[Good Morning Stock Market] Will US-China Conflict Diminish Economic Recovery Expectations?

US-China Tensions Intensify Over 'Hong Kong Issue'
Economic Activity Optimism May Shift to Caution
However, Fed's Additional Interest Rate Cuts Likely Limited

[Asia Economy Reporter Minji Lee] Following China's forcible passage of the Hong Kong National Security Law, tensions between the United States and China have reached a peak. Trump announced that he would begin the process of revoking Hong Kong's special status as a retaliatory measure, while China has labeled the U.S. actions as interference in internal affairs and warned of further retaliatory measures. Meanwhile, major U.S. economic indicators to be released this week are expected to come in below market expectations, potentially dampening hopes for economic reopening.

[Image source=Yonhap News]

◆ Jinhyeok Na, Researcher at Hana Financial Investment = The financial market is placing greater emphasis on global policy coordination and expectations for the resumption of economic activities rather than concerns over the economic shock caused by COVID-19. However, the results of key U.S. economic indicators this week could shift this optimism toward caution over the slow economic recovery.

Recently, China's National Bureau of Statistics announced that the May Manufacturing PMI recorded 50.6, significantly below the market consensus of 51.5. This suggests that the conflict between the U.S. and China, exacerbated by the COVID-19 blame game and the Hong Kong National Security Law, may negatively impact the recovery of manufacturing conditions.

Accordingly, the May ISM Manufacturing Index scheduled for release this week is likely to fall short of the already low expectation of 43.7. Considering the weak Chinese PMI, the sharp drop in the University of Michigan Consumer Sentiment Index's future expectations, and the Chicago PMI shock for the same month, concerns are growing that the rebound in the manufacturing index compared to the previous month (41.5) may be limited.

Additionally, the Bloomberg consensus for the U.S. Department of Labor's May unemployment rate and nonfarm payrolls to be released this week predicts a historic worst result of 19.6% unemployment and a loss of 8 million jobs. Following the employment shock in April, the Atlanta Federal Reserve had already downgraded the Q2 U.S. GDP forecast to -34.9%, but last weekend it further slashed this figure to -51.2%.

The bigger issue is that the sharp conflict between the U.S. and China could change market sentiment. This could spread from a Q2 economic bottoming scenario to a Q3 earnings downgrade narrative.

◆ Yeosam Yoon, Researcher at Meritz Securities = The conflict between the U.S. and China centered on the Hong Kong National Security Law is intensifying, and the European economy is failing to gain momentum despite policy stimuli. Corporate bankruptcy filings are increasing, and concerns in emerging markets are rising. At this point, even a small crack could cause risk assets to falter again.

Although risk asset preference is maintained as major countries including the U.S. resume economic activities, the renewed U.S.-China tensions are supporting bond purchases, a safe asset, despite low interest rates. News that President Trump is at a disadvantage in this year's U.S. presidential election polls is likely to trigger political instability going forward. The market generally assesses that, except for Asian countries such as China and Korea where COVID-19 is being controlled quickly, it is still too early to talk about economic improvement.

Nevertheless, I do not expect further interest rate cuts by the Federal Reserve. The slight rebound in the New York Fed's economic activity index and the Citi Global Economic Surprise Index signaling economic activity improvement are noteworthy. These factors reduce the likelihood of additional rate cuts. Recently, the Fed's daily Treasury purchases have decreased significantly to $5 billion compared to March, and Fed Chair Powell has expressed a negative view on implementing negative federal funds rates. Global interest rates are expected to reach a turning point around July.

It is also important to consider that the current situation is not severe enough to break the initial trade agreement. We need to recall the learning effect that last year's trade dispute ultimately ended in an agreement.