Volatility Hits Markets With Geopolitics Adding to Set of Risks

(Bloomberg) — Global financial markets whipsawed as risk sentiment remained fragile, with US House Speaker Nancy Pelosi’s Taiwan trip adding to the list of investor stocks ranging from a restrictive Federal Reserve policy to the specter of an economic recession.

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In a session of many reversals, the S&P 500 ended lower after several attempts to stay in the green. A gauge of US-listed Chinese shares halted a three-day slide. Ten-year US yields jumped to 2.75%, following an earlier plunge that drove them to around 2.5%. The Japanese yen and gold erased gains. The offshore yuan advanced.

“It’s going to be volatile,” said Ellen Gaske, economist at PGIM Fixed Income. “Geopolitical risks are obviously elevated on a more persistent basis here. So I think that imparts a degree of volatility to markets, and that’s on top of the volatility in rates markets that we are already seeing because of the Fed being on the move, and because it is uncertain how far the Fed will actually have to go from here.”

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Pelosi became the highest-ranking American politician to visit Taiwan in 25 years, prompting China to announce missile tests and military drills encircling the island. She plans to hold a joint press briefing with President Tsai Ing-wen at 10:53 am on Wednesday, Taiwan’s Foreign Ministry said in a statement.

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. Analysts have warned about the tailrisk of a conflict between the world’s two largest fish 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.

While the White House has sought to dial back rising tensions by insisting there is no change in its position toward Taiwan, which considers Chinas as part of its territory, Beijing has called Pelosi’s visit a “dangerous gamble” with grave consequences.

The Taiwan dollar hit its lowest since May 2020, while paring the drop on signs that local banks were selling the greenback to meet the needs of foreign funds.

Equity markets in China and Hong Kong were the worst performers in Asia as security analysts outlined potential military responses from Beijing.

American depositary receipts of Taiwan Semiconductor Manufacturing Co. and Baidu Inc. retreated, while those of Alibaba Group Holding Ltd. posted a 2.5% gain.

Some analysts warn the impact of Pelosi’s visit will hasten the deterioration in US-China ties.

The concern is that the trip and China’s reaction to its worse 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 drop below 2.5% this week, they wrote in a report.

“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.”

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 US rates market.”

(Updates market moves throughout. A previous version of this story corrected the spelling of BMO strategist Ian Lyngen.)

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