Daily Comment (March 6, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with some observations on the important high-level government meetings that began in China over the weekend and included an announcement that China will target a relatively modest economic growth rate of just 5% in 2023.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a new statement by European Central Bank President Lagarde which pointed to further aggressive interest-rate hikes in the Eurozone and signs that the U.S. junk bond market is weakening again ahead of a likely recession.

China:  Over the weekend, the country opened its annual “two sessions,” consisting of key meetings of the National People’s Congress and the People’s Political Consultative Conference.  Among the key decisions already reported, outgoing Premier Li Keqiang announced a relatively conservative economic growth target of “around 5%” in 2023, compared with about 5.5% in  2022, while the proposed national budget would hike Chinese military spending by 7.2%.

  • Later in the meetings and potentially this week, President Xi is expected to secure a precedent-breaking third term in office to go along with his October success in gaining a third consecutive term as head of the Communist Party.
  • The meetings are also likely to approve a new set of top government officials and agency restructurings that would further consolidate power into Xi’s hands, including the establishment of a new data regulator.

China-Hong Kong:  The Shanghai, Shenzhen, and Hong Kong stock markets have jointly announced the stocks that will participate in China’s expanded “Stock Connect” program, which allows mainland investors to buy certain equities in Hong Kong, and vice versa.  About 80 additional foreign stocks trading in Hong Kong will now be available to mainland investors, including the stocks of British bank Standard Chartered (SCBFY, $19.03) and Australian coal miner Yancoal Australia (YACAF, $4.15).  Foreign investors will gain access to hundreds of additional yuan-denominated stocks trading in Shanghai and Shenzhen.  Nevertheless, as the U.S.-China geopolitical competition intensifies and the countries squeeze the capital flows between them, the expanded program may have little practical effect for U.S. firms or investors.

United States-China:  U.S.-China relations continued to fray over the last week, as the Biden administration placed 28 additional Chinese firms on its “Entity List” of companies that are off limits for U.S. exporters.  Under law, the Commerce Department has the authority to put foreign companies on the list and cut them off from U.S. exports if they are working against U.S. interests.  Many of the hundreds of Chinese companies now on the list are there because they provide advanced technologies and computing services to China’s surveillance, intelligence, and military systems.  As we have reported many times in the past, the U.S. has also taken aggressive steps to restrict the flow of advanced technology and investment capital to China as a way to suppress its ability to establish itself as the new global hegemon.

  • At the same time, China continues to impose its own restrictions on trade and capital flows. In an interview with Fox Business last week, billionaire investor Mark Mobius said Chinese authorities are preventing him from withdrawing and repatriating personal funds that he has at a bank in Shanghai.
  • Even though Mobius was the longtime chief of emerging market investments at Franklin Templeton and a recognized China bull, he stated in the interview that investors should be “very, very careful” now about investing in China due to the government’s tight control over the economy. Instead, Mobius said he is increasing his exposure to other emerging markets such as India and Brazil.

Japan-South Korea:  The governments of Japan and South Korea appear to be nearing a deal to resolve a conflict over Japan’s use of forced labor from South Korea in World War II.  Under the developing agreement, the South Korean government would ensure compensation payments to Koreans who were forced to work for Japan through a government-backed foundation, instead of asking Japanese companies to do so.  In return, Japan would lift restrictions on certain technology exports to South Korea and agree on the resumption of reciprocal visits by the countries’ leaders.

  • The potential rapprochement between the two countries is driven in part by a shared concern about China’s growing geopolitical aggressiveness. Our analysis suggests that both Japan and South Korea will be key members of the evolving U.S.-led geopolitical and economic bloc.
  • If an agreement is reached, it could significantly improve relations between Japan and South Korea, potentially boosting trade and investment between the two countries.

Iran:  International Atomic Energy Agency Chief Grossi visited Iran on Saturday to address concerns over evidence that Tehran has been processing uranium to near-weapons grade purity levels.  However, all he appears to have gained was Iranian promises to voluntarily allow the IAEA to reinstall some cameras and other monitoring devices that Iran shut down last year.  With Iran still appearing intent on advancing its nuclear program, the stage is increasingly being set for a potential Israeli attack on Iran that would attempt to stop Tehran from achieving a workable nuclear weapon.

Pakistan:  In an apparent effort to muzzle Former Prime Minister Khan and end his calls for early elections, the government of Prime Minister Sharif sent police to arrest Khan yesterday on what appear to be trumped-up charges of corruption, but Khan refused to meet with them.  The standoff suggests that Pakistan will continue to face political paralysis even as it tries to secure an important IMF loan to stave off default on its foreign debts.

Eurozone:  In an interview with Spanish newspaper El Correo, European Central Bank President Lagarde warned that the upward pressure on consumer prices in the Eurozone will remain sticky for the foreseeable future and could require further interest-rate hikes to bring them under control.  To limit the damage to the region’s economy, she also urged banks to reschedule debt repayments for households struggling to cope with soaring borrowing costs on variable-rate mortgages.

Estonia:  Prime Minister Kaja Kallas and her liberal Reform Party won the biggest share of votes in yesterday’s parliamentary election, putting her in position to remain in power with a new, refreshed governing coalition.  The result ensures that the Estonian government will remain strongly pro-Western and anti-Russian, and that it will retain its current center-left stance.

Russian Invasion of Ukraine:  Russian forces continue to make incremental gains in their effort to surround the northeastern Ukrainian town of Bakhmut, even as they keep launching artillery, missile, and air attacks on infrastructure elsewhere around Ukraine.  Despite a range of analysts judging that the Russians would not be able to capture Bakhmut in the near term, Ukrainian forces still appear to be considering a tactical withdrawal from the town in order to conserve troops and equipment for a potential offensive elsewhere later in the spring.

U.S. Junk Bond Market:  Various indicators suggest that the rebound in junk bond prices during January and February is already reversing course as overall bond yields began rising again.  Any renewed weakness in junk bond prices, with the associated rise in yields, would likely put added pressure on financially weaker companies as the economy hurtles toward a likely recession.

U.S. Labor Market:  New research posted by the National Bureau of Economic Research confirms that wage growth among lower-paid and less-educated workers has outstripped wage growth among the better-paid and more highly educated since the onset of the COVID-19 pandemic.  The research suggests lower-paid, less-educated workers have benefited not only from stronger demand for their services, but also from the way the pandemic forced people out of their old jobs and made the labor market more dynamic.

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