Morning Commentary: China’s Surprising Investment Rally

Foreign Exchange - Morning Commentary
China’s Surprising Investment Rally
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Despite being plagued by trade tensions and the ramifications from US tech sanctions, China hasn’t seen the large outflows of direct investments from multinational firms as expected.  Instead, recent foreign direct investment (FDI) data has shown an improvement of 12.2% YoY through July.  This is an interesting result given expectations for a re-shoring of production away from China.  Moreover, this increase in investments into China comes amid the COVID-19 outbreak when almost all capex decisions are more often than not postponed.

Looking closer at the data, FDI in the services sector was the main driver of growth, especially in high-tech services such as information services and research.  Origin wise, FDI from Hong Kong, Singapore and the UK has shown the most YoY resilience.  Investment from the US rose 6% YoY in 1H20 after growing only 0.4% in 2019.

It should be noted that while investments increased on net, it has been a mix of gains and losses.  For example, Samsung announced the closure of its PC manufacturing line while Pepsi and Starbucks announced investments.  For Starbuck’s part, the company will be building a production facility in Jiangsu, its first such facility outside the US.

Admittedly, the structural shift in FDI flows targeting Chinese consumers and services (vs. manufacturing and exports) has been going on for years.  The trade tensions between the US and China only reinforced the move.  Back in the early 1980s, the FDI boom into China started and was driven by cheap production costs, fast developing infrastructure and favorable policies.  However, China has since set the goal of moving up the value chain and reduced preferential tax and other benefits tailored for manufacturing FDI.  Unsurprisingly, manufacturing FDI to China has mostly contracted since 2012 with services FDI continuously expanding.  Interestingly, while FDI inflows into China have been skewed to services, those same flows into the US have skewed to manufacturing.

Going forward, this trend for continued services FDI into China should continue due to a favorable policy environment, higher income levels in China and less protectionism (US investments into services targeting Chinese consumers should lead to less disputes over low-income US jobs).  Moreover, while the US-China relationship will be bumpy with many uncertainties, the potential of the Chinese market makes a halt in manufacturing or multinational firm divestment unlikely. 
  • The ECB held its policy rate unchanged and kept its Pandemic Emergency Purchase Program target at EUR 1.35 trillion through at least June 2021.  Nevertheless, expectations remain for further asset purchases by the end of the year.  The ECB faces twin headwinds in negative inflation and a strengthening currency.  Lagarde has been asked about the euro’s level and reiterated the relationship between exchange rates and inflation but refused to be drawn into a discussion about currency levels.  The euro is up on the day as the ECB agreed (per news reports based on ECB sources) that there was no need to overreact to EURUSD gains.  In essence, the markets are ok with the ECB monitoring the currency as long as the bank doesn’t concluded it is a problem that needs to be addressed with policy tools. 
  • US initial jobless claims disappointed expectations at 884K versus consensus for an 850K print.  Louisiana and Virginia saw the biggest jumps in claims.  Continuing claims also disappointed, rising to 13.4 million from 13.3 million. 
  • The US Senate will hold a procedural vote today on the Republican’s skinny virus relief deal.  Democrats have the votes to prevent it from reaching the floor, so this is more a test of Republican unity as the skinny bill is an intra-party compromise between deficit hawks and vulnerable Senators up for re-election.   
  • The UK published its Internal Market Bill which would allow the UK government to override parts of the Withdrawal Agreement.  For the EU’s part, it responded by saying it was considering legal actions against the UK as it was a “clear breach of substantive provisions” of the Withdrawal Agreement.  Formal Brexit talks wrap up today with no material progress made as expected.
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