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Russia and China vs The West

Last Week in the City provides a round-up of market movements and the global investing outlook. This covers the week to 1 July 2022.

| 11 min read

High profile meetings between world leaders meant global politics took centre stage this week, but the most significant news appears to be a change of stance by NATO that puts China in its sightlines. China was one of the defence organisation’s strategic priorities for the first time, claiming Beijing challenged the West’s “interests, security and values”. The deterioration of relationships between autocracies such as Russia and China and democracies in the West continues unabated.

The first half of 2022 saw inflationary pressures erase much of the equity market gains since the Covid-19 pandemic sell off. However, the FTSE 100 fared significantly better than rival indices. The UK blue-chip index’s large skew towards commodity producers and healthcare prevented it falling as much as rival indices. Technology led the sell off, as much of the sector is funded by debt and the cost of borrowing is rising. The absence of major technology sector players listed in London proved an advantage for the first time in numerous years. In the first half of 2022, the S&P 500 fell by a fifth and the Nasdaq Composite by almost a third, with the FTSE 100 falling just 3%, although it was down 5.5% in June and there were significant divergences in the performances of individual index members.

Over the week, the blue-chip FTSE 100 index was 0.5% lower by mid-session on Friday, with the more UK-focused FTSE 250 down 2.3%.

Understand your enemies: Which is the bigger threat – inflation or recession?

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How high will inflation go? In our latest episode of Charles Stanley Radio, Chief Investment Commentator Garry White and Chief Global Strategist John Redwood discuss whether inflation is reaching its peak.

Geopolitics

NATO listed China as one of its strategic priorities for the first time, arguing that Beijing’s ambitions and its “coercive policies” challenged the West’s “interests, security and values”. NATO issued a new Strategic Concept (PDF), that lays out its priorities for the next decade.

World leaders assembled at the “Group of Seven” summit in Germany were faced with numerous serious issues to resolve. The world's largest advanced economies and wealthiest liberal democracies are its members: Canada, France, Germany, Italy, Japan, the UK and the US. The European Union (EU) is a 'non-enumerated member'. Representatives from India, Indonesia, Senegal and South Africa attended the summit to observe proceedings.

Members of the G7 said they will explore ways of curbing energy costs, including a US plan to place possible caps on the price of Russian oil and gas to prevent Moscow funding its “war of aggression” against Ukraine. The G7 also called on Russia to lift the blockade on Ukrainian Black Sea ports and cease actions contributing to global food insecurity. Countries continue to worry about the weaponisation of food and fuel supplies by Moscow.

The G7 also detailed plans to mobilise $600bn in funding over five years for the developing world to counter China's Belt-and-Road initiative. The Partnership for Global Infrastructure and Investment (PGII) relaunches a scheme unveiled at last year's G7 talks in England. The scheme would allow countries to "see the concrete benefits of partnering with democracies," the US president added. The US promised to raise $200bn of the total through grants, federal funds and private investment, while the EU has announced a further €300bn ($313bn).

Finland and Sweden look likely to become full NATO members, with the alliance expanding to border Russia, after Turkey dropped its opposition to the move. Ankara approved the invitation for the two Nordic countries to join the military alliance, after it received pledges addressing some of its security concerns. The move “sends a very clear message to President Putin that NATO’s door is open,” Secretary General Jens Stoltenberg said.

The EU appeared to be getting closer to striking a compromise deal with Moscow over transport to Kaliningrad. The Russian enclave, which is bordered by EU states and relies on railways and roads through Lithuania for most goods, has been cut off from some freight transport from mainland Russia since June 17 under sanctions imposed by Brussels. Trade could start returning to normal after the weekend, it was suggested, relieving rising tensions over the issue.

Ukraine conflict

Russian President Vladimir Putin issued a decree that seized full control of the Sakhalin-2 gas and oil project in Russia's far east, a move that could hit Shell, Mitsui and Mitsubishi. The five-page decree indicates the Kremlin will now decide whether the foreign partners can stay – or whether the gas project will be nationalised. The move may unsettle an already tight liquified natural gas (LNG) market, introducing another inflationary problem in the energy sector.

Concerns about food shortages in the Middle East are rising, prompting worries about potential civil unrest.

