Daily Comment (September 18, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with signs that the Chinese government is working to prevent further financial market contagion related to its faltering real estate sector.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a desire by the U.K.’s opposition leader to improve relations with the EU and new warnings about debt-financed short positions in the market for short-term U.S. Treasury futures.

Chinese Real Estate Market:  Shadow-banking giant Zhongrong International Trust, which sparked concerns about a financial crisis when it missed payments on some of its trust products over the summer, said it has engaged two state-owned financial companies to help fix its operational problems.  The company insists that the arrangement isn’t a government bailout and that the two state-owned firms won’t have responsibility to make up the missed payments to investors.

Chinese Gold Market:  The central bank has lifted its temporary ban on gold imports into the country, which was imposed in August to reduce selling pressure on the renminbi (CNY).  We have recently been noting stronger central-bank purchases of gold around the world, and we believe those purchases have been instrumental in buoying the price of the yellow metal.  Stronger personal demand for gold in China could add to the upward pressure on gold prices.

India-China:  An India-based official of iPhone assembler Foxconn (HNHPF, $6.54) said the company aims to double its workforce, investment, and activity in India in the coming year, as part of its effort to diversify production out of China.  That would help keep the company on track to produce half of its iPhones in India by 2027.  The plan is a further reflection of how companies are increasingly trying to hedge their bets by moving production out of China amid worsening tensions between China and the West.  We believe India will be a prime beneficiary of that trend.

United Kingdom-European Union:  In a Financial Times interview, Keir Starmer, the leader of the U.K.’s opposition Labor Party, said he would seek a major re-write of the Brexit agreement between the UK and the EU if his party wins the next election.  According to Starmer, his goal in such a re-write would be to improve the U.K.’s economic relations with the EU as a way to boost economic growth.  For example, he would seek to improve the deal’s veterinary standards to ease U.K.-EU trade in animals and farm products.

U.S. Fiscal Policy:  Consistent with our latest Bi-Weekly Asset Allocation Report, more analysts are starting to focus on the end of the pandemic-era moratorium on student loan payments on October 1.  Over the weekend, an article in the Wall Street Journal estimated that re-starting student loan payments will cut overall consumer demand by about $100 billion in the coming year, as millions of consumers with student loans have to start paying $200 to $300 on their education debt again.  The drop in consumer demand has the potential to finally bring about the long-expected recession, with the associated negative implications for corporate earnings and stock values.

U.S. Monetary Policy:  The Federal Reserve will begin its latest policy meeting tomorrow, with its decision on interest rates due on Wednesday at 2:00 PM EDT.  The policymakers are widely expected to hold the benchmark fed funds rate steady at its current range of 5.25% to 5.50%.  The more important question is whether they will provide any guidance on future policy changes.  While many investors continue to look for outright rate cuts in the coming months, we continue to believe they will be disappointed.  We believe Chair Powell should be taken at his word when he says he will try to keep policy tight for an extended period to make sure consumer price inflation is really snuffed out.

U.S. Bond Market:  Against the backdrop of the Fed’s hawkish monetary policy, we’re seeing more official warnings about “basis trades” by hedge funds.  In its quarterly report today, the Bank for International Settlements said the associated buildup in debt-financed short positions on two-year U.S. Treasury futures could spark chaotic trading.  According to the BIS, “Margin deleveraging, if disorderly, has the potential to dislocate core fixed-income markets.”  We will continue to monitor the situation closely.

U.S. Labor Market:  Last week, the U.S. Army said it met its annual re-enlistment goal early, allowing it to suspend retention bonuses paid to re-enlisting troops at least until the end of the federal fiscal year on September 30.  The U.S. Navy said it will miss its recruiting goal by about 7,000 sailors, but that is actually better than the 13,000 shortfall it expected at the beginning of the fiscal year.

  • Over the last couple of years, strong labor demand in the civilian economy has made it difficult for all the services to recruit new personnel or keep current troops from leaving.
  • The better-than-expected re-enlistment and recruiting figures could reflect weakening in the civilian labor market, potentially leading to slower wage growth, reduced price pressures, and an end to the Federal Reserve’s long campaign of interest-rate hikes.

U.S. Auto Industry:  After launching their strike against the Big Three automakers last Friday, the United Auto Workers said it resumed negotiations for a new labor contract with each of the companies over the weekend.  The union suggested in a statement that it is making its best progress with Ford (F, $12.61).  However, in a test of the union’s novel tactic of simultaneously striking just one assembly plant at each of automakers, the firms began to warn that the strikes will force them to stop production and furlough workers at related plants.  We suspect the UAW would see that as an effort to “divide and conquer,” prompting the union to expand the strike.

U.S. Real Estate Industry:  Demand for office space in downtown San Francisco has reportedly started to recover from its deep plummet during the coronavirus pandemic.  The stronger leasing activity and renewed office-building sales stem partly from increased demand by firms in the fast-growing artificial intelligence space.  Nevertheless, some of the increased building sales also reflect the fact that some owners have capitulated on price, selling their properties at steep losses.

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