Morning Commentary: No Longer Free

Foreign Exchange - Morning Commentary
No Longer Free
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Tensions between the US and China continue to rise.  In China, lawmakers approved a proposal for sweeping new national security laws despite the threat of retaliation from the US.  In response to the situation in China, the US certified that Hong Kong is no longer politically autonomous from China.  By certifying that Hong Kong is not politically autonomous, the US has raised doubts around the special trading status the former British colony has had with the US and adds to the long list of questions around the US-China relationship. 

From an economic perspective, there are two central issues.  The first concerns what constitutes free trade.  When China was admitted into the WHO in 2001, the widespread assumption was that it would gradually move towards a market-based democratic system.  However since 2013, when President Xi assumed power, China has become authoritarian with a state-sponsored push into the high tech sector.  

This brings up the second point of contention, and arguably most difficult issue, which is the tech sector.  China sees advances into tech as simply the next natural step in becoming a developed economy.  From the US’ point of view, China’s push raises flags.  The state-sponsored element means unfair trade advantages that could displace key parts of the US economy.  Additionally, a rise in China’s tech prominence raises cyber security and loss of military advantage concerns.  

After the end of the 2018-19 trade war, the expectation was for a de-escalation heading into the election with a possible escalation afterwards.  However, a desire from both countries to deflect from COVID-19 handling issues could have accelerated this timeline.  

In the US, growing bi-partisan support to get tough on China makes hawkish measures a politically beneficial move.  From China’s side, relative containment of the virus and a less dire economic outlook could embolden its leadership.  At the start of the 2018-19 trade war, the US argued that relative economic strength gave it an advantage.  Now with China already through its bad quarter, that dynamic is no longer as clear.  Reopening experiences in Singapore and Korea also show that China’s aggressive testing, tracking and quarantining system gives it an advantage in containing the virus with targeted shutdowns that are less harmful to the economy.  

To state the obvious, the economic impact will depend on how things evolve.  Thus far, battles have been largely symbolic.  For example, if Chinese companies are delisted from US exchanges, this would increase their cost of capital on the margin but would have limited economic impact.  In contrast, other forms of escalation can have a material impact as the uncertainty from the 2018-19 trade war took an estimated 1% off US GDP.  
  • While the US no longer considers Hong Kong to be autonomous, it does not necessarily mean there will be an immediate removal of Hong Kong’s special status but rather opens up a wide range of options.
  • Congress passed a sanctions bill against China in response to alleged human rights concerns against Muslim minorities.  Additionally, the US plans to cancel the visa of Chinese graduate students and researchers in the US with ties to universities affiliated with the People’s Liberation Army.   
  • US initial jobless claims came in at 2.1 million and brought the ten week total to over 40 million.  Today’s print continues the downward trend in weekly jobless claims but absolute amount of weekly claims remains historically large.  
  • New York Fed President Williams stated that the Fed is thinking “very hard” about targeting yields.  Yield curve control has been floated as an alternative to negative yields and would ensure that yields stay low even during a recovery.  
  • Dovish comments continue out of the BoE with Governor Bailey indicating the bank is studying negative rates and MPC member Saunders saying it’s better to err on the side of too much easing rather than too little.  
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