FIG Topics of Interest



Six experts weigh in on what this means for the U.S. stock market.
Ian Shepherdson, chief economist at Pantheon Macroeconomics, says the day’s news isn’t too much of a surprise.
“Chinese trade is $600 billion with the U.S. every year. Huawei is a piece, but it’s not a gigantic piece. I suspect that they thought this was coming at some point, because this talk about the Chinese ability to disrupt European-U.S. networks has been bubbling away for a long time. I can’t imagine it came as a total surprise.”
Scott Nations, chief investment officer at NationsShares, says there are bigger implications to the Huawei story.
“The problem is that the China trade issue is spreading; it’s no longer just a trade deal. It’s now Google cutting off Huawei and Qualcomm, Intel telling their employees they’re not going to sell to the company until further notice. So, I think the market is afraid that President Trump has so many balls in the air when it comes to what’s going on geopolitically that one of them is going to drop.”
Mohamed El-Erian, chief economic advisor at Allianz, says the U.S. can win the trade war but might suffer collateral damage.
“This massive divergence in the U.S. — part of it can be explained that the U.S. is in a better place to deal with higher oil prices and it’s in a relatively better place to deal with the trade tensions. Remember, we win a relative trade war. In absolute terms, we suffer, but we win relative to others, so I think the markets have understood that the U.S. is in a better place than the rest of the world. The question is can we stay there.”
Craig Moffett, founder and senior analyst at MoffettNathanson, says the decision to cut off Huawei also has political consequences.
“I think it’s much more [tied] to national security, but you can’t escape that it also has implications for this narrative that China beating us in 5G is politically a very cogent argument, right? And so, to the extent that we can limit the expansion of the 5G network elsewhere by cutting off Huawei from its suppliers helps that narrative.”
Jim Cramer, host of CNBC’s “Mad Money,” says:
“If you own these [tech] stocks please recognize the risk, because nobody is going to raise numbers here and everybody is going to cut numbers. Every one of those companies that you see, those numbers are too high … There’s some that aren’t related and getting thrown out with the SMH.”
Mark Mahaney, lead internet analyst at RBC Capital Markets, breaks down what this could mean for Google.
“I don’t recall Google ever doing anything like this in the past. It’s probably not material for Google. Google doesn’t really have any exposure to the China market except for Chinese exporters who do look to advertise on Google. Potentially, I don’t look at the phone sector that closely, but for a company if you’re not able to have a full robust suite of Android apps on your phone I don’t know what you have. You’ve got something that’s akin to a brick. The reason people buy these phones isn’t because of communication, it’s because of the functionality embedded in all the Android and Google apps and services. So, there’s a real problem on one side, and it’s a little unclear to me what the issue is going to be for Google moving forward.”

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“This is serious,” said Joseph Glauber, former chief economist for the U.S. Agriculture Department. “It’s worrisome to me that you could set prices that would really influence planting decisions, potentially distorting production.”
The administration’s signals on trade aid has sowed confusion and the sense that a $15 billion or even $20 billion program with major ramifications for agriculture and commodity markets is being improvised on the fly.
Last year’s $12 billion trade assistance program broke with more than two decades of American agricultural policy, which has tied payments to farmers’ historic plantings rather than current production. Disparities in the way crops were treated also provoked criticism, particularly a $1.65 per bushel rate for soybeans versus 1 cent per bushel for corn.
Last year’s trade assistance package was announced near the end of the growing season, when it was too late for farmers alter their production plans. This time, much of the crop has yet to be planted. As of Monday, only 30% of the corn crop had been planted and 9% of the soybean crop, according to the Agriculture Department.
“Because of planting, there probably isn’t a worse time for the president to go out and announce a payment to farmers,” said Jonathan Coppess, former head of the U.S. Farm Service Agency, which oversees farm subsidies.

A rainy spring in the Midwest has already created an incentive to shift away from corn to soybeans, which can be planted later in the year, said Coppess, now an agricultural policy professor at the University of Illinois.

“If you’re in Illinois or Indiana or Iowa watching it rain, then the potential of a large soybean payment could be a real factor,” Coppess said. “Last year, U.S. farmers planted close to 90 million acres to corn and almost another 90 million to soybeans, and many farmers in the Midwest rotate on a 50/50 basis between the two crops, so the impact could be millions of acres and hundreds of millions of bushels.” 

