中国元

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.

特別レポート

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.

特別レポート

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.

特別レポート

エグゼクティブ・サマリー 第4次台湾海峡危機が現実化していることを受けて、世界の大国間での大規模な戦争の確率は上昇しました。 当社のディシジョンツリーは確率を約20%と示唆しており、これはロシアのウクライナ戦争だけを起点に想定した水準の2倍に相当します。世界は五発リボルバーで「ロシアンルーレット」をしている状態です。 今後の基本見解としては、米中の国内政治イベントが今秋に一段落した後、台湾緊張は横ばい（悪化はしないが改善もしない）になると見ています。 しかし、もし中国が第20回党大会後に緊張をエスカレートさせれば、侵攻の確率は大幅に上昇します。 台湾で紛争が発生した場合、ロシアが欧州でさらに攻勢的になる確率が高まります。 イランは核兵器の追求を強く進める可能性が高いです。   2022年下半期にポジティブな触媒は多くない 五連発拳銃によるルーレット 五連発拳銃によるルーレット タクティカル推奨開始日リターン 米国10年国債ロング2022-04-141.3% グローバルのディフェンシブ／サイクリック株式ロング2022-01-2013.8% 結論：投資家は少なくとも中国の党大会と米国の中間選挙が今秋に終わるまでは防御的なポジションを維持すべきです。来年の地政学的リスクは中国の台湾海峡での行動次第です。 特集   チャート 1 第三次世界大戦をめぐる臆測が高まる 五発のリボルバーを使ったルーレット 五発のリボルバーを使ったルーレット 世界の出来事に注意を払う悲観論者たちは、近年第三次世界大戦が勃発するリスクを懸念するようになりました。用語の検索は2019年以降増えていますが、懸念の理由は特定の危機事象というよりもむしろグローバルな多極化という基調にあります（チャート 1）。1 米中、あるいは米露間での大規模な戦争の確率はどのくらいでしょうか。どのように算出できるでしょうか。本レポートでは一連の「ディシジョンツリー」を提示し、各シナリオと確率を形式化して示します。 もしWWIIIを米国がロシアあるいは中国、または両方と直接交戦する戦争と定義するなら、今後数年以内にWWIIIが勃発する確率は20%に達すると計算されます！ これは非常に高い確率ですが、歴史はこうした確率が非現実的でないことを示しており、投資家は油断してはなりません。政治学者グレアム・アリソンは長期的に見た米中戦争の確率は約75%であると歴史的類推に基づいて示しています。 要点は、各国がこのWWIIIリスクを直視し、拒否しない限り世界の政治環境は改善しないということです。最もあり得るのは、WWIIIおよびそれがもたらす核戦争のリスクが最終的な制約となり、各国がそれを認識して行動を改めるケースですが、現在の大国の振る舞いはまだ制約を認識しておらず、短期的には瀬戸際政策を続ける意向が窺えます。 中国による台湾侵攻の確率 まず問いは、中国が台湾に侵攻するかどうかです。2021年4月に当社は第4次台湾海峡危機が12～24か月以内に発生すると予測しましたが、全面戦争には発展しないと見ていました。この見方が今試されています。 図表 1では、中国の台湾に対する政策選択肢をマッピングし、それぞれに確率を割り当てるディシジョンツリーを示します。 図表 1 第4次台湾海峡危機に関するディシジョンツリー（次の24か月） 五連発の拳銃によるルーレット 五連発の拳銃によるルーレット   中国は台湾を侵攻する能力を獲得しましたが、特に核三本柱（トライアド）のさらなる進展がない限り、失敗の確率は依然として高いです。したがって、即時に侵攻のために動員をかける確率は20%と見積もります。 