Eyeing China’s Response to US Policy
What happened last week?
After a second presidential debate, news coverage of the US election is set to heat up further in coming weeks. The temperature is set to “boil.”
In matters such as foreign policy and regulation, the differences between candidates Harris and Trump shouldn’t be minimized.
With Federal Reserve interest rate cuts coming and a very strong US dollar as a starting point, the pressure to “absorb pain” is absent. And once feared as a “ticking time bomb,” China’s holdings of US Treasuries have diminished to less than 3% of US borrowing.
While its financial linkages to the world remain very limited relative to its size, its impact on global trade and corporate profits remains enormous.
3 Things to Know
Election Uncertainty to Weigh on Investor Sentiment
Even after the Harris/Trump debate, current US presidential polling shows a close race.
The much larger number of Senate Democrats facing re-election in November than Republicans (roughly 3 to 1) suggests a higher probability of a Republican “red sweep” if Trump wins the presidency than if Harris wins for Democrats.
One prediction market shows an 80% chance of a Republican Senate win. However, polling data also suggests a solid chance that the closely divided House of Representatives swings to Democrats. In short, we see the chance of a divided government of some sort (with either house of Congress or the Presidency differing in party) at slightly above 50%.
A divided government would be forced to compromise on US fiscal issues that demand attention, limiting the scope for aspirational changes.
Policy Changes May Be Muted
It would take an act of Congress to raise corporate taxes, dividend income taxes or put new wealth taxes into place.
Using so-called “reconciliation procedures,” a unified government could approve such changes without a filibuster-proof super-majority of 60 Senate votes.
Yet since the chance of a Democrat “blue sweep” seems quite low even if Harris wins the Presidency (see above), we see the probability of any new forms of taxation or radically higher tax rates as low.
China’s Response: To Look and Invest Within
China’s economy may now be performing worse than official data suggests. Survey data suggest that industrial production is slower than the reported 5%.
Deep property declines and weak manufacturing suggest fixed investment might be negative, rather than the 2% pace reported. Retail sales growth at 2.7% also seems high compared to the unemployment rate and confidence measures.
This could also mean that we’re closer to action from officials. Real GDP growth of 4.7% Y/Y in 2Q shows weak momentum with more action needed to restore growth to meet the 5% target.
But it is important to understand why China has taken the policy steps that it has over the past few years. It’s been a reaction to perceived domestic social threats to stability and external concerns about security.
A side effect of China’s priority shifts is US and broader western disapproval of China’s direction. This has clearly accelerated as China became more assertive in foreign policy. In terms of polarization, it appears the US may not accept a compromise that the Chinese government is willing to make as sufficient to de-escalate.
With the above understanding, it is easy to see why China had chosen industrial capacity building as a way to both ensure self-sufficiency and to counteract western containment. This does nothing to alleviate deflationary pressure in China’s economy, which it is exporting (if marginally) to the world.
See our weekly CIO Strategy Bulletin for more details