Daily Comment (August 21, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a discussion of the important U.S.-Japan-South Korea summit on Friday and what it means for the global national security environment.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including further interest rate cuts in China, elections in Latin America, and real estate and weather news here at home.

United States-Japan-South Korea: President Biden, Japanese Prime Minister Kishida, and South Korean President Yoon on Friday formalized an important new series of trilateral commitments on diplomatic, economic, and military cooperation at a Camp David summit.  For example, the military agreements include a multi-year plan for joint exercises, deeper coordination on ballistic missile defense, and a new crisis-communication hotline.  The agreements don’t include any mutual defense commitments like those of the North Atlantic Treaty Organization, but they do mark a stepped-up effort at unity and coordination as the democracies face rising geopolitical challenges from Beijing’s evolving geopolitical bloc, which includes countries ranging from China and Russia to North Korea, Iran, and Cuba.

  • The summit illustrates how the rising geopolitical threat from the China/Russia bloc has forced the U.S. and its allies to coalesce and overcome some of their past divisions, such as the longstanding enmity between Tokyo and Seoul over Japan’s brutal behavior on the Korean peninsula before and during World War II.
  • The rising geopolitical threats have also generated a renewed bipartisan commitment to U.S. hegemony among centrist Republicans and Democrats. The Biden administration has relied heavily on their support as it tries to rebuild U.S. global leadership and rally allies to defend against the threat.  However, it’s important to remember that the overall trend over at least the last decade was for many U.S. voters to question the costs of maintaining global dominance.  Strong populist forces remain on both the left and the right of the political spectrum, and they could still ultimately derail the U.S.’s new globalist approach and push policy back toward isolationism.

China-Africa: New reporting shows the Chinese Communist Party has started to offer training in authoritarian governance to the ruling parties in key African countries.  The training is offered through a “leadership school” that focuses on topics such as party governance, party discipline, anti-corruption methods, “Xi Jinping Thought,” and poverty alleviation.

  • The development suggests Beijing is becoming more comfortable with explicitly exporting its authoritarian political model.
  • Since many of the targeted countries are important suppliers of key mineral resources, it appears the effort is partly aimed at locking up those resources to benefit China.

China: Following up the central bank’s interest rate cut last week, the nation’s banks today cut their one-year prime lending rate slightly to 3.45% compared with 3.55% previously.  Observers had expected the five-year prime rate to be cut as well, but it was left unchanged at 4.20%.

  • The rate cuts are an effort to rebuild economic momentum in China, but the limited nature of the cuts also illustrates policymakers’ reluctance to implement big changes.
  • China continues to struggle with what some economists are calling the “four Ds”: Demand weakness, Debt overhang, Demographic decline, and De-coupling in international trade, investment, and technology flows.
  • With policymakers reluctant to revert to China’s traditional countercyclical strategy of increased debt and infrastructure investment to offset those trends, investors are becoming increasingly pessimistic about Chinese assets. That’s especially the case now that another major real estate developer is apparently facing liquidity problems and property-sector debt issues are starting to affect the broader financial system.  Chinese stocks trading on the mainland and in Hong Kong are trading lower so far this morning, and the renminbi has weakened to about 7.33 per dollar, near a record low.

European Union: Reports last week said the EU’s natural gas storage facilities have been almost completely filled, well ahead of the winter heating season, helping drive down the continent’s gas prices.  Nevertheless, new data from the Bruegel think tank suggests weak underlying demand is also putting downward pressure on prices.

  • The slowdown in demand partly reflects Europe’s slowing economic growth and slow passthrough of wholesale price cuts to consumers.
  • Perhaps more interesting, the think tank says weaker gas demand is also being driven by surging investment in alternative heating technologies, such as electric heat pumps and solar panels.

Russia-Ukraine War: Officials in Ukraine are reportedly negotiating a risk-sharing deal with global insurers so that the firms could cover up to 30 grain ships traveling from the country’s southeastern ports.  Now that Russia has pulled out of the previous deal allowing Ukraine to export grain, such a deal could potentially help ensure that Ukrainian grain can get to world markets, which would likely help hold down future prices.

Turkey: The government and central bank yesterday announced a series of moves aimed at discouraging savers and businesses from using foreign currency-protected savings accounts.  Those accounts, which reimburse their owners at government expense when the lira weakens against the dollar and euro, were implemented in late 2021 to encourage people to keep holding lira.  Along with recent interest rate hikes and import restrictions, the move signals that the government continues to shift toward more orthodox economic policies now that President Erdogan has been re-elected.  Over the summer, that shift has given a significant boost to both the lira and Turkish stocks.

Cyprus: Ethnic Turks on Friday violently pushed back United Nations peacekeepers who were trying to block the construction of an unauthorized road in the buffer zone separating the recognized Turkish Cypriot territory from the Greek Cypriot territory.  The road would link the Turkish Cypriot territory to what the UN says is an illegal military outpost in the buffer zone.  The incident could signal aggressive new moves by Turkish Cypriots to expand their area of control on the island, which would likely generate increased tensions with Greece.

Guatemala: In a run-off presidential election yesterday, center-left sociologist and corruption fighter Bernardo Arévalo won 58% of the vote, handily beating former first lady Sandra Torres, the conservative establishment candidate.  Arévalo campaigned on promises to rejuvenate the country’s democracy, stamp out corruption, reduce crime, and improve the public health and education systems.  If he can overcome Guatemala’s vested interests and make progress on those issues, there is a chance he could eventually reduce the high numbers of Guatemalans trying to emigrate to the U.S.

Ecuador: In the other major Latin American presidential election yesterday, leftist former lawmaker Luisa González won 33% of the vote, and center-right businessman Daniel Noboa won 24%.  They will now face each other in a run-off election on October 15, with the winner likely to be determined by the candidate voters think can re-establish social order and end the country’s current out-of-control violence and crime.  For U.S. investors, the key issues are probably how the eventual winner will manage Ecuador’s extensive mineral resources and whether he or she can reduce crime enough to stem the flow of migrants to the U.S.

U.S. Commercial Real Estate Industry: Despite the challenges in commercial real estate sectors such as office buildings and regional malls, new data suggests demand remains high for free-standing retail buildings and open-air malls.  The good supply and demand dynamics in those areas partly reflect the dearth of building after the Great Financial Crisis, which allowed the market to absorb excess properties.

U.S. Weather: After being downgraded from hurricane status, Tropical Storm Hilary roared into Southern California yesterday afternoon and evening, but the resulting rains, winds, flooding, and power outages were less severe than feared.  Even a series of small earthquakes that happened at the same time weren’t enough to cause major damage.  Nevertheless, public facilities such as schools and the Death Valley and Joshua Tree national parks have been closed as a precautionary measure.

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