Chinese Military Drills Circling Taiwan, what does China Try to Do?

China-U.S. Relations

Summary:

Despite China warnings, the Speaker of the House Nancy Pelosi had finished her Taiwan visit and had left Taiwan already.

Hu Xijing, the journalist of the China state-run Global Times wrote, "If US fighter jets escort Pelosi's plane into Taiwan, it is invasion…The [Chinese Army] has the right to forcibly dispel Pelosi's plane and the US fighter jets, including firing warning shots and making tactical movement of obstruction. If ineffective, then shoot them down."

We have realized that threat didn't happen and fell in vain. Did the journalist's publication truly represent China's military goal? Why did China leave Nancy Pelosi unharmed? Are they playing a different strategy that nobody has realized right now? Let's do some analysis based on the most recent China military action:

What is happening right now is that China has Taiwan surrounded with massive military live fire drills. China military exercises are expected to last until Sunday, but that can prolong if China decides to do so. I have talked about those long-range artillery live-fire shooting drills that were placed in China, Fujian, prior to Nancy's visit. It reminds people of the Golden Gate Artillery Battle in 1958 - Artillery units were placed in the Golden Gate Island in Fujian and fired to the other side, and that was led by the founder of China, Mao Zedong ("Chairman Mao"). The classic artillery strategy has been applied again these days. It implies that China is demonstrating to the world that China Civil War has not been over yet.

Chinese Military Drills Circling Taiwan, what does China Try to Do?_1

China has been watching the Russia-Ukraine war closely and also has been paying attention to U.S.' reaction. The U.S. is supporting Ukraine only by offering military equipment to them, but so far, the U.S. has not yet sent any of their troops to fight against Russia.

Although during the visit, the House Speaker declared, "it is unequivocally clear that the United States would not abandon Taiwan", it is still too early to know how intensive that potential military response might be and how much military budget that the U.S. government is prepared to spend to fight with China. But what we might know is what the China military exercises trying to achieve, and that can be summarized as the following:

1. Taiwan has the world's busiest shipping lanes. China surrounded military exercises are disrupting these shipping lanes. It will create a problem for supply chains. Carrying goods will be delayed to arrive countries and regions including but not limited to Japan, South Korea, Europe and the United States. If China make its military exercises as an usual event in the future, these markets will be hindered and Taiwan economy will be hurt. And that can be a sort of economic sanction to Taiwan.

2. It is also possible that China might consider to conduct a nuclear test on the surface of the nearby ocean or on a small island in order to declare that China is also prepared for using unclear weapons like Russia does today. In that case, it is possible that Taiwan will be left alone by the United States and other U.S. allies.

3. China might release a list of names including some core members of the Democratic Progressive Party (DPP) like Cai Ing-wen and makes a public announcement that these people violate the laws by causing disunity to China and make them responsible for inciting wars. Taiwan might choose peace instead of wars by handing these people to mainland China and chooses to practice "One Country, Two Systems" policy.

4. An ultimatum might be sent to Taiwan announcing, "if anyone wants to join war with mainland China will be given a tittle as 'committing war crimes'".

5. Since the United States has deployed most of its military in Europe. It has comparatively far less influence in East Asia region because the United States currently is mainly focusing on countering Russia from further pushing to other places in Europe. If a war has to be happened, unlike the Russia-Ukraine war, it is projected that China won't spend months to demilitarize Taiwan. It could be done under several hours. There won't be enough time for U.S. military to make a reaction.

China certainly prefers to bring unity without having to go for a war. They will choose war if the best option is not available. All of these potential plays are only my military assessment. It is unclear what military strategy China will eventually choose, but what it is crystal clear right now is that, China wants unity. China wants to defend its state sovereignty over Taiwan, regardless of countering U.S. military.

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Alex

The Japanese yen's rise against the U.S. dollar since mid-July is a temporary shift, nearly two-thirds of currency strategists in a Reuters poll said, despite looming uncertainties over the global economy that have curbed the U.S. currency's rally.

The yen was down as much as 17.5 per cent against the dollar for the year just three weeks ago, at one point hitting a 24-year low of 139.38 per dollar. It then rallied 6.9 per cent to 130.40 in two weeks before settling above that level.