明らかに、中国が侵攻を計画しているという具体的な兆候があれば真剣に受け止めるべきです。 2021年にウクライナ周辺でのロシアの軍事増強を投資家やメディアが軽視したことは損失を招きました。 同時に、米中は台湾海峡の現状を試しているだけであり、現状は今回のエピソード後に強化される可能性が高いという見方もあります。結局のところ、今回の危機は第4次台湾海峡危機であり、過去の危機はいずれも戦争には至りませんでした。 バイデン大統領と習近平が、今秋に予定される重要な国内政治イベントを前にそれぞれの力を誇示しているだけなら、両者は既に目的を達成しています。少なくとも今後数年間にわたっては、これ以上の軍事的見せつけは不要です。 我々は、過去一週間の緊張が残るが現状が強化されるシナリオに40%の確率を割り当てます。 その場合、台湾海峡の構造的問題は2024年の米国と台湾の大統領選挙の後、つまりこの図表の時間枠の外で再燃するでしょう。 残念ながら我々は長期的には悲観的であり、台湾での戦争の確率は高いと考えています。 そのため、我々は今後2年間で状況が悪化するシナリオにも同じく40%の確率を割り当てます。 もし中国が党大会後に演習や制裁を拡大するなら、習指導部が単なる国内向けパフォーマンスではないことが明らかになります。 同様に、もしバイデン政権が中間選挙後も対中ハイテク輸出管理の強化を推し進め、同盟国やパートナーにも同様の対応を求め続けるなら、米国は中国が何らかの攻勢作戦を準備していると暗に判断していることになります。その場合、侵攻の危険性は20%から40%に上昇します。 それでも、米中の危機外交が2023-24年に全面戦争を防ぐという見方は依然として妥当ですが、誤算のリスクは非常に高まります。 このディシジョンツリーの最後の要素は、中国が第二次世界大戦で見られたような従来型の上陸侵攻ではなく、「グレーゾーン戦術」やハイブリッド戦を好むという前提です。理由は複数あります。 第一に、上陸侵攻は最も困難な軍事作戦です。第二に、中国軍は未熟である一方、米国と同盟国は守備を固めています。第三に、ハイブリッド戦は米国の同盟国間に対応の分裂を生みます。第四に、ここ14年でロシアはハイブリッド戦が機能することを何度も示してきました。それは戦略的便益を最大化し、コストを最小化する手段です。 西側が小規模な侵攻にどう反応するかは世界が知っている：経済制裁だ。しかし大規模な侵攻にどう反応するかはまだ分かりません。したがって中国は小さく噛み切るインセンティブを持ちます。 とはいえ台湾の場合、こうした戦術が持続可能でない可能性もあります。当社の台湾に関するディシジョンツリーは、ハイブリッド戦や「代理戦争」が大規模戦争に進展する可能性を完全には織り込んでいません。しかしその可能性は実際には高いのです。したがって我々は米中の大規模戦争のリスクを過小評価しているわけではありません。 結論： 今後2年間で、台湾を巡る米中の代理戦争の主観的確率は約32%、直接的な米中戦争の確率は約4%です。 真の試練は習近平が今秋の党大会で権力を固めた後に訪れます。 我々は習氏が経済の再起動に注力すると予想します したがって我々は中国と台湾を除く新興アジアの市場を引き続き推奨します。 ロシアとNATOの戦争の確率 第二の問いは、ウクライナの戦争が西側とのより広範な戦争に変貌するかどうかです。ウクライナでは既に戦争が継続しているため、ロシアと西側の大規模戦争の確率は中国の場合よりも高くなります。一方、台湾海峡の緊張は現時点ではまだ虚勢の段階にすぎません。 投資家のベースケースとしては、ウクライナ戦争はウクライナ内に限定されると考えるべきです。欧州諸国はドンバスのためだけにロシアと壊滅的な戦いを望んでいません。しかし戦時には物事がしばしば誤ることがあります。 重要な問いは、ロシアがNATO加盟国を攻撃するかどうかです。そうなれば同盟条約の第5条が発動され、「欧州または北米における一つ以上の（同盟）加盟国に対する武力攻撃は、すべての加盟国に対する攻撃と見なされる」ことになり、必要に応じて安全回復のために武力行使が正当化されます。 