Global financial markets whipsawed, with stocks rebounding from an earlier slide and Treasuries wiping out their rally as U.S. House Speaker Nancy Pelosi’s Taiwan trip failed to further undermine risk sentiment.
In a session of many reversals, the S&P 500 erased a drop of almost 1% amid a tech rally. A gauge U.S.-listed Chinese shares climbed 2.5%. Ten-year U.S. yields hit 2.7%, following a slide that drove them to around 2.5%. The Japanese yen slipped after touching a nearly two-month high. The yuan rose. Gold pared gains significantly, while still trading near a four-week high.
“As soon as she landed safely the market took off,” said Jay Hatfield, founder of Infrastructure Capital Advisors, referring to Pelosi’s arrival in Taipei.
While there are few signs China is planning a full-scale invasion of Taiwan, Beijing has responded to past visits by foreign officials with large sorties into Taiwan’s air defense identification zone or across the median line that divides the strait.
China condemned Pelosi’s visit and announced it would conduct missile tests starting on Tuesday night. Beijing also announced military drills in different areas surrounding the main island of Taiwan from Aug. 4 to Aug. 7.
Pelosi’s trip is creating a fresh pressure point for investors already dealing with the prospects of a US recession, worldwide rate hikes and surging inflation.
The moves so far suggest traders are hedging against tension escalating, with analysts warning of the tailrisk of a conflict between the world’s two largest economies that wreaks havoc on global markets.
“China will show her displeasure by ratcheting up retaliatory actions, but it won’t get out of hand given its economy is weak,” said Rajeev De Mello, a global macro portfolio manager at GAMA Asset Management in Geneva.
“However, the risk is if there is any military ‘incident,’ which could lead to an accidental military escalation, which would stress global financial markets.”
While the White House has sought to dial back rising tensions by insisting there is no change in its position toward Taiwan, which China considers as part of its territory, Beijing has called Pelosi’s visit a “dangerous gamble” with grave consequences.
Equity markets in China and Hong Kong were the worst performers in Asia as security analysts outlined potential military responses from Beijing.
The Taiwan dollar hit its lowest since May 2020, before paring the drop on signs that local banks were selling the greenback to meet the needs of foreign funds. One-month non-deliverable forwards for the currency fell the most since June 14 on an intraday basis.
Some analysts warn the impact of Pelosi’s visit will hasten the deterioration in U.S.-China ties. The concern is that the trip and China’s reaction to it worsens the longer-term relationship on trade, and plays out in markets over weeks or more, with implications for Treasuries, according to BMO Capital Markets strategists Ian Lyngen and Benjamin Jeffery. Yields on the 10-year benchmark may well drop below 2.5% this week, they wrote in a report.
Pelosi became the highest-ranking American politician to visit Taiwan in 25 years, prompting China to announce military drills encircling the island. In a statement, she said her visit “in no way contradicts longstanding United States policy” and that America “continues to oppose unilateral efforts to change the status quo.”
“The expectation is that China’s reaction will mostly be confined to some signaling actions, instead of something really hurting their economy, and therefore at this stage, we view the market’s reaction has so far been relatively mild,” Becky Liu, head of China macro strategy at Standard Chartered Bank Plc, told Bloomberg Radio. “We just need to be concerned about the medium-to long-term implications.”
U.S.-listed shares of Taiwan Semiconductor Manufacturing Co. reversed direction to trade up 0.9%. American depositary receipts of Baidu Inc. fluctuated, while those of Alibaba Group Holding Ltd. posted a 3.7% gain.
Still, investors may need to prepare for a drawn-out reaction in financial markets, something which could underpin haven assets like Treasuries.
“Pelosi’s visit carries with it the presumption of a limited time frame for a tradable response; an assumption that we’ll characterize as misplaced,” BMO’s Lyngen and Jeffery wrote in their note.
“Any response could be weeks away or further and for this reason we anticipate that the geopolitical backdrop will once again contribute to the bullish underpinnings for the U.S. rates market.”
