Chinese Yuan

Investor sentiment on China and EM has become bullish. Meanwhile, the reflation plays have begun fraying on the edges. Cracks always appear first in the most sensitive reflation plays and then spread to the core. The narratives of the Fed's imminent pivot and China's recovery will be questioned in the coming months. Thus, China/EM assets and related plays will sell off, and the US dollar will rebound.

In Section I, we explain why we do not see the deceleration in US inflation, the likely near-term pickup in European growth, and the end of China’s dynamic zero-COVID policy as signs of a sustainable rebound in global economic activity over the coming 6-12 months. The key question is not whether inflation will fall back to central bank targets, but rather how quickly this will occur. For now, our indicators point to slower but still elevated inflation this year. In Section II, we explore what it will take for the Fed to cut interest rates, and note that nonrecessionary rate cuts are possible but not especially likely.

Informe especial

Global investors should sell Chinese assets on strength this year and diversify into other emerging markets. American investors should limit China exposure. Short CNY-USD.

In this week’s report, we look at whether global growth conditions remain conducive for a continued decline in the dollar. Our findings are mixed, while there are some economic green shoots, the overall growth picture remains weak. This argues for some consolidation of dollar losses in the near term.

Informe especial

In this report, we argue that the dollar will enter a volatile trading range, before a bear market begins in earnest. That said, fundamental forces are aligning for US dollar downside.

Investors should go long US treasuries and stay overweight defensive versus cyclical sectors, large caps versus small caps, and aerospace/defense stocks. Regionally we favor the US, India, Southeast Asia, and Latin America, while disfavoring China, Taiwan, Hong Kong, eastern Europe, and the Middle East.

Informe especial

Resumen Ejecutivo Con la materialización de la cuarta crisis del Estrecho de Taiwán, las probabilidades de una gran guerra entre las potencias mundiales han aumentado. Nuestros árboles de decisión sugieren que las probabilidades son alrededor del 20%, o el doble de lo que estaban sólo por la guerra rusa en Ucrania. El mundo está jugando a la “ruleta rusa” … con un revólver de cinco cartuchos. De cara al futuro, nuestro caso base es que las tensiones sobre Taiwán se aplanarán (pero no disminuirán) después de que concluyan los eventos políticos domésticos en EE. UU. y China este otoño. Sin embargo, si China intensifica las tensiones después del vigésimo congreso nacional del partido, entonces las probabilidades de una invasión aumentarán significativamente. Si estalla un conflicto en Taiwán, entonces las probabilidades de que Rusia se vuelva aún más agresiva en Europa aumentarán. Es muy probable que Irán persiga armas nucleares.   Pocos Catalizadores Positivos en la 2.ª Mitad de 2022 Ruleta con un revólver de cinco tiros Ruleta con un revólver de cinco tiros Recomendación TácticaFecha de InicioRetorno IR LARGO EN TESOROS A 10 AÑOS DE EE. UU.2022-04-141.3% IR LARGO EN VALORES DEFENSIVOS / CICLÍCOS GLOBALES2022-01-2013.8% Conclusión: Los inversores deberían mantenerse posicionados de forma defensiva al menos hasta que el congreso del partido chino y las elecciones intermedias de EE. UU. concluyan este otoño. El riesgo geopolítico del próximo año dependerá de las acciones de China en el Estrecho de Taiwán. Artículo   Gráfico 1 Crece la Especulación Sobre la Tercera Guerra Mundial Ruleta con un revólver de cinco tiros Ruleta con un revólver de cinco tiros Los pesimistas que prestan atención a los acontecimientos mundiales se han preocupado en los últimos años por el riesgo de que pueda estallar la tercera guerra mundial. El término ha aumentado en las búsquedas en línea desde 2019, aunque es la tendencia subyacente de multipolaridad global, más que los eventos críticos específicos, lo que justifica la preocupación (Gráfico 1).1 ¿Cuáles son las probabilidades de una gran guerra entre EE. UU. y China, o EE. UU. y Rusia? ¿Cómo podría calcularse eso? En este informe presentamos una serie de “árboles de decisión” para formalizar los diferentes escenarios y probabilidades. Si definimos la Tercera Guerra Mundial (WWIII) como una guerra en la que Estados Unidos se involucra en combate directo con Rusia o China, o con ambos, entonces llegamos a una probabilidad del 20% de que estalle la Tercera Guerra Mundial en los próximos un par de años. Esas son probabilidades inquietantemente altas, pero la historia enseña que estas probabilidades no son irreales y que los inversores no deben ser complacientes. El politólogo Graham Allison ha mostrado que las probabilidades de una guerra entre EE. UU. y China a largo plazo son de aproximadamente el 75% basándose en analogías históricas. La conclusión es que las naciones tendrán que afrontar este riesgo de Tercera Guerra Mundial y rechazarlo para que el entorno político global mejore. Lo más probable es que lo hagan, ya que la Tercera Guerra Mundial, y el riesgo de guerra nuclear que conllevaría, constituyen la restricción última. Pero el comportamiento actual de las grandes potencias sugiere que aún no han reconocido sus restricciones y están dispuestas a continuar con maniobras de riesgo a corto plazo. Las Probabilidades de Una Invasión China de Taiwán La primera pregunta es si China invadirá Taiwán. En abril de 2021 predijimos que la cuarta crisis del Estrecho de Taiwán ocurriría dentro de 12-24 meses pero que no derivaría en una guerra a gran escala. Esta opinión ahora está siendo puesta a prueba. En Diagrama 1 ofrecemos un árbol de decisión para trazar las opciones políticas de China hacia Taiwán y asignar probabilidades a cada opción. Diagrama 1 Árbol de Decisión para la Cuarta Crisis del Estrecho de Taiwán (Próximos 24 Meses) Ruleta con un revólver de cinco tiros Ruleta con un revólver de cinco tiros   Aunque China ha alcanzado la capacidad para invadir Taiwán, las probabilidades de fracaso siguen siendo demasiado altas, especialmente sin mayor progreso en su tríada nuclear. Por lo tanto, damos sólo un 20% de probabilidad a que China se movilice para una invasión de inmediato. No hace falta decir que cualquier signo concreto de que China está planeando una invasión debe tomarse en serio. Los inversores y los medios subestimaron la acumulación militar de Rusia en torno a Ucrania en 2021 en su detrimento. Al mismo tiempo, existe una buena probabilidad de que EE. UU. y China simplemente estén probando el statu quo en el Estrecho de Taiwán, que se reforzará tras el episodio actual. Después de todo, esta crisis fue la cuarta crisis del Estrecho de Taiwán: ninguna de las crisis anteriores condujo a la guerra. Si los presidentes Biden y Xi Jinping simplemente están mostrando músculo antes de importantes eventos políticos domésticos este otoño, entonces ya han logrado su objetivo. No son necesarias más demostraciones de fuerza por ninguna de las partes, al menos durante los próximos años. Damos un 40% de probabilidad a este escenario, en el cual las tensiones de la semana pasada persistirán pero se reforzará el statu quo. En ese caso, el problema estructural del Estrecho de Taiwán volvería a estallar en algún momento después de las elecciones presidenciales de EE. UU. y Taiwán en 2024, es decir, fuera del marco temporal del diagrama. Desafortunadamente somos pesimistas a largo plazo y daríamos alta probabilidad a la guerra en Taiwán. Por esa razón, otorgamos probabilidades iguales (40%) a una situación que se deteriore dentro de los próximos dos años. Si China amplía los simulacros y las sanciones después del congreso del partido, una vez que Xi haya consolidado el poder, entonces quedará claro que Xi no está simplemente actuando para su audiencia interna. De manera similar, si la administración Biden continúa presionando por controles de exportación de alta tecnología más estrictos contra China después de las elecciones intermedias, e insiste en que los aliados y socios de EE. UU. hagan lo mismo, entonces EE. UU. implícitamente cree que China se está preparando para algún tipo de operación ofensiva. El peligro de invasión aumentaría del 20% al 40%. Incluso en ese caso, aún se debería creer que la diplomacia de crisis entre EE. UU. y China evitará una guerra a gran escala en 2023-24. Pero el riesgo de cálculo erróneo sería muy alto. El último elemento de este árbol de decisión sostiene que China preferirá las “tácticas de zona gris” o la guerra híbrida en lugar de una invasión anfibia convencional del tipo visto en la Segunda Guerra Mundial. Las razones son varias. Primero, las invasiones anfibias son las operaciones militares más difíciles. Segundo, las fuerzas chinas son inexpertas mientras que EE. UU. y sus aliados están atrincherados. Tercero, la guerra híbrida sembrará división entre los aliados de EE. UU. sobre la mejor respuesta. Cuarto, Rusia ha demostrado varias veces en los últimos 14 años que la guerra híbrida funciona. Es una forma de maximizar los beneficios estratégicos y minimizar los costos. El mundo sabe cómo reacciona Occidente ante invasiones pequeñas: aplica sanciones económicas. Aún no sabe cómo reaccionaría Occidente ante invasiones grandes. Por eso China estará incentivada a dar mordiscos pequeños. Y, sin embargo, en el caso de Taiwán esas tácticas pueden no ser sostenibles. Nuestro árbol de decisión sobre Taiwán no contempla la probabilidad de que una guerra híbrida o una “guerra por poder” evolucione hacia una guerra mayor. Pero esa probabilidad es, de hecho, alta. Así que no estamos sobreestimando el riesgo de una gran guerra entre EE. UU. y China. Conclusión: En los próximos dos años, las probabilidades subjetivas de una guerra por poder entre EE. UU. y China por Taiwán son de aproximadamente el 32%, mientras que las probabilidades de una guerra directa EE. UU.