U.S. Trade War Shifting to a New Front: A War on Capital?

Market Analysis /
30 Sep 2019

Note October 1-7th China will be on Holiday (Golden Week) – China PMI's kick off the macro news this week, but any follow-through in assets might be limited as investors head for the sidelines.

 

Weekend News

U.S. Treasury says no current plans to block Chinese listings

Fortunately for risk markets – and before traders in China and Asia had a chance to engage the frightful capital capping headlines today – the US Treasury on Saturday talked down Friday’s hysteria in saying there are no current plans to stop Chinese companies from listing on U.S. exchanges.

However, the statement didn’t exactly clarify the White House position, nor did it rule out other courses of action. Unquestionably, floating this story at a time when US-China harmony is most needed suggest the US administration isn’t exactly rolling out a red-carpet welcoming party for China’s high-level trade negotiators for next week’s trade talks.

The timing of this story right on the cusp of another round of high-level trade talks between the worlds most massive economies adds another layer of muck to an already befouled trade war narrative. Moreover, without a complete walking down of this aggressive US posturing, the latest trade war salvo may continue to hang over the markets like a foul stench as storm clouds continue to gather on the horizon.

With the US bringing focus on China’s debt rating agencies, it opens a whole new can of worms and takes this highly competitive rivalry for global capital investment flows to a whole new level at a  time when China has been opening their capital markets to fund the belt and road initiative.  

When adding a capital war to an already toxic brew of tariff war, impeachment noise and possible Iran escalation it's not exactly the best springboard for risk assets, suggesting equity market volatility may be the name of the game in the weeks ahead.

If there was ever a time the markets needed a trade war breakthough, now is about as good a time as any.

Source: AxiTrader

Capping capital flows to China

However, assigning a risk factor to a financial market ruination scenario of this magnitude is next to impossible. Still, if a war on capital is the new face of the trade war, and the Trump administration imposes limits on U.S. portfolio flows into China, it will make the current tit for tat tariff escalation look like a board game of axis and allies.

While this is an evolving story and the theoretical magnitude of the impact near impossible predict, it may well be argued that it could be exponentially more damaging to the global economy than the current level of the trade war.

China's debt rating issues

China's bond market is opening to foreign flows big time and their debt rating system, murky as it is, has never experienced a harsh test from the markets. Moreover, as mainland economic fissures appear left, right and centre, now with trillions of foreign inflows funding President Xi’s BnR initiative, isn't it prudent for U.S. regulators to be concerned?

Indeed, this would seem to be a very reasonable concern. Even prudent. However, the problem is that U.S. investors’ welfare was likely the last thing playing on the administration's mind when they floated this news on Friday. If anything, the news leak appears consistent with the US administration intensifying their brand of scorched earth trade policy where no one wins, and everyone gets burned.

The Yuan and the US dollar

The Yuan's adverse reaction to the news runs contrary to the U.S. administrations trade policy suggesting if President Trump were to consider capping US investment into China, US policymakers would need a counter lever to weaken the U.S dollar.

Hence the reason why a recent bipartisan bill submitted in the US Congress calling for higher taxation on capital inflows into the US to undermine the dollar may return to focus. Applying a withholding tax to foreign investment flows would be the equivalent of the Federal Reserve Board (Fed) cutting rates, something which the US President has been pushing. Importantly, the narrative towards taxing foreign capital has been openly adopted by US Democratic Presidential nominees as well. 

 Source: AxiTrader

The politics of taxing capital flows

If there is one thing democratic nominee Elizabeth Warren, who is surging in the polls, and President Trump agrees, it’s higher taxation on capital inflows into the U.S. to weaken the U.S. dollar. 

Limiting U.S. government pension inflows into China is no small matter but taxing China inflows into the U.S. is massive as China is, of course, a much bigger player in U.S. portfolio markets than the US is in Chinas.

If the trade war does change fronts and starts attacking global capital flows, the policy may have dramatically negative consequences for the US dollar if the above scenario unfolds.

The greenback has had a remarkable haven run on the back of the tit for tat tariff war, but not all wars lead to a stronger dollar.

 

Oil markets

The long oil position bulge that grew across the curve after the terrorist attack has given way to position shorts that have returned to fashion as traders appear to be making a significant U-turn in strategy.

