China weaves Australia a yarn

China-Australia trade war heats up

The Australian press today is reporting that China is warning cotton mills not to buy Australian cotton, or risk having their import quotas slashed. The press further suggests that China is set to slap tariffs on Australian cotton. If correct, it will be another escalation in China’s reprisals against Australia as China continues to signal its displeasure with Australia’s diplomatic posture towards it.

If correct, that will be Australian wine, beef, barley, coal and cotton exports by my count, that China is restricting into its markets. Except for wine and barley, most of the intervention appears to be verbal at the moment, thereby saving China a date with the World Trade Organisation. The products themselves are, notably, easily replaceable from international markets and not the sacred cow that is Australian iron ore. The lesson appears to be, that if you are not the United States, and you disagree with China publicly, China will use its power as the buyer of everything of last resort to punish you economically.

Although cotton exports to China only total AUD 800 million, not a massive number in the macroeconomic scheme of things, they are 65% of the not so luck countries cotton exports. It’s the thought that counts, and other countries around the world with China as a critical market (i.e. everyone), may need to look at the definitions of pragmatism and ideology closely. That won’t be an issue for Asia, with Japan telling the US today that they won’t be excluding Chinese firms from telecommunications networks. Other parts of the world, unless you are the United States, may need to think carefully on what they consider a good global citizen to be, and what China’s definition of it is. Would you like some more Belt and Road money, sir?

The Australian dollar is likely to remain under pressure today on this disquieting news, with pro-cyclical currencies on the back for anyway after risk hedging led to a surge by the US dollar overnight. Unless China or Australia’s governments start messing with iron-ore though, the ever-optimistic Australian equity markets should take this development in their stride.

Elsewhere, financial markets had a decidedly negative tone, driven by the explosion of the second wave of Covid-19 across Europe and the United States, with national restrictions coming into force across Europe. I would argue the second wave is a misnomer for the US; it never got out of the first one. US Initial Jobless Claims also rose overnight, adding to the frayed nerves. Although the continuing claims fell, the rise in initial claims comes against a backdrop of fiscal stimulus impasse in Washington DC. Notably, the Senate Republicans have split with President Trump, refusing to countenance a giant stimulus package, despite the President asking for even more than the Democrats USD2.2 trillion. Looking at the president’s polling numbers, I can’t help feeling that this could be the start of the Senate Republicans cutting him loose to save their own jobs at the upcoming election. Watch this space.

One week’s poor claims data does not make a trend. However, with financial market’s already nervous over Covid-19’s potential effect on the economic recovery in Europe and the US, a US election two weeks away, Brexit nerves, and no sign of US fiscal stimulus, the timing is terrible. Markets will struggle to give the benefit of the doubt this week, but if initial jobless claims spike next week, we could see an ugly stampede for the exit door ahead of the US elections. That won’t be good for the FOMO buy-everything equity crowd, and the prime beneficiary will be the US dollar and the Japanese yen. The US dollar rose overnight, and I am now expecting it to continue to do so until the US election, barring a miraculous US fiscal stimulus agreement that the Senate will pass.

Another item giving me cold sweats is a Bloomberg report today that Hong Kong brokers are offering 20-1 leverage to retail investors for the upcoming Ant Financial IPO. Leverage, Mum and Dad investors, and a sure thing, in one sentence never ends well. While I do not doubt the success of Ant Financial, the price action on the days after its IPO could be emotional. The only mitigating factor being that the IPO will be so oversubscribed, Mum and Dad’s probably won’t get much. But if they are leveraged 20x, and the stock price turns down, watch for the rush for the door. Leverage is a powerful tool, but one should note that 20x the profits on a “sure thing”, also equals 20x the losses if it turns out it isn’t, especially if thousands of you have identical “sure thing” positions. The Ant Financial IPO could represent “peak-FOMO” in the strange year that is 2020.

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