-China son de alrededor del 4%. La verdadera prueba llega después de que Xi Jinping consolide el poder en el congreso del partido de este otoño. Esperamos que Xi se concentre en reiniciar la economía por lo que seguimos favoreciendo los mercados emergentes asiáticos excluyendo China y Taiwán. Las Probabilidades de Guerra de Rusia con la OTAN La segunda pregunta es si la guerra de Rusia en Ucrania derivará en una guerra más amplia con Occidente. Las probabilidades de una gran guerra Rusia-Occidente son mayores en este caso que en el de China, ya que una guerra ya está en curso, mientras que las tensiones en el Estrecho de Taiwán hasta ahora son meros desfiles de fuerza. El caso base de un inversor debería mantener que la guerra en Ucrania permanecerá contenida en Ucrania, ya que los europeos no quieren pelear una guerra devastadora con Rusia sólo por el Donbás. Pero a menudo las cosas salen mal en tiempos de guerra. La pregunta crítica es si Rusia atacará a algún miembro de la OTAN. Eso desencadenaría el Artículo Cinco del tratado de la alianza, que establece que “un ataque armado contra uno o más [miembros de la alianza] en Europa o América del Norte se considerará un ataque contra todos ellos,” justificando el uso de la fuerza armada si es necesario para restaurar la seguridad. Desde la invasión rusa de Ucrania este año, el presidente Biden ha declarado repetidamente que EE. UU. “defenderá cada pulgada del territorio de la OTAN,” incluidos los estados bálticos de Letonia, Lituania y Estonia, que se unieron a la OTAN en 2004. Esto no es un cambio de política pero sí es la línea roja de EE. UU. y es muy probable que sea defendida. Por lo tanto, es una restricción importante para Rusia. En Diagrama 2 trazamos las diferentes opciones de Rusia y asignamos probabilidades. Diagrama 2 Árbol de Decisión para la Guerra Rusia-Ucrania (Próximos 24 Meses) Ruleta con un revólver de cinco disparos Ruleta con un revólver de cinco disparos   Damos un 55% de probabilidad de que Rusia declare la victoria tras completar la conquista de la región del Donbás en Ucrania y el corredor terrestre hacia Crimea. Comenzará a buscar legitimar sus conquistas mediante algún acuerdo diplomático, es decir, un alto el fuego. Este es nuestro caso base para 2023. Hay evidencia de que Rusia ya está empezando a moverse hacia la diplomacia.2 La razón es que la economía rusa está sufriendo, los precios globales de las materias primas están cayendo, se está gastando sangre y tesoro ruso. El presidente Putin habrá logrado en gran medida su objetivo de incapacitar a Ucrania mientras controle la boca del río Dniéper y el resto del territorio que ha invadido. Putin necesita sellar sus conquistas e intentar rescatar la economía y la sociedad. Cuanto antes mejor para Rusia, de modo que se pueda prevenir que Europa forme un consenso e implemente un embargo total de gas natural en los próximos años. Sin embargo, existe el riesgo de que la ambición de Putin lo supere. Por eso damos un 35% de probabilidad a que la invasión se expanda al suroeste de Ucrania, incluyendo la estratégica ciudad portuaria de Odesa, y al este de Moldavia, donde tropas rusas están estacionadas en la región separatista de Transnistria. Esta nueva campaña dejaría a Ucrania totalmente sin salida al mar, neutralizaría a Moldavia y daría a Rusia mayor acceso marítimo. Pero unificaría a la UE, precipitaría un embargo de gas natural y debilitaría a Rusia hasta un punto en que podría volverse desesperada. Podría contraatacar y esa represalia podría concebirse que conduzca a una guerra más amplia. Asignamos sólo un 7% de probabilidad a que Putin ataque a Finlandia o Suecia por intentar unirse a la OTAN. Stalin fracasó en Finlandia y el ejército de Putin ni siquiera pudo conquistar Kiev. El Reino Unido se ha comprometido a apoyar a estos estados, por lo que un ataque contra ellos muy probablemente desencadenaría una guerra con la OTAN. Una decisión de atacar a Finlandia solo ocurriría si Rusia creyera que la OTAN planea desplegar bases militares allí, es decir, la línea roja declarada de Rusia. Cualquier ataque ruso contra los estados bálticos es menos probable porque ya están en la OTAN. Pero existe cierto riesgo de que ocurra si Putin se vuelve desesperado. Ponemos el riesgo de una invasión de los bálticos en un 3%. En resumen, si Rusia usa su estrangulamiento energético sobre Europa no para negociar un alto el fuego favorable sino para expandir sus invasiones, entonces las probabilidades de una guerra más amplia aumentarán. Conclusión: El resultado es una probabilidad del 55% de desescalada durante los próximos 24 meses, un 35% de una pequeña escalada (por ejemplo Odesa, Moldavia) y un 10% de una escalada mayor que involucre a miembros de la OTAN y probablemente conduzca a una guerra OTAN-Rusia. Tácticamente, los inversores deberían comprar moneda y activos de mercados desarrollados europeos si la economía global se recupera y Rusia realiza un claro giro hacia detener su campaña militar y perseguir conversaciones de alto el fuego. Cíclicamente, se necesita una comprensión más profunda entre EE. UU. y Rusia para un mercado alcista duradero en activos europeos. Las Probabilidades de Ataques de EE. UU. e Israel contra Irán La tercera crisis geopolítica que tiene lugar este año podría posponerse mientras salimos a impresión, si el presidente Biden y el ayatolá Ali Khamenei acuerdan reincorporarse al acuerdo nuclear EE. UU.-Irán de 2015. Pero seguimos siendo escépticos. La administración Biden quiere reincorporarse al acuerdo nuclear de 2015 y liberar alrededor de un millón de barriles por día de crudo iraní para reducir los precios en la bomba antes de las elecciones intermedias. La gran estrategia de EE. UU. también quiere comprometerse con Irán y estabilizar Oriente Medio para que EE. UU. pueda reorientarse hacia Asia. La UE propone el acuerdo ya que tiene una necesidad aún mayor de los recursos iraníes y quiere prevenir que Irán obtenga armas nucleares. Rusia y China también apoyan porque quieren eliminar las sanciones estadounidenses para comerciar con Irán y no necesariamente desean que Irán tenga armas nucleares. Solo hay un problema: Irán necesita armas nucleares para asegurar la supervivencia de su régimen a largo plazo. La pregunta es si Khamenei está dispuesto a autorizar un acuerdo con los estadounidenses por segunda vez. El primer acuerdo fue traicionado a gran costo para su régimen. El presidente Ebrahim Raisi, que espera reemplazar al supremo Khamenei de 83 años antes o después, seguramente se opone firmemente a apostar su carrera y seguridad personal a que los republicanos ganen las elecciones de 2024. Irán ya ha alcanzado la capacidad de ruptura nuclear – tiene suficiente uranio enriquecido al 60% para construir dispositivos nucleares – y no está claro por qué alcanzaría esta capacidad si no pretendiera finalmente obtener un elemento disuasorio nuclear. Especialmente dado que podría necesitar algún día proteger su régimen de ataques militares por parte de EE. UU. y sus aliados. Sin embargo, nuestro nivel de convicción es medio porque el presidente Biden quiere levantar las sanciones y puede hacerlo unilateralmente. La administración Biden no ha tomado ninguna de las acciones preliminares para que un acuerdo se materialice, pero eso podría cambiar.3 Hay un buen caso cíclico que favorecería un acuerdo temporal y de corta duración. Según Bob Ryan, estratega de materias primas y energía de BCA, Arabia Saudita y los EAU sólo tienen aproximadamente 1.5 millones de barriles de capacidad de producción de petróleo excedente entre ambos. El embargo petrolero de la UE y las sanciones occidentales sobre Rusia forzarán la detención de alrededor de dos millones de barriles por día, absorbiendo la mayor parte de la capacidad de la OPEP. Por tanto, la administración Biden necesita el millón de barriles que Irán puede aportar. No podemos negar que los iraníes podrían firmar un acuerdo para permitir que Biden levante las sanciones. Eso beneficiaría su economía. Podrían permitir inspectores nucleares mientras secretamente desplazan su foco al desarrollo de ojivas y misiles balísticos. Aunque Irán no renunciará a la larga a la búsqueda de un disuasivo nuclear, es experto en ganar tiempo. Aun así, la política doméstica de Irán no respalda un acuerdo, y su gran estrategia sólo apoya un acuerdo si EE. UU. puede proporcionar garantías de seguridad creíbles, cosa que EE. UU. no puede hacer porque su política exterior es inconsistente. La gran estrategia de EE. UU. apoya un acuerdo pero sólo si es verificable, es decir, no si Irán lo