Trump Signs HK Bill, China Vows to Retaliate. What's Next?

US President Donald Trump has signed the Hong Kong Human Rights and Democracy Act of 2019 into law. He also signed another bill banning the sale of ammunitions including tear gas and rubber bullets to Hong Kong police. A move that is sure to complicate ongoing trade negotiations and anger Chinese officials against the backdrop of an already fraught relationship between the US and China.

The bill, though largely symbolic in nature and somewhat toothless, stipulates annual reviews of Hong Kong’s special trade status and sanctions officials engaged in human rights abuses. But the problem is that for Beijing, this bill is viewed as interfering with internal affairs and they have previously threated to retaliate should the bill be signed.

This threat has again been reiterated today but lacked details of retaliatory proceedings with China saying the move to sign the bill violates international laws and aims to damage the practice of "one country, two systems,". A representative from the Ministry of Foreign Affairs tweeting, “US is a complete bully. Holding high the banner of "America first", it is only thinking about taking advantage of others. It raises tariffs whenever it likes. It abuses the monopoly status of US dollar while imposing unilateral sanctions & long-arm jurisdiction at every turn.”

As the news that Trump had signed the bill into effect broke this morning US futures and Asian indices exhibited a sharp risk off move, the yuan slid and yen, gold and treasuries were bid, despite US stocks making fresh record highs overnight. Despite China’s vows to retaliate the yuan fix, a key barometer of tensions between the two sides, was in line with estimates and raised by 78 pips relative to yesterday’s fix. Perhaps signalling that Beijing’s bark may be worse than their bite on this occasion.

Although there is no doubt this move will aggravate Beijing, congress essentially had a veto-proof majority and Trump had little choice but to sign the bill as it passed through the House on a 417-1 majority. The landslide win for pro-democracy candidates in Hong Kong earlier this week should also help US trade negotiators persuade Beijing that the bill shouldn’t derail ongoing negotiations as Trump’s hands were tied and that Hong Kong should be a separate issue to the interim deal. But as always this is further evidence that a partial/interim deal will only provide temporary relief from long-term bilateral tensions.

If US trade negotiators can persuade Beijing that the bill shouldn’t derail ongoing negotiations, although a bitter cup to drink, delaying the December 15^th tariff hike could soften the blow for China. But given the recent rally in risk assets markets have priced in a great deal of hope and optimism around trade with equity markets largely priced for a phase one deal to be signed. This added uncertainty will see some of that complacency unwind somewhat, particularly given the shortened Thanksgiving trading week which likely sees traders eager to lock in some profits and wait to see how the story develops.

The key risk being that if China does retaliate and tie the Hong Kong bill to the partial trade deal, liquidity is thin given the shorter trading week, the VIX is compressed, a lot of optimism is priced, and valuations are stretched as equities have been fuelled by trade hope and multiple expansion not economic realities. Meaning a ratcheting higher in tensions could see some sharp downwards moves. Any Q4 2018 style meltdown would likely be avoided as we are dealing with a different Fed, rate hikes are no longer on the table and they have already kowtowed to the markets demands for liquidity. Not just the Fed, but globally central bankers have taken an accommodative stance. In Australia the RBA have delivered three rate cuts to date and we expect further easing will be delivered.

Given both the US and Chinese economies are now more visibly slowing than when talks broke down previously, there seems to be impetus on either side to close a partial deal so our base is that the signing of the Hong Kong bill will not derail negotiations. There is enough low hanging fruit to put together a watered-down deal, despite our long-held notion the two sides remain far apart on fundamental issues. We still maintain that China will concede little that is not within their own self-interest and the broad reaching core issues will remain unaddressed. However, an olive branch from Trump that defers the December 15^th tariffs and a few more tweets about how imminent a deal is, likely sees dip buyers step in and risk off moves reversed.

Medium term we still maintain that growth continues to be buffeted by both cyclical and geopolitical headwinds, despite nascent signs of stabilisation. But this is not currently driving the tape action in markets. Improving sentiment has largely been propelled by “less bad news” and the Feds liquidity injections, but incoming data shows the synchronised global slowdown has persisted into Q4 and leading indicators are still deteriorating. OECD leading indicators remain weak across the globe highlighting that the recent stabilisation across manufacturing PMIs could be a false flag and it is too early to sound the all clear. When we cut through the headlines, it is clear the global economy continues to slow but the downdraft may be stabilising, so now is the time to be avidly data dependant. Whilst also remembering, a trade deal will not save late cycle dynamics from materialising. For the global economy to truly benefit from the any trade deal there needs to be a revival in animal spirits that reignite capex and manufacturing, thus arresting the bleed into the services sector where the bulk of employment sits. For that to happen there must be a comprehensive deal that covers a roll back of tariffs, removes uncertainty and reignites business confidence.