ANDREAS STENO: Hi, everyone. And welcome to the Daily Briefing at Real Vision. I'm Andreas Steno, the Senior Editor at Real Vision sending to you live from Copenhagen, Denmark, Tuesday the 2nd of August. We've got a bunch of things to unpack in relation to the situation in Taiwan as well as the major moves that we've seen in financial markets today.
And I have a couple of great guests joining me for the next 30 minutes. Firstly, Taylor Fravel, Professor at Political Science and Director of the Security Studies Program at MIT. Welcome, Taylor. It's very good to have you here.
TAYLOR FRAVEL: Thanks for having me.
ANDREAS STENO: You'll help us unpack the developments in Taiwan in a second. But also a warm welcome back to the show to you, Tony Greer, the founder of TG Macro.
TONY GREER: How are you doing, Andreas?
ANDREAS STENO: Good, Tony. Good to see you. Firstly, Taylor, I wanted to ask you. Nancy Pelosi basically just landed in Taiwan, was it a few hours ago. Is this part of a bigger strategy orchestrated by the White House, or what's the reason for this visit?
TAYLOR FRAVEL: No, I don't think it's part of a bigger strategy by the White House at all. In fact, for weeks they very quietly, I think, tried to persuade her not to make this trip because they were worried about how China might react and the potential for a crisis across the Straits. But nevertheless, she was clearly committed to going. This trip was originally planned for April but was rescheduled after she came down with COVID.
And as the Speaker of the House, I think she's probably long wanted to make a trip to Taiwan. Depending upon how the elections this coming fall in the United States, she may not be Speaker for much longer. And of course, China has featured prominently in her role in Congress going all the way back to a trip she made to Beijing in 1991 in support of the student demonstrators and workers in Tiananmen Square.
And so, she clearly has strong personal reasons, I think, for making this trip. I think she also probably believes that she wants to demonstrate US support for Taiwan. And this would be the opportunity to do so before she steps down as Speaker.
ANDREAS STENO: Pelosi has basically defied a load of Chinese warnings ahead of this visit. Should we expect a major response from China to this visit?
TAYLOR FRAVEL: We should. And we're already seeing it in the military domain. Literally within moments of her touching down in Taipei, the Xinhua news agency issued a quote, authoritative release, outlining six closure areas in which military exercises, including live fire exercises would be held on the 4th of August and the 7th of August. There are reports last night that 100 Taiwanese firms were barred from exporting some goods, some agricultural goods, I believe, in particular from Taiwan to China.
And so, clearly China made threats before that there would be consequences. And now I think it's going to carry through on those threats because of the importance that the leadership in Beijing attaches to the issue.
ANDREAS STENO: Tony, I also wanted to get your take on the market action in relation to this Taiwan story. What's been on your radar in financial markets today?
TONY GREER: I feel like the market, Andreas, is more focused on this battle royale right now between the inflation Bulls and the recession Bears, if that's fair to say. Right now, when I look at the tape, it looks like they are tearing each other's arms off and beating each other over the head with them.
Today, we had the biggest-- all the action today was in the bond market. There was a two sigma spike higher in yields really without a corresponding commodity move on the tape, which was kind of interesting to me. It looks like that could have been somewhat of a blow-up or exit trade or something like that.
But that does speak to the inflationary action and inflationary vibes that we've been getting from the market. We just went through a week of CPI and PPI where they were both much higher than expected. We came through a weekend where the media's still really focused on this recession that the bond market is pricing in and the administration is trying to redefine. None of that matters.
The market is, in fact, pricing in somewhat of a recession. And it feels like it may have overshot a little bit on the downside, Andreas. With this yield move higher today, we had a big move higher and break-evens at the end of last week. It looks like the market-based inflation expectations may have overshot to the downside.
What feels like to me like there's still a lot of negative sentiment though in the equity market. I feel like everybody on Fintwit is talking about the next shoe to drop. That's not to say that it's not going to drop. It's just to say that I pick up some bearish sentiment from the internet, and that's about it.
So today's leadership really isn't anything to get excited about. The S&P started off in the red, rallied into the black, ended up in the red again. The leadership was from a mixed bag but mostly from some of the sectors that are down on the year again, cannabis, social media, internet stocks. There were big upside moves in Tilray and Aurora Cannabis and [INAUDIBLE] and names like that.
The downside was really everything cyclical with an extra focus on homebuilders. There was a two sigma move lower today in XHB, a real big follow through in Pulte Homes after reporting bad news last week, a big reaction to the move higher in rates today. So Andreas, I really see an ongoing push and pull battle between the inflationary Bulls and recessionary Bears, if that's fair to say.
ANDREAS STENO: Absolutely, Tony. And I wanted to get back to you, Taylor, in relation to this uncertainty seen in financial markets today. We've seen a big increase in interest rates, which is usually a signal that markets are getting scared of geopolitical risks again. There is this Russian proverb saying that this is China's final warning. Is this one of those cry wolf events again?
