by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

In today’s Comment, we open with an update on the Russia-Ukraine crisis, with a focus on two key diplomatic meetings yesterday.  We next turn to a range of U.S. developments, including another U.S. hurdle to investments in China.  Following that, we review other international news items that have the potential to move the financial markets today, and we close with the latest news on the coronavirus pandemic.

Russia-Ukraine:  As several divisions of Russian troops remain poised for attack along Ukraine’s borders, and as six additional Russian warships are being transferred to the Black Sea from the Mediterranean, the key developments in the crisis over the last day have centered on two diplomatic meetings, one of which had the characteristic of a carrot and the other a stick.

• Macron’s Carrot for Putin:  After hinting that NATO should be prepared to offer concessions to Russian security concerns, French President Macron met with Russian President Putin for more than five hours of talks inside the Kremlin.
  • At a joint press conference afterward, Putin remained combative and critical of NATO, blaming the West and Ukraine for the crisis, but said Russia would do “everything possible to reach compromises acceptable to everyone” on European security.
  • Macron was more positive, saying Putin had given him assurances that he was open to exploring ways to defuse the crisis.  He said Putin promised not to undertake any new military initiatives and agreed to launch a broad dialogue on Russian troop deployments, including an agreement to withdraw thousands of Russian troops from Belarus after completing their current exercises in the country.  Macron flies to Kyiv to confer with Ukrainian President Zelensky today.
• Biden’s Stick for Scholz:  Meanwhile, President Biden held a meeting at the White House with German Chancellor Scholz.
  • After a press conference alongside the German leader, Biden stated definitively that if Russian forces invade Ukraine again, the Nord Stream 2 natural gas pipeline from Russia to Germany will be shut down.  In Biden’s words, “If Russia invades, . . . then there will be no longer a Nord Stream 2. We will put an end to it . . . I promise you, we will be able to do it.”
  • Notably, however, Scholz continued to refrain from stating the same commitment.  He merely offered assurances that the U.S. and Germany are aligned fully in their approach to Ukraine’s security.
• Overall, these diplomatic moves illustrate the difficulty the NATO allies have in striking the right balance between conciliatory measures and firm threats to rein in Putin.  Macron’s willingness to respond to some Russian concerns has long worried others in the alliance, who fear he is only encouraging Putin’s belligerence.  Germany has also been reluctant to act as firmly as the U.S., the U.K., and NATO’s new Eastern European members.  Behind closed doors, German officials have assured the U.S. that they would shut down Nord Stream 2 in the event of a Russian attack on Ukraine.  However, Scholz’s refusal to say so publicly takes some of the bite out of the U.S. sanctions threats meant to dissuade Russian President Putin from attacking.  Overall, the situation remains fluid, and although we still suspect the crisis will eventually get resolved with Putin backing down, anything could happen.  The world’s financial markets will therefore remain on edge.

United States-China:  Chinese healthcare stocks are selling off sharply today after the U.S. placed 33 health companies on its list of Chinese firms that are restricted from importing certain advanced technologies from the U.S.  Hong Kong’s Hang Seng Healthcare Index ended the day down almost 5%, although some companies in the index fell much more than that.  The development is a reminder that U.S.-China geopolitical and economic tensions continue to present a risk for investors in Chinese companies.

United States-Japan:  The Biden administration has agreed to lift the import tariffs imposed on Japanese steel by the Trump administration in 2018, following a similar deal with the EU last fall.  Under the agreement, Japan can avoid duties on up to 1.25 million metric tons of steel shipped to the U.S. each year, a level similar to its exports in 2018 and 2019.

• The deal will remove an irritant in the countries’ bilateral relationship as the U.S. seeks to strengthen its alliance system to counter China’s growing geopolitical assertiveness.
• The agreement is clearly designed to discourage increases in imports by maintaining tariffs on shipments beyond the agreed-upon level.  All the same, the deal should help lower the cost of imported steel for U.S. users, marginally reducing the U.S. inflation pressures that have been pushing up interest rates and rattling risk markets.

U.S. Fiscal Policy:  House leaders scheduled a Tuesday vote to extend a temporary government funding measure through March 11, buying time for negotiators to work out a comprehensive fiscal 2022 package after a prolonged deadlock over how much to allocate for military and nondefense spending.  Without the passage of the temporary funding, the government would be at risk of a partial shutdown, and investors would once again have to consider the risk of a U.S. debt default.

