The Week Ahead: An Increasingly Complex U.S.-China Relationship
An Increasingly Complex U.S.-China Relationship
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Andrew Kositkun Foreign Exchange Head Trader
Recently, China, the Association of Southeast Asian Nations and other major Asia-Pacific economies signed the Regional Comprehensive Economic Partnership (RCEP). Once RCEP is ratified, it will be the world’s largest free trade agreement covering 30% of global GDP, the global population and an even larger portion of global growth. Because of this, RCEP likely makes it harder for the U.S. to decouple from China.
Broadly speaking, there are two aspects to the U.S.’s attempt to limit trade with China. The first aspect is to constrain China’s access to foreign products. On this dimension, the U.S. has had some success in the semiconductor space as the U.S. has restricted the sale of chips with any U.S. software or technology to Huawei. Because nearly all semiconductor chips contain some U.S. input, Huawei has become reliant on exceptions granted by the U.S. government.
RCEP’s signatories include many traditional U.S. allies that might cooperate with narrow U.S. efforts to limit China’s access to sensitive technology. However, these countries also signed RCEP to access China’s markets massive markets. Even if the U.S. proposes narrow restrictions on China, RCEP countries will have to weigh China’s interests more heavily. If they decide to be selective in what they export to China despite having entered RCEP, they run the risk of Chinese retaliation.
The second aspect of the U.S.’s effort to isolate China is to limit China’s influence in the global supply chain. Specifically, the U.S. is attempting to reduce dependence on Chinese tech products. To this end, some progress has been made as U.S. imports of computers and electronics from China dropped 21% last year and are on pace to drop another 11% this year, although the pandemic has played role in this.
However, RCEP is designed to create deeper integration in regional supply chains. This means that China will play a key role in U.S. tech imports from the Asia-Pacific region regardless of which country tech products are sourced from. Since China gained entry into the World Trade Organization, its tech export gains came at the expense of other countries in the region. Conversely, China’s losses during the trade war have mostly been offset by gain in other parts of the region. In essence, the share of U.S. computer and electronic imports from RCEP signatory countries has remained stable in the 60%-70% range since 2005. This means that a true decoupling from China would mean a decoupling from the entire region. Further adding to the complicated trade picture are reports that China is considering joining the Comprehensive Agreement for Trans-Pacific Partnership (CPTPP), the modified trade agreement that resulted after the Trump administration withdrew from the Trans-Pacific Partnership in 2017.
In the end, even though being tough on China is one of the issues receiving widespread bipartisan support, China’s growing ties with other economies makes breaking up hard.
The euro has traded in the 1.16-1.20 range since late July and is likely to remain in up end of this range. Vaccine optimism has driven a growing expectation for a recovery in 2021, but there is still a long road ahead. Until a vaccine becomes widely available, there are few alternatives to more restrictions in Europe and the U.S., where case numbers and hospitalizations remain high. Further, the Thanksgiving holiday could result in a COVID spike just in time for the next holiday period. While the dollar should remain under pressure, safe haven demand for the dollar should provide support while the U.S.’s economic outperformance relative to Europe, delays in the implantation of the EU fiscal stimulus package and increased expectations for ECB dovishness will likely cap EURUSD gains.
Hopes around a vaccine and positive Brexit news should put a floor underneath GBPUSD. Bank of England chief economist Andy Haldane recently stated that the recent stream of vaccine news was “to the positive side” of central bank assumptions. He added that it was “tough to know for sure” if he would still vote for additional asset purchases if he knew the vaccine news. This is a noteworthy admission, but for now Brexit is the key near-term driver. To this point, key dates for negotiations continue to be pushed out but market consensus is strongly for a deal. This supports the GBP but also makes it vulnerable to last minute saber-rattling. Should a deal be stuck, the pound could rally further as the worst case scenario of a no-deal exit is priced out. However, a skinny deal, which remains the base case, that excludes large parts of the service sector still incurs an economic cost as it means the U.K. will have less favorable terms with its largest trading partner. Once we get past the initial relief rally, it’s possible that markets refocus on the increasingly negative economic backdrop and implementation concerns around Brexit that leads to pound selling.
The yen should remain driven by broader risk sentiment and the USD over the next week. USDJPY has seen spikes of weakness following positive vaccine developments, but these moves have been short-lived. Overall, USDJPY is likely to range trade as the currency remains caught between positive vaccine expectations and resurging infection numbers. Additionally, a pullback in investment flows, relative to the beginning of the year, represents a reduction in what was an idiosyncratic source of yen weakness. Expect further range trading with a bias for yen appreciation.
Over the past month, the Canadian dollar has underperformed many of its G10 peers as COVID-19 cases continue to rise and flags risks for a choppy recovery as the voluntary and official restrictions stall economic momentum. Given this, market optimism regarding vaccine developments has trumped near-term risk factors. Extended fiscal support, optimism for widespread vaccine availability by next year and a shift in strategy to more targeted lockdowns should keep the economy and the loonie supported. Continue to expect the loonie to be driven by broader risk sentiment as markets reassess the recovery outlook with progress on a vaccine offsets winter COVID waves. Overall, the loonie’s current valuation and an improved growth outlook provides a runway for modest strength.
The Chinese yuan moved sideways this past week, but the outlook remains bullish as the factors supporting currency appreciation remain in place. The incoming Biden administration is expected to keep pressure on China, but trade tensions should ease as the U.S. should rely less on tariffs and more on a coordinated approach. Relatively higher yields in China, the inclusion of Chinese equities in global indexes, COVID-19 outperformance, reduced trade uncertainty and a current account surplus economy that continues to perform should warrant a bullish yuan stance.
Three consecutive weeks of positive vaccine developments have given a boost to global risk sentiment that has supported the Aussie. Recent Reserve Bank of Australia (RBA) action and better-than-expected October jobs data likely mean the bank will be on hold for the time being. As such, no action is expected at this week’s policy meeting. Countering positive vaccine news is continuing trade tensions between Australia and China that should continue to weigh on overall sentiment, trade and investments. Overall the AUD is likely to consolidate due to the offsetting forces mentioned above.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain unchanged at 0.10%
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
U.S. ISM Manufacturing PMI
Expectations for a 57.8 print
U.S. ADP Employment Report
Expectations for 440,000 increase
U.S. Initial Jobless Claims
Expectations for 763,000 claims
U.S. Non-farm Payroll Jobs Report
Expectations for 500,000 increase
Canadian Q3 GDP
Expectations for a 10.3% quarter-over-quarter gain
Canadian Jobs Report
Expectations for 50,000 decrease
EZ Unemployment Rate
Expectations for a 0.1% increase to 8.4%
EZ Consumer Price Index
Expectations for a 0.3% decrease month-over-month
German Unemployment Rate
Expectations for a 0.1% increase to 6.3%
Asia/Japan, and New Zealand
Chinese Manufacturing PMI
Expectations for a 53.5 print
Chinese Services PMI
Expectations for a 56.4 print
Japanese Jobless Rate
Expectations for a 0.1% increase to 3.1%
Australian Q3 GDP
Expectations for a 2.4% quarter-over-quarter increase
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