TAYLOR FRAVEL: I don't think it is. I think from China's standpoint, they've been increasingly concerned about changes in the US one-China policy and policies toward Taiwan in particular. This started the tail-end of the Trump administration but has continued and I think escalated-- or their concerns have escalated in the Biden administration.
And so, starting around late last October after Biden made two of his gaffes on Taiwan, Chinese senior leaders began talking very explicitly about the United States hollowing out its one-China policy. In a phone call in November, Xi Jinping told Biden not to play with fire over Taiwan, something he repeated in their recent call just to-- I guess was it last week or the week before last.
And so, I think China's being driven by real concerns that it sees and thus a need to restore credibility with the United States regarding its own commitment to pursuing what it calls reunification or the unification of Taiwan with the mainland.
And I think there's no foreign policy issue more important for China's leaders than Taiwan in the security area, certainly, foreign economic policy is very important in terms of wealth overall. But in terms of security issues, this is it. This is what they care more about than any other foreign policy issue.
So I don't believe they're crying wolf. It doesn't mean necessarily that they are on the cusp of invading either or taking major action. But I think they will-- we will see probably over the coming weeks and months a whole series of actions that are just beginning with these military exercises designed to underscore China's resolve with respect to Taiwan.
ANDREAS STENO: I think we can bring up a chart showing these military exercises around Taiwan currently compared to March 1996, the third Taiwan Strait crisis. And it seems like this time, some of the exercises they actually overlap with Taiwan's territorial waters. Do you see this as an escalation compared to earlier crisis situations in the Taiwan Strait?
TAYLOR FRAVEL: I think these exercises have the potential to be much bigger than those that took place in March of 1996. Not just because of the overlap with the territorial waters but simply because of the way in which these closure areas effectively attack Taiwan from the North, to South, the East, and the West.
They also target key Chinese ports in the Northern and Southern parts of the country. One of them is astride the median line and probably the most likely vector of an amphibious assault. And the one to the East is where China has announced that it will conduct conventional missile tests with the prospect for the first time that Chinese missiles could fly over Taiwan on their way to landing in this identified zone.
They could be launched on other vectors that might not take them over Taiwan. But certainly, there is this possibility, especially if they're launched from the short-range ballistic missile units that are immediately off the-- or on the Chinese coast adjacent to Taiwan.
So in that sense, I think the scope and scale are probably much larger. The main difference will be that in 1996, apart from the two missile tests in the small black boxes that you see on the chart, the majority of China's response is to simulate an amphibious assault along basically the Chinese coast. So simulating an assault of Taiwan. But all the action is taking place basically right off the coast of China.
In this case, it's going to be mostly air and sea exercises. And they're going to mostly take place right off the coast of Taiwan. So this is a huge difference in terms of how the exercises are likely to unfold.
And again, we have to also remind ourselves that in the 1995 and 1996 crisis, which really went from the summer of '95 through March of '96, there were about three or four major exercises. And the map that we're looking at in this chart was only the most-- well, it was the last one of those series of exercises.
And so, I think there's great potential here for these exercises to continue perhaps through the party Congress which will be scheduled for some time this fall. Especially if China believes that it has not reached some modus vivendi with the United States over one-China. And that is probably unlikely given the electoral pressures President Biden and the Democrats are going to feel going into the midterms.
ANDREAS STENO: I wanted to ask you as well whether there are any parallels to the ongoing crisis in Ukraine. Do you think China will look at the Western willingness to sanction Russia and think twice about these military exercises in Taiwan?
TAYLOR FRAVEL: I don't think the potential for sanctions along the scope and scale that have been placed on Russia will deter China from conducting these exercises so long as it believes it can do so without targeting advertently or inadvertently US or Taiwanese assets in the area. In other words, if they can cap the potential for escalation.
I think China, of course, has paid great attention to those sanctions and has been considering how to properly sanction-proof its economy in response. But I don't think it would believe these sort of sanctions along such a broad scale would be implemented in response to exercises versus a kinetic use of force that would be intended to basically seize some or all of Taiwan from the Republic of China.
And so, in that sense, I don't think the scenarios are quite analogous. But certainly it has to be a factor in the back of the mind of Chinese leaders, that were this to escalate, there is an economic cost that they could pay.
And so, I think their approach will be to pursue a Goldilocks strategy, whereby they have a very robust of display of military force that foreshadows what could happen in the future without crossing that kinetic line, starting a war, and thus facing the potential brunt of sanctions that they might face.
Also on sanctions, I would note, we have to at least ask ourselves would the Europeans be as eager to sanction China as they have been to sanction Russia? And so, this would be a conflict happening in a very different geography than the one we're witnessing in Ukraine.
And although I think the unity of the Western approach to Russia is striking, and noteworthy, and commendable, it remains to be seen if that same level of unity would be achieved if the crisis were concerning China and Taiwan and then the United States.
