From Not Great to Worse
Mid-January saw agreement on a “phase one” trade deal, suggesting that US President Donald Trump and China’s President Xi Jinping were looking to calm a tense business environment and its attendant negative economic consequences. As of early June, this situation has changed markedly. Throughout the pandemic, Trump has made no qualms about implicating China for the global spread of the disease, while Secretary of State Mike Pompeo has paid deference to otherwise unproven claims that COVID-19 originated at a Wuhan research facility. China’s government has reacted in kind, particularly in its domestic messaging, which has been critical of US leadership and its pandemic response. All of this is taking place as many Western business leaders undertake a reconsideration of global supply chains – many of them China-dependent. It seems that over the near term, COVID-19 will accelerate de-globalization trends, as considerations of self-sufficiency and disaster preparedness rule the day.
US Rules Tighten
The US Commerce Department has announced that any company utilizing American semiconductor equipment must obtain a license before supplying chips to the Chinese multinational Huawei. Recent expansions of this rule seek to close loopholes regularly exploited in the months preceding the COVID-19 crisis. This is significant, not least because recent sales have made Huawei the world’s second-largest provider of mobile phones.
The US House of Representatives will soon weigh in on a Senate-approved bill that could ultimately force some Chinese companies from being listed on American stock exchanges. The Senate legislation would prohibit the trading of foreign equity issues if the Public Company Accounting Oversight Board is denied access to historical financial data. The law would also force companies to establish that they aren’t owned or controlled by a foreign government.
Tensions in Hong Kong
China’s Parliament has approved a new national security law that it says is designed to rein in terrorist activity and foreign interference in Hong Kong. Critics suggest the move is a bold attempt to ostensibly end Hong Kong’s involvement in the “one country, two systems” arrangement that has held since the British handed over the territory per treaty agreement in July 1997. Supporters of an independent Hong Kong suggest China is taking legislative action now that it could not take prior to the COVID-19 pandemic’s curtailing of massive street demonstrations. Those demonstrations were spurred in part by proposed legislation that would have allowed China to extradite individuals accused of crimes from Hong Kong to the mainland. Secretary of State Pompeo and other US officials have criticized China’s Hong Kong Security Law as a violation of the territory’s political rights, and the Trump administration has threatened repercussions. As events unfold in Hong Kong, they have the potential to influence the city’s status as a global financial center, including its role as a base for multinational companies and conduit between Chinese markets and the rest of the world.
Tensions in Taiwan
As of late May, the US has plans in place to sell $180 million worth of advanced torpedoes to Taiwan, which maintains unofficial status as a US ally. Officially, Taiwan remains a self-governing entity of China, under the aforementioned “one country, two systems” arrangement. US arms sales to Taiwan will undoubtedly anger President Xi. Pompeo and the Trump administration have continued to break with long-standing diplomatic tradition by referring to Taiwan’s leader Tsai Ing-wen as “president.” In other news, Taiwan recently moved to block video streaming services provided by the Chinese company Baidu. In response, Baidu is said to be considering a de-listing from Nasdaq and moving to an exchange closer to China.
Status Quo Turbulence in Emerging Markets
Unfortunately, the diplomatic and policy conflicts between the US and China will likely continue over the near term, at least until the US elections in November. Politicians from both parties will seek to influence voters with tough talk on China. In the meantime, the situation remains a headline risk for markets and a near term headwind for emerging market (EM) equities. Russia, Brazil, and Mexico – not insignificant players in the EM space – will also continue to face substantial COVID-19 challenges in the near term. Offsetting fiscal and monetary responses being used by EMs are similar to those being used in developed markets, but they create different risks. Notably, EM currencies are taking the brunt of the worries as capital flight results in currency weakness within weaker economies.
There’s potential here for a negative feedback loop – increased COVID-19 response resulting in growing currency weakness. Investors have plenty to consider as consumers, businesses, and governments reopen from the lockdown while remaining risk aware about the potential for a significant second wave of COVID-19 contagion. It is important to remember that this calculus is likely to be made more challenging by escalating rancor between the world’s two largest economies.
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