The long-term consequences of Covid-19 may well entail accelerating a retreat by countries from global trade and open immigration. The pandemic sure heightens a tense and competitive relationship between the US and China.
In recent months, financial market sentiment has naturally been dominated by the pace and range of support for shuttered economies and the prospect of activity resuming and subsequently managing any second waves of Covid-19.
Now the pace of recriminations between the US and China shapes as complicating the picture for investors. Beyond Donald Trump’s Twitter feed, a US Senate push against the stock exchange listing of some Chinese companies highlights how a trade war is becoming more focused on financial flows.
This comes after a recent amendment of an export rule by the US Commerce Department, designed to stop semiconductors being sent to Huawei Technologies. Citi’s Asia-based economist argues that memory chip exports within the region to China may expand during the 120-day grace period, and then moderate once the ban is effective.
Next up, any reaction from China when the National Peoples’ Congress begins. The FT’s Tom Mitchell writes that President Xi Jinping faces plenty of scrutiny over the handling of the pandemic, while China faces daunting economic and financial challenges. An indication that China plans to impose a new security law in Hong Kong, risks angering the US.
As the global investment team at Citi Private Bank observes:
“Given the extent of real economic and financial ties between China, the US and intermediaries, much larger negative economic outcomes are possible compared to those felt in the so-called ‘trade war’ of 2018-19.”
But many think any potential broadening of hostilities between the two powers can only run so far before backfiring given the economic and financial cost for both the US and China.
Sebastien Galy at Nordea Asset Management says:
“It is in neither party’s interest to boil it over, especially in the United States given the feedback loop in the equity markets.”
Others are less sure and worry that the upcoming US presidential contest beckons as an exercise in how hard each of the rivals bashes China and encourages a hardening of the faultlines between the two powers that shapes the current decade.
Analysts at TD Securities note:
“There is bipartisan support in the US for pushback against China and irrespective of the outcome of the [presidential] election, we expect the rift between the US and China to grow over time.”
“As with earlier US-China tensions, the main channel for spillover would be business confidence.”
Trade disputes are certainly not fading at the moment with China upping the ante with Australia, although the target list does not include iron ore. An important barometer of global trade is South Korea and its latest data revealed weakness extended from April into the first 20 days of May, with exports contracting more than 20 per cent, while imports fell 17 per cent on a year-over-year basis.
Kristina Hooper at Invesco thinks:
“There is a distinct possibility that the US may levy some tariffs against China in order to extract reparations and retribution for the pandemic — which would likely be met with trade penalties from China.”
“I don’t believe it would be as easy for stocks to shrug off a reignition in the US-China tariff war, especially in the midst of this pandemic.”
For financial markets there is also the challenge of navigating the risk of a capital war. Particularly given the hefty holdings of US Treasury debt by China (at $1.1tn and second only to Japan) and at a time when Washington is stuck with annual $1tn budget deficits. The general view for now is that China is not going to add to its Treasury holdings rather than sell them down.
Also in play, a surge in global currency volatility should the renminbi weaken sharply. For some time these have been scenarios flagged and downplayed given the likely severe consequences for the global financial system.
Analysts at Citi observe that US efforts at “non-tariff escalation” such as technology restrictions and stifling investment flows is likely, but this should not trigger a “sharp renminbi depreciation”. They argue that currency stability “will likely be preferred by China’s policymakers, unless the risk of tariff imposition rises”.
Bank of America is hardly cheerful about the scope for financial tension:
“Trade wars are messy and difficult to win. By contrast, the US advantage in financial markets makes a capital war more likely in 2020 and beyond, in our view.”
The bank’s analysts explain that capital flow rules “are operationally easier to implement, tend to experience less interference from international governing bodies, and can be implemented via Treasury or Commerce” departments or in other words, outside Congress.
President Trump recently halted the investment of federal retirement funds in China. Invesco notes this “means that approximately $6.05bn would have been allocated to Chinese stocks but now will not”.
BofA also estimates:
“US investors own nearly 10 per cent of the 100 largest Chinese companies, with $5.4tn in market capitalisation.”
Investors, business and consumers are all longing to move beyond the pandemic. Eventually we shall, but later this summer with the US presidential contest in full swing, shaking off trade and financial tension may prove rather difficult.
The frustrating aspect of such a scenario is that any eruption in market turmoil likely forces compromise between the parties, but only after subjecting investors to another bout of being strapped in a rollercoaster.
Quick Hits — What’s on the markets radar?
A flurry of global purchasing managers’ reports today duly revealed readings remain well below 50, indicating a contraction in activity. For the optimists, Brown Brothers Harriman also notes “many areas remained shut down in whole or part when the surveys were conducted between May 12 and May 20. This seems to set the stage for stronger readings in June.”
Rather than wait for surveys and official numbers, many investors are watching real-time data for a better sense of how economies are recovering.
Brad Bechtel at Jefferies highlights — through a series of proprietary metrics that monitor the pace of countries reopening — that there are “signs of stability in things like traffic congestion, mass transit usage, flights, etc, but we are not really seeing any major growth yet in those countries who have slowly started to reopen”.