Weekly wrap – Pelosi rocks the boat

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Written by Citadel Global Director, Bianca Botes

PELOSI ROCKS THE BOAT

Just as global risk appetite started to improve, geopolitical tension flared up again. This time between China and the United States (US). US house representative, Nancy Pelosi, on a tour of the region, touched down for a short visit in Taiwan, against the wishes of the Chinese government.

  • Key themes for this week include:
  • China issues warnings to US and launches missiles near Taiwan
  • Bank of England (BoE) hikes interest rates by 50 basis points
  • Corporate earnings bolster Wall Street
  • Oil steady after shedding 4% on Wednesday

INVASION ON THE CARDS?

While many of us know that China wants Taiwan under Chinese rule, not many of us know exactly why. The strained relations between the two countries date back to Civil war in 1940, where Taiwan claimed their independence from China. Beijing insists that Taiwan is still a part of China and should be governed as such, but Taiwan has its own constitution and democratically elected government. However, only a few countries- 13 to be exact- recognise Taiwan as a sovereign country, with the rest of the global community recognising the Chinese Government as the legitimate rulers of Taiwan.

So where does the US fit in to all of this? While the US has no direct ties to Taiwan, the Whitehouse has stated repeatedly that they would assist Taiwan in defending itself against a Chinese invasion.

The next question might be, why is Taiwan, a small island off the coast of China, so important? The answer is quite simple – computer chips. More than half of the world’s technology, ranging from smart phones to watches, contain computer chips manufactured in Taiwan by a company called Taiwan Semiconductor Manufacturing Company or TSMC. A takeover of Taiwan would give China a firm grip on many of the worlds largest and most profitable industries.

Following the touchdown of Nancy Pelosi in Taiwan, China has expressed their dissatisfaction with the visit in several ways, from hacking the Taiwanese government, to firing 11 missiles just off the Taiwanese sea border, and a military drill taking place in six zones surrounding the island. While Taiwan made it clear that they are in no way seeking war with Mainland China, they are, in fact, preparing for it. But what do the experts say? The consensus is split at this stage, with two schools of thoughts in play. The first believe the visit by the US was the final straw for China, who will now prepare a full-scale invasion of Taiwan, and the second says that China is pragmatic in its thinking and will first ensure that Xi Jin Ping secures his seat as the ruler of China in December’s election, before taking any drastic steps against Taiwan.

While both sides make valid points, markets are not receiving the fresh bout of geopolitical tension well, especially after the recent invasion of Ukraine by Russia. All the uncertainty, and fear of further conflict, is derailing any hint of risk seeking behaviour in financial markets.

DATA IN A NUTSHELL

The BoE raised interest rates by 50 basis points, as expected, to 1.75% on Thursday, marking the sixth consecutive British rate hike, and pushing borrowing costs to their highest level since 2009. The hike is the biggest rate increase since 1995. With wholesale gas prices almost doubling since May and feeding through to retail energy prices, real incomes of United Kingdom (UK) households are expected to come under immense pressure, as further increases in near term inflation are expected. According to new BoE projections, Consumer Price Index inflation is expected to rise to 13.3% in October, and to remain at very elevated levels throughout much of 2023, before falling to the 2% target in 2024. Looking at growth, the UK is now projected to enter a recession in the fourth quarter which could last for five quarters.

The unemployment rate in the euro area was unchanged at 6.6% for a second consecutive month in June, a record-low reading and in line with market forecasts. It was a much stronger reading compared to the jobless rate from June 2021, where unemployment was significantly higher at 7.9%. The S&P Global Eurozone Composite PMI (purchasing managers index) was revised higher to 49.9 in July, from a preliminary reading of 49.4, the reading, however, still points to the first contraction in private sector activity since February of 2021.

The number of Americans filing new claims for unemployment benefits rose by 6 000 to 260 000 in the week that ended 30 July, surpassing market expectations of 259 000. On a non-seasonally adjusted basis, claims fell by 9 285 to 205 587 from last week’s downwardly revised value, with notable decreases in Massachusetts and Ohio, while claims rose significantly in Connecticut.

The Caixin China General Manufacturing PMI declined to 50.4 in July 2022 from June’s 13-month high of 51.7, undershooting market forecasts of 51.5. While the print signals a back-to-back rise in factory activity, it also reflects the effect of widespread COVID lockdowns and electricity shortages at some firms. Both output and new orders grew at a softer rate, while employment fell for the fourth straight month, with the rate of job shedding at its highest level since April 2020.

The South African seasonally adjusted Absa PMI fell to 47.6 in July from 52.2 in June, mainly due to electricity supply disruptions. It is the first decline in factory activity since July last year, when the looting and unrest in KwaZulu-Natal and Gauteng disrupted output.

WALL STREET RALLIES ON EARNINGS

US stock futures contracts tied to the three major indices were up 0.5% on Thursday, putting Wall Street on track to extend its recent gains, as impressive quarterly results from corporate America and upbeat economic data eased concerns about an imminent recession. Despite good earnings news, several US Federal Reserve (Fed) policymakers moved this week to halt recent market speculation that the central bank would adopt a less aggressive stance on interest rates. They assured markets that the Bank remains fully committed to taming inflation even at the risk of a recession. On the corporate side, Alibaba’s US-listed shares jumped almost 10% in premarket trading after the Chinese e-commerce giant reported earnings that surprised investors on the upside.

