Opinions

Chinese leaders have repeatedly shown patterns to think ahead over the last 5 decades. Think 1980's industrialization. Think the 2010's manufacturing explosion. We believe China is in the middle of a strategically decoupling process from US. And this is irreversible. Chinese policy makers are fully aware of the AI potential in next few years. They also know US is ahead in the race for now. But China does not want this to be used as a leverage against them by US. Hence China is pursuing self-reliance in AI at every level of technology. While China’s government has long identified AI capabilities as a critical goal, it employs different strategies to aid each layer. The heaviest state support is reserved for the capital-intensive semiconductor sector. Indigenization efforts for software frameworks are entrusted to Big Tech companies. Higher layers, i.e., AI models and applications, benefit from an enabling environment but receive less direct state support. The real strength of Chinese AI space is it's open source nature. China also does not follow the shock and awe policy of announcing large AI capex and data centers. They like the “build it and they will come” way. Chinese decoupling from US in AI is strategic in nature. Both countries are aggressively building mutually exclusive AI ecosystems, as a long-term strategic effort rather than a short-term tactical move. China aims to eliminate all US-origin dependencies in its AI and semiconductor supply chain, building a fully indigenous ecosystem that cannot be disrupted in a crisis. In pursuit of this, Chinese policymakers increasingly prioritize security and strategic resilience over AI performance, accepting near-term efficiency losses as the price of long-term autonomy. All of above leads us to our hypothesis that Chinese long held ambition of unifying Taiwan with mainland is nearing action point. In the 24th Nov call with Trump, Xi focussed on Taiwan while Trump focussed on trade & agriculture. Xi reinforced the point that some kind of compromise over Taiwan is a structural component of creating and maintaining US–China strategic equilibrium, rather than merely a regional issue. He did this on the call by stressing China’s “core interests” and the historical legitimacy of China’s claim. We believe one way or the other, China might look to annex Taiwan by 2027. Either it will come as a part of a large deal with US with Taiwan against Trade & Tech, or plain military action. China is completely prepared for both of the above options seeing the rapid decoupling from US in recent times, specially in the AI field. They don’t want any leverage against them to be there when they act in 2027.

In this week’s budget (Wednesday, 26 November at 12:30 pm), UK Chancellor Reeves looks set to fill a fiscal hole of around £20bn avoiding politically sensitive income/other tax rates that Labour ruled out in its manifesto. We can expect a further £5-10bn of tax rises to raise headroom. The total fiscal tightening should be just shy of 1% of GDP at the point the fiscal rules need to be met (2029-30). We see extra gilt issuance of around £6bn in the current fiscal year (£305bn). Assuming a fiscal hole of £20bn does not include adjustments to the fiscal headroom, then we expect a net fiscal tightening of between £25bn and £30bn to incorporate a rise in the headroom by £5-10bn from its previous £9.9bn. For the purposes of the macro-outlook, two things matter most in this budget: First, the size of the fiscal gap that has opened up, plus any changes that the Chancellor makes to the headroom around her fiscal rules as the sum of these indicates how much net fiscal tightening must be implemented. Second, how the fiscal tightening is distributed over the years of the forecast. While a more front-loaded fiscal tightening and a larger fiscal gap to fill would have even more significant repercussions for the macro -outlook, we still think a more modest backloaded tightening will be sufficient to keep the pressure on the Bank of England to cut interest rates further, and expect 25bp rate cuts each in December and April. To the extent that i) some fiscal measures will likely aim to reduce inflation, and ii) this inflation reduction pulls down on inflation expectations, there may be downside risks to market’s current terminal rate view of 3.35%. On incremental gilt issuance, assuming no major policy changes prior to the start of the next fiscal year (2026-27), we assume the miss on the deficit will show up in an additional financing need of £6bn, i.e. £305bn total for the year versus £299.1bn previously. The Bloomberg consensus expects £9bn higher gilt issuance in 2025-26 (i.e. to just over £308bn). We remain bullish on UK 10yr Gilts as we have written in our opinion piece & trade recommendation pieces written on 15th Nov & 16th Nov. Following was our trade recommendation on 16th Nov: BUY 10 YEAR UK GILTS (YIELD 4.58), TP 4.20 & SL 4.80.

In today’s hearing in the IEEPA case at SCOTUS, the US Supreme Court appeared skeptical of President Donald Trump’s sweeping global tariffs, as key justices suggested he had overstepped his authority with his signature economic policy. Chief Justice John Roberts, Justice Neil Gorsuch & Justice Amy Coney Barrett appeared to find IEEPA use illegal. Justice Brett Kavanaugh seemed to be the only judge to look agreeable to Trump’s use of IEEPA. Justice Samuel Alito seemed to suggest an appetite for resolving the refunds matter sooner rather than later. We now expect a 7-2 version in favor of IEEPA being declared void. Trump still does have other options to replace IEEPA but all of them carry their own risks. Eliminating IEEPA implies refund of 150 BN USD which will be a vexing affair for court to decide. From a market perspective, any ruling that deems the IEEPA tariffs illegal would likely trigger initial weakness in DXY as markets price in a lower terminal rate and a renewed disinflation trend. But the long end UST yields will drift higher due to fiscal worries. This will lead to a steeper curve and a weaker dollar. From a tariff point of view, the trade weighted average tariff rate will fall to 6% from the current 15% if SCOTUS deems IEEPA illegal. Some of the upswing in long end UST yields has already happened today but 10yr UST yield is likely headed higher towards 4.20-4.25 if the Supreme Court ruling does come any time soon.

