ANALYSIS: Pelosi’s risky visit to Taiwan

Analysis details (09:55)

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  LONG-STORY-SHORT: Tensions have escalated between the world’s two largest economies over the visit of US House Speaker Pelosi to Taiwan. The move has struck a nerve in Beijing with recent rhetoric from China of a military nature. The visit will likely not lead to any joint economic policies between Taipei and Washington during the brief visit, however, it will cause China to question the US’ acknowledgement of Beijing’s “One China principle” which does not see Taiwan as a sovereign nation, with Pelosi being the highest-ranking US official to visit the island since 1997. Desks have also flagged the timing of the visit - August marks the 95th anniversary of the founding of the People's Liberation Army (PLA), and thus a visit to Taiwan from the US comes at a sensitive time for Beijing. From the US side, some officials, including National Security Advisor Sullivan, have warned against the trip as it escalates the risk of a conflict. However, heading into the US midterms in November, “many Republicans, and a few Democrats, have urged Pelosi to proceed, arguing that any decision to postpone or cancel would be capitulating to China”, according to the FT.


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  BRIEF HISTORY: The rhetoric over Taiwan was somewhat stable until the leak of Speaker Pelosi’s potential visit to Taiwan. China for years has spoken against the growing alliance between the US and Taipei, an area China claims territory over. China has urged the US to cut official ties with Taiwan and to stop upgrading substantive relations, interfering in China's internal affairs, and to stop undermining peace and stability across the Taiwan Strait, as well as US/China relations. A full history via BBC can be found here.


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  SCHEDULE: Taiwanese and US media said the House Speaker plans to visit Taipei on Tuesday night, with the arrival at Songshan airport expected at 21:30 local time (14:30BST/09:30EDT), according to SET News. She is then due to meet Taiwan’s President Tsai on Wednesday.

BEIJING RETALIATION:

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  MILITARY: Global Times' Hu Xijin tweeted on Tuesday "Based on what I know, in response to Pelosi's possible visit to Taiwan, Beijing has formulated a series of countermeasures, including military actions.", whilst several Chinese warplanes reportedly flew close to the median line of the Taiwan Strait (see figure below) on Tuesday morning and several Chinese warships have stayed close to the median line of the Taiwan Strait since Monday, according to a Reuters source briefed on the matter. Further reports also highlighted that the Chinese military will hold exercises in the South China Sea from August 2-6 and a warning was issued - with entry to an area in the sea prohibited due to military exercises from Tuesday to Saturday, according to Global Times. SCMP highlights some potential military options the PLA can take:

1. Sending warplanes to Taiwan Air Defence Identification Zone (ADIZ)


2. Flying across the median line – a buffer zone the US established in 1954 which China denies (see figure below) - and/or flying over Taiwan.


3. Deploying warships in waters near Taiwan.


4. Conducting missile tests in waters near Taiwan.

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  ECONOMIC: SGH Macro Advisors, citing their sources, suggest that “Beijing has floated economic retaliation against the United States as well”, which if realised, would be an “unexpected and major wildcard for markets” as participants focus on military responses. The desk suggests export restrictions of “daily necessities” to the US could be targeted in a bid to directly influence supply and thus exacerbate inflation at a time of elevated prices and slowing growth.

MARKET IMPACT

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  STOCKS: Chinese and Taiwanese stocks took a hit during Tuesday’s session, with downbeat sentiment observed across European cash and US futures. Economic retaliation from Beijing will likely keep stocks under pressure. It’s also worth being aware of the Chinese giants listed in the US – such as Alibaba, and Tencent, whilst Taiwanese contract chip manufacturer TSMC is also watched amid the Co’s over-50% market share in the chip production sector – any hindrances in operations could be bearish for chip supply.


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  FX: Desks note of potential haven flows into the Buck amid Pelosi’s risky trip, with ING warning of potential shockwaves across FX markets: “The dollar, the yen (which may break below 130.00 already today) and CHF should be the main beneficiaries, while CNY and China-sensitive currencies (along with high-beta currencies in general) could come under pressure. Here, AUD and NZD appear mostly vulnerable in G10”, ING says.


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  BONDS: Haven bids in the fixed income space have been clear, with the upside continuing in Europe’s Tuesday trade. It’s also worth noting that reports last week suggested that Mainland China has reduced its holding of US debt, with the total dropping under the USD 1tln mark for the first time in 12 years, with analysts in China suggesting US Treasuries themselves are risk assets.

MAP

Military facilities and strategic security locations in Taiwan, and mainland China's amphibious staging areas, via AFP.

02 Aug 2022 - 09:56- Fixed IncomeEconomic Commentary- Source: Newsquawk