It last traded around 134, remaining down about 14 per cent for the year.

In the Aug. 1-3 poll of global currency analysts, 17 of 28 respondents, or 61 per cent, said the yen's recent strength against the dollar would not last.

The yen was unlikely to rally over the short term, analysts said, as the Bank of Japan (BOJ) remained an outlier among global central banks by sticking to its ultra-easy monetary policy.

"The yen will stay weak whilst the BOJ maintains its YCC (yield-curve control) policy," said Tony Nyman at Informa Global Markets, referring to the central bank's framework to implicitly cap the 10-year Japanese government bond (JGB) yield at 0.25 per cent.

This year's rise in U.S. Treasury yields has put upward pressure on benchmark 10-year JGB yields, sending the BOJ in a frenzy to protect its de facto yield cap with massive bond-buying that fuelled the yen's slide.

The BOJ has firmly rejected speculation about any adjustment to the YCC framework to allow benchmark yields move higher, which might take some pressure off the yen.

Even strategists who said the yen's recent appreciation is not temporary think the turnaround would be slow.

"The process of USD/JPY turning lower could take some time," said Jane Foley, head of FX strategy at Rabobank, who projected that the yen would eventually strengthen to 128 per dollar in the next 12 months.

The median three-month forecast of 54 currency specialists in the poll has the yen trading at 134.00 per dollar, a weaker projection than July's 133.00.

In six months' time, analysts projected the USD/JPY rate to stand at 131.33, the median forecast showed, little changed from July's 131.00.

Twelve of 52 respondents expected the yen to weaken again to 135 or below per dollar by end-January, while only four saw it strengthening to 125 or beyond.

Source: Reuters

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Owen Li

Strong earnings at Credit Agricole and Lufthansa lifted stocks on Thursday as tension over Nancy Pelosi's visit to Taiwan eased and markets bet the Bank of England will hike interest rates by the largest amount since 1995 to quell inflation.

The STOXX index of leading European companies gained 0.33% after German airline Lufthansa returned to an operating profit, while French bank Credit Agricole joined the growing roster of better-than-expected earnings at banks.

Shares in Hong Kong rose 2%, tracking broader gains in Asia, reeling in some of the losses suffered after Sino-US frictions flared over a visit to Taipei this week by House of Representatives Speaker Pelosi, which angered China.

Oil prices rebounded from six-month lows, while the US dollar was underpinned by US Federal Reserve officials pushing back against suggestions they will slow the pace of interest rate hikes, with one saying a 50 basis point hike would be "reasonable".

After large interest rate hikes by Fed and the European Central Bank to stop decades-high rises in prices, investors expect the Bank of England to follow suit with a 50 basis point increase when it announces the outcome of its monetary policy meeting at 1100 GMT.

Sterling could struggle in the absence of a hawkish surprise — especially as the British economic outlook is looking weak while US data has offered some upside surprises.

Sterling was trading at US$1.2162, up slightly on the day.

"People are leaning towards a 50 basis point rise, a split decision probably. Then it's really a matter of how to see the outlook going forward," said Michael Hewson, chief markets analyst at CMC Markets.

"The UK economy is going into recession and there is nothing they can do about that and the Bank of England's primary focus should be on pulling inflation down from its current levels, and frontload like the Fed is doing," Hewson said.

A survey from the European Central Bank showed that consumers in the euro zone are bracing for the economy to shrink and for high inflation to continue.

S&P 500 futures were little changed ahead of Wall Street's open, with Friday's non-farm payrolls a key piece of data for the week.

No earnings reset yet

Kasper Elmgreen, head of equities at asset manager Amundi, said the illusion that decades-high inflation would be transitory was now firmly gone as fuel bills surge and companies have difficulties finding staff.

"The big picture here is that it's going to require quite a lot to restore price stability. The risk here is that we underestimate how powerful a force it is we are dealing with," Elmgreen said.

The second quarter earnings season now underway has not provided a major "reset" to what Elmgreen sees as still too high earnings expectations for 2022 overall given the economy is slowing.

"I think that might come in the third quarter or fourth quarter as we start to see more demand impact," Elmgreen said.

