Pelosi's trip to Taiwan is raising alarm in global financial markets

(Bloomberg) — Traders braced for the expected arrival of U.S. House Speaker Nancy Pelosi in Taipei on Tuesday to raise tensions with China, sending stocks lower and global havens the yen and government bonds rising.

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Taiwan’s stock index fell as much as 2.1 percent, shares in Hong Kong and China tumbled, while the Japanese currency hit a two-month high. The yield on the 10-year Treasury note fell for a fifth day to near 2.5%, a level last seen in April. The Taiwan dollar hit its lowest level since May 2020.

Pelosi’s trip creates a new pressure point for investors already dealing with the prospect of a U.S. recession, global interest rate hikes and rising inflation. Tuesday’s moves suggested traders were guarding against escalating tensions, with analysts warning of the risk of a conflict between the world’s two largest economies wreaking havoc on global markets.

“Some sort of economic response against Taiwan is inevitable, otherwise the face loss for China after all the threats would be unbearable,” said Alvin Tan, head of Asia currency strategy at RBC Capital Markets in Singapore. “Risk appetite will remain cautious, with the biggest concern focused on Greater China markets, but beyond that we will have to see the concrete response from China.”

China considers Taiwan part of its territory and has promised “serious consequences” for the most senior US official to set foot on the island in 25 years. Taiwan is an important supplier of semiconductors and other high-tech goods.

Some warn that the consequences can be exciting. The worry is that the trip and China’s response to it are straining long-term trade relations and playing out in markets for weeks or more, with implications for government securities, according to BMO Capital Markets strategists Ian Lingen and Benjamin Jeffrey. The yield on the benchmark 10-year could exceed 2.5% this week, they wrote in a report.

Biden’s team tries to tame China’s ire as Pelosi turns to Taiwan

The White House has sought to play down rising tensions, insisting there is no change in stance on Taiwan and urging Beijing to refrain from an aggressive response. The US outlined an analysis of possible actions China could take, including launching missiles into the Taiwan Strait, launching new military operations and crossing an unofficial no-fly zone between Taiwan and the mainland.

One-month dollar-Taiwanese dollar risk reversals – an indicator of the expected direction over that time frame – jumped to their highest level since May, signaling traders are betting the island’s currency will weaken.

Despite the tensions, global risk assets are relatively resilient. China’s offshore yuan was little changed on Tuesday. S&P 500 futures were down just 0.5%.

“China’s reaction is expected to be mostly limited to some signal actions rather than anything really damaging to their economy, and therefore at this stage we think the market reaction has been relatively mild so far,” Becky Liu, head of China macro strategy at Standard Chartered Bank Plc, Bloomberg Radio said. “We just have to be concerned about the medium to long-term implications.”

Chinese stocks tumbled on geopolitical risks and growth concerns

Taiwan Semiconductor Manufacturing Co., the world’s largest chipmaker, fell as much as 3.1 percent. Shares have fallen about 20% this year, with Taiwan’s benchmark stock down about 19%, slightly worse than the 17% drop in the MSIC AC Asia Pacific index.

Pelosi could land in Taipei as soon as Tuesday, according to people familiar with the matter. Her trip comes after a decade-long history of antagonizing China over its human rights and growing global influence. As speaker of the House of Representatives, she is second in line to the US presidency, making her visit to the democratically-ruled island an affront to Beijing.

Pelosi’s Taiwan Trip Hits Chinese Stocks, Raises USTs: Street Wrap

Still, investors may need to brace for a prolonged reaction in financial markets, something that could support safe-haven assets like Treasuries.

“Pelosi’s visit carries with it the presumption of a limited timeframe for a negotiable response; an assumption we would characterize as inappropriate,” BMO’s Lingen and Jeffrey wrote in a note. “Any response could be weeks away or later, and for that reason we expect the geopolitical backdrop to once again contribute to the bullish fundamentals for the US interest rate market.”

(Updated levels. A previous version of this story corrected spelling by BMO strategist Ian Lyngen.)

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