Why China-Taiwan tensions came to the forefront of financial market concerns

It is an island off the coast of China, with a land area comparable to Maryland and Delaware combined. Its population is about 1 million higher than that of Florida.

Often overlooked in global headlines, Taiwan is capturing financial market attention as the biggest macro risk of the day, leading many traders and investors to turn away from worries about recession, inflation, central banks and Russia’s war against Ukraine. The focus is on the speech by US President Nancy Pelosi. visit to taiwanwhat is triggering fears of retaliation by the island’s giant neighbor, China.

Earlier on Tuesday, global stocks sold off on geopolitical tension as investors rushed to the safety of US Treasuries and traders revised their positions across assets. After Pelosi’s plane landed safely in TaipeiIn Taiwan’s capital, market sentiment appeared to improve in the stock market, with the S&P 500 index and the Nasdaq Composite rising.

“Macro investors have been counting on the reopening of China to stabilize positions,” said Jim Vogel, Memphis-based executive vice president and interest rate strategist at FHN Financial. They have reduced equity allocations and relied on floors for commodity prices, as well as limits on downward price action in fixed income.

Now, however, relying on China “as an engine of international growth is unreliable,” Vogel wrote in a note on Tuesday. Furthermore, China’s intentions towards Taiwan “have been obvious and threatening for years,” and the narrative between the two “will not go away for years.”

Pelosi is the highest-ranking US politician to visit the island of Taiwan in 25 years, when then-President Newt Gingrich arrived in 1997.

On Tuesday, nervousness first surfaced in Asian markets, which were “unsettled” Tuesday morning amid fears China’s military planes “might buzz into Pelosi’s plane,” said Greg Valliere, senior strategist. head of US policy at AGF Investments. Valliere described the possibility of a mistake on either side as “pretty serious.”

Chinese President Xi Jinping is seen by intelligence experts as needing a “diversion” from his country’s struggling economy and trying to recover from “exceptionally harsh” COVID restrictions, according to Valliere. At the same time, China’s president “cannot afford to appear weak” as he seeks a third term in office later this year.

Meanwhile, Beijing sees Taiwan as a threat, given the health of the island’s economy and personal freedoms. Taiwan is generally considered to be the most democratic place in East Asia. Pelosi’s visit will have a “major” impact, resulting in a further deterioration in US-China relations, “with little hope of a reconciliation on trade,” the AGF strategist said.

Frantic traders had been tracking every move of Pelosi’s plane on the popular flight trackers, and it was the flight-to-safety sentiment that sent bond yields lower earlier on Tuesday, according to Ben Emons, managing director of global macro strategy at Medley Global Advisors in New York. He described the bond market moves as the result of “the Nancy Pelosi rampage.”

According to senior analyst Neil Thomas and others at the Eurasia Group, a New York-based consulting firm, “Pelosi’s visit will significantly increase tensions between the United States and China, but it is unlikely to produce a Chinese reaction that could generate a conflict”.

Eurasia Group sees “a 25% chance of a major security crisis, such as a protracted military confrontation between the United States and China that threatens further escalation,” they wrote in a note. Still, Beijing could order additional air and naval military exercises, could sanction the US delegation and freeze bilateral exchanges, and has the potential to consider boycotts and sanctions on Taiwanese and US businesses, he said. the consultant.

On Tuesday, the main US stock market indices DJIA,
-0.78%

SPX,
-0.31%

comp,
-0.06%
mixed up late in the morning trade. Meanwhile, investors sold government bonds, sending yields higher across the board in a reversal of Tuesday’s previous bond rally.

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