This weekend’s intensification of the Hong Kong protests reminds us that the Chinese authorities have more pressing problems than the US-China trade dispute. Originally started in March of 2019 to protest against the Fugitive Offenders amendment bill by Hong Kong authorities—which would allow the extradition of persons detained in Hong Kong to Taiwan or China even though no extradition treaties exist—that many viewed as a back-door dilution of civil liberties by Chinese-controlled Hong Kong leadership.
The protests started as a million strong, peaceful demonstration, but has since become more forceful, partly in response to Hong Kong police escalation. Yesterday’s protester occupation of the Hong Kong Polytechnic University is just the latest scene of chaotic images featuring tear gas and improvised firebombs. This presents a distinct quandary for mainland Chinese authorities, who can’t be seen bowing to protester pressure lest they find a dozen similar protests crop up on the mainland. At the same time, the current escalation has real economic costs to a city considered a bastion of capitalism and model for capitalist/communist economic cooperation. Increasing the use of force would likely alienate investors and represent a victory at too high of a cost. That’s a tough balancing act indeed.
Given their precarious position in Hong Kong, it's no wonder Chinese trade negotiators have avoided concessions with the US. The perception of weakness on trade would likely decrease their negotiating position on a range of other domestic issues. All the while, growth continues to slow at a faster pace than anticipated. Traditionally the People’s Bank of China—which has more direct control of lending activities than other central banks—has introduced countercyclical policy aimed at infrastructure investment in times of decreased economic activity. Recently, however, the PBOC has been more restrained in loan growth, electing to take the near-term hits to economic growth instead. There are no easy answers to any of these issues, but it's reassuring that the authorities seem to be a taking a long-term view rather than the more populist stance common in the west.
Bottom line: The PBoC has cut its overnight lending rate by a modest five basis points and is expected to follow up with a five-ten bps decrease to the loan prime rate (the central bank's main policy rate) later this month. This is likely the beginning of a subtle and incremental easing action in response to falling growth, but careful attention must be paid to the other lending terms it delivers to banks in addition to the lending rate, to ascertain the degree to which policy can ultimately be loosened.
Last week was a good one for the Sterling trade-weighted Index as it posted moderate gains against its counterparts. The Pound reached an interbank high of 1.2920 against the US Dollar on Friday as the pair currently trades at the upper end of its recent trading range; resistance remains at the 1.30 handle. Sterling also briefly breached the 1.17 mark against the Euro, extending its gains back into March/April’s trading range—1.18 will probably provide a source of significant resistance as this level has only been surpassed once in the past year. The focus will remain on the UK’s upcoming general election and its ramifications for Brexit.
Positive sentiment that a partial or phase one US-China trade deal was being finalised meant that the Dollar softened through most of the past week. Markets stepped away from the safe-haven appeal of the Greenback, in favour of more risky assets. The trade-weighted Dollar Index has extended below the 50 and 100-day moving averages and is currently trading just above the 200-day. A break below this level could see a run towards the lows of mid-June/late-July.
The common currency’s trade-weighted index began and ended the week at roughly the same level but briefly moved to its lowest since late September. This weakness took the Euro back below 1.10 against the Greenback for the first time in about a month. To shine some positivity on the outlook, the combination of Dollar weakness and a Euro rebound towards the end of the week took the pair back above the 50-day moving average, meaning a further move higher isn’t out of the question.