ロシアのウクライナ侵攻以降、バイデン大統領は繰り返し米国は「NATO領土の一インチたりとも防衛する」と述べており、これは政策の変更ではなく米国のレッドラインであり極めて高い可能性で防衛されるでしょう。したがってこれはロシアにとって重大な制約です。 図表 2ではロシアの選択肢をマッピングし、確率を割り当てます。 図表 2 ロシア・ウクライナ戦争に関するディシジョンツリー（次の24か月） 五発のリボルバーを使ったルーレット 五発のリボルバーを使ったルーレット   我々はロシアがドンバス地域とクリミアへの陸路を確保し、勝利を宣言する確率を55%と見ています。ロシアは征服地を何らかの外交合意、つまり停戦という形で正当化しようと動き始めるでしょう。これが我々の2023年のベースケースです。 ロシアが既に外交に向けた動きを始めている証拠があります。2 理由はロシア経済が打撃を受け、世界のコモディティ価格が下落し、人的・物的資源が消耗しているからです。プーチン大統領はドニエプル川河口など、侵攻した地域を支配している限り、ウクライナを弱体化させるという目的は大部分達成したと見なすでしょう。 プーチンは征服地を固め、経済と社会を立て直す必要があります。早ければ早いほどロシアにとって有利であり、欧州がコンセンサスを形成して将来的に天然ガスの全面禁輸を実施するのを防げます。 しかしプーチンの野心が彼を破滅に導くリスクもあります。 我々は侵攻が南西ウクライナ（戦略的港湾都市オデッサを含む）やモルドバ東部に拡大する確率を35%と見積もります。モルドバでは親ロシア派が分離統治するトランスニストリア地域にロシア軍が駐留しています。 この新たなキャンペーンはウクライナを完全に内陸化し、モルドバを無力化し、ロシアにより大きな海上アクセスを与えるでしょう。しかしそれはEUを結束させ、天然ガス禁輸を誘発し、ロシアを弱体化させて絶望的な状況に追い込む可能性もあります。報復に出れば、広範な戦争につながることも考えられます。 フィンランドやスウェーデンがNATO加盟を試みたことでプーチンが攻撃する確率は7%にすぎないと見ます。スターリンはフィンランドに失敗し、プーチンの軍はキエフすら征服できませんでした。英国はこれらの国の支援を約束しており、攻撃はNATOとの戦争を引き起こす公算が大きいでしょう。フィンランド攻撃の決断はロシアがNATOがそこに基地を置く計画を立てていると本当に信じた場合にのみ生じるでしょう。つまりそれがロシアの宣言したレッドラインです。 バルト三国に対するロシアの攻撃は、それらが既にNATOに加盟しているため可能性は低いです。ただしプーチンが絶望的になれば起こり得るというリスクはあります。 我々はバルト侵攻のリスクを3%と見積もります。 要するに、ロシアが欧州に対するエネルギーの締め付けを停戦交渉で有利な合意を引き出すためではなく侵攻の拡大に使うなら、より広範な戦争の確率は上昇します。 結論： 結果として、今後24か月での鎮静化の確率は55%、小規模なエスカレーション（例：オデッサ、モルドバ）は35%、NATO加盟国を巻き込みNATOとロシアの戦争に発展する大規模なエスカレーションは10%です。 戦術的には、もし世界経済が回復しロシアが軍事作戦を中止して停戦交渉に舵を切る明確な転換を示すなら、先進国の欧州通貨および資産を買うべきです。景気循環的には、欧州資産で持続的な強気市場が実現するには米露間のより深い理解が必要です。 米国・イスラエルによるイラン攻撃の確率 今年起きている第三の地政学的危機は、バイデン大統領とアリー・ハメネイ師が2015年の米国・イラン核合意に再加盟することで当面先送りになる可能性があります。しかし我々は懐疑的です。 バイデン政権は2015年の核合意に再加盟して、イランの原油を日量約100万バレル市場に戻し、中間選挙前にガソリン価格を下げたいと考えています。米国のグランドストラテジーはまたイランと関与して中東を安定化させ、米国がアジアへ軸足を移せるようにしたいと考えています。 EUはイラン資源への需要がより大きく、イランの核獶取得を防ぎたいので合意を提案しています。