When the balloon goes up

The recent Chinese weather balloon incident has highlighted the tensions between China and the US.

Relations have further soured with the US warning China against supplying ‘lethal’ aid to Russia for its war against Ukraine. The latest ‘spat’ is the Netherlands restriction on sales of the ‘most advanced’ micro-processor chips, made by ASML, to China after pressure from the US.

The Centre for Strategic and International Studies (CSIS) recently conducted one of its most complex wargames yet, involving a hypothetical Chinese invasion of Taiwan in 2026 – ‘The First Battle of the Next War.’ The simulation was run by the CSIS twenty-four times and in most cases, after a three-week fight the US emerged victorious. However, it also led to America’s global position being damaged for many years. The CSIS report concluded a war over Taiwan was not ‘inevitable.’ It thought the Chinese leadership might instead adopt a ‘strategy of diplomatic isolation, grey zone pressure, or economic coercion against Taiwan.’

What the CSIS wargames will not have been able to accurately forecast is the damage to the global economy from an invasion. Given Taiwan’s strategic position within global supply chains particularly the supply of semi-conductor chips, the UK needs an emergency plan. Conservative MP Tobias Ellwood, chairman of the Defence Select Committee said ‘the UK has no resilience and no contingency plan, unlike the US which is building a microchip factory in Arizona.’

Hopefully, the CSIS conclusion that a war is not inevitable proves correct. The problem however is that President Xi Jinping has clearly outlined China’s longer- term aspirations regarding Taiwan. China is exiting lockdown and the economy should pick-up as 2023 progresses. With the economy no longer held back by the zero-tolerance Covid policy, will China become emboldened? China recently announced that it intends to increase defence spending by over 7% to $225bn in 2023. With some of the US defence spending being allocated to supplying weapons to Ukraine, a few analysts are suggesting that China’s military forces could achieve broad parity with those of America by 2027/2028.

Today, PM Rishi Sunak is in America for talks with his US and Australian counterparts to agree details of the AUKUS pact, which will involve supplying nuclear-powered submarines to Australia. He has also pledged to increase UK defence spending by an extra £5bn over the next two years including increasing funding projects to build high-tech surveillance balloons.  Apparently, last year Defence Secretary Ben Wallace signed a £100 million research deal with a US-based company to develop ‘stratospheric uncrewed air systems.’

 

What have we been watching?

 

The ‘tug-of-war’ between inflation and interest rate expectations continues to dictate the mood of global markets but particularly US equities. There has been a major shift in US interest rate expectations in recent weeks. Hopes of a ‘Fed pivot’ have been pushed back from late 2023 and into 2024.  While markets are anticipating a sharp drop in inflation as 2023 progresses, some elements of inflation are proving to be ‘sticky’. For example, US used car prices had been falling as global supply chain pressures eased but have risen for three months in a row in 2023.

After more than a decade of record low, near zero interest rates it was inevitable that the rapid hike in interest rates was going to lead to at best unforeseen, unintended consequences in hitherto stable corners of the financial system. Silicon Valley Bank (SVB) has proved to be one of these ticking timebombs and at the end of last week, the US tech lender became the biggest banking failure since the 2008 financial crisis. Markets wobbled on Friday on worries about further systemic failures within the US banking system. However, authorities on both sides of the Atlantic have acted swiftly to address the financial crisis that would have seen many small tech start-ups in the UK without access to banking liquidity. This morning, HSBC has acquired the loans and deposits of SVB UK.             

The global supply chain disruption arising from pandemic lockdown of manufacturing facilities looks to be ending. The New York Federal Reserve’s Global Supply Chain Pressure Index dropped below the historical average in February for the first time since August 2019. However, many companies have been carrying ‘buffer’ stocks over this period to ensure continuity of customer service. As interest rates have risen and economic conditions have become more challenging and businesses are reporting customer de-stocking across a wide range of industries as companies seek to improve cash flow. This has led to an increasing number of profit warnings!

Russia carried out a fresh wave of missile attacks on Ukraine’s energy network. The head of the IAEA  issued an urgent warning after the Zaporizhzhia nuclear plant lost-offsite power. This is the sixth-time that this has happened at Europe’s largest nuclear power plant. 

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In the UK, the main focus will be on the UK Budget on Wednesday with some leaks already over the weekend. Markets are not expecting a giveaway and Chancellor Jeremy Hunt has said any tax easing is likely to be focused on companies. The Energy Price Guarantee is likely to be extended for a further three months.

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In the US, Jerome Powell, Chair of the Federal Reserve (Fed) testified to the Senate in his semi-annual address. He said that inflationary pressures are running higher now than when the Fed recently met and is prepared to step up the pace of interest rate hikes if warranted. Peak interest rate expectations moved up from just below 5.5% to 5.65% from the current 4.75%.

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China saw both lower imports and exports for the January-February period. Imports were down by over 10% which was lower than expected while exports were down by 6.8%, also below forecast.

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Brent oil drifted back to $83 on higher US interest rate expectations.

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Finally, following last week’s Alpha Bites Diddly Squat. The Royal Horticultural Society said that its online sales of vegetable seeds jumped by nearly 50% last month while sales of compost, seed trays, propagators and pots had also been strong. With the trend to smaller gardens, many people are growing vegetables on patios and in window boxes. While the government said the current fruit and vegetable shortage would last 3-4 weeks, some growers have said the supply problems could last until May.

 

Read Last Week’s Alpha Bites – Diddly squat

 

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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.