Russia technically defaulted on its debt for the first time since 1998. Moscow has the money to make a $100m payment, which was due on Sunday, but sanctions made it impossible to get the sum to international creditors. Kremlin spokesman Dmitry Peskov argued that "statements of a default were absolutely unjustified” as an intermediary bank had “unlawfully” withheld the money and Russia had the funds to pay. The White House argued that Russia had defaulted on its international bond payment, citing western-backed sanctions which it said had effectively cut Russia off from the global financial system.

Concerns about food shortages in the Middle East are rising, prompting worries about potential civil unrest. In 2020, Russia and Ukraine provided 43% of the wheat imported by the Middle East and North Africa (MENA), compared to just 19 percent in 2008. The region also depends heavily on Russian and Ukrainian corn. In Iran, the government announced it would cut wheat subsidies sparking a wave of protests that called for the overthrow of Tehran’s clerical regime. Egypt, one of the world’s biggest wheat importers boosted stockpiles. This week the country made its largest single purchase of wheat since 2012 which was sourced from France, Romania and Bulgaria.

Covid-19

There were hopes that better prospects for China’s economy are close at hand after Beijing slashed the quarantine time for inbound travellers by half. It was a major easing in a country that has continued to enforce strict and ultra-restricted lockdown policies in response to outbreaks of Covid-19. The rules have deterred cross-border travel and resulted in international flights running at just 2% of pre-pandemic levels. President Xi Jinping will leave the mainland for the first time since January 2020 this week when he visits Hong Kong. The relaxation of rules for travellers sparked hopes that there may be some easing up of the country’s economically harmful lockdowns, which has caused a shortage of goods and components for western companies. This policy is therefore regarded as one of the factors that has delayed the peak in inflation in developed economies – with any easing of the rules positive for Chinese growth and – potentially – western inflation.

However, any investors hoping for a swift change in domestic policies should pause for thought. Beijing Daily, the official Chinese Communist Party (CCP) newspaper for the Chinese capital, reported that the city's party chief Cai Qi – a close ally of President Xi – had once again given strong backing to the strict CCP policy on Covid-19 outbreaks.

Beijing recently conceded that its ‘zero-Covid’ strategy means it’s all but certain to miss its economic growth target by a large margin for the first time ever. Central planners have a target of “around 5.5%” GDP growth for China this year, but current consensus expectations indicate economists expect the figure to be closer to 4.5%. Beijing has admitted to missing the goal just once since first setting it three decades ago – by just 0.2 percentage points in 1998. It didn’t set a target in 2020, when the Covid-19 pandemic first emerged.

Supply chains

The city state of Singapore has confirmed that some pandemic-related conjecture is correct. Many predicted there would be an acceleration of automation, artificial intelligence and Singapore unveiled further details of a $40bn project to build the world’s biggest fully-automated port by 2040 — one that will double existing space and feature drones and driverless vehicles that are not prone to illnesses such as Covid-19.

Economics

Americans are becoming increasingly pessimistic. US consumer confidence slipped to its lowest level since the middle of the Covid-19 pandemic, as persistent inflation and rising interest rates continue to squeeze household budgets. The Conference Board’s consumer confidence index slipped to 98.7 in June from 103.2 in May, the second straight monthly decline and the lowest level since February 2021. The business research group’s expectations index, based on consumers’ six-month outlook for income, business and employment-market conditions, tumbled to 66.4 in June – the lowest level since 2013 – down from 73.7 in May. “Consumers’ grimmer outlook was driven by increasing concerns about inflation, in particular rising gas and food prices,” according to the Board’s Lynn Franco. “Expectations have now fallen well below a reading of 80, suggesting weaker growth in the second half of 2022 – as well as growing risk of recession by year end.” At least central bankers recognise that they have a problem.

Travel

Heathrow Airport was instructed to cut passenger charges for airlines each year until 2026 by the regulator, the Civil Aviation Authority (CAA). The airport currently charges airlines £30.19 per passenger, but the CAA wants the cap to fall to £26.31. The CAA said the plan to reduce the charge "reflects expected increases in passenger numbers as the recovery from the pandemic continues and the higher level of the price cap in 2022, which was put in place in 2021 to reflect the challenges from the pandemic at the time". Heathrow wants to charge £41.95 for the cost of operating terminals, runways, baggage systems and security – which are paid by airlines but ultimately passed onto consumers via airfares.

Mergers & acquisitions

Boots owner Walgreens Boots Alliance has abandoned the sale of the UK high street health and beauty retailer after potential buyers failed to meet its asking price. The US giant said that no interested party had made an offer that “adequately reflects the high potential value of Boots”.

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Russia and China vs The West

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