An ISM survey on Wednesday showed the US services industry unexpectedly picked up in July, prompting a sell-off in bonds and rallies for US stocks and the US dollar, with the Nasdaq up 2.5% to a three-month high.

Fed officials have provided a hawkish chorus this week, battering the short end of the yield curve. Two-year Treasury yields were trading at 3.1040%, while the benchmark 10-year year yields traded at 2.7318%, both slightly weaker.

The US dollar has halted a decline that began in the middle of July, with support from both hike expectations and heightened political tension.

Fed funds futures remain priced for rate cuts to be under way by the middle of next year and the inversion of the US yield curve, with 10-year yields below two-year yields, suggests investors think that the hiking path will hurt growth.

"I think the market's going to remain choppy," said David Ratliff, head of banking and capital markets for Asia Pacific at Wells Fargo in Hong Kong. "People are starting to read through the current round and pace of Fed tightening."

The dollar index was trading at 106.30, down 0.169%. A euro weighed by Europe's energy crisis bought US$1.0185.

Brent crude futures were slightly weaker at US$96.75 a barrel as supply concerns triggered a rebound from multi-month lows on Wednesday after US data signalled weak fuel demand.

Spot gold rose 0.5% to US$1,773 an ounce.

Source: Reuters

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Devin

Italy plans to approve on Thursday a new aid package worth around 14.3 billion euros ($14.5 billion) to help shield firms and families from surging energy costs and consumer prices, government officials said.

The scheme, one of the last major acts of outgoing Prime Minister Mario Draghi before a national election next month, comes on top of some 33 billion euros budgeted since January to soften the impact of sky-high electricity, gas and petrol costs.

A draft decree seen by Reuters showed that Rome planned to extend to the fourth-quarter of this year existing measures aimed at cutting electricity and gas bills for low-income families as well as reducing so-called "system-cost" levies.

Designed to help finance initiatives ranging from solar power subsidies to nuclear decommissioning, the levies typically accounted for more than 20% of Italian energy bills before the government started to act.

Among a raft of measures, the government will extend a 200 euro bonus paid in July to low and middle-income Italians to workers who did not previously receive it.

A cut in excise duties on fuel at the pump scheduled to expire on Aug. 21 is set to be extended to Sept. 20.

Rome is also considering preventing energy companies from making unilateral changes to electricity and gas supply contracts for households until October, according to the draft.

With tax revenues doing better than forecast, funding for the package will not drive up the public deficit target, which Rome last week confirmed at 5.6% of national output this year.

Some 1.6 billion euros will go to reducing in the second half of this year the so-called tax wedge, the difference between the salary an employer pays and what a worker takes home, with the benefit going to employees with an annual income worth less than 35,000 euros.

The Organisation for Economic Cooperation and Development (OECD) estimated that in 2021 the average single worker in Italy lost 46.5% of his gross salary in taxes and social contributions, the fifth-highest ratio out of a group of 38 advanced nations.

To support purchasing power of elderly people, the government will bring forward to the fourth quarter of 2022 a 2% revaluation of pensions scheduled for 2023, at a cost for state coffers of around 2.4 billion euros.

($1 = 0.9835 euros)

Source: Reuters

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Owen Li

Central Bank

Traders are dialling back rate hike bets in emerging Asia as growth concerns steadily overtake inflation angst.

Swaps in South Korea, Malaysia, India and Thailand have all been dropping since mid June amid easing price pressures and concerns over spillover effects from stumbling growth elsewhere. This volte face followed the three months to June when an index of EM Asia bonds registered losses of 6%, the largest since 2016, as inflation galloped to multi-year highs.

"Hawkish bets in EM Asia have been falling partially as a response to policy rates being overpriced on the way up," said Galvin Chia, an EM FX strategist at Natwest Markets in Singapore. "Global factors such as US rates rallying over the last few weeks has also played a major role."

