Iran Strikes Israel and China Eyes Taiwan

Welcome back to SovereignBeat! Let’s get straight to the business

In this publication:

• EU set to outdo US in rate cuts this year

• Oil holds steady at $90/barrel; IEA foresees reduced demand

• Cocoa futures hover close to $11k amidst persistent global supply drought

• China's charm offensive to win over Taiwan for peaceful unification

• Iran's first-ever massive attack on Israel from its own soil

Let’s dissect

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Markets Snapshot

Bond Markets

• U.S and EU: Rate cuts in Europe appear more imminent than in the US, as it is more difficult to find economic justification for the Fed intervention. This shift reflects the growing divergence between the US and European economies, where softer inflation and lower growth in the EU are driving market expectations of four ECB rate cuts by year-end, compared to only two or three for the Fed. The benchmark US Treasury yield has jumped by 0.6 percentage points to 4.5% this year, while the German Bund rose only by 0.3 percentage points to 2.4%, signaling higher selloff for the US bonds.

• Europe's inflation outlook is rosier compared to the US. The ECB anticipates annual inflation in the eurozone at 2.3% in 2024, with GDP growth forecasted at just 0.6%. This contrasts with the Fed's projection for the core personal consumption expenditures index to ease to 2.6% and growth to reach 2.1% by year-end.

• Lower inflation and slower growth in the EU imply a greater need for central bank intervention later this year to stimulate the economy, unlike the US, where a bustling and resilient labor market drives growth, albeit posing risks of persistent inflation. Nonetheless, if the ECB implements rate cuts more aggressively than the Fed, the euro could weaken against other major currencies, leading to higher inflation.

• China: China is holding the yuan steady despite a strong USD and negative investor sentiment, with the daily reference rate for the currency remaining largely unchanged. This strategy underscores the significance of yuan stability, as the People's Bank of China's successful interventions maintained the currency near policy thresholds thus far. Despite the potential export advantages of a weaker yuan, policymakers are wary of currency pressures affecting local financial markets.

• On a separate note about the country, Fitch revised China's outlook from stable to negative, citing expectations of rising debt as the country rebounds from a real estate downturn. Despite China's public debt nearing 80% of GDP, the risk of a debt crisis is mitigated as the country borrows in its own currency. On Friday, China's 10-year sovereign bond yield remained at around 2.29%.

Commodity Markets

• Oil: During the week, oil prices approached a six-month high amid concerns about Iran, the third-largest OPEC producer, retaliation against Israel (more on this below).

  Brent crude futures surpassed the symbolic threshold of $90 per barrel on April 5th and closed at the same level on Friday, marking an increase of nearly $8 per barrel since early March.

  The International Energy Agency revised down its forecast for 2024 world oil demand growth by roughly 100 thousand barrels per day (kb/d) to 1.2 million barrels per day (bpd), following exceptionally weak deliveries in the Organisation for Economic Co-operation and Development (OECD) countries at the start of the year. Interestingly, Organisation of Petroleum Exporting Countries (OPEC) stated that world oil demand will actually increase by 2.25 million bpd in 2024. Analysts noted that currently, the market leans more towards OPEC's demand projection rather than the IEA's reduced forecast. Nonetheless, sustained output cuts enforced by the OPEC+ alliance imply that non-OPEC+ producers, led by the US, will remain pivotal in driving world oil supply growth through 2025.

• LNG: European natural gas prices reached a two-week high due to a shift in LNG shipments to Asia and geopolitical supply risks, including recent Russian attacks on gas storage in western Ukraine. Despite Europe's high gas inventories following a mild winter, it now faces competition from Asia for LNG amid reduced Russian pipeline gas supplies. Russia's gas-transit agreement with Ukraine is also set to expire at the end of the year, raising uncertainty about whether these volumes will continue flowing into Europe. The general consensus is that the agreement will not be extended, for obvious reasons.

• Cocoa: As we previously wrote two weeks ago, cocoa prices surged to $10,000 due to ongoing concerns over supply shortages. On Friday, New York cocoa futures reached a new record high of more than $10,800 per tonne, representing a 140 percent increase since the beginning of the year. Poor harvests in West Africa, notably in Cote d'Ivoire, the leading cocoa producer, have resulted in a projected third consecutive annual deficit. Regulators in Cote d'Ivoire have requested buyers to postpone receiving around 130,000 tons of beans until the mid-crop harvest due to the scarcity.

Geopolitics

Iran Missile and Drone Attack on Israel

• Iran launched a barrage of drones and missiles at Israel on Saturday night in retaliation for Israel’s strike of the Iran's embassy in Syria two weeks ago that resulted in the deaths of several Iranian commanders. Israeli officials reported that Iran fired more than 300 projectiles, which included 170 drones, 30 cruise missiles, and 120 ballistic missiles directly at Israel.

• The attack was signaled in advance and led to the interception of 99% of the missiles by Israel. Iran said its objectives with the attack had been met. The strike marked the first time Iran directly targeted Israel. In the last six months, Israeli forces have clashed often with Hezbollah in Lebanon, while Iranian proxies in Iraq, Syria, and Yemen have launched missiles and drones at Israel. Despite their historic enmity, Iran and Israel have never directly exchanged fire from their own soil. These developments have escalated tensions in the Middle East, significantly raising the risk of a full-blown conflict in the region.

Our thoughts

• The crucial question now is whether calm and rational leadership will prevail, preventing a dangerous escalation in tit-for-tat actions. In the coming weeks, Gulf states will play a pivotal role, especially those with ties to both sides, in attempting to de-escalate the situation.

China’s Unwavering Desire to Unite with Taiwan

• Chinese president Xi Jinping met with former Taiwan president Ma Ying-jeou at Beijing's Great Hall of the People, a venue usually reserved for foreign leaders meeting with senior officials, in an effort to advocate peaceful unification as the alternative to Taiwan's military annexation. Xi utilized the meeting to underscore his conviction that Taiwan and China were fated for what he describes as "reunification."

• Xi Jinping has previously claimed Taiwan too be a province of China and vowed to annex it if necessary. China has spreadheaded an extensive campaign of political, economic, and cognitive warfare, coupled with daily military intimidation, to coerce Taiwan into accepting Chinese rule. Despite this, the majority of Taiwan's population rejects the idea of unification. We've previously covered Taiwan's politics and its geopolitical significance in more details here.

Our thoughts

• Xi Jinping showcases the Communist Party's openness to dialogue with Taiwan's opposition, contingent upon the island's acknowledgment of being part of China. This meeting, though mainly symbolic, occurred just before a crucial summit in Washington involving the US, Japan, and the Philippines, focusing on concerns about China's regional activities. China used this opportunity to signal that peaceful unification through "winning over hearts and minds" remained Beijing's preferred option.

• The meeting with Ma could also indicate a struggle to engage active senior political figures in Taiwan who are willing to adopt more conciliatory stance towards China and its rhetoric. In fact, no sitting president of Taiwan has ever visited China.

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Our Further Reading Recommendations

• America’s moment of truth on Ukraine (FT)

• Erdogan's Party's Defeat Reshapes Turkey's Political Landscape (RFI)

• How Russia’s extended and reorganized its presence in Africa in the “post-Prigozhin era” (FT)