by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with an update on the war in Iran, where new attacks on shipping add to evidence that the conflict will continue for some time. We next review several other international and US developments that could affect the financial markets today, including news that the US and Canada have reached a preliminary agreement on a new trade deal and another unexpected primary election win for a Democratic Socialist.

United States-Israel-Iran: According to the United Arab Emirates military, Iran fired two ballistic missiles at commercial ships in the Strait of Hormuz yesterday, hours after it hit a bulk carrier in the strait east of Oman. The US military evidently did not respond to either attack, although it still appears to be enforcing the US blockade on Iranian ports. The lack of a US response to the latest attacks seems to reflect the administration’s decision to focus on economic pressure to force Iran to allow shipping in the waterway.

• However, as we’ve argued in the past, the hardline Iranian leadership appears to have the tactical advantage in the war and is likely to keep trying to escalate the violence to show the US as impotent or force it into again launching politically unpopular military strikes. The Financial Times yesterday said the Iranian military has even weighed striking US and allied assets in Europe to keep increasing the cost of the war for the US.
• Either way, the conflict looks set to keep going and create a continued risk of disruption to world energy markets.

United States-Canada: President Trump last night said that US and Canadian negotiators have agreed in principle on a new trade deal, so he will pause a threatened 50% import tariff on certain goods from Canada for three days to give them time to finalize it. The Office of the US Trade Representative said the deal would include improved market access for US goods in Canada, along with “economic security commitments” and “alignment” on digital trade issues that have long caused tension between the two countries.

United States-China: US semiconductor giant Nvidia has reportedly received permission from Beijing to send small batches of its H200 artificial intelligence chip to China. Major Chinese technology firms such as ByteDance and Tencent have each received about 10,000 of the processors in recent weeks, while a few other Chinese tech groups could soon get approval for shipments of similar size.

• Beijing had previously banned the US chips to support its domestic AI chip industry, but now it has apparently relented to help its AI labs in their race against US model developers.
• Nvidia’s H200 processor is still at least two generations behind the firm’s most advanced chips, but China has shown that it can leverage even less-than-cutting-edge technology to advance its AI models. That could potentially help US chip suppliers.

China-United States: New federal data shows China’s holdings of US Treasury obligations fell from $659.3 billion in May to $633.4 billion in June. China’s official portfolio of US Treasurys has therefore declined by more than 50% since its peak in 2015 and now stands at its lowest level since September 2008. The figures may not capture some indirect Chinese holdings in third countries, but the data nevertheless shows how key countries have cut their exposure to the US and the US dollar over time.

• Foreign central banks and institutions have been working to reduce their exposure to the US for a number of reasons, from fear of financial sanctions to concern over the US’s expanding budget deficit, rising debt, and shifting monetary policy.
• As we’ve noted before, however, no other major currency offers the same advantages as the greenback, such as big, deep, well-regulated financial markets and full currency convertibility. Therefore, China and other foreign investors will probably continue diversifying away from the dollar and US Treasurys only gradually. The trend may put upward pressure on US bond yields over time, but it won’t necessarily lead to a sudden outflow that sparks a sharp financial crisis.

Japan: Concerns about Prime Minister Takaichi’s health have grown after she unexpectedly spent 6-1/2 hours in what was supposed to be a routine checkup on an arthritic hand she injured while campaigning in February. Government officials say the extended exam found no particular problems, but observers note that her intense work schedule and habit of getting very little sleep could put her health at risk. Of course, if Takaichi were to suddenly become incapacitated, it would likely spark volatility in Japan’s financial markets.

Singapore: The Monetary Authority of Singapore today said it plans to remove the tax paid by investment professionals relating to profits from fund management services. It will also set up an investment program to provide hedge fund managers operating in Singapore with capital, while loosening visa rules for senior fund-management staff. The growth-friendly moves aim to help the city state compete for investment management business now that Hong Kong is cutting its taxes on the industry as it tries to regain its cachet as a financial center.

US Politics: Florida’s Democratic primary for the US Senate yesterday was unexpectedly won by state Rep. Angie Nixon, a Democratic Socialist who had campaigned on Medicare for All and a federal minimum wage of $25 per hour. Nixon is widely expected to lose the general election against GOP Sen. Ashley Moody in November, but her win in the primary will likely keep alive the narrative that the Democratic Party is drifting farther to the left — a narrative the Republicans will use against the party’s candidates ahead of the mid-term elections.

US National Security Policy: The US Navy this week said it will accept its newest nuclear-powered attack submarine, the USS Massachusetts, without the customary final sea trials. According to Vice Adm. Rob Gaucher, the Navy’s director of submarine programs, early acceptance is a calculated risk, but it would make the Massachusetts available for operations sooner and allow shipyards to accelerate their production of other subs.

• The decision probably reflects White House and Pentagon pressure on the Navy to reverse the chronic delays in producing major combat vessels.
• As noted by Vice Adm. Gaucher, the decision to forego the traditional final sea trials raises the risk that the Massachusetts will be found to have problems. However, it will also help slow the current slide in the number of combat ships available to the Navy.

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