The Grey Zone

War or at peace, or somewhere in between? Grey zone warfare tactics are aimed at weakening an adversary, over a prolonged period.

Military analysts believe this is what China is trying to do with Taiwan. Last month, a record number of Chinese fighter jets crossed the unofficial border between them. By regularly crossing Taiwan’s Air Defence Identification Zone (ADIZ), Beijing is testing how far Taipei will go to reinforce it. It also allows China to test its own capabilities such as force co-ordination and surveillance and by applying increasing levels of military pressure, China can test Taiwan’s defences and international support for the island.

An ‘ADIZ,’ is self-declared and technically counts as international airspace, but governments use it to monitor foreign aircraft. Anyone watching the recent Channel 5 series ‘Top Guns Inside the RAF’, will appreciate the challenges from routine Russian incursions into NATO airspace.

This pressure on Taiwan is not only from the air, but from the sea as well. China has repeatedly rehearsed encircling Taiwan with fighter jets and navy ships. The manoeuvres have fallen short of an invasion and stayed within the ‘grey zone.’ However, pressure is likely to increase and next year Beijing is bringing into service its new Fujian aircraft carrier, which will enhance its ability to seal off the Taiwan Strait. However, China’s tactics go beyond Taiwan as it looks to dominate the South China Seas. Beijing has built large military structures on reefs in disputed waters where the Philippines, Taiwan, Malaysia, and Vietnam have rival claims.

Meanwhile, besides the formation of AUKUS, the US and its allies have also stepped up their military presence with exercises in the South China Sea.

Incursions into Taiwan’s airspace tend to increase with ‘foreign triggers,’ such as when Taiwan’s president visited the US. China reacted to the visit by practicing sealing off Taiwan. Ominously, President Xi Jinping has said he “will never promise to give up the use of force and that Taiwan must and will be united with China.”

 

What have we been watching?   

Global markets remained in cautious mood last week with fears of conflict spreading into the broader Middle East triggering a spike in energy prices and a shift to safe-haven assets such as gold. Earlier in the week, markets had received some support from comments by a member of the US Federal Reserve who said that the central bank ‘is on target to tackle inflation without pushing the country into a damaging recession.’  However, markets then had a reality check as US inflation data came in very slightly above expectations. This saw the yield on US 10-year Treasury stock rise to 4.65%. Central bankers will be concerned that higher energy prices could feed into a pick-up in inflation.    

While media attention was on the tragic events in Israel and Gaza, the spill over from the war in Ukraine re-surfaced. A year after the Nord Stream gas pipeline between Russia and Germany was damaged there were reports of possible Russian sabotage against an undersea gas pipeline between Finland and Estonia. UK natural gas prices jumped by 14% on this news and are now the highest level since February.  Elsewhere, tension between the US and China is ongoing with the Biden administration considering a ban on AI semiconductors to the overseas operations of Chinese controlled companies.      

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In the UK, while gas prices spiked the weather has remained very mild for the time of year. There was some better news on UK food price inflation which slowed to its lowest rate for fifteen-months heading into October at 11%, down from 12.2%. The UK economy recovered modestly in August with growth of 0.2% on the previous month helped by a re-bound in the service sector with the removal of the drag from strike action. However, the underlying growth picture continues to look weak with the risk that the third quarter will see a small quarterly contraction unless September growth matches that of August.

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In Europe, the German government slashed its growth forecast and it now expects the economy to contract by 0.4% in 2023. Elevated energy prices due to former dependence on Russian gas and the weakness in key trading partner China are to blame.  The economy is expected to recover in 2024 with growth of 1.3% projected followed by 1.5% in 2025. German inflation is forecast to be 6.1% in 2023 before dropping to 2.6% in 2024.

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Producer price inflation in the US unexpectedly in September rose to 2.2% from 2% the previous month. This was followed by consumer price inflation data which came in very slightly above estimates at 0.4% due to higher energy prices. Annualised core inflation in September was 4.1%. Meanwhile, the role of Speaker of the House of Representatives remains unfilled, with Republicans yet to unite around a candidate.

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Travelling and consumer spending over China’s Golden Week climbed strongly on the previous year but was only marginally higher compared with pre-Covid 2019 and lower than the authorities had hoped for. Meanwhile, China’s sovereign wealth fund has acquired stakes in the country’s biggest banks presumably with a view to boosting sentiment in mainland markets. China’s trade data was better than expected but continued to decline in September while inflation dropped to zero in a sign of struggling consumer spending. Another long-term structural challenge for China remains its birth rate which fell to just over 9.5 million in 2022 – the lowest rate since records began in 1947.

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As the conflict in the Middle East continued to escalate, Brent oil climbed to $90.

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Finally, are American consumers tightening their belts? US food & drink companies have seen their share values fall after the CEO of Walmart noted changes in purchasing behaviour by American consumers who are taking new weight loss drugs made by Eli Lilly and Novo Nordisk. These act as an appetite suppressant and have shown to be very effective at bringing about weight loss. The situation in the UK and Europe is much different given limited availability of the drugs currently but that could obviously change.

Read Last Week’s Alpha Bites – Palm Oil. A Sustainable solution is in hand

 

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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.