China Fights Economic Slowdown while the EU Fights to Fund Ukraine

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In this publication:

• Higher than expected growth of the U.S economy

• ECB halts rate cuts

• Regional uncertainties push oil prices higher

• China is ramping up stimulus to boost market

• EU’s unwavering commitment to Ukraine

Let’s dissect

Markets Snapshot

• At the World Economic Forum in Davos, global leaders acknowledged a favorable economic environment but expressed caution due to geopolitical risks such as conflicts in Ukraine and the Middle East, along with tensions in the Red Sea. ECB Chief Christine Lagarde highlighted the importance of strengthening Europe through a unified market, while German Finance Minister Christian Lindner advocated for a more cautious approach.

Debt Securities

• USA: The US 10-year Treasury yields have reached a six-week high of 4.17% this week. Despite this, the US economy beat expectations in Q4 2023, growing at 3.3% annually, surpassing the predicted 2% rise. The overall 2023 growth reached 2.5%, up from 1.9% in 2022. Consumer spending saw a shift from goods to services, slowing down its growth. Government spending increased at a slower pace, while exports accelerated and imports grew less.

  Previously, Fed's Mary Daly suggested that anticipating imminent rate cuts is premature, given recent strong retail sales and a notable increase in consumer sentiment. As a result, market expectations for a Fed rate cut in March have decreased to a 40% likelihood.

• EU: The ECB has opted to maintain interest rates at their current record-high levels. The main refinancing operations rate stays at a 22-year high of 4.5%, and the deposit facility rate remains steady at an all-time high of 4%. Despite easing inflation pressures, Lagarde deems it premature for interest rate cuts. This cautious stance echoes concerns over persistent price pressures and geopolitical tensions, like the Red Sea blockade.

• Japan: The Japanese central bank kept its -0.1% short-term rate and maintained its yield curve control parameters. It stands as a global outlier, contrasting with hints of rate cuts by the FeD and the ECB. The yen strengthened as investors sought clues on the BOJ's exit from ultra-loose monetary policy.

Oil Prices

• Crude oil prices rose by more than 6% to USD 82 per barrel, driven by supply disruptions and strong demand. Ongoing conflicts in Gaza, shipping attacks by Iran-aligned Houthis despite US countermeasures, a fire at a Russian energy firm's Baltic Sea export terminal, and the restart of Libya's Sharara oil field are influencing the market. The resumption of Libya's largest oil field will allow for an increase in production capacity of around 270,000 barrels per day (bpd).The decision to restart follows the Tripoli government's agreement to meet most of the demands made by protesters, as stated by Deputy PM Ramadan Boujannah.

Global Finance

Chinese Battles Against Slowing Economic Growth

• The CSI 300 index (top 300 stocks traded on the Shanghai Stock Exchange) hit a five-year low this week, wiping out over $6 trillion in market value from Chinese and Hong Kong stocks since their 2021 peak—equivalent to Japan's entire market capitalization. To stabilize the market, Chinese authorities are mulling a package of measures, mobilizing about 2 trillion yuan ($278 billion) from offshore accounts of state-owned enterprises for a stabilization fund to buy shares onshore through the Hong Kong exchange link.

• The country has also committed to reducing the reserve requirements for its banks early next month to stimulate its struggling economy. Starting from Feb. 5, reserve ratio requirements for banks will be cut by 50 basis points, injecting 1 trillion yuan ($139.8 billion) in long-term capital according to Pan Gongsheng, the People’s Bank of China (PBOC) governor.

• China grapples with a property crisis, weakened consumer sentiment, declining foreign investment, and waning confidence among local businesses due to years of volatile policymaking, creating pressure on both the economy and markets. Despite this, last week's data revealed that the world's second-largest economy expanded by 5.2% in 2023, closely in line with official projections. The fourth-quarter GDP print also reached 5.2%, falling just slightly below economists' median estimates.

• Household wealth and consumer demand in China are heavily influenced by the property sector, constituting between a quarter and a third of GDP. However, demand for new homes is currently subdued. The value of new home sales among the 100 largest real estate companies fell by 16.5% in 2023, experiencing a significant 34.6% year-on-year decline in December.

Our thoughts

• Statements from the PBOC officials suggest that the central bank is likely to pursue a cautious approach, refraining from injecting massive stimulus into the economy. The reduction in the reserve ratio by 50 basis points is one of these prudent measures. Announcing change in the ratio in advance also suggests that there are no other effective tools available to curb the market rout.

• Nonetheless, investors may see this as an exit opportunity if the equity market rebounds in the short run after implementing the mentioned measures—unless additional policies address structural issues, particularly in the property market.

Geopolitics

EU Finding Ways to Support Ukraine

• The EU is considering to revamp a fund that provides Ukraine with military aid. The European External Action Service (EEAS) has proposed establishing a Ukraine Assistance Fund with an annual budget of approximately €5 billion, pending agreement from EU governments.

• The existing mechanism, known as the European Peace Facility (EPF), necessitates unanimous consent for disbursements and reimburses member states for providing weapons to Ukraine. Since Russia's full-scale invasion of Ukraine almost two years ago, 7 packages totaling €3.5 billion have been approved, along with €2 billion allocated for ammunition supply. Member states have been in disagreement over reimbursement rates and the use of the facility to offset purchases, largely due to Hungary, which has blocked an eighth funding tranche (We have already written about Orban's pro-Russian stance here)

• The EEAS proposal suggests establishing fixed reimbursement rates, and offering a higher bonus for collaborative initiatives between EU and Ukrainian industries. While reimbursements for deliveries from stocks and unilateral procurement would phase out gradually.

• The fund aims to support Ukraine through joint European procurement, providing both lethal and non-lethal assistance, along with continuous training for Ukrainian troops. It complements bilateral aid from member states and addresses urgent needs, including artillery, specialized munitions, drones, air defense, and non-lethal elements like demining and cyber capabilities.

• The European Commission (EC) has also drafted a proposal suggesting that the revenues generated from Russia's frozen assets be directed through the EU budget to support Ukraine. The proposal targets approximately $300 billion of Russia's central bank assets, encompassing mainly foreign exchange reserves in major currencies, gold, and government bonds held in the West. It is estimated that these assets could generate up to €3 billion in income annually, which can be used to support Ukraine. Previously, The US, backed by the UK, Japan, and Canada, has put forth a proposal within the G7 countries, to explore methods for seizing $300 billion in frozen Russian assets.

Our thoughts

• The current setup of the EPF is losing effectiveness, with several countries either depleting available stock that they can provide to Ukraine and/ or facing challenges in obtaining political approval from their governing bodies. Involving EU industries in the procurement process would certainly benefit the EU economy. However, for Ukraine's practical benefit, weapons should be sourced from wherever they are immediately available.

• Nonetheless, the fund marks a positive step in structuring and formalizing military aid processes, following the EU's failure to approve €50 billion in aid for Ukraine last month, blocked by Hungary.

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