With Saudi oil production mostly back online, the focus shifts again to the trade war narrative and consequential demand devastation, which is getting intensified by the U.S. administration’s possible capital clampdown as they investigate the efficacy of capping U.S. investment flows into China.

Indeed, when stop and reverse trading strategies kick in, they can have an exponentially significant impact on price action and far weightier than a simple cut and run exit strategy. All of which suggests there may have been considerable downside momentum in play last week.

Iran and oil

A war of words between the US and Iran is unlikely to have a significant impact on oil prices. Moreover, neither will the US patriot missile system which is expected to be deployed for defensive measures only, as President Trump knows that any perceived offensive military escalation in the middle east could send US crude prices soaring.

The last thing President Trump wants is a rise in consumers’ fuel expenses which could harmfully impact broader US retail consumer spending habits. After all, the US consumer has singlehandedly buttressed the US economy for most of 2019.

Economic data and oil

Economic data will be in focus this week and while the US data has been surprisingly resilient, how long can this exceptionalism last. However, even if the US data held up the decidedly disappointing PMI figures out of Europe last week, and the wobbly PPI and IP data from China on Friday, there’s little reason for Oil investors to be optimistic over global demand.

Baker Hughes rig count

Possibly feeling the glut but likely getting impacted by tighter capital constraints, the US driller reduced the number of rigs by six last week to 713, the lowest since May 2017, according to data released by Baker Hughes on Friday.

 

Gold markets

The latest trade war salvo and its impact on U.S. bond yields and the US dollar may offer the best clues for Gold's next direction. However, Investors may still need to do a bit of soul searching this morning, at some point, it is possible that the U.S. trade war shifts to a new front: a war on capital. All of which suggests the markets may remain in a defence posture until further notice which could be a welcoming environment for gold markets as investors may view a defensive strategy as the best offence.

Last week was a stressful time in the gold market as a multitude of crosscurrents saw gold prices rise early in the week only to fall into the weekend.

As any seasoned Gold trading veteran worth their salt will tell you, trying to predict gold price movements over the short term is challenging at best, given the number of paper leverage contracts that banks and fast money traders can use to trigger takedowns that may scare weak hands out of their positions.

Source: AxiTrader

The capital war headline impact on gold

Until the headline hit that the White House is weighing limits on US portfolio flows into China, prices were toppling. Gold was struggling with little significant news, which may have been a result of speculative fast money flow or even possibly one-off quarter-end portfolio reallocation related flows.

Sure, some of the market impeachment worries calmed when US President Trump released part of the Ukraine call recordings, and then he suggested a trade deal with China is closer than everyone thinks, but that doesn't explain the full extent of the move to the mid $1480s

Indeed, more tangible trade calming news flows could send US bond yields higher, leaving the massively long COMEX and ETF gold positions prone to a significant correction.

Gold and Fed speak

Also, for gold markets, it’s possibly all about Fed amid a growing awareness that the FOMC’s aggressive easing narrative may have reached its expiration date with traders now waking up to the fact that a policy centrist like Fed Evans continues to double down on their hawkish rhetoric as the Fed rate cut probability in October recedes – not the most bullish view for Gold markets at all.

Gold and weak physical demand

While the COMEX and ETF demand have remained robust, there’s a significant element of the market missing in action. Physical demand remains weak and could have helped ice the recent rally.

Physical demand is typically high this time of year. Usually demand out of India tends to be very strong in the lead up to the wedding season and ahead of festivals while physical buying from China tends to pick up in preparation for peak demand around the Lunar New Year. The consumer demand is not there, which is a bit of a concern for gold bulls who typically expect decent demand in the physical market from India over Diwali.

Gold investors on the sidelines?

The other possibility is perhaps gold investors have taken to the sidelines, preferring to wait until all quarter-end flows are through before re-engaging. 

 

ASEAN Currency Markets

It's unclear if the so-called war on capital is but a tempest in a teapot or something that will trigger nightmares from here to eternity for emerging market traders. However, with the US Treasury on Saturday talking down Friday’s hysteria, it was a much calmer open than expected.

However, with the Yuan completely in trader crosshairs, any thoughts of having a peaceful week on RMB desks over the Chinese long holiday might have flown out the window with the latest round trade/capital war escalation.

 

Read more market views from Team AxiTrader: https://www.axitrader.com/int/market-news-blog/.

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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