I want to use the news flow to highlight several issues that I am following that should have a major impact on the economy and financial markets in the next year. All of these topics are laden with risks that skew to the downside. And that could cause meaningful underperformance both economically and for risk assets.
My list from the last 24 hours’ news flow:
- The Cold War 2.0 with China
- US trade with China/NAFTA
- Monetary policy
- Earnings and IPOs
- Regulation of big tech
- Brexit
I am going to try to be as brief as possible to cover a lot of topics. So forgive me if I’m not as thorough in covering where my thought process is on each of these. I will do this in two parts and hopefully, as I reiterate views over the coming weeks and months, a more complete picture will come through.
Huawei CFO arrest and the new Cold War with China
Just as jitters about Tariff Man’s deal with China hit stocks Monday and Tuesday, we are now grappling with the arrest of Chinese tech giant Huawei’s CFO in Canada. The proximate cause of the arrest is about trade sanctions with Iran, that the US wants to enforce globally. But, the Cold War 2.0 is the elephant in the room looming behind this.
And that was made clear by the simultaneous news that British telecom giant BT will rip Huawei products out of its infrastructure for fear of espionage. Here’s the report from the Guardian newspaper:
BT has confirmed it is removing Huawei equipment from key areas of its 4G network after concerns were raised about the Chinese firm’s presence in critical telecoms infrastructure.
The company said the removals were merely the continuation of a policy which began when it purchased the mobile phone carrier EE in 2015, to ensure that both parts of the combined network ran on the same technology. Many peripheral parts of BT and EE’s systems still run on Huawei equipment, and there were no plans to alter that.
Governments in the US, New Zealand and Australia have already moved to block the use of Huawei’s equipment as part of the future rollout of 5G networks. Earlier this week the head of MI6 also suggested the UK needed to decide if it was “comfortable” with Chinese ownership of the technology being used.
On Wednesday it emerged that Canada has arrested Huawei’s global chief financial officer in Vancouver, where she is facing extradition to the US in a move likely to exacerbate tensions between the US and China.
Meng Wanzhou, one of the vice-chairs on the Chinese technology company’s board and the daughter of the company founder Ren Zhengfei, was arrested on 1 December. A court hearing has been set for Friday, according to Canada’s department of justice.
Do you see how the British have connected these two in one article? That’s the right approach here. Yes, the Huawei CFO arrest is all about enforcing sanctions. But, you have to put it into a broader context of China’s ascendancy economically and the rivalry this has created with the US.
The trade spat between the US and China is all about that rivalry. What Trump is saying is that China has grown on the back of unfair trade practices, which include outright IP theft. And since he’s “a Tariff Man”, he is going to stop China through unilateral action unless the government cracks down on those practices. The Huawei situation fits very much into that narrative.
So what is the US asking China to do on trade?
Here are the demands the US side is making on China for the 90-day truce:
- Forced technology transfer: stop China’s trying to extract technological know-how from foreign companies as a condition for accessing the Chinese domestic market. Note that, in October, Chinese Commerce Minister Zhong Shan said: “I want to emphasise that China’s laws and regulations do not contain any requirement for technology transfer and that companies’ purchases of technologies and patents are pure market behaviour.” So, how likely is that China will cave on this point?
- IP protection: From AP – “China announced Tuesday stiffer punishments for serious infringers of intellectual property — including barring some from buying real estate or going on expensive holidays — as Washington clamours for action on the issue following a trade war truce. The National Development and Reform Commission, China’s state planner, along with 37 other government departments, released a joint action plan to deal with serial IP infringers, who could face a raft of tough punishments and restrictions if blacklisted.” So, China has already ceded ground on this point
- Cyber intrusions and cyber theft: This is what the Huawei/BT announcement is all about. In 2015, Xi Jinping and Barack Obama had agreed to reduce the scale of cyberattacks. But, that really hasn’t happened. And Chinese attacks on US companies increased when the US implemented the first round of tariffs in July. According to McClatchy, these attacks were directly linked to the People’s Liberation Army aka the Chinese government. I have nothing on this front.
