(Bloomberg) — From an accelerated decoupling of the world’s two largest economies to a discussion about whether China could weaponize its vast holdings of government bonds, investors outline how the US parliament’s trip, Nancy Pelosi, to Taiwan over the global markets could ripple.
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Haven’s assets went into disarray as concerns about the level of China’s military response faded and Treasuries sold on aggressive comments from Federal Reserve officials. The yen made an abrupt reversal, falling more than 1% on Tuesday after its strongest four-day run since 2020, but rose again on Wednesday. Most stocks and stock futures struggled to gain traction.
Pelosi’s visit has sparked new trepidation among investors who already feared the threat of a global slowdown amid rising inflation. Some strategists warned against prematurely rejecting China’s first response — military exercises and some trade restrictions in Taiwan — with markets vulnerable to any hint of a deterioration in Sino-US relations.
“This issue is going to linger much longer than the market’s attention span allows,” said Michael Every, head of Asian financial market research at Rabobank. “Yet geostrategists are largely united in the view that we are still alarmingly close to a possible fourth crisis in the Taiwan Strait.”
China and treasuries
Investors continued to analyze headlines and market movements on Wednesday for clues as to how China might retaliate. The staggering rise in government bond yields overnight sparked discussions about whether Beijing could arm its stack of nearly $1 trillion US Treasuries. Chinese defense stocks rose while Taiwanese shipping and tourism stocks retreated.
Volatility Hits Markets With Geopolitics Contributing To Range Of Risks
“Given the magnitude of the sell-off, it was only a matter of time before there was speculation that China would use its sizable government bonds in retaliation for Pelosi’s visit,” said Ian Lyngen, strategist at BMO Capital Markets. “In the event that this is the case (which we doubt), bearishness should be mitigated as the near-term influences are overshadowed by the negative impact on the global macro outlook.”
Others, such as Huang Huiming, a fund manager at Nanjing Jing Heng Investment Management Co., are bracing for Beijing’s launch of “salami tactics” — a patchy approach to dividing and conquering an opposition — and how this impact on those already stifled supply chains.
“If you look closely at the practice zones, this is the closest to the island ever and surrounds it — all military operations are initially disguised as exercises,” Huang said. “We may be concerned if the exercises get longer and more intense to affect supply chains, but there is no sign of that now.”
Pelosi Meets Taiwan Leader As China Opens Military Exercises
While some investors are looking to sell the rumor and buy the news for now during Pelosi’s visit, others are charting a longer-term macro view of how this could be a groundbreaking moment in Asia-Pacific history and potentially the allocation of assets could change in the region. Taiwan is a vital global supplier of semiconductors and other high-tech goods.
There are risks of a longer-term economic decoupling between the world’s two largest economies, with a range of potential consequences, including new supply chain tensions that exacerbate inflation. Beijing has already announced the start of an economic response, halting exports of natural sand to Taiwan and halting imports of fruits and fish.
“The official return of US influence in Asia-Pacific will inevitably accelerate the decoupling between the US and China,” said Xiadong Bao, fund manager at Edmond de Rothschild Asset Management in Paris. “Given it is an evolving event, investors should brace themselves for a test of nerves that could involve high market volatility in the near term.”
When things look this uncertain, sometimes the biggest transactions are buying the traditional safe havens of the world — treasury bills and the dollar.
That is the view of Jessica Amir of Saxo Capital Markets, who thinks the latest tensions will only further weaken investor nerves, leading to safer assets outperforming.
“Right now, we think the tone has been set for equities for August and the rest of the year. Geopolitical tensions will increase,” Amir said. “We are also seeing the return to safe harbors and the dollar to see more purchases.”
It’s a view shared by Shane Oliver, chief economist at AMP Capital Markets, who sees gains for Treasuries to gold if the visit actually sparked conflict. “Longer term, this points to a further escalation of Cold War tensions between the West and China/Russia, meaning higher risk premia,” he said.
Feeling to recover
In Zurich, fund manager Jian Shi Cortesi sees parallels in market performance between Newt Gingrich’s trip to Taiwan in 1997 and Pelosi’s today. At the time, the Hang Seng index and the Taiwanese stock exchange both fell before the visits, but then recovered strongly. This time before Pelosi’s trip, investors saw similar weakness for stocks from China, Hong Kong and Taiwan.
China’s military exercises near the island of Taiwan “can still keep investors on their toes,” GAM Investment Management’s investment director said. “Market sentiment will recover once the military exercise ends.”
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