The recent trade deal between Xi & Trump is at best an unstable equilibrium. Most of the terms released by WH today imply equal give and take between China & US. While China has delayed new export controls on RREs & committed to buying Soybean/other agri goods from US, US has postponed the 50% affiliate rule of the BIS export control regulation for one year. US has also reduced Fentanyl tariff to 10% from 20%. Effective US tariff on China now stands around 35% after all exemptions. But the highlight of the summit was the G-2 reference from Trump on China. Is it a new reality or a temporary truce? We believe US & China has no shared ideology or mutual trust. Hence the G2 phrase is more of a Trump ploy to pamper Xi for the time being. Ttump will visit China in Apr'26. This will potentially define a new world order since we believe Taiwan will see a genuine Chinese effort to annex it in CY27 whether Trump has a deal with Xi or not. Till then both sides are biding their time and hiding their powers. During this truce period of almost 6 months, we might see more Chinese efforts to internationalize RMB. Chinese policy makers see strong RMB as the core of the financially strong nation they aim to build. Though we do not see an outright intention to push for RMB appreciation, but policy agenda might curb devaluation risk. This implies PBOC might not pursue ultra loose monetary policy and fiscal levers might be used more for shifting to consumption model than the current investment driven Chinese model of growth.

The US Supreme Court will hear oral arguments on 5 November on President Trump’s use of the International Emergency Economic Powers Act (IEEPA) to impose tariffs on a broad range of goods and countries. The US government could be forced to refund any where between USD 150-200 billion of tariff revenue if IEEPA were to be declared illegal in it's entirety. The single largest implication if the IEEPA in it’s entirety was to be declared illegal will be on US fiscal deficits. In September, the Congressional Budget Office (CBO) estimated that existing tariffs would generate revenue of USD 3.3tr between 2025 and 2035, and up to USD 4tr in savings, assuming lowered interest expense of narrower deficits. Assuming a 150-200 BN USD refund, implies 7-8% of 2025 US Federal budget deficit. This implies a steeper UST yield curve as long end gets unhinged due to fiscal implications while short end moves lower or remains same due to better rate cut probabilities. DXY will also sharply drop lower in case of complete removal of IEEPA. US equities might do well as corporates gain additional revenue or see better consumer demand but it won’t be sufficient to defend DXY as higher long end yields will push DXY lower.

The 4th Plenum of the CCP Central Committee concluded on 23rd October and policymakers approved the proposal (a high-level summary) of the 15th Five-Year Plan (FYP; for 2026-30). Policymakers set technology, security, and people’s livelihood as top priorities for China’s development strategy over 2026-30, reflecting the long-term pursuit for “high-quality growth” and “high-level security”. Our main takeaway is Chinese leaders have become more confident in China's technological capabilities and economic resilience, despite observing a more changing external environment for the coming years. They have adjusted policy priorities accordingly and three new priorities stand out to us: 1) Accelerating technological application/commercialization by industries 2) Strengthening economic ties with outside world 3) Improving people's wellbeing. We think these policies will benefit innovative private firms in emerging industries, accelerate Renminbi's internationalization, and boost domestic consumption. For FX, we think that the 15th FYP (Five Year Plan) is generally supportive of further RMB strength. Any positive progress on key topics (e.g. rare earth and purchase of US goods) should make a stronger case for a consistent decline in USD/ CNY fix. Therefore, we recommend buying 6m USD/CNH puts. From an equity market perspective, China's pledge to intensify its pursuit of technological self-reliance and boost domestic demand will likely drive more investment into sectors from semiconductors to green energy. The emphasis on core technologies and domestic consumption highlights Beijing's drive to insulate its economy from external shocks while sustaining growth momentum. The plan reinforces China's long-term ambition to dominate key technologies, a theme that could shape future capital flows into semiconductors, AI, and green tech. Among the twelve policy areas, "High-Standard Opening Up" has shifted the most in priority, advancing to 5th place from 10th five years ago. This shift aligns with recent commentaries in the People’s Daily, which greatly emphasized international relations. The leadership recognizes that many of China’s biggest challenges in the next five years will be external, and thus seeks to deepen trade and economic collaboration with other countries. Among the policy areas, improving public wellbeing has risen in priority to 9th place, moving ahead of green transition. This likely implies the government will devote more fiscal resources to people’s well-being, deviating from its previous model of focusing primarily on productive hard infrastructure.