utiliza como cobertura para perseguir una bomba de todas formas. Irán no se ha rendido después de tres años de sanciones máximas de EE. UU., una pandemia y la agitación global. Y Irán ve una perspectiva mucho mayor de extraer beneficios estratégicos de Rusia y China ahora que se han vuelto agresivos contra Occidente. Moscú y Pekín pueden ser socios estratégicos debido a su acrimonia compartida hacia Washington. Mientras que EE. UU. puede traicionar a la administración Raisi tan fácilmente como traicionó a la de Rouhani, con el resultado de que la economía volvería a ser zarandeada y el Líder Supremo y el establecimiento político serían, a los ojos del público, el doble de engañados. Diagrama 3 expone las opciones de Irán. Diagrama 3 Árbol de Decisión para la Crisis Nuclear de Irán (Próximos 24 Meses) Ruleta con un revólver de cinco disparos Ruleta con un revólver de cinco disparos   Si las negociaciones colapsan (50% de probabilidad), entonces Irán dará una carrera loca por un arma nuclear antes de que EE. UU. e Israel ataquen. Si EE. UU. e Irán acuerdan un pacto (40%), entonces Irán podría cumplir los términos del acuerdo hasta las elecciones de EE. UU. de 2024, retirando el tema de las preocupaciones de los inversores por ahora. Pero su interés a largo plazo en obtener un disuasivo nuclear no cambiará y el conflicto se reavivará después de 2024. Si las conversaciones continúan sin resolución (10%), Irán hará progresos graduales en su programa nuclear sin las restricciones del acuerdo (aunque puede que no necesite apresurarse). En resumen, Rusia y China necesitan a Irán independientemente de si éste congela su programa nuclear, mientras que EE. UU. e Israel formarán una alianza Abraham de equilibrio de poder para contener a Irán incluso si congela su programa nuclear. Conclusión: Los inversores deberían asignar un 40% de probabilidad a un acuerdo nuclear temporal y de corta duración entre EE. UU. e Irán. La caída del precio del petróleo sería fugaz. La oferta a largo plazo no se expandirá porque EE. UU. no puede proporcionar a Irán las garantías de seguridad que necesita para detener irreversible su programa nuclear. Las Probabilidades de la Tercera Guerra Mundial Ahora viene la parte imposible, donde intentamos poner estas tres crisis geopolíticas juntas. En lo que sigue estamos simplificando en exceso. Pero el propósito es formalizar nuestro pensamiento sobre los diferentes actores y sus opciones. Diagrama 4 comienza con nuestras conclusiones respecto al conflicto China/Taiwán, ajusta las probabilidades de una guerra rusa más amplia como resultado, y añade nuestra opinión de que es muy probable que Irán persiga armas nucleares. De nuevo, el marco temporal es de dos años. Diagrama 4 Árbol de Decisión para la Tercera Guerra Mundial (Próximos 24 Meses) Ruleta con un revólver de cinco disparos Ruleta con un revólver de cinco disparos   El escenario alternativo de conflicto a la Tercera Guerra Mundial consiste en “guerras limitadas”: un concepto peligroso que se refiere a guerras híbridas y por poder en las que EE. UU. no está involucrado, o sólo está involucrado de forma indirecta. O podría ser un conflicto con Irán que no involucre a Rusia y China. Comenzamos con China porque es la potencia global más capaz y ambiciosa en la actualidad. El ascenso estratégico de China está trastornando el orden global y desafiando a Estados Unidos. También empezamos por China porque tenemos alguna evidencia este año de que Rusia no pretende expandir la guerra más allá de Ucrania. O China toma acciones agresivas adicionales en Taiwán – creando una oportunidad única para que Rusia asuma mayores riesgos – o no. Si no, las probabilidades de la Tercera Guerra Mundial caerán drásticamente durante el período de dos años. Este escenario es nuestro caso base. Pero si China ataca Taiwán y EE. UU. defiende a Taiwán, damos una alta probabilidad a que Rusia invada los bálticos. Si China realiza ataques híbridos y EE. UU. sólo apoya a Taiwán de forma indirecta, entonces aumentamos las probabilidades de agresión rusa sólo marginalmente. El resultado es una probabilidad del 20% de la Tercera Guerra Mundial, es decir, una guerra directa entre EE. UU. y Rusia, o China, o ambos. Si esta guerra podría permanecer limitada es debatible. Los ejercicios de guerra desde 1945 muestran que cualquier guerra entre grandes potencias nucleares es más probable que escale que lo contrario. Pero las armas nucleares traen destrucción mutuamente asegurada, la restricción última. El riesgo de escalada nuclear es la razón por la que redondeamos a la baja la probabilidad de la Tercera Guerra Mundial en nuestros árboles de decisión. El escenario más probable del 59% de “guerras limitadas” puede parecer un resultado positivo, pero incluye aumentos importantes en las tensiones geopolíticas respecto al nivel actual, como una guerra híbrida china contra Taiwán. Conclusión: Según este ejercicio, las probabilidades de la Tercera Guerra Mundial podrían ser tan altas como el 20%. Esto es el doble del nivel en nuestro árbol de decisión sobre Rusia, lo cual es apropiado dado que nuestro pronóstico sobre la crisis de Taiwán se ha materializado. El factor crítico es si Pekín continúa escalando la presión sobre Taiwán después del congreso del partido este otoño. Eso podría desencadenar una peligrosa reacción en cadena. La economía global y los mercados financieros todavía enfrentan riesgo a la baja por la geopolítica, pero 2023 podría ver mejoras si Rusia se mueve hacia un alto el fuego y China retrasa la acción contra Taiwán para reiniciar su economía. Conclusiones para la Inversión Cuando Rusia invadió Ucrania a principios de este año, nuestro colega Peter Berezin, estratega global jefe, argumentó que las probabilidades de un Armagedón nuclear eran del 10%. Como mínimo, esta es una probabilidad razonable para las probabilidades de que Rusia y la OTAN lleguen a las manos. Ahora la esperada crisis de Taiwán se ha materializado. Calculamos que las probabilidades de una gran guerra se han duplicado al 20%. La correlación es una probabilidad del 80% de un mejor resultado. Analíticamente, seguimos viendo a Rusia persiguiendo un objetivo limitado – neutralizar a Ucrania para que no sea próspera ni militarmente poderosa – mientras que China también persigue un objetivo limitado – intimidar a Taiwán para que busque la subordinación en vez de la condición de nación. A menos que estos objetivos cambien, todavía estamos lejos de la Tercera Guerra Mundial. El mundo puede convivir con una Ucrania lisiada y un Taiwán subordinado. Sin embargo, no se puede negar que la trayectoria de los asuntos globales desde la crisis financiera global de 2008 ha seguido un camino incómodamente similar al que condujo a la Segunda Guerra Mundial: crisis financiera, recesión económica, deflación, agitación interna, depreciación de la moneda, proteccionismo comercial, monetización de la deuda, rearme militar, inflación y guerras de agresión. Si la ruleta es el juego, entonces las probabilidades de una guerra global son de una sexta parte o 17%, no muy lejos del resultado del 20% de nuestros árboles de decisión. Incluso suponiendo que seamos alarmistas, el hecho de que podamos formular un argumento coherente y formal de que las probabilidades de la Tercera Guerra Mundial son tan altas como el 20% sugiere que los inversores deberían esperar a que las tensiones actuales sobre Ucrania y Taiwán disminuyan antes de hacer grandes apuestas nuevas y arriesgadas. Una lista de comprobación simple muestra que el contexto macro global y geopolítico es sombrío (Tabla 1). Necesitamos mejoras en la lista antes de mostrarnos más optimistas. Tabla 1 Pocos Catalizadores Positivos en la 2.ª Mitad de 2022 Ruleta con un revólver de cinco tiros Ruleta con un revólver de cinco tiros     Gráfico 2 Mantenerse en Posición Defensiva en la 2.ª Mitad de 2022 Manténgase en posición defensiva en el segundo semestre de 2022 Manténgase en posición defensiva en el segundo semestre de 2022 Específicamente, lo que los inversores necesitan es estar razonablemente tranquilos de que Rusia no expandirá la guerra a la OTAN y de que China no invadirá Taiwán en el corto plazo. Esto requiere un nuevo entendimiento diplomático entre Washington y Moscú y entre Washington y Pekín que evite el conflicto. Ese tipo de entendimiento sólo puede forjarse en la crisis. Las crisis relevantes están en curso pero aún no han concluido. Es probable que haya más caídas para los inversores en renta variable global antes de que los riesgos de guerra se disipan mediante la solución habitual: la diplomacia. Espere mejoras concretas y creíbles en el sistema global antes de adoptar una postura generalmente sobreponderada hacia activos de riesgo. Favorezca los bonos gubernamentales sobre las acciones, las acciones estadounidenses sobre las globales, los sectores defensivos sobre los cíclicos, y desfavorezca la moneda y los activos chinos y taiwaneses (Gráfico 2).     Matt Gertken Director de Estrategia Geopolíticamattg@bcaresearch.com  Notas al Pie 1      Véase Graham Allison, Destined For War: Can America and China Escape Thucydides’s Trap? (Nueva York: Houghton Miffin Harcourt, 2017). 2     Por ejemplo, el acuerdo mediado por Turquía para enviar grano desde Odesa, el apoyo diplomático para reincorporarse al acuerdo nuclear de Irán de 2015, los referendos en territorios conquistados como Jersón y los intentos de aumentar la influencia en conversaciones de reducción de armamentos. Cortar la energía de Europa es en última instancia un plan para coaccionar a Europa a aceptar un alto el fuego favorable para Rusia. 3     Irán sigue planteando demandas extraneous – más recientemente que el OIEA deje de investigar cómo ciertas partículas de uranio producidas por el hombre aparecieron en sitios nucleares no divulgados en Irán. El OIEA no ha abandonado esta investigación y su credibilidad sufriría si lo hiciera. Mientras tanto, Biden está aumentando y no reduciendo sanciones sobre Irán, aunque el alivio de sanciones es una demanda iraní central. Biden no ha eliminado a la Guardia Revolucionaria Iraní ni a la Fuerza Quds de la lista de terrorismo. Ninguno de estos obstáculos es prohibitivo pero al menos esperaríamos ver algún movimiento antes de cambiar nuestra opinión de que un acuerdo es más probable que fracase que que tenga éxito. Temas Estratégicos Posiciones Tácticas Abiertas (0-6 Meses) Recomendaciones Cíclicas Abiertas (6-18 Meses) Matriz Regional de Riesgo Geopolítico "Promedio de Aciertos": Operaciones de Estrategia Geopolítica ()