ANDREAS STENO: That's certainly a fair question mark. I also wanted to ask you about Joe Biden's policy on tariffs on China. He's publicly debated the possibility of scaling back on some of the tariffs implemented by the Trump administration. Are such policy moves off the table in your opinion now?
TAYLOR FRAVEL: It probably makes them politically harder to do, even though economically I think they make a lot of sense. Because the purpose was to generate leverage to pursue other changes in the Chinese economy. And what, we're three years into tariffs, and I don't think there's been a single change [LAUGHS] in the aspects that were targeted. So in that sense, the tariffs haven't been a great policy tool.
It's also probably one of the few tools he could manipulate to lower inflation. Economists and folks like you guys probably have a better sense of what that actual impact would be. But it is at least a policy tool that you can pull or a policy lever you can pull to do something about inflation. And so, I think there are good reasons to reduce the tariffs, because they've been either counterproductive or have contributed to inflation.
But politically, I think it would be seen now as caving to China in some way or rewarding China for its belligerence across the Strait. And so, therefore, it's probably off the table, at least until after the midterms.
ANDREAS STENO: I wanted to allow for a final question from the audience to you, Taylor, before you leave the discussion. And it's from Ralph asking you, what have China and Taiwan learned from the Russian invasion of Ukraine?
TAYLOR FRAVEL: I think Taiwan has probably learned that-- or the very impressive lesson of the will of the Ukrainians to survive and to fight for the survival of their country. Ukraine is a much-- it's not as weak relative to Russia as Taiwan is to China. But nevertheless, this sort of will to fight I think is remarkable in Ukraine-- defied the expectations of many analysts before it occurred, who thought that Ukraine would collapse pretty quickly. And quite the opposite has occurred.
And so, I think there are great potential for Taiwan looking at the lessons of Ukraine to do much more to defend itself and to defend itself quite robustly with mobile anti-ship and anti-air systems, which would really frustrate China's military operations, especially in a very large amphibious assault.
I think from China's standpoint, there are lots of questions. I think effectively, though, they would ask just how ready the PLA really is, and has corruption really been rooted out as much as they have tried to do so.
Because one lesson we're learning from Russian operations in Ukraine is the continued depth of corruption in that military and the consequences it has for military effectiveness. I think they would also be asking whether or not the reforms they put in place in 2015 have created the nimble kind of force that is really able to conduct high intensity joint operations.
I think it's important to bear in mind that what Russia has tried to do in Ukraine in the scope of modern military operations is really the most straightforward, surging forces across the land border, primarily conducting combined operations within your ground forces, not joint operations combining air, sea, and ground forces. What China would want to do across the Strait would be orders of magnitude more complicated.
And so, seeing the Russians face this challenge in conducting relatively simple operations, even though they've adapted to some degree, I think would probably be a pretty bracing lesson for China to think about with respect to the capability of the PLA, which despite two decades of massive recapitalization in terms of new platforms such as stealth fighters, and surface combatants, and so forth, the open question is just how well can that equipment operate and to what effect. And so, I think that will probably induce some caution and contribute to the maintenance of deterrence across the Strait.
ANDREAS STENO: Taylor Fravel, Professor of Political Science and Director of the Security Studies Program at MIT. Thanks so much for joining the Daily Briefing today.
TAYLOR FRAVEL: Thanks so much for having me. A pleasure to be with you.
ANDREAS STENO: Tony, back to you and the discussion on financial markets. It's been a crazy day. We've seen this massive move in interest rates. What do you make of this move in interest rates and the spillovers potentially to the commodity space and the equity space in the days ahead?
TONY GREER: Yeah. I feel like it's really hard to break down right now, Andreas. There's not a lot of correlation in the tape. Things are flying off in their own direction. It feels like the bond market is still reacting to the CPI and PPI data at some level, or at least the fact that the bond market likely overshot the recession on the downside and then got this upside surprise in the inflation data and is now adjusting.
It's also adjusting at a very precarious time for the crude oil market. That's front and center for me right now. Because crude oil is testing the 200 day moving average, which is a big deal for us technicians. On the bull side, we've still got a lot to hang our hat on. GasBuddy says that gas-- local gasoline demand is literally at record levels through nine and 1/2 million barrels of gasoline a day, well above historic averages.
We've got still firmly backward-dated markets. But we've got them much looser than they were, say, a month, a month and a half ago. So what we've got is the crack spread backing off from the mid 50s to 38. We've got Sept/Oct diesel fuel backing off from $10 to $4. While $4 is still massively backward-dated, it has now been cut in half since its widest prices. So naturally, you see pricing back them off. We see the gasoline market testing the 200-day moving average for the first time this year I believe.
So the market-- the oil markets are respecting the fact that the financial markets are pricing in that recession. It looks like they may have priced them in a little bit too far. It looks like the equity market is still sort of treading water around here but more likely downside maybe to come.
It could be a situation where we have one of those ripping bear market rallies if commodities can get on their feet here with this move higher in yields. But it's really tricky right now, Andreas. There's a