London shares rebounded from their recent lows to move into positive terrain on Thursday, as investors digested the latest monetary decision from the BoE, while welcoming upbeat corporate results. On the corporate side, shares of clothing retailer, Next, advanced roughly 1% after it increased its full-year sales and profit forecasts, indicating higher demand for new clothes amid warm weather.

European equities rose for a second consecutive day on Thursday, with the pan-European STOXX 600 and the DAX 40 adding roughly 1%, following Nancy Pelosi’s departure from Taiwan, as the focus was back on the ongoing earnings season. Banking Group, Credit Agricole, joined its French peers, BNP and Societe Generale, in reporting higher-than-anticipated quarterly profits.

The Nikkei 225 Index climbed 0.69% on Thursday, rising for the second straight session, lifted by a weaker yen and upbeat domestic corporate earnings. Japanese shares also tracked the strong rally on Wall Street, as robust earnings reports and a better-than-expected US July services PMI reading eased concerns about a potential recession. Heavyweight firms led the advance, with gains from SoftBank Group, Tokyo Electron and Nintendo. Japanese shippers also advanced on solid quarterly results, including Kawasaki Kisen, Nippon Yusen and Mitsui OSK. Meanwhile, car manufacturer, Subaru jumped 8.5% and was the best performer on the Nikkei after a positive earnings report and optimistic forecast for futures sales in the US. Meanwhile, Yahoo! holding company, Z Holdings, tumbled 11% on weaker-than-expected earnings, while Toyota dropped 3% after posting a 42% annual decline in operating profit.

South Africa Stock Market Index, the SA40, gained 0.52% on Thursday. Over the past four weeks, the SA40 gained 6.06%, and is up 0.52% over the past 12 months. Analysts believe that there is room for additional gains on the JSE in the coming weeks and months.

GOLD’S GAINS SHORT-LIVED

Brent Crude futures found some stability near $97 per barrel on Thursday after shedding almost 4% in the previous session, as traders weighed a modest supply increase from expanded Organisation of the Petroleum Exporting Countries, OPEC+, against rising US crude inventories and signs of declining US gasoline demand. The group of major producers agreed to raise oil output by a paltry 100 000 barrels a day in September and warned of “severely limited” spare capacity, in a setback to US President Joe Biden’s attempts to convince Arab leaders to pump more crude. Meanwhile, official data from the International Energy Agency indicated that US crude stockpiles expanded by about 4.5 million barrels last week, despite expectations for a 629 000 barrel decline. The same report also indicated that Americans are now driving less than they did in the summer of 2020 despite pandemic restrictions during that period, with surging inflation continuing to weigh on demand, as observed by Bloomberg.

Gold extended its drive towards the $1 790 per ounce mark, a level not seen since early June, as fears of a recession remain on the horizon. Meanwhile, brewing tensions between the US and China boosted demand for the safe-haven asset. Gold will now take its cue from the monthly jobs report in the US, which will be released this afternoon.

US natural gas futures bounced back to around $8.30/MMBtu (one million British Thermal Units), recovering from a two-week low of $7.60/MMBtu touched earlier this week after Freeport LNG, a key export terminal in Texas, reached an agreement with regulators to restart operations as soon as October. At the same time, prospects of an increasing need for cooling, amid hotter-than-normal temperatures in the United States and continued robust demand from Europe, continued to support prices. The key Nord Stream 1 pipeline from Russia to Germany is currently running at 20% capacity. Russia has already halted shipments to Demark, Finland, Bulgaria, the Netherlands, and Poland, and reduced supplies to Germany for not consenting to its natural gas payments demand in Russian rubles.

Copper futures held below $3.50 per pound on Thursday, losing more than 3% so far this week, facing renewed pressure from fears that rising interest rates would hamper global growth and dent demand for the metal. Brewing tensions between the US and China, and signs of slowdown in major economies, are also keeping markets on edge and clouding the overall outlook for metals. Meanwhile, major copper producers have recently reported declining output and flagged supply risks, providing a floor to falling copper prices.

DOLLAR NEAR ONE-MONTH LOWS

The dollar index held steady around the 106 mark on Thursday, after recovering from one-month lows earlier this week, as investors prepared for Thursday’s key monthly jobs report that acts as a guide for US monetary policy. The dollar weakened in mid-July amid speculations that the Fed may raise interest rates less aggressively in the coming months to avoid a recession. However, the greenback recouped some losses after several Fed officials recently pushed back against such expectations, voicing their determination to keep hiking rates until inflation abates.

The euro remained below $1.02, not far from the key $1 parity mark, as more data points to an impending recession. The European Union (EU) agreed to cut back gas usage by 15% between 1 August 2022 and 31 March 2023, as the region aims to make savings over winter in preparation for bigger disruptions of gas supplies from Russia. Markets are also scaling back their monetary policy tightening expectations from the European Central Bank, as economic turmoil remans rife in the EU Region.

The South African rand kicked off the week trading around R16.50/$, on the back of a weaker dollar, recovering from a two-year low touched in late July. The currency remains very sensitive to shifts in global market sentiment, while the country continues to battle with prolonged worker strikes and rolling blackouts, in addition to growing global recession fears. Meanwhile, some reprieve came for consumers as government moved to cut fuel-pump prices in an attempt to ease pressure on household finances and cool inflation.

The rand is trading at 16.62/$,17.00/€ and 20.17/£.