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The Missile – May 29

President Trump yesterday said he will give a press conference today on China. Mr. Trump will presumably announce sanctions against China as punishment for China’s new national security law for Hong Kong. China’s parliament approved that legislation yesterday, although it will take a matter of months before the legislation becomes final.

The State Department on Wednesday determined that Hong Kong no longer has enough autonomy to warrant its special trade status. The State Department’s determination, however, was only advisory and had no immediate impact other than to open the door for Mr. Trump to decide on penalties, if any.

On the lighter end of sanctions, Mr. Trump could just limit visas and place sanctions on some Communist Party officials involved in implementing the new security law. On the heavier end, the U.S. could fully retract Hong Kong’s special trade status, impose tariffs on imports from Hong Kong, and restrict dual-use technology exports to Hong Kong.

China’s Foreign Ministry spokesman on Wednesday warned the U.S. against interfering in Chinese affairs. He said, “If anyone insists on harming China’s interests, China is determined to take all necessary countermeasures. The national security law for Hong Kong is purely China’s internal affair that allows no foreign interference.”

The markets are waiting to see if China will retaliate against the U.S. for what it sees as interference in its internal affairs. The list of actions by the U.S. against China in the past few weeks has grown long enough that China, who fears of looking weak, are likely to retaliate in some form or fashion. China has said it may name U.S. companies to its “unreliable entities” list, which would mean investigations and likely restrictions on the sales by those companies in China.

U.S. companies with exposure to Chinese retaliation include companies such as Apple, Starbucks, Nike, Boeing, and chipmakers like Intel, Qualcomm, TI and others. China could also encourage Chinese consumer boycotts against U.S. products.

The markets are also watching to see if China allows the yuan to depreciate to soften the blow from any new U.S. tariffs or sanctions. The Chinese yuan on Wednesday fell sharply to a new 9-month low but then recovered somewhat on Thursday after the PBOC announced a stronger-than-expected currency fix, suggesting that the Chinese government does not want to see any fast depreciation of the yuan. Chinese authorities must be careful not to let a decline in the yuan get out of control since Chinese investors and businesses could panic and engage in heavy capital flight, which in turn would hurt the Chinese stock market.

White House advisor Kudlow on Thursday said that China will be held accountable for its moves on Hong Kong. He said, “If need be, Hong Kong may now have to be treated the same way China is treated.”

Mr. Kudlow also said that the US/China phase-one trade deal “does continue to go on for the moment and we may be making progress there.” Mr. Kudlow seemed to suggest that the phase-one trade deal is not in jeopardy, at least not from the U.S. side. However, the US/China trade situation could deteriorate quickly if the U.S. slaps tariffs on Hong Kong to match the tariffs on the China mainland. China could respond by canceling the phase-one trade deal and its promise to buy $200 billion of extra U.S. goods during 2020-21.

The consensus is for today’s April PCE deflator to fall sharply to +0.5% y/y from March’s +1.3% y/y, undercut by the plunge in oil prices during April. However, the core PCE deflator is also expected to drop sharply to +1.1% y/y from March’s +1.7%. A drop in the core deflator to +1.1% would leave inflation at about half of the Fed’s inflation target of +2.0%. The plunge in the U.S. economy of about -10% in the first half of 2020 has put heavy downward pressure on the price of all sorts of goods and services.

The Fed has already pulled out all the stops on its monetary policy to try to support the economy and prevent a deflationary spiral. Still, the Fed is likely to face a long period of low inflation that requires interest rates to remain near zero. Europe’s core CPI inflation rate has averaged only +1.0% over the past five years, far below the ECB’s inflation target of just under +2.0%. Japan’s core CPI inflation rate has averaged only +0.3% over the last five years and fell to the deflationary level of -0.1% y/y in April.

The consensus is for today’s final-May University of Michigan U.S. consumer sentiment index to be revised slightly higher by +0.3 points to 74.0, which would leave the index up by +2.2 points from April instead of the preliminary report of +1.9 points. May’s small improvement in U.S. consumer sentiment is a step in the right direction. However, the expected overall +2.2-point increase in April sentiment is a drop in the bucket compared with the overall -29.2-point plunge in the index seen in March-April.

U.S. consumers are undoubtedly relieved that the U.S. economy is starting to open back up. However, whole sectors of the U.S. economy will remain mostly closed and there will still be many people who are unemployed for months. Any major improvement in consumer sentiment is likely to be months away.

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