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DBS economists predict new 'cold war' between US and China

Ng Qi Siang
Ng Qi Siang • 6 min read
DBS economists predict new 'cold war' between US and China
As the US-China bilateral relationship spirals into greater acrimony, investors brace themselves for a new Cold War.
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SINGAPORE (May 26): Three decades after the fall of the Berlin Wall, DBS Group Research’s economists have predicted the impending outbreak of a new ‘cold war’, with US-China relations sinking further into suspicion and acrimony.

DBS economist Taimur Baig sees the US-China relationship as increasingly entering the realm of a zero-sum rivalry for dominance as opposed to healthy, win-win competition. Renewed political unrest in Hong Kong, he warns, could see tensions a further escalation of tensions as Beijing seeks to suppress dissent in the Special Autonomous Region and project power abroad.

Such dire predictions came following Beijing’s passage of a new National Security Law for Hong Kong at this year’s National People’s Congress (NPC) plenary session. Seeking to control pro-democracy protests in the city, the act has invited renewed protests in Hong Kong and condemnation from Washington amid growing hostility between both great powers.

“The United States condemns the People’s Republic of China (PRC) National People’s Congress proposal to unilaterally and arbitrarily impose national security legislation on Hong Kong,” declared US Secretary of State Mike Pompeo. “We stand with the people of Hong Kong.”

Recovering investor confidence following the easing of lockdowns has been dampened by the recent developments in Hong Kong, especially with Washington threatening to remove the city’s special trading privileges. Despite a modest drop in US yields with the 10-year tenor now at 0.66%, DBS analysts Eugene Leow and Duncan Tan see market pessimism being confined to Hong Kong markets, with HIBOR remaining elevated relative to LIBOR for an extended period.

With US elections set for November 2020, it is in the interests of the Trump administration to ramp up tensions with China to divert attention away from its disastrous handling of Covid-19. With a Pew Research Centre survey showing that two-thirds of the US population now have a negative view of China -- the worst result since 2005 -- this message could prove effective in energising support for Trump in the Rust Belt, where anti-China sentiment is well-received.

“Nobody in 50 years has been weaker on China than Sleepy Joe Biden. He was asleep at the wheel. He gave them everything they wanted, including rip-off Trade Deals. I am getting it all back!” tweeted the US president against his prospective political opponent. Biden himself had also called for the US to get tougher on China, a rare point of bipartisan agreement in an increasingly polarised country.

Washington has since begun taking a tougher line against US technology firms, with theUS Bureau of Industry and Security (BIS) announcing rule changes to restrict Chinese tech giant Huawei’s ability to use US technology and design for semiconductor manufacturing.

Owing to the important role that US technology plays in the fabrication process, Bank of Singapore’s Eli Lee and Conrad Tan anticipate that this could severely damage Huawei’s business in 2021. The White House has moreover pressured US firms to reroute supply chains from China and may pass an Executive Order targeting pharmaceutical supply chains.

Additionally, the US has passed regulations making it harder for Chinese firms to list in the US. On May 20, the US senate passed the Holding Foreign Companies Accountable Act, which requires foreign companies listed in the US to disclose if they are owned or controlled by a foreign government and forbids firms failing such an audit three years in a row from listing. Chinese regulations do not currently allow audit documents to be removed from the country for examination by foreign regulators.

“If the Holding Foreign Companies Accountable Act is passed into law, we see this as a negative development over the long term as it could make new IPOs of Chinese ADRs more difficult, especially for unprofitable companies with a short operating history,” say Lee and Tan, who note that some ADRS could potentially be delisted as a result of the new act. Chinese firms may also make secondary listings abroad, with Hong Kong likely to be the main beneficiary.

Still, the analysts say that short-term impacts of this policy are likely to be minimal. Besides the three-year time frame for compliance, US institutional and retail investors are also likely to suffer collateral damage, necessitating a more gradual rollout of delisting. Lee and Tan estimate that one third of Chinese ADR equities worth about US$350 billion (S$497.4 billion) are held by US investors -- nearly half of their Chinese equity holdings.

These moves will make already fraught US-China trade negotiations more tense, say Lee and Tan. While China successfully implemented Phase 1 trade deal obligations to avoid currency manipulation, enhance IP protection, end forced technology transfer, and liberalise its financial sector, the Covid-19 shock has made it difficult for China to meet purchase targets of US goods. China, they expect, may seek to renegotiate the deal in light of present circumstances.

These geopolitical risks have put increased foreign exchange pressure on the Chinese Yuan (CNY), with its mid-rate set at a new high of CNY7.1209 since 2008, with DBS’s Philip Wee noting that the USDCNY has been holding a 2% band around 7 after the second tariff war last year. Beijing’s unwillingness to implement economic stimulus as yet may offset CNY weakness.

“In periods when US-China tensions flared up, the currency traded higher than its implied level – incorporating various trade war-related risk premia. Although tentative, this divergence has re-emerged as frictions between the US and China have made a comeback,” comments Lombard Odier’s FX team. They have raised USDCNY predictions to a possible 7.05 -7.10 level to account for risk premiums from growing geopolitical tensions, though economic recovery in China, restraint in trade disputes and foreign capital inflows as potential drivers of CNY strength.

Nevertheless, such tensions have not had much of an impact on US offshore bond markets, which have actually improved in spite of growing the acrimony. Impact on risk assets -- including offshore Chinese credit -- have remained relatively stable due to both sides continuing to honour the terms of the trade deal. Firmer secondary market pricing and a recovery in primary issuance highlights more optimistic sentiments on offshore Chinese assets, with high-yield credit becoming increasingly accessible amid heightened global risk, says Chang Wei Liang of DBS.

Still, Lee and Tan warn that US-China rivalry could prove a powerful headwind against post-Covid-19 economic recovery in Asia ex. Japan, with global equities falling 20% in 4Q18 with the advent of US tariffs on Chinese imports. With interest rates likely to remain at “ultra-low” levels for some time, they expect demand for emerging market high yield assets to remain strong over the long-term, with Asian high-yield likely to be an attractive prospect for investors.

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