding his political base”, the bank says, in a noted dated Tuesday. “In order to demonstrate his toughness and shift blame toward China, he may feel tempted to reach for the tariff toolkit again, both as a threat and a way to gain remedial action”.
And yet, BNP notes that China’s quick recovery from the epidemic may mean Beijing believes it has leverage. BofA echoes those sentiments. “China’s leaders believe containment of the virus and a less dire economic outlook provide an opportunity for moving ahead aggressively”, the bank’s US economics team said Wednesday.
“Attitudes towards relations with the US have hardened considerably since January [and] the importance of the American market to Chinese exporters has shrunk from 19% of total exports in 2017 to only 14.8% in the first four months of 2020”, BNP went on to remark. “If negotiations run into difficulties, a critical flaw of the deal emerges, which is that there was no credible enforcer or binding legislation, only executive fiat”.
That’s a nice way of saying what I emphasized over the weekend in “‘The Stakes Keep Getting Higher’: US-China Cold War Likely To Continue Regardless Of Who’s President” – namely that markets always doubted the deal for a laundry list of reasons, not least of which is that both parties to the agreement (China and Donald Trump) are notoriously unreliable and prone to negotiating in bad faith.
“Recall that at the start of the trade war President Trump and his advisors argued that the relative strength of the US economy gave them an advantage”, BofA’s Ethan Harris writes. “Today, to some degree, the shoe is on the other foot: China has already weathered its bad quarter and second quarter data shows a significant pick-up in activity”.
On Wednesday evening in the US, the House passed the Uighur bill, opening the door to sanctions on Chinese officials (among other things) in connection with human rights abuses in Xinjiang.
The (proxy) vote was 413-1. Having already cleared the Senate, it now goes to Trump’s desk. He has not said whether he will sign it.