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  • Stage set for U.S. sanctions on Hong Kong
  • EU proposes landmark 750 billion euro recovery fund
  • Treasury market set to absorb record-sized 7-year T-note auction
  • Today’s U.S. reports expected to show continued economic devastation


Stage set for U.S. sanctions on Hong Kong
 — The markets are waiting for the Trump administration to announce sanctions for China’s move to impose a new security law on Hong Kong.  President Trump on Tuesday said that his administration was looking at the situation “very strongly,” and that he expected action by the end of this week.

Secretary of State Pompeo on Wednesday delivered the State Department’s conclusion that Hong Kong no longer has autonomy from China’s government.  Last year’s Hong Kong Human Rights and Democracy Act requires an annual report from the State Department certifying that Hong Kong retains a high degree of autonomy from China.

The Trump administration now has a wide range of options for imposing sanctions.  On the lighter end, the Trump administration could just limit visas and place sanctions on some Communist Party officials involved in implementing the new security law.  On the heavier end, the U.S. could end Hong Kong’s special trade status, impose tariffs on imports from Hong Kong, and restrict dual-use technology exports to Hong Kong.

China’s Foreign Ministry spokesman on Wednesday warned the U.S. against interfering in Chinese affairs.  He said, “If anyone insists on harming China’s interests, China is determined to take all necessary countermeasures.  The national security law for Hong Kong is purely China’s internal affair that allows no foreign interference.”

In a separate blow to US/China relations, the House on Wednesday passed the bill authorizing sanctions on China for its alleged repression of its Muslim minority.  The House sent the bill to President Trump for his signature, although the White House has not yet said whether Mr. Trump will sign the bill.

The markets are waiting to see if China will retaliate against what it sees as interference in its internal affairs.  The list of actions by the U.S. against China in the past few weeks has grown long enough that China will look weak if it doesn’t retaliate in some way.  China has said it may name U.S. companies to its “unreliable entities” list, which would mean investigations and likely restrictions on the sales by those companies in China.

China might also retaliate by allowing the yuan to depreciate, thus boosting the competitiveness of Chinese exports and hurting the competitiveness of U.S. products.  Indeed, the Chinese yuan on Wednesday posted a 9-month low and closed the day sharply lower by -0.45% at 7.1671 yuan/USD.  The yuan is just slightly above the 12-year low of 7.1876 posted in September 2019.  President Trump will not be happy with the new depreciation in the yuan, although the yuan is dropping in large part because of the Hong Kong tensions and worries about whether the U.S. will impose severe sanctions on China and Hong Kong.

The US/China phase-one trade deal so far remains intact, but could eventually become a casualty of deteriorating US/China relations, resulting in new round of US/China tariffs.

EU proposes landmark 750 billion euro recovery fund — The markets were pleased with the European Commission’s proposal for a 750 billion euro recovery fund, backed by bonds issued by the European Commission and paid for from the EU’s regular budget process.  That fund was larger than the 500 billion euro fund recently proposed by Germany and France.  The proposal includes 500 billion euros of grants and 250 billion euros of loans.

The problem is that the money will not become available until later this year or even early next year since all of the EU countries must unanimously agree to the proposal and then approve the measure in their national parliaments.  Sweden has already said it is opposed.  The markets are hoping for some progress on the fund at the EU Summit on June 19.

The 10-year Italian bond yield on Wednesday fell to a 2-month low and closed the day down -5 bp at 1.50% on the recovery fund news.  The spread of the 10-year Italian bond yield over Germany also fell to a 2-month low and closed the day -6 bp at 192 bp.

Treasury market set to absorb record-sized 7-year T-note auction — The Treasury today will sell $38 billion of 7-year T-notes, concluding this week’s $147 billion T-note package.  Today’s 7-year T-note issue was trading at 0.53% in when-issued trading late yesterday afternoon.  The $38 billion size of today’s 7-year T-note is up by $3 billion from April’s $35 billion auction and up by $6 billion (+19%) from the $32 billion auction size that prevailed during 2019 and early 2020.  The national debt is currently at $25.4 trillion, which is more than triple the $8 trillion level seen before the Great Recession.

Today’s U.S. reports expected to show continued economic devastation — Today’s weekly initial unemployment claims report is expected to remain very high at 2.1 million, although at least down from last week’s 2.438 million.  A total of 39 million people have filed unemployment claims since the end of February.  Today’s continuing claims report is expected to rise +677,000 to 25.75 million, producing an overall rise of 23.4 million since the end of February, 

Today’s Q1 GDP report is expected to be unrevised at -4.8% (q/q annualized).  Today’s Apr durable goods orders report is expected to plunge by -19.3% and -15.0% ex-transportation, adding to March’s decline of -14.7% and -0.4%, respectively.  Today’s Apr pending home sales report is expected to plunge by -15.0% m/m and -28.1% y/y following March’s report of -20.8% m/m and -14.5% y/y.

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