These four charts show how rate hike expectations have ebbed in South Korea, Malaysia, India and Thailand:

South Korea

Won swaps are pricing for the Bank of Korea to hike to around 2.75% in the next six months, which appears to be the terminal rate of expectations as the one-year swaps have also converged on the same level. In mid-June, the same one-year swaps were pricing for rates to rise to 4%. Hawkish Bets Ebb in Asia as Global Recession Fears Spill Over_1

Hawkish Bets Ebb in Asia as Global Recession Fears Spill Over_1

Expectations for a shallower rate hike curve have been building, with a Bank of Korea board member warning last month that the pace of policy tightening may be tempered due to growing risks facing the domestic economy.

Malaysia

Traders have been betting on a less hawkish Bank Negara Malaysia since mid June, with ringgit one-year forward one-day rates factoring for a cumulative 75 basis points of benchmark rate increases over the next 12 months to 3%, down from expectations of 3.50% in early June. This is in line with expectations for the policy rate to rise to 3% by the second quarter of next year, according to a median of economist surveyed by Bloomberg. Hawkish Bets Ebb in Asia as Global Recession Fears Spill Over_2

Hawkish Bets Ebb in Asia as Global Recession Fears Spill Over_2

CGS-CIMB is projecting for Malaysia's gross domestic product growth to slow to 4.1% in 2023, from an estimated 5.2% this year, as the nation's external trade will feel the impact of the global slowdown, according to a July 25 note.

India

Rupee overnight indexed swaps are factoring rate increases of around 130 basis points over the 12-month horizon, which would bring the policy rate up to 6.20%. This would be marginally higher than economist median expectations for the benchmark rate to be increased to 6% by mid-next year.

In contrast, swaps were pricing for rate hikes of as much as 150 basis points on July 18. Hawkish Bets Ebb in Asia as Global Recession Fears Spill Over_3

Hawkish Bets Ebb in Asia as Global Recession Fears Spill Over_3

Traders have been making less hawkish calls for the Reserve Bank of India as inflation showed signs of moderating. Retail price growth came in below estimates in May and June, after beating expectations in four straight months to April. India releases July retail inflation data on Aug 12.

Thailand

Thailand's one-year non-deliverable interest rate swap is factoring in at least 75 basis points of rate hikes over the next 12 months, with the swap currently at around 1.35%, down from a three-year high of 1.78% in mid June. A median of economists surveyed by Bloomberg forecast the policy rate to rise to 1% by middle of next year. Hawkish Bets Ebb in Asia as Global Recession Fears Spill Over_4

Hawkish Bets Ebb in Asia as Global Recession Fears Spill Over_4

Bank of Thailand meets on Aug 10 and is widely expected to hike at this decision.

Source: Bloomberg

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Jason

USD: Wide spreads keep the dollar supported

Short-term dollar yields have found more support this week as the Fed has pushed back against the idea of a 2023 easing cycle. Even the historically dovish Fed member, Neel Kashkari, has discounted any prospect of easing next year. This is understandable in that the Fed is battling its toughest inflation challenge in 40 years and it will not help to keep inflation expectations contained if it starts outlining that this year's rate increases will be reversed next year. Arguably this could be the Fed's position until year-end when the Fed funds rate could be in the 3.25/3.50% region. Overnight USD rates at that level will be very high for the world's reserve currency and the risks are certainly of the dollar staying stronger for longer.

Expect a quiet day in FX today ahead of tomorrow's July US jobs data. And in terms of speakers, we have the Fed's Loretta Mester at 18CET today - who can be expected to add her remarks to this week's hawkish Fed pushback. Expect the dollar to remain reasonably bid against the low yielders (EUR and JPY) and DXY could nudge back towards the 107 area.

EUR: Two big drivers weighing on the euro

If we were to pick out two big drivers keeping EUR/USD depressed right now we would say: i) 2 year EUR:USD swap spreads at their wides of the year and ii) the eurozone's terms of trade near its lows for the year as natural gas prices continue to tick higher.

On the former, there seems no compelling reason to expect swap spreads to narrow in favour of EUR/USD anytime soon. The bigger risk looks to be the market pricing more into the Fed cycle, where the policy rate is only priced now at 3.38% for the December meeting. This can easily move higher. Regarding gas prices, Gazprom seems intransigent in its view that a key turbine cannot be put back into use to improve gas supplies to Europe - which really should not be a surprise given events in Ukraine.

