Chess in the South China Sea

While the war of attrition continues in Ukraine, a longer-term power struggle is developing in the Far East, between the US and its allies and China.

In previous Alpha-Bites we have highlighted China’s increasing presence in the South China Sea, while the US has strengthened ties with Australia through the AUKUS agreement. Both military powers look to be securing strategic islands or what effectively are ‘un-sinkable aircraft carriers’ which are key to controlling some of the world’s key maritime trade routes.

The latest island caught up in this long-term strategic game is Diego Garcia, part of the Chagos Islands that makes up the British Indian Ocean Territory, an overseas territory of the UK. Between 1968 and 1973, Diego Garcia’s population of just over 900 was forcibly expelled by the UK government to Mauritius so a joint UK/US military base could be established. The US air base at Diego Garcia helped support both invasions of Iraq, hosting long-range stealth bombers.

However, the ownership of Diego Garcia has become a political hot potato for the UK government. This is because in 2019 the International Court of Justice issued a non-binding ruling that the British occupation of the islands was unlawful and that the archipelago was part of Mauritius. This was later endorsed by the International Tribunal for the Law of the Sea. The government started negotiations to transfer sovereignty of the islands to Mauritius. However, in 2021, Mauritius signed a free trade agreement with China. Not surprisingly, the US is alarmed that it will lose a key defensive asset and fears that China will build its own military facility on the archipelago. Conservative MP Sir Iain Duncan Smith, co-chair of the Inter-Parliamentary Alliance on China has urged the government to draw up a new agreement with Mauritius to resolve the ‘strategic mess.’

The long-term strategic game of chess between the US and China continues with Diego Garcia the latest pawn as both super-powers look to secure key assets in the Pacific.

 

What have we been watching?

 

Slightly more subdued markets as higher interest rates appear to be feeding through into softer economic activity indicators in some regions, particularly in the service sectors. China continued to release disappointing economic data with weaker than expected exports.

The main focus this week is on the Federal Reserve interest rate decision, and whilst the expectation is of no change, there is heightened uncertainty following surprise interest rate increases from central bankers in both Canada and Australia.

Military activity appears to be increasing in the war in Ukraine. Russian forces were accused of blowing up the Nova Khakovka dam leading to widespread flooding along the Dnipro River. The IAEA said it was monitoring the Zaporizhzhia nuclear power plant which relies on cooling water from Nova Khakovka.

The UN’s food and agriculture world food price index fell to a 2-year low in May with wheat prices also near a 2-year low due to bumper supplies from Russia.This should be helpful for inflation. In the UK, there was some encouraging news on food inflation as the rate of price increases slowed to 15.4% in May according to the British Retail Consortium.

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In Europe, German factory orders fell again marking the fourteenth consecutive month of decline. The Eurozone services PMI for May was 55.1 while the composite index hit a three-month low at 52.8. However, there was some more encouraging news on the inflation front with the seventh straight monthly decline in the regional PPI (producer prices index).

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The US ISM Service Sector index fell to 50.3 in May which was slightly lower than expected. The US trade deficit hit a six-month high of $74.6bn in April as exports fell by 5.3% which is likely to be a drag on GDP growth in the second quarter.

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China’s authorities have asked the country’s largest lenders to lower their deposit rates following data that showed credit and new loans have softened significantly as consumers and businesses cut on spending and borrowing. Chinese inflation data continued to show a moderation in prices, with the fourth month in a row of falling prices.

Meanwhile, China’s exports fell in May for the first time since February. Exports were down by 7.5% which was weaker than expected while imports also dropped by 4.5% which will place more pressure on the Chinese authorities to provide further policy support.

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Brent oil edged up to $77 following the latest Saudi Arabian oil production cut, before falling back to finish the week just below $75.

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The ‘shopping trolley,’ Boris Johnson, returned to the headlines with the dramatic announcement of his resignation as an MP, likely ahead of being forced out by the upcoming, Conservative dominated, Privileges Committee Investigation. This and the arrest of Nicola Sturgeon, in connection with the probe into SNP finances, was no doubt welcomed by the Labour party, who are increasingly styling themselves as a Government in waiting.

Finally, following the replacement of paper banknotes with plastic banknotes. The Bank of England estimates that almost £9bn in old banknotes have not been cashed in across the UK. While no longer legal tender, the withdrawn notes can still be deposited or exchanged. Just pop into your local bank branch ……hang on a minute, where do you see one of those these days?

Read Last Week’s Alpha Bites – G7 Chinese Takeaways

 

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.