by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Today’s Comment begins with tantalizing news that Russia may be pulling back its military forces from the Ukrainian border, although it’s important to stress that the move is not confirmed, and anything can still happen.  Given that our discussion of the Russia-Ukraine crisis is quite detailed, we next cover only the most significant developments in the U.S. and abroad.  We wrap up with the latest news on the coronavirus pandemic.

Russia-Ukraine:  In a potential sign that President Putin is backing down from his threatening stance toward Ukraine, a spokesman for the Russian Ministry of Defense said units from the country’s southern and western military districts have completed their “training exercises” and have begun returning to their bases.  Of course, there can be no assurance that the statement is true.  It could easily be a ruse to get the U.S. and its NATO allies to let their guard down while Putin proceeds with an attack.  Besides, the statement came as German Chancellor Scholz was about to meet Putin in an effort to defuse the crisis.  The announcement could simply be aimed at weakening German resolve in resisting Putin’s designs on Ukraine.  The Ukrainian government has already expressed skepticism that Russia is really pulling back, and NATO General Secretary Stoltenberg has said the alliance has still not seen any concrete evidence of a Russian stand down.  It may well take several days before commercial and government imagery or other intelligence confirms a Russian move to de-escalate the situation.  Until then, we can only be cautiously optimistic.

• There have been tantalizing hints that President Putin was setting the stage to back away from a confrontation; we think this is more likely the scenario.
  • Russian television often airs footage of highly choreographed meetings between Putin and his advisors to portray Putin as a tough leader in total control of his government or present the case for a policy initiative.  In one such meeting broadcast yesterday, Russian Foreign Minister Lavrov tells Putin that the West is ignoring the Kremlin’s core security demands but that Moscow should continue negotiations.  In reply, Putin says “Good,” raising hopes he may be signaling a desire to avoid war.
  • Kremlin spokesman Peskov yesterday said that if the Ukrainian government formally abandoned its 2008 application for membership in NATO, it would help address Russia’s security concerns.  Some Ukrainian officials have floated that possibility as a way to diffuse the crisis, but Zelensky said in his press conference with Scholz that he wouldn’t abandon Ukraine’s effort to join the alliance.
• All the same, the Russian statement is at odds with the country’s continued military buildup near the Ukrainian border.  U.S. officials say Russia has now boosted its military forces near Ukraine to 105 battalion tactical groups, up from 83 units earlier this month.  In addition, the military has moved about 500 combat aircraft within range of the country and has 40 combat ships in the Black Sea.
  • Meanwhile, the Russian Duma today will begin considering two bills recognizing the independence of Ukraine’s breakaway Russian-dominated provinces of Donetsk and Luhansk.  If approved, either bill could provide a pretext for Russia to cross into Ukraine, ostensibly at the invitation of Donetsk or Luhansk in order to protect ethnic Russians living in those regions.
  • These developments would be consistent with intelligence reports suggesting this Wednesday is a potential target date for a Russian invasion.
• If a Russian military pullback is confirmed, it would probably have a significant impact on the financial markets.  Already today, equity values are rebounding, while gold and crude oil prices are sliding.  Bonds are selling off, boosting yields again.  There could also be broader geopolitical implications:
  • A Russian pullback would offer tantalizing clues regarding what can be accomplished with reinvigorated U.S. leadership and global engagement.  As we’ve noted before, the U.S., and the Biden administration in particular, knows how to do great-power politics.  Success in diffusing the Russia-Ukraine crisis and utilizing its new information-warfare skills would likely burnish U.S. prestige and repair some of its influence worldwide.
    • In one example, the U.S. would likely pressure its NATO allies to invest more in their own defense so they can be better prepared to stand up to Russia in the future.  Indeed, after feeling the hot breath of the Russian bear on their necks, NATO countries may well be incentivized to boost their defense efforts in any case.  The Polish government has even started to ease some of its tensions with the European Union.
    • U.S. officials have said that their firm stance against Russia aims, in part, to signal that the U.S. and its Indo-Pacific allies would take a strong stance in protecting Taiwan from Chinese aggression.
  • Of course, diffusing the Russia-Ukraine crisis would also be a domestic political win for Biden, as it could help people forget about the chaotic U.S. withdrawal from Afghanistan last year.  With the administration seemingly unable or uninterested in bringing down inflation, it would probably be happy to try to turn their attention to foreign policy wins ahead of this fall’s mid-term elections.

U.S. Financial System:  The Federal Reserve Board, Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency yesterday issued a report that flagged mounting vulnerabilities across a number of sectors hardest hit by the coronavirus pandemic, including commercial real estate.

• The report shows that excessive borrowing and declining creditworthiness remained a problem in 2021.
• The fragility mentioned in the report is a key reason we think the Fed won’t be able to hike interest rates this year as fast or as far as investors currently expect.  With the fragilities that have built up in some financial sectors during the Fed’s slow pivot away from loose monetary policy, it will probably only take a few rate hikes and reduced asset purchases to expose problems and force the Fed to retreat.

United States-Mexico:  The U.S. has suspended essentially all imports of Mexican avocados until further notice after a threatening message was sent to a U.S. plant safety inspector working in the state of Michoacan, a center of drug-cartel activity.  If the import cut-off lasts too long, it would likely cause a spike in avocado prices and further feed into investor concerns about inflation and interest-rate hikes.

Canada:  A day after police cleared truckers blocking the Ambassador Bridge linking Detroit to Windsor, Ontario, Prime Minister Trudeau yesterday took the rare step of declaring a national public order emergency to end the truckers’ anti-vaccine protests in the capital city of Ottawa.

• Invocation of the Emergencies Act confers enormous, if temporary, power on the federal government, including the ability to freeze the protestors’ bank accounts.
• Although the protests have proven quite disruptive in Ottawa and at U.S.-Canadian border crossings, the government’s disciplined, measured approach so far has contained the situation.  The clearance of the Ambassador Bridge suggests the government will soon get control of the situation.  If so, its actions could serve as a template for governments struggling to contain potentially violent populist protests.

Japan:  Fourth-quarter gross domestic product (GDP) rebounded to grow by a seasonally adjusted 1.3%, equal to an annualized rate of 5.4%.  That was more than enough to offset the decline in the previous quarter, and it meant the economy avoided slipping into recession.  Given the size of Japan’s economy, the return to growth could signal momentum in the broader global economy at the end of last year, which would be positive for equities.

COVID-19:  Official data show confirmed cases have risen to  413,746,208 worldwide, with 5,827,947 deaths.  In the U.S., confirmed cases rose to 77,919,052, with 922,473 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 213,962,983, equal to 64.4% of the total population. 

• In the U.S., data continues to suggest the highly transmissible Omicron mutation is in retreat.  The seven-day average of people hospitalized with a confirmed or suspected COVID-19 infection fell to 89,158 yesterday, down some 36% from just two weeks ago.
• French liquor firm Pernod Ricard (PRNDY, 42.91) has asked its top executives in Hong Kong to temporarily relocate as the municipal government’s zero-COVID policies become increasingly onerous.
• In Japan, the situation is looking better than in Hong Kong.  The government is starting to see a decline in daily new COVID-19 cases—a major relief after infections rose exponentially in the past month—but experts say it’s still too early for people to let their guard down, especially since past waves have shown that critical cases and deaths continue to rise well after daily cases peak.

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