Listen to a short summary of this report.     Executive Summary The Euro And The Chinese Credit Impulse The US dollar has bounced off its 50-day moving average. In the recent past, that had led to a period of cyclical strength. The yen rally can be explained by the decline in Treasury yields and the fall in energy prices. Where next for the yen will depend on the time horizon. For investors trying to time the bottom, the euro is not yet a buy, but the common currency is incredibly cheap. Much depends on global/Chinese growth (Feature Chart). One of the key drivers of the dollar is volatility, and the correlation with the MOVE index. Less uncertainty will ease safe-haven demand. Stay short EUR/JPY and CHF/JPY. Remain long EUR/GBP. Maintain a limit sell on CHF/SEK at 10.76. RECOMMENDATIONS inception date RETURN Short EUR/JPY 2022-07-21 3.68 Bottom Line: We are tactically neutral the dollar but will be sellers on strength. Questions And Answers Chart 1Currencies And Yield Differentials It is rare that we receive clients in our Montreal office. This has obviously been doubly the case due to the pandemic and the general hassle of travel nowadays. But when we do, it is a delight. In this week’s report, we got asked a few difficult questions on a tea date. The most important was not surprisingly the dollar view, but also our highest conviction trades in FX markets. We enjoyed the conversation and the intellectual debate, so we thought we would share this with our clients. Hopefully, this answers some of the most pressing questions. We have sliced this into as brief and concise a conversation as we could. Question: It is hard not to notice the steep decline in the dollar over the last few weeks. Should we fade this decline or lean into it? That is a tough question, but our educated guess is to fade it for now. That said, longer-term asset allocators should really be looking at buying extremely cheap G10 currencies on any declines. The drivers of dollar downside have been clear. First, long-term interest rates in the US have fallen substantially. The US 10-year Treasury yield has fallen from 3.5% to 2.7%. In real terms, they have also declined. The 10-year TIPS yield has fallen from 0.85% to 0.23%. On a relative basis, the market is also pricing in that the Fed will cut interest rates next year much faster than other central banks. More simply put, 2-year real bond yields in the US are rolling over, relative to the euro area and Japan, the biggest components of the DXY index (Chart 1). Related Report  Foreign Exchange StrategyHow Deep A Recession Is The Dollar Pricing In? Specific to Japan and the euro area, there has also been another critical factor – the decline in energy import costs. Germany’s trade balance improved markedly in June (Chart 2). This has been the first genuine improvement in a year. There is also discussion to extend the life of existing nuclear power plants, which will help assuage energy import costs. In Japan, trade balance data comes out on Monday next week, so we will see what it reveals. But what has been clear is a political drive to restart nuclear power and wean the Japanese economy off its dependence on oil and gas (Chart 3). Japanese prime minister Fumio Kishida has been very vocal about this in recent speeches. Chart 2Euro Area And Japanese Trade Balances Are Improving Chart 3A Nuclear Renaissance In Japan? Turning to the more important part of your question, should we fade the decline or lean into it? We are of two minds on this to be honest, and here is why. The DXY has bounced off its 50-day moving average, which has been a sign in the past that the rally is not over (Chart 4). Our Geopolitical and Commodity & Energy colleagues are telling us not to trust the decline in oil prices. Our bond strategists think US yields are heading higher, with a whisper floor of 2.5%. Chart 4The DXY Has Support At The 50-Day Moving Average Given these crosscurrents, there are many better opportunities that exist in FX at the crosses, rather than playing the dollar outright. But of course, the dollar call is critical. We would be neutral over the next three-to-six months but be incremental sellers of the dollar on strength. Question: Okay, neutral dollar for now, but bearish long term. We tend to consider longer-term investments as well, and we are confused about the euro, but even more so about the yen. Would you buy the yen today? If so, why? Our starting point for many currencies is valuation. On this basis, the yen is incredibly cheap. So, if you have a five-to-ten-year horizon, you can unlock incredible value in Japan, simply on a buy-and-hold basis. Our in-house curated model shows that the yen is at a multi-general low in value terms (Chart 5). Currencies mean-revert. Consider this for a minute – we are not equity experts, but Toyota trades at a P/E of 10.75, while Tesla trades at a P/E of 109.15. And yes, Toyota has electric cars. Chart 5The Japense Yen Is Incredibly Cheap Chart 6The Yen Is A Favorite Short It is true that a winner-takes-all mantra can be attributed to Tesla’s valuation over Toyota, but our colleagues in the Global Investment Strategy are telling us this era is over. As such, at a 40% discount, the yen is a long-term buy in our books. Interestingly, nobody likes the yen, at least by our preferred measure – net speculative positions. It is one of the most shorted G10 currencies (Chart 6). A cheap currency that is the most shorted ranks quite well in our evaluation of bargains in currency markets. Given my discussion above about the dollar, we have played the yen at the crosses. We are short EUR/JPY and CHF/JPY. On the euro, Japanese car manufacturers are simply becoming more competitive than their eurozone or US counterparts. This is not only related to the car industry, but according to the OECD, EUR/JPY is expensive on a purchasing power parity basis (Chart 7). Meanwhile, a short EUR/JPY trade is a perfect hedge for a pro-cyclical portfolio. The DXY index has historically traded in perfect inverse correlation to the euro-yen exchange rate (Chart 8). This suggests the collapse in the yen, relative to the euro, is very much overdone. In a risk-off environment, EUR/JPY will sell off. Meanwhile, there are also fundamental reasons to suggest that the yen should trade higher vis-à-vis the euro. Chart 7Remain Short ##br##EUR/JPY Chart 8The DXY And EUR/JPY Usually Track Each Other Question: Okay, let’s switch to the euro. I know you are short EUR/JPY, which has been working out well in the last few days. But the euro touched parity and I get a sense that it has bottomed. You have often mentioned that the euro has priced in one of the deepest recessions in the eurozone. I am surprised you are not trumpeting this currency and a once-in-a-lifetime buying opportunity. We agree somewhat with your conclusion but not the premise. Let’s consider the narrative over the last few months in the media. The first was that eurozone inflation will never catch up to the US, because the economy was structurally weak. Well, it did, albeit due to an exogenous shock.  