In today’s briefing, we focus on the rise of protectionism and nationalism, and the effect on global supply chains as the so-called strategic competition between the US and China continues to simmer in the wake of the coronavirus pandemic. Eurasia Group explains why the threat of vaccine nationalism looms on the horizon and how more generally the healthcare, food and tech sectors are likely to be in the eye of the storm, with a particular focus on firms seen as an alternative to China’s Huawei. Arete Research, meanwhile, analyses the implications for the tech sector of the latest US sanctions on the Chinese firm, which some believe could reshape the industry’s global supply chain. Elsewhere, LC Macro considers whether Franco-German proposals for a €500 billion coronavirus recovery fund represent a “Hamilton” moment for the EU, while Variant Perception and Schulte Research sound warnings over the equities, credit market, and EM debt markets respectively, as the Fed looks to avoid policy mistakes and negative rates. Schulte also previews China’s new daring 5-year plan.
Substantive's Top Themes - Best of the Broker Notes
1. Credit spreads offer bad news – SELL, Another Latam debt crisis, China's daring 5-year plan
Schulte Research track weekly changes in the Fed's balance sheet and in this note they observe some worrying developments which could have negative implications for credit. They note small changes in the balance sheet, which are all coming from bank deposits as these institutions have continued to ''fob off'' excess cash to the Fed, as not doing so, argues Schulte, would create negative rates. The result of this anaemic build-up of deposits is to reduce Fed firepower and as a result the elevated gap in HYL spreads to IG spreads just won't budge, the report says. All this comes at a time when there has been a deluge of fallen angel paper entering the market, which is causing a lot of indigestion. Schulte has put together a comprehensive chart book that provides a blow-by-blow description of what they describe as the ''carnage”. The report also updates Schulte's analysis on emerging market debt. With credit rating agencies are on the warpath in EM, the report offers a global summary of the actions, and which sectors have been hit hardest. At a country level, Mexico is the most vulnerable, they say. Schulte is convinced Latin America will be the centre of the coming debt crisis, with Chile and Colombia being collateral damage. Based in Hong Kong, Schulte also provides valuable insight on China in their research, particularly on fintech and the political economy. This report also outlines their views on the rollout of China's daring 5-year plan at this week's National People's Congress (NPC). They say these next five years will focus on COVID-19, employment, AI technology, environment, legal reform and financial deregulation through accelerated fintech.
2. The Fed giveth, and the Fed can taketh away
The collision of two powerful and opposing forces has created an uncertain outlook for equity markets that risks policy error from the Federal Reserve, according to the latest note from the team at Variant Perception. Aggressive stimulus from the Fed has seen markets rebound strongly, while leading indicators continue to collapse, showing the US economy is in a deep recession that will take time to recover from they say. However, it will be hard for the market to continue to focus on the Fed and ignore the deep recession as the pace of new Fed announcements slows, says the team. They cite the Chinese stock-market rescue in 2015 as offering lessons for how markets react to aggressive attempts by authorities to prop up prices in the face of challenging fundamentals. Initial Chinese stimulus caused a sharp equity rally, notes the team, which then attempted to consolidate at higher levels, but ultimately gave way to another sell-off as the pace of government intervention slowed. They see a similar dynamic at play today with the US market as the Fed tries to contain expectations for negative rates. As the team explains, the Fed put is powerful, but there will still be windows of market vulnerability as equity markets grind higher, such as a policy error from the Fed. VP recommends lightening up equity allocations or add short-term portfolio hedges.
3. The French and German proposal; is it a breakthrough?
LC Macro’s seasoned EU-watcher Lorenzo Codogno, has taken a closer look at French and German plans for a €500 billion recovery fund to help repair the economic damage from the coronavirus pandemic in the EU. The proposals, he says, certainly had an immediate market impact, but he asks how significant they really were, and whether they represents a “Hamilton” moment for the eurozone and the EU, equivalent to when Alexander Hamilton and other US founding fathers agreed the federal authorities should assume the debts of the states. At face value, says Codogno, the fact that the overall amount of the plan has shrunk to €500 billion might be seen as a negative, however, he says the fact that it does not refer to loans, but instead to grants, suggest the programme, if initiated, should be much more effective than previous proposals. However, he says, whether the proposals will go through when the EU Commission announces its plans on May 27 is still far from clear, with the days long gone when other EU members simply acceded to the will of Berlin and Paris. Nevertheless, Codogno expects the Commission proposals “to lean in the directions” suggested by France and Germany, which should be considered as a good development for further economic and political integration in the EU, but not a breakthrough - or at least not yet. If confirmed next week, he adds, financial markets, and especially peripheral government bond spreads, will probably welcome the move.
4. US versus Huawei; Lockdown?
Arete Research has published a note on the prospects for the semiconductor sector in the wake of new US sanctions on Huawei that many believe will reshape the global tech supply chain and put the Chinese company’s survival at stake. Any company that wishes to manufacture computer chips to Huawei’s designs with US tools now needs to apply for a licence. The US has therefore given itself the ability to fully isolate Huawei from the global semiconductor foodchain, says Arete’s Jim Fontanelli, and the key question is the extent to which it will use this lockdown capability. He believes the US policy change may ultimately centre on restricting Huawei’s 5G infrastructure, rather than handsets, but in the short-term will capture the entirety of Huawei shipments. If this is the case, says Fontanelli, then the real negative impact to the broader semis sector likely comes from China’s response, not the direct Huawei hit. As he explains, political escalation is the real risk, with China economic retaliation likely capturing a broader swathe of end-demand and targeting US tech. For now, among chipmakers, Fontanelli explains how Taiwan’s TSMC will inevitably be hurt, while US manufacturers, which have, to varying degrees, sharply reduced their sales to Huawei in the last 12 months are likely to be relatively unscathed.
5. The threat of vaccine nationalism looms; other strategic sectors to watch
Eurasia Group has published two notes focusing on the rising spectres of protectionism and nationalism fostered by the coronavirus pandemic as the growing blame game between China and the US continues to ratchet up the mistrust between two of the world’s key economic and military powers. In the first, Threat of vaccine nationalism looms on the horizon (May 18), Eurasia’s Global Health Advisor Scott Rosenstein explains how political and economic tension over access to a Covid-19 vaccine will heat up over the summer as clinical trials continue and manufacturing capacity is expanded. This view seem contrary to what has been said publicly by China. Rosenstein says recent technological advances plus unprecedented levels of urgency and resources has generated cautious optimism that one or some of the current vaccine candidates will demonstrate safety and efficacy by the end of 2020. In this scenario, says Rosenstein, a battle for vaccine access will ensue, stretching well into 2021 and possibly 2022. Countries rich and poor will engage in aggressive procurement efforts with significant political, economic and public health implications, he adds, and existing international institutions and agreements will struggle to minimize this “vaccine nationalism” as supply chains are unable to deliver complex and costly vaccination campaigns. In the second report, Strategic sectors in the wake of Covid-19 (May 18), Eurasia’s David Livingstone explains why in the wake of the coronavirus crisis, countries will increasingly take actions to protect domestic resources and industries—in some cases, accelerating nationalist and protectionist trends already in motion, and in others, claiming national security and strategic concerns over new sectors. This, he says will have particular implication for the healthcare and food sectors, in which shortages and distribution difficulties will lead to higher prices for companies and potential government intervention to shore up stockpiles and ensure sufficient domestic supply. Governments will also move to expand and secure digital infrastructure, according to Livingstone, with benefits for Western firms seen as alternatives to China’s Huawei .