- Services and agriculture: After China retaliated against US soybeans and other US ag products, this became a major area of contention. The US says that a part of the 90-day truce quid pro quo is that China will now buy “a very substantial amount of agricultural” products. As far as I know, China has not said whether this is true. But the South China Morning Post reports that China is said to be resuming imports of US liquefied gas and soybeans amid the trade war truce. Let’s see.
- Foreign company Chinese market access: This was not mentioned at all in the China truce discussion. But this is the sticky wicket in US-China trade relations. Chinese companies have unfettered access to the US market because the US has a laissez-faire economic approach. But foreign companies in China do not operate on a level playing field. And there are significant non-tariff barriers to competition above and beyond the ones I mention in points 1 through 3. I don’t seeing this getting solved anytime soon. And so, when the 90-days are up at the beginning of March, it will be interesting to see what they say about this issue.
I will leave it there.
Uncertainty over NAFTA’s successor
China – US trade isn’t the only thing creating macro-economic uncertainty. Trump’s recasting of NAFTA has also created uncertainty, which contributed to the Bank of Canada’s decision to leave rates unchanged yesterday.
And now, Canadian newspapers are pointing out that the NAFTA replacement deal, USMCA, is not a slam dunk if Trump tries to ram it through in an uncompromising fashion. Here’s the Toronto Star on the politics:
Donald Trump’s push to get Congress to quickly pass his NAFTA replacement trade deal will require the president to take an uncharacteristic approach in negotiations: seek compromise while resisting strong-arm tactics.
So far, though, Trump is sticking with his coercive instincts, threatening to nullify the existing agreement a day after signing the new accord on the sidelines of the Group of 20 summit. The threat, intended to spur lawmakers to ratify the U.S.-Mexico-Canada Agreement, illustrates the challenge his administration will face as it negotiates with a Democratic-led House and sets limits on changes sought by lawmakers from each party…
According to congressional sources, an infrastructure package is the most likely way Trump could appease Democrats in exchange for their approval of the new trade deal. The president sought to put pressure on Congress Dec. 1 when he pledged to formally terminate NAFTA, which would give lawmakers a six-month window to ratify USMCA or end up with no North American agreement at all.
Starting the NAFTA exit process while talks between the White House and Congress are ongoing, however, would surely blow up chances for success, the congressional sources said.
Bank of Canada leading the Fed on policy rate action
Sticking with Canada, here, it’s noteworthy that the US is not the only major central bank that has been raising interest rates. The Bank of Canada is tightening policy too. But yesterday, it opted to leave rates unchanged at 1.75%, with the pause likely to last. I see this as a potential harbinger of what to expect in the US. The key reasons the BoC is ahead of the Federal Reserve in reversing course is Canada’s acknowledgment of its dependence on a weakening oil and gas sector and protecting the overstretched household sector as the global economy downshifts.
As oil prices have plunged by about a third, Canadian policy makers had been waiting for some sort of bounce. We haven’t got it. And since oil is an important source of export revenue, the difficult situation in Alberta, that has prompted production cutbacks, means the energy industry’s contribution to growth will be “materially weaker” than what was expected just a couple of months ago.
Going forward, the BoC says:
The persistence of the oil price shock, the evolution of business investment, and the bank’s assessment of the economy’s capacity will also factor importantly into our decisions about the future stance of monetary policy.
Though the move was anticipated, the BoC’s cautious statement caught traders out. And the result was a plunging Canadian dollar, which hit a six-month low as government bonds rallied. Market odds for a January rate increase have now dropped to about 40% from 65% to 70% earlier this week.
This should offer some relief to households. But the Achilles heel of the Canadian economy is household debt because house prices never fully adjusted downward in the Great Financial Crisis. And there has been a boom in housing since then, particularly in Vancouver and Toronto. Household debt is around 170% of disposable income in Canada today, where that ratio was at about 100% 20 years ago.
Bank of Canada Governor Stephen Poloz will deliver a speech in Toronto on Thursday. Let’s see what he has to say.
Part two is next.