So, among a ranking of stagflationary candidates, the euro area is a top contender. If you believe in the idea that currencies are driven by real interest rates, rising inflation, and falling growth are an anathema for the exchange rate. When we typically have doubts about the euro area economy, and the outlook for its financial markets, we consult with our European Investment Strategy colleagues. We did just that and Mathieu Savary, who heads the service, mentioned two things: one – Chinese import volumes are imploding. For net creditor nations, this is a negative as their source of income is waning. The euro area falls into that category. The second thing to consider is that the dollar is a momentum currency. So is the euro. We mentioned earlier that the dollar bounced off its 50-day moving average, which explains euro weakness in recent trading days. In the end, Mathieu and the FX team did not really disagree, but I highlighted two charts to track. The euro tracks the Chinese credit impulse due to the importance of Chinese import demand for the euro area. It looks like our measure of that impulse has bottomed (Chart 9). If it has, you buy the euro on a long-term view. Relatedly, financial conditions are easing in China. As the Chinese bond market becomes more open and liberalized, bond yields become a financial conditions valve. That has been the case and has perfectly tracked the propensity for imports in the last few years (Chart 10). Chart 9The Euro And The Chinese Credit Impulse Chart 10Financial Conditions Are Easing In China In short, we will buy the euro if it touches parity, and even more so below parity with a 5–10-year view, but we think EUR/USD could touch 0.95 in the near term. I guess what we are saying is that a 5%-7% move is big in FX markets, but a 26% move (the undervaluation of the euro) is a whale. We do not see the catalyst for a whale in our current compass. Question: We have talked about the yen and the euro. I do not want to get into the pound, Australian dollar, and other currencies as you have told me your team has upcoming reports on those. But the Chinese yuan is very important in my investment portfolio. Any ideas on its next move? USD/CNY topped out near 6.8 in May. Since then, it has been in a trading range despite the DXY breaking to multi-decade highs (Chart 11). When a pattern like this emerges, it is always useful to revisit fundamentals. Those fundamentals are real interest rate differentials. We care about the yuan because China is a big trading partner of the US. As such, it is also a huge weight in the broad trade-weighted dollar index. China has huge problems, especially related to the property market, which need to be resolved. Bond yields have also collapsed. But the real interest rate in China is very attractive (Chart 12). It is also important to consider that if the dollar is the global safe haven, that means that the yuan could be becoming the haven in Asia. So, yuan downside is not a big risk for our long-term dollar bearish call. That said, we will be short CNY versus the yen, but not the dollar. Chart 11The RMB Has Been Relatively Resilient Chart 12The RMB Has Undershot Real Rate Differentials Question: I think I could sit with you all morning to discuss other aspects of FX,  but I respect you have a tight stop due to the BLU meeting. Any concluding thoughts? I have one. Very often, we debate with our colleagues about capital flows. The dollar rises (in general), as capital inflows accelerate into the US and vice versa. It is often said that getting the dollar call right gets everything else right. So, if you can predict the path of the dollar, the performance of, say, US versus non-US equities becomes easy. Chart 13The Dollar And Earnings Revisions We agree that the dollar is a real-time indicator of relative fundamentals. But here is one important observation: relative earnings revisions are deteriorating in the US vis-à-vis other countries (Chart 13). That has historically had an impact on exchange rates, as it affects equity capital flows. If the Federal Reserve also cut rates next year as the market is predicting, that will also be a negative for bond inflows. We think the global economy will avoid a deep recession, and that will allow growth to pick up outside the US. When the euro area and China bottom, then the dollar will truly peak, as capital flows to these economies will accelerate. So we are watching relative earnings and bond yield differentials closely.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Trades & Forecasts Strategic View Cyclical Holdings (6-18 months) Tactical Holdings (0-6 months) Limit Orders Forecast Summary

Informe especial

Executive Summary Autocracy Hurts Productivity Over the next six-to-18 months, the Xi Jinping administration will “let 100 flowers bloom” – i.e., relax a range of government policies to secure China’s economic recovery from the pandemic. The first signs of this policy are already apparent via monetary and fiscal easing and looser regulation of Big Tech. However, investors should treat any risk-on rally in Chinese stocks with skepticism over the long run. Political risk and policy uncertainty will remain high until after Xi consolidates power this fall. Xi is highly likely to remain in office but uncertainty over other personnel – and future national policy – will be substantial. Next year China’s policy trajectory will become clearer. But global investors should avoid mistaking temporary improvements for a change of Xi’s strategy or China’s grand strategy. Beijing is driven by instability and insecurity to challenge the US-led world order. The result will be continued economic divorce and potentially military conflicts in the coming decade. Russia’s reversion to autocracy led to falling productivity and poor equity returns. China is also reverting to autocratic government as a solution to its domestic challenges. Western investors should limit long-term exposure to China and prefer markets that benefit from China’s recovery, such as in Southeast Asia and Latin America. Bottom Line: The geopolitical risk premium in Chinese equities will stay high in 2022, fall in 2023, but then rise again as global investors learn that China in the Xi Jinping era is fundamentally unstable and insecure. Feature Chart 1Market Cheers China's Hints At Policy Easing In 1957, after nearly a decade at the helm of the People’s Republic of China, Chairman Mao Zedong initiated the “Hundred Flowers Campaign.” The campaign allowed a degree of political freedom to try to encourage new ideas and debate among China’s intellectuals. The country’s innovative forces had suffered from decades of foreign invasion, civil war, and repression. Within three years, Mao reversed course, reimposed ideological discipline, and punished those who had criticized the party.  It turned out that the new communist regime could not maintain political control while allowing liberalization in the social and economic spheres.1 This episode is useful to bear in mind in 2022 as General Secretary Xi Jinping restores autocratic government in China. In the coming year, Xi will ease a range of policies to promote economic growth and innovation. Already his administration is relaxing some regulatory pressure on Big Tech. Global financial markets are cheering this apparent policy improvement (Chart 1). In effect, Xi is preparing to let 100 flowers bloom. However, China’s economic trajectory remains gloomy over the long run – not least because the US and China lack a strategic basis for re-engagement. Chinese Leaders Fear Foreign Encroachments Mao’s predicament was not only one of ideology and historical circumstance. It was also one of China’s geopolitics. Chinese governments have always struggled to establish domestic control, extend that control over far-flung buffer territories, and impose limits on foreign encroachments. Mao reversed his brief attempt at liberalization because he could not feel secure in his person or his regime. In 1959, the Chinese economy remained backward. The state faced challenges in administration and in buffer spaces like Tibet and Taiwan. The American military loomed large, despite the stalemate and ceasefire on the Korean peninsula in 1952. Russia was turning against Stalinism, while Hungary was revolting against the Soviet Union. Mao feared that the free exchange of ideas would do more to undermine national unity than it would to promote industrialization and technological progress. The 100 flowers that bloomed – intellectuals criticizing government policy – revealed themselves to be insufficiently loyal. They could be culled, strengthening the regime. However, what followed was a failed economic program and nationwide famine. Fast forward to today, when circumstances have changed but the Chinese state faces the same geopolitical insecurities. Xi Jinping, like all Chinese rulers, is struggling to maintain domestic stability and territorial integrity while regulating foreign influence. Although the People’s Republic is not as vulnerable as it was in Mao’s time, it is increasingly vulnerable – namely, to a historic downshift in potential economic growth and a rise in international tensions (Chart 2). The Xi administration has repeatedly shown that it views the US alliance system, US-led global monetary and financial system, and western liberal ideology as threats that need to be counteracted. Chart 2China: Less Stable, Less Secure In addition, Russia’s difficulties invading Ukraine suggest that China faces an enormous challenge in attempting to carve out its own sphere of influence without shattering its economic stability. Hence Beijing needs to slow the pace of confrontation with the West while pursuing the same strategic aims. Xi Stays, But Policy Uncertainty Still High In 2022  2022 is a critical political juncture for China. Xi was supposed to step down and hand the baton to a successor chosen by his predecessor Hu Jintao. Instead he has spent the past decade arranging to remain in power until at least 2032. He took a big stride toward this goal at the nineteenth national party congress in 2017, when he assumed the title of “core leader” of the Communist Party and removed term limits from its