ロシアと中国も対米制裁解除とイランとの貿易を望むため支持的ですし、必ずしもイランに核が持たれることを望んでいるわけではありません。 ただし一つ問題があります：イランは体制の長期的生存を確保するために核兵器を必要としている。 問題はハメネイが再び米国との合意を承認するかどうかです。最初の合意は彼の体制に大きな代償をもたらして裏切られました。近い将来ハメネイに代わって権力を握ることを望むエブラヒム・ライシ大統領は、自らのキャリアと個人の安全を2024年の大統領選の共和党勝利に賭けることには強く反対するでしょう。 イランは既に核ブレイクアウト能力を達成しています—核装置を構築できるだけの60%濃縮ウランを保有している—そして最終的に核抑止力を獲得しようとしない理由が不明です。特に将来的に米国やその同盟国からの軍事攻撃から体制を守る必要が生じる可能性があるためです。 ただし当社の確信度は中程度です。バイデン大統領は制裁解除を望んでおり一方的にそれを行うことができるからです。バイデン政権はいまだ合意を成立させるための予備的措置を講じていませんが、それは変わる可能性があります。3 短期的なつなぎ合意には好循環的な理屈があります。 BCAのコモディティ＆エネルギー・ストラテジスト、ボブ・ライアンによれば、サウジアラビアとUAEの間の予備生産余力は合わせて約150万バレルに過ぎません。EUの石油禁輸と西側諸国の対ロシア制裁は約200万バレル／日を市場から押し出すため、OPECの余力の大部分を吸収します。したがってバイデン政権はイランが市場にもたらし得る100万バレルを必要としています。 我々はイランが制裁解除を認める合意に署名し、バイデンに制裁解除を可能にする可能性を否定できません。それは彼らの経済に利益をもたらします。彼らは核査察を許容しつつ、密かに弾頭や弾道ミサイル開発に注力を移すかもしれません。イランは不可逆的に核計画を放棄するわけではなく、時間稼ぎに長けています。 それでもイランの国内政治は合意を支持しておらず、米国が提供できる信頼できる安全保障の保証がなければ、イランのグランドストラテジーは合意を支持しません。米国はその外交政策の一貫性の欠如からそのような保証を提供できないのです。米国のグランドストラテジーは合意が検証可能であれば支持しますが、イランが合意を口実に爆弾を追求するようなケースは容認しません。 イランは3年間の最大制裁、パンデミック、世界的混乱を経ても屈服していません。そしてロシアと中国が西側に攻勢をかけるようになったことで、戦略的利益を引き出す見通しがより大きくなったとイランは見ています。 モスクワと北京は対ワシントンの共通の不満のため戦略的パートナーになり得ます。一方で米国はルーハニ政権を裏切ったのと同じようにライシ政権を裏切ることも容易であり、その結果として経済は再び翻弄され、最高指導者と政治体制は国民から二重に愚か者と見なされるでしょう。 図表 3はイランの選択肢を整理しています。 図表 3 イラン核危機に関するディシジョンツリー（次の24か月） 五連発拳銃でのルーレット 五連発拳銃でのルーレット   交渉が決裂した場合（50%）、イランは米国とイスラエルが攻撃する前に核兵器確保へ向けて突進するでしょう。 米国とイランが合意に達した場合（40%）、イランは2024年の米国選挙まで合意の条件に従う可能性があり、当面は投資家の懸念材料が除かれます。しかし長期的に核抑止力を得ようとする利害は変わらず、2024年以降に紛争が再燃するでしょう。 協議が決着せず継続する場合（10%）、イランは合意の制約なしに核計画を漸進的に進めるでしょう（ただし突発的な突進を必ずしも必要としないかもしれません）。 要するに、ロシアと中国はイランが核計画を凍結してもイランを必要としますが、米国とイスラエルはイランを抑止するために勢力均衡のアブラハム同盟を形成するでしょう—たとえイランが核計画を凍結してもです。 結論： 投資家は短期的なつなぎの米国・イラン核合意に40%の確率を割り当てるべきです。