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  • Max Gnesi

The 3 Pivots (3Ps)

Ruminations on emerging Inflection Points

Over the past few months and weeks, the market has been focusing on downside risks. Several market indicators have been flashing the rising probability of a US recession and a global economic downturn. The US Dollar shortage has become evident and the market has been often scrambling for collateral. In addition, the more recent data on the real estate sector, not only in the US but in several major economies, are also starting to provide evidence that the housing market is beginning to cool off.


In this post, I would like to focus, instead, on a few inflection points in the trajectory of the current policy which could be the catalyst for a turnaround in market sentiment over the medium term: the FED's Pivot, the China Pivot and the G-20 in Bali Pivot. It would be great to hear the readers' and subscribers' feedback on how likely are these scenarios to materialize. Guys, you can use the comments section below to post your considerations.


The Fed's Pivot

Over the past few trading sessions, the market narrative has been slightly changing. Price action is now starting to give some credibility to the Fed's pivot. This view seems to be corroborated by some recent statements by a few Fed officials. Even Jim Bullard, the St. Louis Fed perma-hawk, after advocating for a front-loading of rate hikes this year, seems inclined towards a pause holding on to a terminal rate of 4.75%-5%, for at least a few months. This would allow the FED to observe the lagged effects that monetary policy will have on the trajectory of the incoming data. Besides, yesterday's surprise decision by the Central Bank of Canada to slow down the pace of hikes to 50bps coming short of calls for another 75bps move has been fueling hope that a Fed's Pivot is now imminent. Today, the ECB, as well, despite delivering another 75bps interest rate hike and leaving on the table another big rate hike for December, sounded dovish at the press conference. The European central bank believes it has already made substantial progress toward normalization, implying a slower pace going forward. Lagarde also emphasized significant downside risks to growth and last but not least she signaled that QT is not going to happen anytime soon.

It is perfectly understandable that BoC - as we can see from the chart above - is taking a dovish turn as it has been one of the most aggressive central banks, in the advanced economy complex, to ramp up the fight against inflation. But the fact that also the ECB is signaling that they are getting closer to the neutral rate, seems to me like a coordinated effort - now coming from different angles - to slow down the fight on inflation. Do they know something that we don't?


However, a second-order consideration on a potential Fed's Pivot is: what does pivoting exactly mean? A Fed's pivot does not necessarily mean that they are done with hiking. And it does not mean that the next move is slashing interest rates. That's certainly a possibility, but it will depend on the developments in the unemployment and inflation data. For me, that means that the market will remain volatile especially if the data will provide a mixed bag of information as it will be unlikely to see a quick turnaround in the inflation data.


China Pivot

I am picking up on this from a recent podcast by Louis Gave from Gavekal. I found his arguments convincing and that's interesting food for thought while planning the next trading and investment actions. The China pivot has two dimensions. The first is related to a scenario where Xi-Jinping is relaxing the zero-covid policy. The second is more long-term and it is related to a shift in focus from the "Economy and Reforms" toward "Security & Technology". The recent 20th Communist Party Congress, which saw Xi-Jinping tightening his grip on power, could be the catalyst for an inflection point in policy. Xi could relax the zero Covid policy and take the necessary steps to reignite China's growth, especially in those sectors that are now becoming strategic: Security, Technology, and above all Semiconductors.


The message is shifting. But How?

A recent article, published by Bloomberg, analyzes the frequency of certain buzzwords in Xi's last report to the Communist Party in Beijing. Xi-Jinping mentioned "security" 91 times compared with 55 mentions in his last report 5 years ago. The word "Economy" appeared 60 times this time. It is the first time that the focus on economic development has been eclipsed by the concerns over Security

Source: Bloomberg


The Chart above, with data compiled by Bloomberg, shows how this shift has been underway for decades but it is significantly accelerating under Xi's leadership. The other key element of Xi's vision is the relevance of Technology. As we can see in the chart below, compiled by Bloomberg, the buzzword "Technology" has been employed over 40 times and that's a significant spike compared to the past Party Congresses.

