Hong Kong Crisis; Trump threatens pipeline sanctions; Cooler Inflation Drives Fed Rate Cut Bets

Hong Kong is in danger of blowing up and could drag mainland China along with it.  Beijing appears set on ending the one country, two systems principle as it pushes forward in supporting an extradition bill that would allow Hong Kong residents to be sent to the mainland.  The extradition bill is something that threatens Hong Kong’s autonomy and will discourage many business and investors staying in Hong Kong.

Thousands of protesters marched on major highways attempting to storm the Legislative Council in protest of the extradition bill and that could continue for days. The situation remains tense as tear gas was used during yesterday’s protests.  The protest leader Jimmy Sham noted demonstrators will remain in the streets until the government withdraws the proposed bill.

Chief Executive Carrie Lam noted that the withdrawal of the proposed extradition bill would weaken Hong Kong’s rule of law.  It appears we could see an extended standoff here.  China is in tough position as they are short dollars and running down their reserves.  They use Hong Kong as a hub to raise dollars for their working capital to do trade with the rest of the world.  Most of their transactions are done with the dollar, but if Hong Kong loses favor with the international community, Chinese growth would be dealt another blow.

The Hong Kong crisis could continue to escalate in the coming days and should weigh on risk appetite.  Trade deal updates could fall to the second page of papers, but eventually we could see Chinese politics blend together.

US stocks finished the day modestly lower across the board as trade tensions wiped away earlier gains that stemmed from the morning release of cooler US inflation data that cemented many analysts view that rate cuts are coming this July.

• Chinese Politics – Hong Kong Protests to weigh on trade deals
• Fed – Rate cut bets supported on soft inflation readings
• EUR – Trump considering blocking Nord Stream 2
• GBP – Parliament Rejects Bill to block no-deal Brexit
• Hong Kong Dollar – Surges on funding squeeze
• Oil – Crude Production Continues to Outpace Demand
• Gold – Higher on Hong Kong protest, Trade uncertainty and Fed rate cut bets

Chinese Politics

Markets are still processing how the Hong Kong protests could unravel Chinese politics and possible trade deals.  Will the US link these developments to the trade deal? Beijing’s push for this extradition bill could prove costly as investors and businesses value Hong Kong’s autonomy.  Uncertainty with Hong Kong’s autonomy will dampen business prospects and put a further strain on Chinese growth.  If the US and Europe become involved it could complicate relations and future trade deals.

Hong Kong is China’s primary spot for raising US dollars is critical for China’s business with the rest of the world.  The US could escalate this political problem into a major trade issue that could see the ending of Hong Kong’s favored trading status.

Hong Kong is the most over levered economy in the developed world.  The banking system is close to 900% of GDP.  If we see this proposed extradition bill become law over the next couple months, we could see Hong Kong’s economy crumble.

US Inflation

Softer than expected US inflation in May supported Fed rate cut bets to occur at the July 31st meeting.  Slowing economic readings will continue to solidify the end of the Fed’s tightening cycle and expectations should grow for two rate cuts to get priced in by the summer.

Odds for a rate cut at the July 31st meeting rose to 7 percentage points to 82.3%, while the next week’s meeting remained around 20%.  The core consumer price index which removes energy and food costs climbed 2% from a year earlier missing forecasts of 2.1%, while the monthly reading delivered its fourth straight monthly.  Muted inflation will make the Fed’s job easier and with the risks of increased hitting the global economy, the question is no longer will they cut, but by how much.  The yield on 10-year Treasuries slumped 2.3basis points to 2.120%, while the dollar initially fell to the weakest levels in almost two months but settled slightly higher on the day.

EUR

The euro sank after President Trump stated he is considering sanctions to block the Nord Stream 2 gas pipeline between Russia and Germany.  The US has been skeptical of thwarting off Germany’s dependence on Russia for energy and this is one of the rare topics that Trump does have bipartisan support.

The Nord Stream 2 is under construction and could split the eastern European nations away from the central and western parts.  The US is concerned this will solidify Russia’s control over the region’s energy supply, possibly threatening fuel to the Ukraine, which is now a key transit hub.

Sanctions on companies contracted to work on the pipeline could derail the pipeline which is expected to begin at the end of the year.  The effects to the Russian economy would be very negative on lost energy revenue and loss of doing business with the west.

Today’s headlines reminded market participants Trump remains the tariff man and that the eventual trade talks between the US and Europe will likely see a barrage of tariff threats to enhance the US negotiating stance.

GBP

While expectations remain low for any new conservative leader to deliver Brexit by October 31st, the risk of a no-deal Brexit remain firmly in place.  MPs voted 309 to 298, rejecting Labour’s attempt of stopping a no-deal Brexit.

Boris Johnson kicked off his partly leadership campaign and assuaged cable traders after stating, “I am not aiming for a no-deal Brexit outcome.”  The candidate that was supposed to be the one leading the charge for a hard Brexit appears to be trying to win over votes with a slightly softer stance.

HKD

The protests over the extradition bill is delivering a squeeze in local lending rates, which makes it more expensive to borrow the Hong Kong dollar in the front end, which has strengthened HKD today. The Hong Kong currency is at its strongest levels since December.  Expectations are for HKD to return to the weaker part of the band after the funding squeeze ends.

Oil

The EIA crude inventory report delivered another surprising build of 2.21 million barrels last week.  Expectations were for a draw of 1 million barrels, with a wide range of estimates of a 3.7 million draw to a 3.0 million build.  Oil was already sharply lower going into the data and eventually extended losses.  Cushing accounted for 2.096 million barrels of the total build, confirming the API’s rise which saw the strongest gains since February.  The rise in Cushing is mainly being attributed to the Midwest flooding that disrupted many pipelines and refineries.

West Texas Intermediate crude fell to a four-month low following Trump’s gloom comments on trade.  Oil prices will be unable to shrug off global growth concerns along with rising US inventories.

Gold

Gold prices rose as uncertainty persists with how Chinese political uncertainty and trade deals will unravel in the coming month.  The yellow metal also got a boost from cooler inflation data that also increased Fed rate cut bets, which could coincide with a pullback with the US dollar.  The softer than expected inflation data should be supportive gold in the short-term as a July Fed rate cut appears to be firmly priced in.

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