原油価格の下落は一時的なものにとどまるでしょう。長期的な供給拡大は、米国がイランに不可逆的に核計画を停止させるのに十分な安全保障保証を提供できないため期待できません。 第三次世界大戦の確率 ここからが難しい部分で、これら3つの地政学的危機を合わせて考えます。以下では単純化しすぎていますが、異なるプレーヤーとその選択肢について我々の考えを形式化するのが目的です。 図表 4は中国／台湾紛争に関する結論から出発し、その結果としてロシアのより広範な戦争の確率を調整し、イランが核兵器追求に極めて積極的であるという見方を加えたものです。時間枠は再び2年です。 図表 4 第三次世界大戦に関するディシジョンツリー（次の24か月） 五発の銃を使ったルーレット 五発の銃を使ったルーレット   WWIIIとは異なる紛争シナリオとしては「限定戦争」があり—これは米国が関与しない、あるいは間接的にしか関与しないハイブリッド戦や代理戦争を指す危険な概念です。あるいはロシアと中国を巻き込まないイランとの紛争である可能性もあります。 我々は中国から議論を始めます。なぜなら中国は現代で最も有能で野心的なグローバルパワーだからです。中国の戦略的台頭は世界秩序を揺るがし米国に挑戦しています。また今年のいくつかの証拠から、ロシアは戦争をウクライナ外に拡大する意図を持っていない可能性が示唆されていることも理由です。 中国が台湾に対してさらなる攻撃的行動を取れば、ロシアがより大きなリスクを取るユニークな機会が生まれます。そうでない場合、WWIIIの確率は2年間で急落します。これが我々のベースケースです。 しかし中国が台湾を攻撃し米国が台湾を防衛する場合、我々はロシアがバルト三国に侵攻する確率が高まると見ています。もし中国がハイブリッド攻撃を行い米国が台湾を間接的にしか支援しないなら、ロシアの攻勢の確率はわずかにしか上がりません。 結果として、WWIII（米国がロシアまたは中国、あるいは両者と直接戦う戦争）の確率は20%になります。こうした戦争が限定的に留まるかどうかは議論の余地があります。1945年以降の戦争ゲームは、主要核保有国間の戦争はエスカレートしやすいことを示しています。しかし核兵器は相互確証破壊という究極の制約をもたらします。核エスカレーションのリスクがあるため、我々はディシジョンツリーにおけるWWIIIの確率を下方に丸めています。 より確からしい59%の「限定戦争」シナリオは一見ポジティブな結果のように見えるかもしれませんが、そこには今日の水準からの地政学的緊張の大幅な上昇、例えば中国の台湾に対するハイブリッド戦などが含まれます。 結論： この試算ではWWIIIの確率は最大20%に達し得ます。これは我々のロシアに関するディシジョンツリーの水準の倍であり、当社の台湾危機の予測が現実化したことを考慮すると妥当です。 重要な要因は、今秋の党大会後に北京が台湾への圧力をさらにエスカレートさせるかどうかです。それが危険な連鎖反応を引き起こす可能性があります。 世界経済と金融市場は地政学的リスクからの下振れリスクを依然として抱えていますが、ロシアが停戦に向かい、中国が台湾への行動を遅らせて経済再起動に集中する場合、2023年には改善が見られる可能性があります。 投資の示唆 今年初めにロシアがウクライナに侵攻した際、当社の同僚であるチーフ・グローバル・ストラテジストのピーター・ベレジンは核による破滅の確率を10%と主張しました。 少なくともこれはロシアとNATOが衝突する確率として合理的な数値です。 今や予想された台湾危機が現実になりました。我々は主要な戦争の確率が20%へと倍増したと推定します。 逆に言えばより良い結果が起こる確率は80%です。分析的には、我々は依然としてロシアが限定的な目的—ウクライナを繁栄や軍事的に強大にさせないよう弱体化する—を追求していると見ており、中国も限定的な目的—台湾を国家たる存在としてではなく従属へと向かわせることで威嚇する—を追求していると見ています。 これらの目的が変わらない限り、我々はまだ第三次世界大戦からは遠いと考えます。 