US-Sino Tensions Rise After Chip Ban

Major indices came under pressure on Tuesday, October 17, as the market reacted to US plans to halt AI chip shipments to China coupled with robust US data. 

Somewhat upbeat earnings reports helped keep indices at bay, with the exception of tech-heavy Nasdaq (US-TECH 100)  falling  0.25% on the backdrop of the decline in chip stocks like NVIDIA. The Dow Jones Industrial Average (USA 30) ended the session up a mere 0.04%, while the S&P 500 (US 500) lost 0.01%.

The upbeat economic data in the US were seen as adding to the probability of a January 2024 interest rate hike after holding in November, with chances of tightening in December also slightly higher. As a result, the rate-sensitive 2-year US Treasury yield spiked to a high not seen since 2006.

Main Session Drivers

Tuesday's price action occurred in the context of grim news for US chipmakers, combined with the latest Retail Sales and Industrial Production data and notable upbeat earnings reports.

Chip stocks such as Nvidia (NVDA) and Advanced Micro Devices (AMD) sold off as the Biden Administration announced plans to tighten restrictions on AI chip exports to China. The President's restrictions aim to slow China's technological advances and keep the chip industry in the US, making it more difficult for chipmakers to sell their products to China.

Moreover, US Retail Sales for September rose  0.7% month-on-month, more than doubling expectations of 0.3%. The data suggested that consumer spending remained resilient in the face of potential Fed hikes, with Oil (CL) prices as the main contributor. 

August's print was also revised higher from 0.6% to 0.8%, showing continued momentum. The Core figure, which excludes autos, was up 0.6%, also surpassing the 0.2% projection of analysts, with the control group used for GDP calculation up by 0.6% as well.

Meanwhile, quarterly earnings were a mixed bag on Tuesday, October 18. Shares of United Airlines (UAL) fell by about 5% on weak guidance, while JB Hunt (JBHT) declined over 3% on disappointing results. 

In the context of major banks reporting Tuesday, Goldman Sachs (GS) fell amid a 33% profit slide, while Bank of America (BAC) advanced after reporting its best Q3 results in more than a decade. However, statistics show that 83% of companies that have already reported have exceeded expectations.

US Ban on Chip Exports to China

The US Department of Commerce decided to curb sales of advanced AI chips to China to prevent Chinese access to semiconductors that could be used for military purposes. Nvidia's H100, H800, A100, A800, L40, L40S, and RTX 4090, as well as entire designs including the chips, are now considered banned without a license. 

The curbs would also limit access to processors and chipmaking tools to other nations, including Iran and Russia. Of the major chipmakers exporting to China, some expect Nvidia to be hit the most, as it generates 10% to 20% of its AI sales from China. However, the company said it expected that the changes would not have an immediate financial impact.

The new restrictions could also affect chipmakers Intel (INTC) and AMD (AMD), as well as Applied Materials (AMAT), Lam Research (LRCX), and KLA (KLAC). However, consumer product chips used in gaming consoles or smartphones will not be subject to controls. The new restrictions on shipment are expected to be announced sometime this week.

Future Implications

Despite making strong headlines, chips bans to China are not new to chipmakers. In October 2022, the US government imposed restrictions that prevented Nvidia from shipping two of its most advanced AI chips to Chinese customers for developing chatbots and other AI systems. The actions led to retaliatory measures from China, such as banning the sales of chips made by US companies and restricting exports of materials critical to semiconductor manufacturing. 

However, the new measures aim to close regulatory loopholes and will be modified on an annual basis, suggesting no near end to the rift.

With China seeing the US-China chip war as a direct challenge to its sovereignty while the US remains committed to defending Taiwan, the technology trade war between them has become one of the biggest “geopolitical risks for companies to manage”, according to Korean President Yoon Suk-yoel. 

China opposed the new restrictions imposed by the US, but it was not alone in its call for de-escalation. The Semiconductor Industry Association also criticised the US government, stating that broad controls risk harming the US semiconductor industry. But with the upcoming election in Taiwan in January 2024 making chips a critical strategic asset, the United West might keep restricting access to chips, intensifying the trade war. (Source:The Wall Street Journal)

Conclusion

A spike in retail sales appeared favourable for the US economy and helped raise the chances of a Fed hike in one of its upcoming meetings. However, weakness in chip stocks weighed on sentiment, and earnings were somewhat of a mixed bag with an upbeat tone. 

The announcement of chip restrictions is considered harmful to the US semiconductor industry by most actors but has also raised concerns over "resource nationalism" in general.

The question now is, will China retaliate again and whether the united West will put efforts on the back burner ahead of Japan's 2024 elections in January?