The world is dealing with continued uptick in infections – with coronavirus cases having crossed above a sombre 20mn mark recently. This comes at a time when its two biggest powers of US and China are bickering over issues as wide-ranging as HK autonomy one day and app for teenagers on another.
Set against the backdrop of uncertainties, however, market anxiety has been conspicuously absent. Indeed, our Market Stress Index has been meandering about at such a low level that we see little need to update you on it recently. Still, as much as we are encouraged by the lower global market anxiety, we thought it prudent to be aware of a host of risk factors out there.
In particular, any boiling over of Sino-US tensions is the most immediate risk factor that may trigger renewed market stress. While it remains our baseline expectation to see the Phase 1 deal staying intact despite China’s shortfall in US imports, the continually rising antipathy among Americans towards China in a close election year risks upsetting the apple cart.
Not much action
When we launched our Market Stress Index in mid-April, with memory of the market tumult in late March still fresh on the mind, we thought it would mark an exciting way to track the potential ups and downs of various measures of anxiety in global and emerging markets alike.
As it turns out, tracking the index readings has been about as nail-biting as watching the paint dry. The index has been flatlining at low level with negligible gyrations since then.
At the latest reading of 0.44, it also marks the lowest point since anxiety levels triggered by the pandemic started to cause trouble for the market in March.
Looking at the various component indicators, a similar story of steady decline in volatility levels can be seen. Indeed, the volatility of US Treasuries market is actually lower now than even before the start of the pandemic anxiety. The spread of commercial paper yield over US government papers is not far behind as well, a signal that it will be hard to find signs of funding pressure akin to what we saw in the market in late March.
The same story still holds within the EM space, with continued broad stabilization in the spreads for EM bonds, be it in hard or domestic currencies. While the EM currency volatility has picked up slightly, it appears to have been driven by idiosyncratic development in Turkey.
Hence, broadly speaking, market stress as signalled by our index and subcomponents, has subsided to such a low level (and staying there for so long) that we start to wonder if we are missing anything.
To put it another way, even as the latest reading tells us that market does not seem to be particularly perturbed about risk factors currently, the fact that it could jump up – and jump up so suddenly before – also reminds us that there is always a potential for things to snap.
With that in mind, we zoom in on the US-China tensions which might start to feature more prominently on the market radar screen.
Two months ago, we noted that, as much as US President Trump would be keen to ratchet things up against China partly to help bolster his re-election chances, he had left the Phase 1 Deal largely intact – and thus allow for at least some semblance of peace and cooperation between the two sides. Since then, while the deal remains on the table, the tensions between US and China have continued to simmer further as consulates are shut, sanctions are placed on personnel, as war of words heat up.
Thus far, the saving grace is that the response from China has stayed largely proportional. It shut the US consulate in Chengdu in response to the closure of its own representation in Houston. Most recently, China placed sanctions on 11 American officials, including senators Ted Cruz and Marco Rubio. This is a mirror image of the action taken by US, which placed 11 Chinese officials, including HK Chief Executive Carrie Lam, on its own sanctions earlier.
An eye for an eye may make the whole world go blind, to be sure, but the proportional response by China is perhaps one reason why global markets have not been too bothered by the deterioration in the most important bilateral relationship in the world.
Could this change? After all, if the year 2020 has taught us anything, it is that the so-called tail risks might well be the central theme of the year. For one, as discussed in our July 20th report on the road toward US election, foreign policy towards China is likely to be one of the key factors in the race. Indeed, market ought to keep a close eye on this weekend’s meeting between officials from China and US, on the half-yearly progress check on the Phase 1 trade deal.
While it remains our baseline expectation for the deal to remain in place – in part so that Trump can continue to claim success on his hard-line tariff imposition strategy that compelled China to agree to the deal to begin with – market should not take that for granted.
For one, there might not be much progress to report on the execution of the deal in terms of how much China has imported from the US. Going by our calculations, if China were to be on track to fulfil the terms of the deal, it would have bought over USD83bn of goods from the US by the end of June this year. Instead, the tally thus far amounted to only USD 49.5bn, just short of what it has imported from the US over the same period in 2019.
Now, to be sure, the slump in both China’s demand and America’s production, as well as logistical backlogs between the two due to the pandemic would have affected trading activities in general. And there is indeed room for bilateral consultations between the signatories in the trade deal if “a natural disaster or other unforeseeable event outside the control of the parties delays a party from timely complying with its obligations.”
If the relationship between the two is amicable and we are living in normal times, then it would have been perfectly understandable for the two sides to renegotiate a new deal involving lower purchase amount to reflect the changed circumstances.
Alas, that is not such the case now and there is always the possibility of Trump administration being tempted to talk tough on China’s shortfall to score political points ahead of the election. If Trump opts to scrap the deal on account of the shortfall, tariffs would have to be re-imposed on imports from China, which could all but smother the nascent recovery in global trade that we have seen in the last month or two.
The flipside, blue-sky scenario of him agreeing to any cut in the trade target – only to be forced to defend the decision of giving China some breathing room in the campaign trails – would have been quite unthinkable.
Hence, on balance, the best thing from the market perspective now is for both sides to downplay the shortfall and preserve the status quo of keeping the deal intact at least on paper, even as the possibility of fulfilling it to a tee has diminished considerably.
All in all, however, even as Phase 1 deal is likely to stand, the frictions between the two sides have developed beyond the issue of trade alone, with the latest spats over TikTok. Indeed, in a sign of how broad-based the conflict could further escalate to, what was once just an app for teenagers to post mundane short videos to now a pawn on the great geopolitical game.
As we have mentioned before, one fundamental driver of the escalation of the conflicts has been the degree of antipathy between the people of the two countries.
While there might be any good gauge of the feeling of the Chinese towards the Americans, polls for the other way round have not been encouraging. Indeed, judging from the Pew Research poll, the number of Americans holding an unfavourable view towards China has increased considerably.
The latest surveys, done between June 16th to July 14th, indicated that as many as 73% of Americans possess negative view towards China, an uptick from the already record-high 66% when the poll was conducted three months before. As per before, the sharp uptick in antipathy cuts across the political spectrum, with 83% of Republicans and 68% of Democrats holding the view.
Hence, even as we continue to hold out the hope that global market sentiment can stay supported and market stress can stay low, we cannot help but remain mindful of the potential for the bilateral tensions to surprise the market – and not in a good way.
Written by: Wellian Wiranto, Economist, Global Treasury – Research & Strategy, OCBC Bank
Read more: Top 4 Ways to Predict Market Movements