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China cut its U.S. Treasuries holdings to the lowest level since 2017 in March amid the trade dispute between the world’s two biggest economies.

It was only a slight reduction -- the stake slipped by $10.4 billion, the first drop since November -- but that was enough to bring the position down to a two-year low of $1.12 trillion, according to data the U.S. Treasury Department released Wednesday.

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Japan’s three largest banks all reported lower annual profits on Wednesday, highlighting the challenges faced by the banking industry as the world’s third-largest economy looks to be headed for another downturn.
The size of the declines varied - Sumitomo Mitsui Financial Group had a 1% drop while rival Mizuho reported an 83% dive - all three show the difficulty banks have in navigating Japan’s ultra-loose monetary policy.

A government assessment this week showed Japan may already be in recession due to the impact of a U.S.-China trade war and weak external demand. That is likely to drive up bad debt costs for banks as more loans go sour.

“Our core profit fell for a fourth straight year. We had expected this, but the environment is very tough,” Kantesugu Mike, the chief executive of top lender Mitusbishi UFJ Financial Group, told a briefing.

MUFG, one of the world’s largest banks by assets, reported a 12 percent slide in annual net profit, reflecting the squeeze on lending margins. The bank was also hit by a one-time charge from suspending development of a new system at a credit unit, reflecting increased competition from cashless services.

Mizuho, Japan’s second-largest bank by assets, reported an 83% percent decline in net profit, to 96.6 billion yen ($884 million), in the year through March 2019.

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To be clear, there are well-done studies showing that the recent tariffs have translated into higher prices for U.S. consumers. I am not contesting that research. The question is whether those studies give sufficient weight to all relevant variables for the longer run.
To see why the full picture is more complicated, let’s say the U.S. slaps tariffs on the industrial inputs (whether materials or labor) it is buying from China. It is easy to see the immediate chain of higher costs for the U.S. businesses translating into higher prices for U.S. consumers, and that is what the afore-mentioned studies are picking up. But keep in mind China won’t be supplying those inputs forever, especially if the tariffs remain. Within a few years, a country such as Vietnam will provide the same products, perhaps at cheaper prices, because Vietnam has lower wages. So, the costs to U.S. consumers are temporary, but the lost business in China will be permanent. Furthermore, the medium-term adjustment will have the effect of making China’s main competitors better exporters.
Another risk for China is this: As its access to U.S. markets becomes more difficult, China may be tempted to look to Europe. It remains to be seen whether the European Union will adopt additional protectionist measures, but China must consider that the possibility is more than zero.

To understand another feature of the longer-term perspective, consider that the impact of tariffs can be felt in at least two ways. In highly competitive markets, prices have to match costs, and so a cost-boosting tariff really does translate into higher consumer prices. (This is the case with many of the recent U.S. tariffs on China.) But for profitable branded goods, the economics aren’t the same. If the U.S. puts higher tariffs on Mercedes-Benz, for example, the prices of those cars will still exceed their costs of production. Mercedes, wishing to keep some of its strong market position, will probably decide to suffer some of the cost of the tariffs in the form of lower profits, rather than passing them along to its customers.

China has prominent brands as well, be it Huawei in electronics or other firms in exotic food products, and over time it aspires to climb the value chain and sell more branded goods to Americans. In fact China has an industrial policy whose goal is to be competitive in these and other areas. Tariffs will limit profits for these companies and prevent Chinese products from achieving full economies of scale. So this preemptive tariff strike will hurt the Chinese economy in the future, even if it doesn’t yet show up in the numbers.

There is also a broader reason why a trade war with the U.S. hurts China, and this gets to an important point with trade agreements more generally. A U.S. trade agreement with China would (if enforceable) certify China as a place where foreigners can invest and be protected against espionage, intellectual property theft and unfair legal treatment. That prospect of certification is now suspended. That makes investing in China less desirable for many multinationals, not just U.S. ones. That, in turn, limits Chinese domestic wages as well as long-term learning and technology transfer. A U.S. certification of China might even boost Chinese domestic investment, but again that is now off the table.