世界は不活化されたウクライナと従属した台湾と共存できます。 しかし否定できないのは、2008年のグローバル金融危機以降の世界情勢の軌跡が第二次世界大戦前の道筋と不快なほど似ているということです：金融危機、経済後退、デフレ、国内不安、通貨切り下げ、貿易保護主義、債務の貨幣化、軍備増強、インフレ、そして侵略戦争。ルーレットがゲームなら、世界戦争の確率は6分の1、すなわち17%であり、我々のディシジョンツリーの20%という結果に近い数値です。 我々が仮に大げさであるとしても、WWIIIの確率が20%に達すると論理的に主張できること自体が、投資家が現在のウクライナと台湾をめぐる緊張が低下するまで大きなリスクを取るのを待つべきであることを示唆しています。 簡単なチェックリストを見ると、グローバルマクロと地政学の文脈は陰鬱です（表 1）。チェックリストの改善が見られるまでより楽観的になるのは控えるべきです。 表 1 2022年下半期にポジティブな触媒は多くない 五発の拳銃を使ったルーレット 五発の拳銃を使ったルーレット     チャート 2 2022年下半期は防御的ポジションを維持 2022年下半期は防御的なポジションを維持する 2022年下半期は防御的なポジションを維持する 具体的には、投資家はロシアがNATOに拡大しないこと、そして中国が当面台湾を侵攻しないことに合理的な安心感を持つ必要があります。 これはワシントンとモスクワ、ワシントンと北京の間で紛争を回避する新たな外交的理解を要求します。 そのような理解は危機の中でしか築かれません。関連する危機は進行中ですがまだ完了していません。 通常の解決策である外交を通じて戦争リスクが払拭されるまで、グローバル株式にはさらに下振れリスクがある可能性が高いです。 世界システムの具体的かつ信頼できる改善が見られるまで、リスク資産に対して一般的なオーバーウェイト姿勢を取るのは控えましょう。株より政府債券を重視し、グローバル株より米国株、景気敏感セクターよりディフェンシブ・セクターを好み、中国・台湾の通貨と資産は評価を下げることを推奨します（チャート 2）。     マット・ガートケン チーフ・ジオポリティカル・ストラテジストmattg@bcaresearch.com  脚注 1      記：Graham Allison、Destined For War: Can America and China Escape Thucydides’s Trap?（New York: Houghton Miffin Harcourt, 2017）。 2     例えば、オデッサからの穀物輸送に関するトルコ仲介の合意、2015年イラン核合意への再加盟を支持する外交的動き、ヘルソンのような征服地での住民投票、軍縮交渉での影響力強化の試みなどです。欧州のエネルギーを断つことは最終的に欧州を停戦に有利な条件で妥協させるための圧力手段です。 3     イランは依然として余計な要求を出しています—最近ではIAEAがイランの未公表の核施設で発見された特定の人工ウラン粒子の出所を調査している件を取り下げるよう要求しました。IAEAはこの調査を取り下げておらず、取り下げればIAEAの信頼性が損なわれます。一方でバイデンは制裁を強化しており、制裁解除はイランの主要な要求です。バイデンはイラン革命防衛隊やイQods部隊をテロ指定から外していません。これらのハードルは決定的ではありませんが、我々の見方を変える前に何らかの進展を見るべきだと考えます。 戦略テーマ オープン・タクティカル・ポジション（0～6か月） オープン・サイクリック推奨（6～18か月） 地域別地政学リスクマトリックス 「打率」：地政学ストラテジーの成果（）

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

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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