Friday, 9th of August 2019
“ You only find out who is swimming naked when the tide goes out.”
________________________________________
Having enjoyed a brief interlude of relative calm so far this summer, markets have been roiled by the sharp re-escalation of US-China trade tensions in the past fortnight. On Thursday last week, President Trump announced sweeping new tariffs on all $300bn of Chinese imports not already subject to special measures. The punitive 10% levies are due to take effect on 1 September, unless he is satisfied that sufficient progress has been made in negotiations by then. The US decision shattered a fragile peace that had prevailed since the G20 Summit in June, when Presidents Trump and Xi agreed to reboot the high-level talks that collapsed at the end of April. It took almost two months for that pledge to become a reality as both sides wrangled over various details and pre-conditions. However, top American and Chinese negotiators finally sat down in Beijing last week in an effort to unlock a deal. In the event, the talks went nowhere and, after US officials reported home that their Chinese counterparts would not commit to buying more agricultural products (allegedly a promise made by President Xi at the G20), the new tariffs were drawn up. China has since retaliated, suspending all US farm purchases by Chinese companies. This is another body blow for the American Heartland that has been relentlessly targeted in the current dispute. China bought close to $10bn of US soy beans and other agricultural goods in 2018, a figure that is already down 50% YoY since 2017 due to the impact of Chinese tariffs hiked in retaliation to previous US measures. Reducing these imports to zero would cause significant anguish among a key voting block who are already sore from the deterioration in US-China relations. Still, polls suggest that most US farmers are sticking by their man in Washington and unless Trump believes that he will pay a political price for his aggressive trade stance he is unlikely to change his approach.
Indeed, on Monday, the Trump Administration opened a new front in the burgeoning economic conflict between the two superpowers by labelling China a currency manipulator after it allowed the renminbi to depreciate beyond Rmb7 per dollar. The US designation is a largely symbolic gesture that mandates the Treasury to demand special talks with the accused in order to alleviate the problem, but it risks adding a currency dimension to the ongoing US-China trade war. ‘Cracking seven’ (as it is known by traders) is considered significant because it reflects a level of weakness not seen since the global financial crisis and Chinese authorities have exhausted substantial dollar reserves to prevent it from happening in recent months. On the substance of the dispute, most economists agree that from 2003 to 2013 China manipulated the renminbi to keep it artificially cheap and boost the country’s export competitiveness. However, there is little evidence that a similar policy has been pursued since then and, just three weeks ago, an IMF report determined that the Chinese currency was approximately fairly valued (while the dollar was overvalued by 6-12%). Ironically, the renminbi depreciation this week took place because China stopped intervening in the FX markets to defend the exchange rate, so it does nothing to bolster the US argument in and of itself. Going forward, the renminbi depreciation will likely help to offset some of the pain inflicted by additional US tariffs. However, it harms China’s transition to a less export-dependent consumer-driven economic model. The Chinese government know this, hence why the currency manipulation of the early 2000s has more or less come to an end…
After a steep stock market decline on Monday, there was an equally impressive recovery towards the end of the week as US officials made concerted efforts to calm the market. They insisted that despite the latest rhetorical salvos, negotiations were still ongoing and cordial with both sides aiming for a major trade deal and a better relationship in future. However, when we look at the many obstacles that remain (e.g., on enforcement and technology transfer) and the potential benefits to both sides of dragging out talks beyond the 2020 election, we are sceptical that a US-China trade deal will be struck anytime soon. As such, we expect stock markets to remain choppy and unpredictable. Moreover, it appears that the recession in global manufacturing is gathering pace with contagion to other sectors now highly likely. Particularly hard hit has been Germany, where the industrial production figures released this week show a -5.2% YoY fall in output in June and business surveys point to a further decline in July. Meanwhile, UK figures for Q2 revealed a -0.2% quarterly decline in GDP as the temporary boost from inventory stockpiling ahead of the 29 March Brexit deadline went into reverse and uncertainty about how the UK will leave the EU continued to cloud the horizon. Finally, the coalition government in Italy is on the brink of collapse as Matteo Salvini’s right-wing League Party eyes opinion polls that suggest it could clinch a majority if a snap election were held today. Going forward, we thus recommend a cautious approach to equities in the second half of the year.
Perhaps the most explosive geopolitical news this week came out of India, where Narendra Modi’s Hindu Nationalist government took the surprise decision to revoke the constitutionally-protected special status of Jammu and Kashmir. The restive Himalayan state has experienced many decades of insurgent violence by Islamist militants (backed by Pakistan) since it agreed to join India in 1947. Previously, J&K was an independent princely state, but it needed protection from a tribal insurgency at the time of Partition and the Indian government promised its leaders a high degree of autonomy if they joined the Indian Federation. In the agreement, J&K maintained responsibility for all areas of policy other than defence, foreign policy and communications which were ceded to the Indian authorities. Today, J&K is claimed by both Pakistan and India which have been to war over the disputed region three times in the past and regularly have skirmishes at the border. In response to the Indian government’s decision, Pakistan has already decided to end all trade with India and has significantly downgraded diplomatic relations. Further measures including a border war cannot be ruled out given the enormous power of the military in Pakistani politics and the importance that they attach to maintaining influence in J&K. Nevertheless, the BJP have long resented J&K’s autonomous status and are determined to push ahead with changing the constitution. J&K is India’s only Muslim majority state, and the BJP believe that the failure to integrate and develop the region has been a driver of separatist violence. Modi is well-aware that protests are an inevitable consequence of his decision and there is now a total communication blackout across the region with little information getting in or out. He is betting that, in the long-term, forcing J&K to become more like the rest of India will quash the rebellion even if violence rises in the immediate future. Local politicians, meanwhile, are worried that the government will change the law to allow non-residents to buy land in J&K in the name of development, only to pursue a Tibet-style ethnic replacement strategy to integrate the region into India. Major sparks could fly.
In March's news roundup, we look at some of the big deals and trends in the London office market, which has seen a very active month driven by the return of private equity (PE) buyers seeking to take advantage of discounted pricing. We highlight some of the biggest deals and what these mean for the capital.
As families expand, diverse perspectives, voices, and expectations emerge. Each generation brings unique dynamics and values, shaping the family business's future. We offer three key considerations for grooming future leaders within the family business context.
In this market update, we discuss the strength of the equity rally this year, the end of ultra-easy monetary exceptionalism in Japan, and the investment case for gold.