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“Matching the U.S. dollar-for-dollar on the U.S. tariffs would imply raising a 25% tariff on all U.S. imports, including those that go into China’s exports,” Setser said. “China certainly could do that, but it would in many cases damage China directly.”
Simply responding with its own tit-for-tat tariffs isn’t China’s most likely move, said Brad Setser, a former Treasury official who’s now a senior fellow for international economics at the Council on Foreign Relations.

Chinese policy makers could devalue the yuan to offset the impact of U.S. duties on China’s economy. The offshore yuan weakened 5.5% against the dollar in 2018, drawing Trump’s ire and fueling speculation that the country was deliberately weakening its currency. While it has fallen 1.3% this week, the currency rose on Friday after the People’s Bank of China set its daily fixing at a stronger-than-expected level.

However, China’s painful experience with devaluing the yuan in 2015, which prompted capital to flee the nation, is likely to dissuade a similar move, according to Tao Wang, UBS Group AG’s chief China economist and head of Asia economic research. “China doesn’t like the self-fulfilling outflows that come as a result of depreciation, which tend to diminish domestic confidence,” she said. “In addition, yuan depreciation last year angered the Trump administration and led to higher U.S. tariffs.”

China owns $1.1 trillion of U.S. government debt, more than any other foreign nation. If it pared back its holdings in that $15.9 trillion asset class, that could be a potent weapon. 
However, China doesn’t really have other good options for where to park its $3.1 trillion in foreign-currency reserves -- the world’s largest stockpile -- making this an unlikely path, according to Ed Al-Hussainy of Columbia Threadneedle Investments.
“Any sharp moves higher in U.S. yields both adversely impact the valuation of their existing Treasuries stock and could spark a dollar rally,” the strategist said. “The financial and FX stability risks of this policy could outweigh the benefits.”
“There are some easy things for China to do,” including withdrawing from soybeans, he said.

Futures on the crop have dropped 11% since April 10.

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“Beijing’s policy focus is sticking to stabilization, rather than chasing a rebound,” said Zhuang Bo, chief China economist in Beijing at research firm TS Lombard. “Some parts of the economy are recovering and there is evidence of green shoots. Obviously, if the trade negotiation goes south with tariff hikes this week, China’s economic policy priority will shift back to easing and stimulus.”
The case for China to keep up stimulus to the economy strengthened, with further incoming evidence that the recovery is not yet self-sustaining as negotiators attempt to stave off an escalation of the trade war with the U.S.

Despite upbeat inflation and import data released in the past two days, the recovery remained fragile in April: Core consumer inflation, stripping out volatile food and energy prices, edged down. The main factory gauge pulled back, exports unexpectedly fell, fiscal income growth slowed, and new credit trailed all economist estimates.

Aggregate financing, the broadest gauge of new credit, fell to 1.36 trillion yuan ($200 billion) in April, according to data released by the People’s Bank of China Thursday. Shadow banking also began to shrink after a March expansion. That underscored weak borrowing demand as well as policymaker caution not to overdo the easing.
What Bloomberg’s Economists Say

“An unexpectedly large fallback in China’s April credit data raises fresh doubts about whether the economy has found a bottom. This reinforces our view that policy should remain supportive on both the broad based and targeted fronts.”
Chang Shu and David Qu, Bloomberg Economics in Hong Kong
Click here for the full note

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“A trade deal had been priced into markets, and now we are living through the fallout of altered expectations, so it wouldn’t be surprising to see continued volatility,” said Kristina Hooper, chief global market strategist for Invesco Ltd. “We’re going to see both sides playing a game of chicken.”
Here are some of the possible outcomes from this week’s negotiations:

Tariffs Rise, Talks Continue
U.S. Trade Representative Robert Lighthizer said tariffs on $200 billion in Chinese imports will increase to 25 percent from 10 percent at 12:01 a.m. on Friday. He also indicated the U.S. wants to keep talking.
The Chinese are preparing their own retaliatory duties on U.S. imports should Trump carry out his threat, according to people familiar on the matter. But they, too, are staying at the table.
“Both sides would walk away angry” if tariffs escalate this week, said Clark Packard, trade-policy counsel at the R Street Institute, a think tank in Washington. “But these two countries are the largest economies in the world. After a cooling-off period, they’ll come back to the table.”
“The negotiation is by nature a process of discussion, and it’s only natural to have differences," foreign ministry spokesman Geng Shuang told a briefing in Beijing. "We hope the U.S. will work along with China and embrace each other half way on the basis of mutual respect."
“My most likely scenario is that there’s no final resolution, not for some time,” said Chris Rupkey, chief financial economist at MUFG Union Bank NA. “They’re talking about changing the way another country is doing business. It’s like another country telling the U.S. to stop being capitalist.”
“This is something you have to take week by week,” said Ed Mills, managing director of Washington policy at Raymond James & Associates Inc. “Our base case for this week is that they find a way to delay the tariffs.”
But any preliminary accord would probably require final approval by Trump and Xi at a face-to-face summit. Even after a deal is signed, it could take years to see it succeed in correcting the trade imbalance. The threat of renewed hostilities won’t soon fade.

“The larger question is: can you get a deal, and can that deal stick? That’s where we’ve always been skeptical,” said Mills of Raymond James.

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The European Commission cut its growth forecasts for the euro area and slashed its projection for Germany as it warned that escalating trade tensions threaten to make the outlook even worse.
By Viktoria Dendrinou (Bloomberg) --

Most of the downgrades were less severe than seen in the previous report in February, apart from Germany, where the 2019 prediction was slashed to just 0.5 percent from 1.1 percent. Officials in Brussels warned that the downside risks to the region’s outlook remain “prominent.’

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Wall Street strategists urged calm after the latest threats from President Donald Trump after a series of tweets Sunday afternoon. Trump warned that tariffs on $200 billion worth of Chinese goods could rise to 25% on Friday.
“President Trump’s announcement that the tariff rate on $200bn of imports from China will rise from 10% to 25% lowers the odds of a successful conclusion to US-China trade talks and raises the odds of further tariff escalation. However, we think it is more likely that the increase will be narrowly avoided and believe the odds of tariffs increasing on Friday are 40%.”
“Unless China walks away from the talks (which is not necessarily the same as Vice Premier Liu canceling his trip but rather having no talks at all), we do not expect an escalation of trade tensions into a trade war. Still, we note that the probability of a ‘Trade War today, Trade Deal tomorrow’ scenario remains high, with the potential to accelerate US inflation and to extend the timetable for a US-China trade deal into the 2020 electoral year. We are cautiously optimistic on a US-China trade deal in 2Q but with the tariffs-threat to remain as a way to get concessions from China and to enforce the agreement.”
“There are no clear reports indicating what led President Trump to harden his stance on trade talks, with media reports suggesting it was designed to “send a message” or was in response to China backtracking on previously negotiated points. The timing of the threat suggests it is a tactic designed to increase leverage going into final trade negotiations”.
Raymond James
“The progress towards a US-China deal has been up-ended with renewed tariff threats by President Trump (25% tariff on $200 billion in Chinese goods by Friday + 25% on $325 billion more), apparent balks by the Chinese (especially on tech transfers), and the threat of the Chinese delegation canceling this week’s round of negotiations. We have previously seen President Trump threaten a new tariff package in the lead up to last year’s G20 meeting last year, only to use it as negotiating leverage, leading to speculation that this is President Trump seeking to use the new tariff threats to get a deal across the finish line. Based upon our conversations with our trade contacts, there appears to be a universal belief that this is not negotiating leverage, but what was almost a done deal last week, has derailed in recent days. There is some hope that negotiations could be salvaged, but this situation highlights how tenuous any US-China deal remains.”
“With that in mind we would not take the President’s tweet as referring to an action planned that is set in stone but rather more an expression of frustration as talks have dragged on without reaching a resolution. We expect that any near-term downside moves by the equity markets could be quick to reverse as the US Presidential election of 2020 and a goal of “Made in China 2025″ remain paramount respective agenda items for the leadership of the US and China. In our view these key dates along with the potential considerable economic cost of a protracted trade war (for both countries as well as for their allies and trading partners) will dictate a positive resolution to the current trade dispute sooner than later notwithstanding a near-term ‘increase in hostilities.’ We suggest that investors consult their shopping lists for stocks that might have ‘gotten away’ from them in the recent rally should some ‘tweet-linked’ volatility waft through the markets and push stock prices lower.”

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