EU Monetary Policy:  After refusing last week to rule out an interest-rate hike this year and saying there was “unanimous concern” about inflation among the Eurozone’s monetary policymakers, ECB President Lagarde yesterday played down the chances of a “measurable tightening” of monetary policy and insisted there was no rush to tackle inflation.  While she did admit Eurozone inflation was no longer likely to fall below the ECB’s target of 2% by the end of the year, her effort to walk back last week’s hawkishness probably reflects her discomfort with the financial market volatility sparked by such rhetoric in Europe, the U.K., and the U.S.

• That sensitivity to market volatility is a significant reason the policymakers at major central banks may not tighten policy this year as much as investors think.  More broadly, there is also some concern about the impact of higher interest rates on less-developed countries.
• If the policymakers ultimately get cold feet, especially as “base effects” start to push down inflation around mid-year, any signal of an early end to rate hikes would likely give a major boost to bond prices and bring yields back down.

EU Industrial Policy:  The European Commission today introduced legislation to make available about $49 billion in public and private funding for the chip-making industry.  The proposal, known as the European Chips Act, could unleash tens of billions of dollars in funding for research and new production facilities, part of the bloc’s economywide effort to boost its commercial independence.

• If successful, the program could eventually help resolve supply constraints that have been driving up prices for computer chips and worsening inflation.
• If the program successfully reinvigorates Europe’s semiconductor industry, it could also eventually expand opportunities for technology investors.

Poland:  Finance Minister Koscinski has resigned amid a widening backlash against the government’s “Polish Deal” economic reforms last year.  The reforms, supported by the EU’s new pandemic relief fund, included higher spending on healthcare and other public services, along with tax cuts for lower- and middle-income people.

• However, implementation has been poor, resulting in some people paying higher taxes than before.
• Political shakeups in major countries always have the potential to affect investors.  If Koscinski’s resignation leads to significant economic policy changes in Poland, it could have big implications for the country’s investment climate going forward.  However, there is no indication right now who might replace Koscinski or how the country’s economic policy might evolve.

Sri Lanka:  Asia’s top high-yield bond issuer, Sri Lanka, is edging closer to default on its billions of dollars of debt.  The South Asian island was plunged into crisis after a cascade of rating downgrades following large tax cuts in 2019 and the loss of tourism during the pandemic.  That has left it unable to tap global markets as it faces some $7 billion in debt service payments due this year.

COVID-19:  Official data show confirmed cases have risen to  397,963,515 worldwide, with 5,753,381 deaths.  In the U.S., confirmed cases rose to 76,853,612, with 905,544 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 212,920,278, equal to 64.1% of the total population.

In the U.S., the seven-day average of people hospitalized with confirmed or suspected COVID-19 dropped to 115,173 yesterday, extending its drop over the last two and a half weeks.  The seven-day average of new cases stood at 265,700 on Monday, after falling under the 300,000 mark on Sunday for the first time this year.

• Even though the highly transmissible Omicron variant appears to be in retreat in at least some major countries, drug firms continue their efforts to develop one-shot vaccines that could be used in the future.
• Officials in several Democrat-led states yesterday said they would lift their mask mandates for schools or other indoor areas in the coming weeks as COVID-19 cases fall.
  • The governors of Connecticut and New Jersey said school districts would be able to determine their own masking policies starting February 28 and March 7, respectively.
  • California Governor Newsom said his state’s indoor mask mandate would expire on February 15.
• In Canada, hundreds of truckers and their big rigs continue to occupy parts of the capital city of Ottawa to protest Prime Minister Trudeau’s vaccine mandates.  The protest, now in its 12^th day, aims to put political pressure on Trudeau to reverse his policies.
  • However, vaccination support among Canadians remains high, with more than 85% of the population fully or partially vaccinated.  Indeed, Trudeau won reelection last fall in part on a promise to impose vaccine mandates.
  • Moreover, the disruptions to everyday life in Ottawa have pressured police to begin taking a hard line against the protestors, including arresting some.
• In contrast to the loosening restrictions and mandates in the U.S. and other countries, Hong Kong is tightening its mandates in conjunction with China’s zero-COVID policy.  Under the new rules, unvaccinated residents will be barred from Hong Kong’s supermarkets and malls.  The restrictions expand a vaccine mandate scheduled to begin on February 24 that already covered venues like restaurants and gyms.

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