Source: Bloomberg


Semiconductor Supremacy

China has been pursuing self-reliance on core technologies for a long time and is now expected to intensify the effort after Washington has been recently passing the "BIS Rule". This new legislation is significantly expanding US restrictions on exports to China of semiconductors, and supercomputer manufacturing. The US has always been restricting exports to China of semiconductors, but the new legislation seems to be finely calibrated to set a clampdown on the advanced chips, which China cannot manufacture itself. Furthermore, the new law is comprehensive and it covers four important areas. First, it prohibits the export of the most advanced chips to China. Second, the new regulation limits the export of the software, equipment, and components China would need to establish a sovereign advanced semiconductor manufacturing capability. Third, Americans with specialist skills are limited from working with Chinese entities. Fourth, the US extends extraterritorial controls on all advanced chip manufacturers outside the US. In response to this, China seems to be willing to take up the challenge and put a lot of effort to play catch-up in the production of cutting-edge technology in the semiconductor space. This is now the top priority for Beijing and it is probably the key element of friction in the Trade War between the US and China.


The End of Zero-Covid

I don't have enough grasp on Chinese politics to gauge what the exact agenda behind the zero-covid policy is, and what is the probability of the scenario, where China finally relaxes the restrictions related to this policy. But I can imagine that this is possibly not a zero-probability event and the ramifications can be significant. The first set of consequences could be related to further easing the supply-side bottlenecks. While the second set of consequences could be that the end of covid-related restrictions could unleash Chinese demand domestically but also abroad.


On the supply side, this policy pivot would ease inflationary pressures, but the boom in demand would certainly add to inflationary pressures not only in the energy space, where China is currently demanding over a million barrels per day less compared to pre-Covid levels, but it could also spur inflationary pressure on goods and services, complicating somewhat a potential Fed's pivot. On the balance, I would not be surprised if the end of the zero-covid policy, especially at this stage, could add to inflationary pressures over the medium term. The impact could be visible, especially on the sticky components of inflation.


Market Implications

The market response to the end of zero-covid could be positive for basic materials, energy, and more broadly for the emerging market complex. On the interest rates side, the market could initially focus on the effect that the easing of the bottlenecks on the supply side. However, in the medium term, growing demand for energy, goods, and services could reverberate in more sticky inflation than anticipated.


On the other side, the long-standing ambition to become a leading semiconductor superpower implies that there will be certainly a limited budget to stabilize the real estate crisis. I am still convinced that China needs still need to resolve the turbulence that has gripped the entire sector. It cannot risk that the real estate shock turns into a full-blown banking crisis, however, it is hard to believe that the government will now spend billions to save the sector like it did in the past.


G-20 Bali Summit Pivot

The 17th G20 Heads of State and Government Summit will take place on the 15th-16th of November in Indonesia. The lead-up events to the G20 summit have not been smooth. The G20 finance ministers' meeting failed to produce a joint communique while July's G20 foreign ministers meeting was boycotted by the G7 countries. But given the bar for talks is so high and given expectations of a productive outcome are so low, I think any diplomatic progress could bear great significance. I believe that there is a growing convergence of interest in finding a common ground. The US is currently fighting on too many fronts. First of all the US is engaged in providing military intelligence and weapons in the Russia-Ukraine war. Secondly, it has been escalating tensions with China just passing a few weeks ago sweeping legislation, restricting semiconductors export to China. Last but not least, J. Biden has been recently trying to resurrect the NOPEC Bill, which authorize the US to apply its anti-trust law and sue OPEC member and their national oil companies for anti-competitive business practices. This was after the US administration lobbying failed to prevent OPEC+ to cut production. It looks like the US will have to scale back on at least one or two fronts. This is probably something to pay attention to.

If the de-escalation of geopolitical tensions comes together with more dovish central banks, the market squeeze could have legs.


Disclaimer

All views expressed on this site are my own and do not represent the opinions of any entity with which I have been, am now, or will be affiliated. I assume no responsibility for any errors or omissions in the content of this site and there is no guarantee for completeness or accuracy. The content is food for thought and it is not meant to be a solicitation to trade or invest. Readers should perform their investment analysis and research and/or seek the advice of a licensed professional with direct knowledge of the reader's specific risk profile characteristics.



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