A Restless Dragon

     

If Ukraine is the storm, then is China the climate crisis?

In a speech to the Chinese Communist Party, President Xi Jinping refused to rule out using force to unify Taiwan with mainland China, but will strive for a peaceful resolution.  Antony Blinken, the US Secretary of State suggested China is pursuing reunification with the self-governed island of Taiwan on a ‘much faster timeline’ than previously expected.

Following Nancy Pelosi’s visit to Taiwan, China stepped up large-scale military drills in the Strait of Taiwan. Last month, President Joe Biden said, renewed the US commitment to defend Taiwan in the event of a Chinese attack. Antony Blinken warned that if China could not achieve unification by peaceful means, it would use coercion and possibly force.  ‘That is what is profoundly disrupting the status quo and creating tremendous tensions.’

China’s President Xi Jinping probably has his hands full for the time being with a deeply unpopular zero-tolerance Covid-19 lockdown strategy, drought, a highly indebted property sector teetering on the brink and a slowing global economy, that is not helpful for China’s exports. China will also have watched closely the imposition of Western sanctions on Russia’s industries. However, the long-term intent regarding Taiwan is clear.

Taiwan has an important role in global supply chains and is a key global supplier of semi-conductors. Therefore, it is not surprising, given the lessons from Russia’s invasion of Ukraine, that countries and companies are now seeking to diversify and strengthen their supply of key raw materials and components outside of China.

The war in Ukraine appears to have stretched Russia’s resources and undermined its military prowess. China is now the leading super-power, alongside the US.

Is the sleeping dragon looking to flex its muscles?

While Xi Jinping has been in power for 10 years and has just secured an unprecedented third term in office, in the UK, we already have the prospect of our third Prime Minister in a year!

What have we been watching?

Another roller coaster of a week with PM Liz Truss getting her P45 after less than 45 days in office! As we write this morning, following the withdrawal of Boris Johnson from the leadership contest, Rishi Sunak is looking the clear favourite and could be the UK’s new PM. While this will not be confirmed before 2pm, nonetheless markets seem to like the return of some stability with Sunak-Hunt being called the ‘dullness dividend’ by some in the city.  This is desperately needed, as over the weekend, global credit-agency Moody’s cut the UK’s economic growth outlook to ‘negative’. Meanwhile, Sterling has steadied at around $1.135 and UK gilt yields are moving lower.

The other key market driver last week continued to be US Federal Reserve (Fed) interest rate policy. Global equity markets turned sharply positive on Friday after the Wall Street Journal, which is widely seen as a mouthpiece for the Fed, reported for the first time that the US central Bank were discussing slowing the increase of interest rate hikes and pausing early next year to see how previous increases have impacted inflation. While ‘not out of the woods’ yet in tackling inflation, markets took hope from this first indication of a potential ‘Fed pivot’ pause. The aggressive interest rate hikes from the Fed relative to other central banks has driven Dollar higher causing challenges globally. For example, the Japanese Yen hit a 32-year low against the Dollar last week making for a 23% fall in 2022. This reflects the Bank of Japan’s ultra-loose monetary policy. Great news for Japanese exporters! Sterling has fallen by about 16% so far this year against the Dollar which is also great for UK exporters but not so good for inflation given the amount of goods we import. At least there was some helpful news on the inflation front last week with gas prices falling amidst mild weather and reports that Germany was close to full storage capacity.

Russia carried out mass drone and missile attacks on the Ukrainian energy network hitting power supplies. Ominously, given Putin has chosen the path of escalation previously, Russia’s defence minister claimed Ukraine might use a ‘false flag’ radioactive ‘dirty bomb’. The West was quick to dismiss the claim, with the US saying ‘it rejected any pretext for Russian escalation.’

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In the UK, new Chancellor Jeremy Hunt prevented a further market sell-off by announcing measures to raise £32bn annually by 2026. This offsets about 70% of the Truss/Kwarteng tax plan and takes the cost of those measures down from £45bn to £13bn. However, compared to the initial IFS estimate to find £62bn, the Treasury estimates £72bn will be required, due to the higher borrowing costs! Jeremy Hunt (assuming he is retained by Rishi Sunak) has to find up to £40bn of further savings when the full fiscal statement and OBR assessment is delivered on 31^st October. This may be partly plugged by spending cuts or further tax increase but might it also require another U-turn with a windfall levy on energy companies? Despite the UK returning to fiscal ‘common sense’, significant damage has been done to business and consumer confidence. Gilt yields have come back from their post mini-budget peak but mortgage rates will still be higher than before the whole fiasco. Last week the average rate for a two—year fixed rate loan rose to over 6.5% -the highest level since the 2008 financial crisis.

UK annual CPI inflation hit 10.1% in September. One of the main drivers was food inflation at 14.5% with the sector adversely impacted by higher energy and fertiliser costs.

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The Fed’s Beige Book highlighted pessimism among US businesses with most expecting the economy to weaken although encouragingly there are signs that some inflationary pressures are easing. Despite the hopes of a ‘Fed pivot’, there were still ‘hawkish’ comments from some members of the Fed who suggested that they had not seen much evidence that underlying inflation has peaked. Futures are pricing in over a 90% likelihood of another 0.75% interest rate hike from the Fed in November.

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The Chinese Communist Party’s congress concluded on Sunday with the confirmation of Xi Jinping’s historic third five-year term in charge. Hong-Kong listed Chinese shares fell on concerns he will continue with his ideology-driven policies at the cost of economic growth. The delayed Chinese economic data was released and showed headline economic growth in the third quarter of 3.9% which was better than expected. However, retail sales were weaker than expected while new home sales fell for the second month in a row. The extension of the zero-tolerance Covid-19 approach continues to weigh on the outlook.

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Brent oil edged up to $93. Tension appears to be escalating between the US and Saudi Arabia after President Joe Biden accused the country of siding with Russia in its war with Ukraine and warning of ‘consequences.’ This follows the recent OPEC+ decision to cut oil production to support the oil price. Meanwhile, Biden has authorised the release of the final 15million barrels of oil from the US strategic reserve.

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Finally, the recent mild spell has seen European gas prices dip but the UK’s energy supplies still depend on the weather this winter. Since our recent Alpha Bites Keep the home fires burning on UK energy security, National Grid has confirmed that in the unlikely event of a gas shortage, that people should be prepared for blackouts between 4pm and 7pm on really, really cold days in January and February. Time to buy shares in a candle maker or manufacturer of thermal underwear?

 

Read Last Week’s Alpha Bites – Dear Oh Dear

 

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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.