EUR/USD looks soft towards the lower end of a 1.0100-1.0300 range and could easily sink back to parity at any time.

GBP: A hawkish 50bp from the BoE should help

Please see our full scenario analysis of today's Bank of England meeting here. There will be many facets to today's meeting (rate decision, minutes, new inflation forecasts out at 13CET) to keep us all busy. Our default view is that an 8-1 vote can keep EUR/GBP steady near the 0.8350 area.

When releasing its last set of inflation forecasts in May, sterling sold off on the view that UK CPI would be below the BoE's 2% target in three years' time assuming market tightening expectations were delivered. This gentle push-back against market tightening expectations clearly has not prevented the BoE from returning to where we are today - i.e. on the verge of a 50bp rate hike. Given high gas prices and a strong dollar - plus BoE remarks that sterling plays a role in monetary conditions - the BoE may be reluctant to push back against tightening expectations today and will probably welcome the 3% bounce in trade-weighted sterling over the last month.

The euro has by far the largest weight in sterling's trade-weighted basket and euro weakness is making sterling look good. Yet the BoE will be aware that monetary policy decisions are having a major bearing on FX pricing. Retaining language that it will still be prepared to act forcefully - even after the presumed 50bp rate hike today - could be enough to send EUR/GBP down to the 0.8275/8300 area.

CZK: The market will test CNB's dedication

Today, the Czech National Bank (CNB) will meet for the first time under the leadership of the new governor and the new board. We expect the central bank to deliver what the governor promised; stable rates, for the first time since May last year when the current hiking cycle began. Surveys and market expectations are still undecided between no change and a 25bp hike. However, we think more interesting will be the press conference, which will be led for the first time by the new governor, who will present the new CNB forecast. As the governor and new board members have not been seen much in the media since their appointment, we don't know much about their views and so there will be no shortage of surprises. However, overall, we believe today's meeting should confirm the CNB's dovish change.

The Czech koruna has been gradually pushing higher in recent days and has been in the CNB's favoured band 24.60-24.70 EUR/CZK since the start of this week, which is likely to force the central bank to be more active in the market. However, we expect the koruna to come under real pressure after today's meeting and the CNB will have to significantly increase its efforts to keep FX under control. For now, this should not be a problem for the central bank, but the increase in the cost of intervention could tell us more about the possible end of this regime.

Source: ING

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Kevin Du

Bitcoin has added 0.8% to $23100 in the past 24 hours, a worryingly weak result. Ethereum strengthened 1.3% to $1650. Other leading altcoins gained between 0.9% (Cardano) and 7.2% (BNB).

Total crypto market capitalisation, according to CoinMarketCap, rose 1.8% to $1.08 trillion overnight. The Cryptocurrency Fear and Greed Index lost 4 points to 30.

Bitcoin's drift towards the lower end of the uptrend channel has paused, but this is a weak result compared to the 2.6% rise in the Nasdaq, with which the cryptocurrency market is closely correlated. We are still left to guess where the most consistent trend and market noise show. The stock market was pushed yesterday by jumps in individual securities after quarterly earnings reports. In general, the macroeconomic situation is somewhat cautious.

The Fed officials were proving to the markets that they were hoping for a quick reversal of monetary policy from tightening to easing. They hinted at their willingness to raise the rate more than previously estimated.

Cryptocurrencies are sensitive to financial conditions, as rising rates reduce the availability of money, and this is especially true for such financial assets.

Michael Saylor, an iconic figure in the crypto industry, is stepping down as CEO of MicroStrategy. The reason for Saylor's departure could be the dissatisfaction of MicroStrategy's investors with the company's financial results, whose losses from BTC depreciation exceeded $1 billion.

The ECB believes that national digital currencies (CBDC) will displace bitcoin and other cryptocurrencies because of their higher potential.

Online broker Robinhood has announced a 23% staff cut amid the collapse of the crypto market. Robinhood issued a negative second-quarter financial report this week. New York authorities fined the crypto platform $30 million for failing to comply with anti-money laundering and cybersecurity measures.

Solana users lost more than $8 million due to a blockchain vulnerability. Hackers hacked about 8,000 SOL-based wallets. Major crypto exchanges said they would improve user security after Solana was hacked.