constitution. This year’s Omicron outbreak and abrupt economic slowdown have raised speculation about whether Xi’s position is secure. Some of this speculation is wild – but China is far less stable than it appears. Structurally, inequality is high, social mobility is low, and growth is slowing, forcing the new middle class to compromise its aspirations. Cyclically, unemployment is rising and the Misery Index is higher than it appears if one focuses on youth employment and fuel inflation (Chart 3). The risk of sociopolitical upheaval is underrated among global investors. Chart 3AStructurally China Is Vulnerable To Social Unrest Chart 3BCyclically China Is Vulnerable To Social Unrest Yet even assuming that social unrest and political dissent flare up, Xi is highly likely to clinch another five-to-ten years in power. Consider the following points: The top leaders control personnel decisions. The national party congress is often called an “election,” but that is a misnomer. The Communist Party’s top posts will be ratified, not elected. The Politburo and Politburo Standing Committee select the members of the Central Committee; the national party congress convenes to ratify these new members. The Central Committee then ratifies the line-up of the new Politburo and Politburo Standing Committee, which is orchestrated by Xi along with the existing Politburo Standing Committee (Diagram 1). Xi is the most important figure in deciding the new leadership. Diagram 1Mechanics Of The Chinese Communist Party’s National Congress There is no history of surprise votes. The party congress ratifies approximately 90% of the candidates put forward. Outcomes closely conform to predictions of external analysts, meaning that the leadership selection is not a spontaneous, grassroots process but rather a mechanical, elite-driven process with minimal influence from low-level party members, not to mention the population at large.2  The party and state control the levers of power: The Communist Party has control over the military, state bureaucracy, and “commanding heights” of the economy. This includes domestic security forces, energy, communications, transportation, and the financial system. Whoever controls the Communist Party and central government exerts heavy influence over provincial governments and non-government institutions. The state bureaucracy is not in a position to oppose the party leadership. Xi has conducted a decade-long political purge (“anti-corruption campaign”). Upon coming to power in 2012, Xi initiated a neo-Maoist campaign to re-centralize power in his own person, in the Communist Party, and in the central government. He has purged foreign influence along with rivals in the party, state, military, business, civil society, and Big Tech. He personally controls the military, the police, the paramilitary forces, the intelligence and security agencies, and the top Communist Party organs. There may be opposition but it is not organized or capable. Chart 4China: Big Tech Gets Relief ... For Now There are no serious alternatives to Xi’s leadership. Xi is widely recognized within China as the “core” of the fifth generation of Chinese leaders. The other leaders and their factions have been repressed. Xi imprisoned his top rivals, Bo Xilai and Zhou Yongkang, a decade ago. He has since neutralized their followers and the factions of previous leaders Hu Jintao and Jiang Zemin. Premier Li Keqiang has never exercised any influence and will retire at the end of this year. None of the ousted figures have reemerged to challenge Xi, but potential rivals have been imprisoned or disciplined, as have prominent figures that pose no direct political threat, such as tech entrepreneur Jack Ma (Chart 4).  Additional high-level sackings are likely before the party congress. China’s reversion to autocracy grew from Communist Party elites, not Xi alone. China’s slowing potential GDP growth and changing economic model raise an existential threat to the Communist Party over the long run. The party recognized its potential loss of legitimacy back in 2012, the year Xi was slated to take the helm. The solution was to concentrate power in the center, promoting Maoist nostalgia and strongman rule. In essence, the party needed a new Mao; Xi was all too willing to play the part. Hence Xi’s current position does not rest on his personal maneuvers alone. The party has invested heavily in Xi and will continue to do so. Characteristics of the political elite underpin the autocratic shift. Statistics on the evolving character traits of Politburo members show the trend toward leaders that are more rural, more bureaucratic, and more ideologically orthodox, i.e. more nationalist and communist (Chart 5). This trend underpins the party’s behavior and Xi’s personal rule. Chart 5China: From Technocracy To Autocracy Chart 6China: De-Industrialization Undermines Stability Xi has guarded his left flank. By cornering the hard left of the political spectrum Xi has positioned himself as the champion of poor people, workers, farmers, soldiers, and common folk. This is the political base of the Communist Party, as opposed to the rich coastal elites and westernizing capitalists, who stand to suffer from Xi’s policies. Ultimately de-industrialization – e.g. the sharp decline in manufacturing and construction sectors (Chart 6) – poses a major challenge to this narrative. But social unrest will be repressed and will not overturn Xi or the regime anytime soon. Xi still retains political capital. After centuries of instability, Chinese households are averse to upheaval, civil war, and chaos. They support the current regime because it has stabilized China and made it prosperous. Of course, relative to the Hu Jintao era, Xi’s policies have produced slower growth and productivity and a tarnished international image (Chart 7). But they have not yet led to massive instability that would alienate the people in general. If Chinese citizens look abroad, they see that Xi has already outlasted US Presidents Obama and Trump, is likely to outlast Biden, and that US politics are in turmoil. The same goes for Europe, Japan, and Russia – Xi’s leadership does not suffer by comparison.  Chart 7China’s Declining International Image External actors are neither willing nor able to topple Xi. Any outside attempt to interfere with China’s leadership or political system would be unwarranted and would provoke an aggressive response. The US is internally divided and has not developed a consistent China policy. This year the Biden administration has its hands full with midterm elections, Russia, and Iran, where it must also accept the current leadership as a fact of life. It has no ability to prevent Xi’s power consolidation, though it will impose punitive economic measures. Japan and other US allies have an interest in undermining Xi’s administration, but they follow the US’s lead in foreign policy. They also lack influence over the political rotation within the Communist Party. The Europeans will keep their distance but will not try to antagonize China given their more pressing conflict with Russia. Russia needs China more than ever and will lend material support in the form of cheaper and more secure natural resources. North Korean and Iranian nuclear provocations will help Xi stay under the radar.  There is no reason to expect a new leader to take over in China. The Xi administration’s strategy, revealed over the past ten years, will remain intact for another five-to-ten years at least. The real question at the party congress is whether Xi will be forced to name a successor or compromise with the opposing faction on the personnel of the Politburo and Politburo Standing Committee. But even that remains to be seen – and either way he will remain the paramount leader. Bottom Line: Xi Jinping has the political capability to cement another five-to-ten years in power. Opposing factions have been weakened over the past decade by Xi’s domestic political purge and clash with the United States. China is ripe for social unrest and political dissent but these will be repressed as China goes further down the path of autocracy. Foreign powers have little influence over the process. Policy Uncertainty Falls In 2023 … Only To Rise Again What will Xi Jinping do once he consolidates power? Xi’s administration has weighed heavily on China’s economy, foreign relations, and financial markets. The situation has worsened dramatically this year as the economy struggles with “A Trifecta Of Economic Woes” – namely a rampant pandemic, waning demand for exports, and a faltering housing market (Chart 8). In response the administration is now easing a range of policies to stabilize expectations and try to meet the 5.5% annual growth target. The money impulse, and potentially the credit impulse, is turning less negative, heralding an eventual upturn in industrial activity and import volumes in 2023. These measures will give a boost to Chinese and global growth, although stimulus measures are losing effectiveness over time (Chart 9).  