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Geopolitical tensions flare on Pelosi visit to Taiwan

Edward Bell - Senior Director, Market Economics
Published Date: 03 August 2022

 

  • Geopolitics takes centre stage for markets again as Nancy Pelosi, speaker of the US House of Representatives, has visited Taiwan and met the country’s leadership in defiance of Chinese demands. China has now planned to conduct military training operations around Taiwan, raising the risk of a geopolitical miscalculation given the heavy military presence in the area. China has also summoned the US ambassador in a clear escalation of tension between the two countries. Risk assets slumped as it became clear that Pelosi was indeed going to go ahead with the visit.
  • Job openings in the US fell in June to 10.7m, lower than market expectations and a sign that some of the tightness in labour markets is easing. The quits rate, the level of workers voluntarily leaving employment, was stable at 2.8%. The July non-farm payrolls report will be released at the end of this week with market expectations of 250k jobs having been added, slower than where it has been for much of the year but still a very strong print.
  • Several Federal Reserve speakers helped to rekindle rate hike prospects after a substantial easing in where markets think policy rates will go at the end of this year and into early 2023. Mary Daly, president of the San Francisco Fed, said that the Fed was “completely united” in getting inflation to the 2% target while Loretta Mester, president of the Chicago Fed, said that she needed to see “very compelling evidence” of a slowdown in inflation. James Bullard, a notable hawk, also said that the Fed should hike rates to up to 4% by the end of the year.
  • The Caixin China services PMI improved in July, rising to 55.5 from 54.5 and beating market expectations. That helped to bring the composite number to 54, down from 55.3 but suggesting that the firms surveyed, which includes smaller, private sector companies than the official PMI, are still managing to report growth even as China maintains is Covid-0 policy.

Today’s Economic Data and Events

  • 09:00 IN Composite PMI July
  • 11:00 TU CPI y/y July: forecast 80.2%
  • 13:00 EC Retail sales y/y June: forecast -1.7%
  • 18:00 Factory orders Jun: forecast 1.2%
  • 18:00 ISM Services index July: forecast 53.5
  • OPEC+ meeting

Fixed Income

  • US Treasuries plummeted on the back of hawkish commentary from Fed officials outweighing the risk-off tone of escalating tension between China and the US. Yields on the 2yr UST soared by 18bps to close at 3.0508%, moving back up above the 3% threshold for the first time since last week. Yields on the 10yr jumped by 18bps to 2.7483%, keeping the curve inverted at about 31bps.
  • Market pricing for Fed Funds shifted higher to a peak of 3.42% by December this year after having moved to around 3.3% earlier in the week. Our own expectation remains for several more hikes in 2022 with the Fed using 50bps hikes to tighten policy.
  • European bond markets also dropped overnight, with yields getting dragged higher by US Treasuries. The 10yr bund yield added 4bps to 0.812% while the 10yr gilt rose by 6bps to 1.864%.

FX

  • The dollar snapped a recent string of losses as geopolitical fears heightened risk-off sentiment while hawkish commentary from Fed officials also helped to push US Treasury yields higher. The broad DXY index jumped by 0.75%, its first gain in the last five days. EURUSD dropped by 0.9%, a heavy move on the back of waning risk sentiment, to settle at 1.0166% while GBPUSD dropped by 0.65% to 1.217. USDJPY failed to maintain its haven allure and rose by 1.2% to 133.17.
  • Commodity currencies dropped across the board with AUDUSD leading the way down, falling by almost 1.5% to 0.692 even as the RBA delivered a 50bps hike. Markets seem to expect that the RBA isn’t prepared to do much more or that its balance between growth and inflation signals a dovish tone. USDCAD added 0.3% to 1.2881 while NZDUSD dropped nearly 1% to 0.6269.

Equities

  • Global equity markets turned lower overnight thanks to a combination of geopolitical risk and hawkish Fed commentary. The Dow Jones fell by 1.2% while the S&P 500 gave up 0.7% and the NASDAQ managed to stem losses somewhat, dropping by 0.16%. European markets also closed lower with the EuroStoxx 50 down by 0.6% and the FTSE marginally lower by about 0.1%.
  • Asian markets have managed to open positively so far today with the Nikkei up by 0.57% and the Hang Seng gaining more than 1%. Regional equity markets may need to see a more meaningful deterioration in relations between the US and China before turning lower again.

Commodities

  • Oil prices steadied overnight with Brent rising by 0.5% to USD 100.54/b and WTI adding a bit more to settle at USD 94.42/b. While a major increase in geopolitical tension between the US and China would be the most risk-off of all scenarios, oil markets still need to balance the tight supply picture.
  • OPEC+ meets today to set policy for September production levels. A token agreement on higher output may be achieved but it will essentially be notional given few countries can actually increase output at this time. Preserving the alliance seems to be the main priority for OPEC+ leaders and that may preclude any increase at all.

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