Chart 8China's Trifecta Of Economic Woes Chart 9More Stimulus, But Less Effectiveness This pro-growth policy pivot will continue through the year and into next year. After all, if Xi is going to stay in power, he does not want to bequeath himself a financial crisis or recession at the start of his third term. Still, investors should treat any rally in Chinese equity markets with skepticism. First, political risk and uncertainty will remain elevated until Xi completes his power grab, as China is highly susceptible to surprises and negative political incidents this year (Chart 10). For example, if social unrest emerges and is repressed, then the West will impose sanctions. If China increases its support of Russia, Iran, or North Korea, then the US will impose sanctions.     Chart 10China: Policy Uncertainty And Geopolitical Risk To Stay High In 2022, Might Improve In 2023 Chart 11China Needs To Court Europe The regime will be extremely vigilant and overreact to any threats this year, real or perceived. Political objectives will remain paramount, above the economy and financial markets, and that means new economic policy initiatives will not be reliable. Investors cannot be confident about the country’s policy direction until the leadership rotation is complete and new policy guidance is revealed, particularly in December 2022 and March 2023. Second, after consolidating power, investors should interpret Xi’s policy shift as “letting 100 flowers bloom,” i.e., a temporary relaxation that aims to reboot the economy but does not change the country’s long-term policy trajectory. Economic reopening is inevitable after the pandemic response is downgraded – which is a political determination. Xi will also be forced to reduce foreign tensions for the sake of the economy, particularly by courting Europe, which is three times larger than Russia as a market (Chart 11). However, China’s declining labor force and high debt levels prevent its periodic credit stimulus from generating as much economic output as in the past. And the administration will not ultimately pursue liberal structural reforms and a more open economy. That is the path toward foreign encroachment – and regime insecurity. The US’s sanctions on Russia have shown the consequences of deep dependency on the West. China will continue diversifying away from the US. And, as we will see, the US cannot provide credible promises that it will reduce tensions. US-China: Re-Engagement Will Fail The Biden administration is focused on fighting inflation ahead of the midterm elections. But its confrontation with Russia – and likely failure to freeze Iran’s nuclear program – increases rather than decreases oil supply constraints. Hence some administration officials and outside observers argue that the administration should pursue a strategic re-engagement with China.3  Theoretically a US-China détente would buy both countries time to deal with their domestic politics by providing some international stability. Improved US-China relations could also isolate Russia and hasten a resolution to the war in Ukraine, potentially reducing commodity price pressures. In essence, a US-China détente would reprise President Richard Nixon’s outreach to China in 1972, benefiting both countries at the expense of Russia.4  This kind of Kissinger 2.0 maneuver could happen but there are good reasons to think it will not, or if it does that it will fall apart in one or two years. In 1972, China had nowhere near the capacity to deny the US access to the Asia Pacific region, expel US influence from neighboring countries, reconquer Taiwan, or project power elsewhere. Today, China is increasingly gaining these abilities. In fact it is the only power in the world capable of rivaling the US in both economic and military terms over the long run (Chart 12). Secretary of State Antony Blinken recently outlined the Biden administration’s China policy and declared that China poses “the most serious long-term challenge” to the US despite Russian aggression.5  Chart 12US-China Competition Sows Distrust, Drives Economic Divorce While another decade of US engagement with China would benefit the US economy, it would be far more beneficial to China. Crucially, it would be beneficial in a strategic sense, not just an economic one. It could provide just the room for maneuver that China needs – at this critical juncture in its development – to achieve technological and productivity breakthroughs and escape the middle-income trap. Another ten-year reprieve from direct American competition would set China up to challenge the US on the global stage. That would be far too high of a strategic price for America to pay for a ceasefire in Ukraine. Ukraine has limited strategic value for the US and it does not steer US grand strategy, which aims to prevent regional empires from taking shape. In fact Washington is deliberately escalating and prolonging the war in Ukraine to drain Russia’s resources. Ending the war would do Russia a strategic favor, while re-engaging with China would do China a strategic favor. So why would the defense and intelligence community advise the Biden administration to pursue Kissinger 2.0? Chart 13US Unlikely To Revoke Trump Tariffs Biden could still pursue some degree of détente with China, namely by repealing President Trump’s trade tariffs, in order to relieve price pressures ahead of the midterm election. Yet even here the case is deeply flawed. Trump’s tariffs on China did not trigger the current inflationary bout. That was the combined Trump-Biden fiscal stimulus and Covid-era supply constraints. US import prices are rising faster from the rest of the world than they are from China (Chart 13). Tariff relief would not change China’s Zero Covid policy, which is the current driver of price spikes from China. And while lifting tariffs on China would not reduce inflation enough to attract voters, it would cost Biden some political credit among voters in swing states like Pennsylvania, and across the US, where China’s image has plummeted in the wake of Covid-19 (Chart 14).   Chart 14US Political Consensus Remains Hawkish On China If Biden did pursue détente, would China be able to reciprocate and offer trade concessions? Xi has the authority to do so but he is unlikely to make major trade concessions prior to the party congress. Economic self-sufficiency and resistance to American pressure have become pillars of his support. Promises will not ease inflation for US voters in November and Xi has no incentive to make binding concessions because the next US administration could intensify the trade war regardless.  Bottom Line: The US has no long-term interest, and a limited short-term interest, in easing pressure on China’s economy. Continued US pressure, combined with China’s internal difficulties, will reinforce Xi Jinping’s shift toward nationalism and hawkish foreign policy. Hence there is little basis for a substantial US-China re-engagement that improves the global macroeconomic environment over the coming years. Investment Takeaways Chart 15Autocracy Hurts Productivity Xi Jinping will clinch another five-to-ten years in power this fall. To stabilize the economy, he will “let 100 flowers bloom” and ease monetary, fiscal, regulatory, and social policy at home. He will also court the West, especially Europe, for the sake of economic growth. However, he will not go so far as to compromise his ultimate aims: self-sufficiency at home and a sphere of influence abroad. The result will be a relapse into conflict with the West within a year or two. Ultimately a closed Chinese economy in conflict with the West will result in lower productivity, a weaker currency, a high geopolitical risk premium, and low equity returns – just as it did for Russia (Chart 15). Any short-term improvement in China’s low equity multiples will ultimately be capped. Over the long run, western investors should hedge against Chinese geopolitical risk by preferring markets that benefit from China’s periodic stimulus yet do not suffer from the break-up of the US-China and EU-Russia economic relationships, such as key markets in Latin America and Southeast Asia (Charts 16 & 17). Chart 16China Stimulus Creates Opportunity For … Latin America Chart 17China Stimulus Creates Opportunity For … Southeast Asia     Matt Gertken Chief Geopolitical Strategist mattg@bcaresearch.com   Footnotes 1     Modern scholarship has shown that Mao intended to entrap the opposition through the 100 Flowers Campaign. For a harrowing account of this episode, see Jung Chang and Jon Halliday, Mao: The Unknown Story (New York: Anchor Books, 2006), pp. 409-17. 2     “At least 8% of CPC Central Committee nominees voted off,” Xinhua, October 24, 2017, english.www.gov.cn. 3    Christopher Condon, “Yellen Says Biden Team Is Looking To ‘Reconfigure’ China Tariffs,” June 8, 2022, www.bloomberg.com. 4       Niall Ferguson, “Dust Off That Dirty Word Détente And Engage With China,” Bloomberg, June 5, 2022, www.bloomberg.com. 5    See Antony J Blinken, Secretary of State, “The Administration’s Approach to the People’s Republic of China,” George Washington University, Washington D.C., May 26, 2022, state.gov. Additionally, see President Joe Biden’s third assertion of US willingness to defend Taiwan against China, in a joint press conference with Japan’s Prime Minister Kishida Fumio, “Remarks by President Biden and Prime Minister Kishida Fumio of Japan in Joint Press Conference,” Akasaka Palace, Tokyo, Japan, May 23, 2022, whitehouse.gov.

Listen to a short summary of this report.       Executive Summary Chinese Stocks Are Relatively Cheap The Chinese economy faces a trifecta of economic woes: 1) The threat of renewed Covid lockdowns; 2) Cooling export demand; 3) A floundering housing market. Trying to reflate the Chinese housing bubble would only damage the long-term prospects of China’s economy. A much better option would be to adopt measures that boost disposable income. Not only would this help offset the drag from slowing export growth and a negative housing wealth effect, but it would also take some of the sting out of China’s zero-Covid policy. With the Twentieth Party Congress slated for later this year, the political incentive to shower the economy with cash will only intensify. Chinese equities are trading at only 10-times forward earnings and about 1-times sales. A significant upward rating for equity valuations is likely if the government adopts broad-based income-support measures. Go long the iShares MSCI China ETF ($MCHI) as a tactical trade. Bottom Line: China faces a number of economic woes, but these are fully discounted by the market. What has not been discounted is a broad-based stimulus program focused on income-support measures.   Dear Client, I will be visiting clients in Saudi Arabia, Bahrain, and Abu Dhabi next week. No doubt, the outlook for oil prices will feature heavily in my discussions. I will brief you on any insights I learn in my report on June 17. In the meantime, I am pleased to announce that Matt Gertken, BCA’s Chief Geopolitical Strategist, will be the guest author of next week’s Global Investment Strategy report. Best regards, Peter Berezin Chief Global Strategist Triple Threat The Chinese economy faces a trifecta of economic woes: 1) The threat of renewed Covid lockdowns; 2) Cooling export demand; 3) A floundering housing market. Let us discuss each problem in turn.   Problem #1: China’s Zero-Covid Policy in the Age of Omicron Chart 1China’s Lockdown Index Remains Elevated China was able to successfully suppress the virus in the first two years of the pandemic. However, the emergence of the Omicron strain is challenging the government’s commitment to its zero-Covid policy. The BA.2 subvariant of Omicron is 50% more contagious than the original Omicron strain and about 4-times more contagious than the Delta strain. While 89% of China’s population has been fully vaccinated, the number drops off to 82% for those above the age of 60. And those who are vaccinated have been inoculated with vaccines that appear to be largely ineffective against Omicron. Keeping a virus as contagious as measles at bay in a population with little natural or artificial immunity is exceedingly difficult. While the authorities are starting to relax restrictions in Shanghai, China’s Effective Lockdown Index remains at elevated levels (Chart 1). A number of domestically designed mRNA vaccines are in phase 3 trials. However, it is not clear how effective they will be. Shanghai-based Fosun Pharma has inked a deal to distribute 100 million doses of Pfizer’s vaccine, but so far neither it nor Moderna’s vaccine have been approved for use. Our working assumption is that China will authorize the distribution of western-made mRNA vaccines later this year if its own offerings prove ineffectual. The Chinese government has already signed a deal to manufacture a generic version of Pfizer’s Paxlovid, which has been shown to cut the risk of hospitalization by 90% if taken within five days of the onset of symptoms. In the meantime, the authorities will continue to play whack-a-mole with Covid. Investors should expect more lockdowns during the remainder of the year.   Problem #2: Weaker Export Growth China’s export growth slowed sharply in April, with manufacturing production contracting at the fastest rate since data collection began. Activity appears to have rebounded somewhat in May, but the new export orders components of both the official and private-sector manufacturing PMIs still remain below 50 (Chart 2). Part of the export slowdown is attributable to lockdown restrictions. However, weaker external demand is also a culprit, as evidenced by the fact that Korean export growth — a bellwether for global trade — has decelerated (Chart 3).  Chart 2China’s Export Growth Has Rolled Over Chart 3Softer Export Growth Is Not A China-Specific Phenomenon Spending in developed economies is shifting from manufactured goods to services. Retail inventories in the US are now well above their pre-pandemic trend, suggesting that the demand for Chinese-made goods will remain subdued over the coming months (Chart 4). The surge in commodity prices is only adding to Chinese manufacturer woes. Input prices rose 10% faster than manufacturing output prices over the past 12 months. This is squeezing profit margins (Chart 5). Chart 4Well-Stocked Shelves In The US Bode Poorly For Chinese Export Demand Chart 5Surging Input Costs Are Weighing On The Profits Of Chinese Commodity Users A modest depreciation in the currency would help the Chinese export sector. However, after weakening from 6.37 in April to 6.79 in mid-May, USD/CNY has moved back to 6.66 on the back of the recent selloff in the US dollar. Chart 6The RMB Tends To Weaken When EUR/USD Is Rising We expect the dollar to weaken further over the next 12 months as the Fed tempers its hawkish rhetoric in response to falling inflation. Chart 6 shows that the trade-weighted RMB typically strengthens when EUR/USD is rising. Chester Ntonifor, BCA’s Chief Currency Strategist, expects EUR/USD to reach 1.16 by the end of the year.   Problem #3: Flagging Property Market Chinese housing sales, starts, and completions all contracted in April (Chart 7). New home prices dipped 0.2% on a month-over-month basis, and are up just 0.7% from a year earlier, the smallest gain since 2015. The percentage of households planning to buy a home is near record lows (Chart 8). Chart 7The Chinese Property Market Has Been Cooling Chart 8Intentions To Buy A House Have Declined China’s property developers are in dire straits. Corporate bonds for the sector are, on average, trading at 48 cents on the dollar (Chart 9). Goldman Sachs estimates that the default rate for property developers will reach 32% in 2022, up from their earlier estimate of 19%. The government is trying to prop up housing demand. The PBoC lowered the 5-year loan prime rate by 15 bps on May 20th, the largest such cut since 2019. The authorities have dropped the floor mortgage rate to a 14-year low of 4.25%. They have also taken steps to make it easier for property developers to issue domestic bonds. BCA’s China strategists believe these measures will foster a modest rebound in the property market in the second half of this year. However, they do not anticipate a robust recovery – of the sort experienced following the initial wave of the pandemic – due to the government’s continued adherence to the “three red lines” policy.1 China is building too many homes. While residential investment as a share GDP has been trending lower, it is still very high in relation to other countries. China’s working-age population is now shrinking, which suggests that housing demand will contract over the coming years (Chart 10). Chart 9Chinese Property Developer Bonds Are Trading At Distressed Levels Chart 10Shrinking Working-Age Population Implies Less Demand For Housing Chinese real estate prices are amongst the highest anywhere. The five biggest cities in the world with the lowest rental yields are all in China (Chart 11). The entire Chinese housing stock is worth nearly $100 trillion, making it the largest asset class in the world. As such, a decline in Chinese home prices would generate a sizable negative wealth effect. Chart 11Chinese Real Estate Is Expensive A Silver Bullet? Trying to reflate the Chinese housing bubble would only damage the long-term prospects of China’s economy. Luckily, one does not need to fill a leaky bucket through the same hole the water escaped. As long as there is enough demand throughout the economy, workers who lose their jobs in declining sectors will eventually find new jobs in other sectors. China needs to reorient its economy away from its historic reliance on investment and exports towards consumption. The easiest way to do that is to adopt measures that boost disposable income, which has slowed of late (Chart 12). Not only would this help offset the drag from slowing export growth and a negative housing wealth effect, but it would also take some of the sting out of China’s zero-Covid policy. The authorities have not talked much about pursuing large-scale income-support measures of the kind adopted by many developed economies during the pandemic. As a result, market participants have largely dismissed this possibility. Yet, with the Twentieth Party Congress slated for later this year, the political incentive to shower the economy with cash will only intensify. Chinese equities are trading at only 10-times forward earnings and about 1-times sales (Chart 13). A significant upward rating for equity valuations is likely if the government adopts broad-based income-support measures. As we saw in the US and elsewhere, stimulus cash has a habit of flowing into the stock market; and with real estate in the doldrums, equities may become the asset class of choice for many Chinese investors. With that in mind, we are going long the iShares MSCI China ETF ($MCHI) as a tactical trade. Chart 12Disposable Income Growth Has Been Trending Lower Chart 13Chinese Stocks Are Relatively Cheap At a global level, a floundering Chinese property market would have been a cause for grave concern in the past, as it would have represented a major deflationary shock. Times have changed, however. The problem now is too much inflation, rather than too little. To the extent that reduced Chinese investment injects more savings into the global economy and knocks down commodity prices, this would be welcomed by most investors. China’s economy may be heading for a “beautiful slowdown.” Peter Berezin Chief Global Strategist peterb@bcaresearch.com Follow me on LinkedIn Twitter   Footnotes   1      The People’s Bank of China and the housing ministry issued a deleveraging framework for property developers in August 2020, consisting of a 70% ceiling on liabilities-to-assets, a net debt-to-equity ratio capped at 100%, and a limit on short-term borrowing that cannot exceed cash reserves. Developers breaching these “red lines” run the risk of being cut off from access to new loans from banks, while those who respect them can only increase their interest-bearing borrowing by 15% at most. View Matrix Special Trade Recommendations Current MacroQuant Model Scores