by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment opens with an update on the Russia-Ukraine war, where we see signs that the Battle for Donbas is starting.  We next review a range of international and U.S. developments with the potential to affect the financial markets today.  We close with the latest news on the coronavirus pandemic.

Russia-Ukraine:  As Russian forces refocus their efforts on seizing control of eastern and southern Ukraine, large-scale battles are starting or intensifying around the Donbas region and the besieged port city of Mariupol.  Ominously, the Ukrainian military said it is investigating a possible Russian chemical weapons attack in Mariupol.  At the same time, a French military policy unit entered Ukraine to help investigate possible Russian war crimes, marking the first deployment of troops from a NATO country into Ukraine since the war started.

• Separately, a meeting of European Union foreign ministers yesterday discussed further energy sanctions against Russia, but they failed to come to a conclusion.  Officials privately admit that hitting Russian oil is just a matter of time, but the sense of urgency that accompanied last week’s discussions has faded.
• However, there does seem to be more progress on a new round of EU arms deliveries to Ukraine.  German Foreign Minister Baerbock has urged Western countries to supply Ukraine with “heavy weapons” while issuing a thinly veiled criticism of her own Chancellor, Olaf Scholz, who has delayed deliveries of tanks to Kyiv.  Separately, a major German defense firm said it could deliver up to 50 Leopard I battle tanks to Ukraine within six weeks, while Slovakia said it is still working on a plan to deliver Soviet-designed MiG-29 fighter jets.
• Ukrainian Finance Minister Marchenko pleaded for financial aid from Western governments, the IMF, and the World Bank so it could keep prosecuting the war.  According to Marchenko, the Ukrainian government’s spending exceeded revenues by about $2.7 billion in March. He expects the gap to expand $5 billion to $7 billion a month in April and May.
  • Yesterday, the Kyiv School of Economics estimated that Ukraine’s total economic losses from the war total as much as $600 billion.
  • Marchenko demanded that Russia pay reparations for “the destruction of private and public property” during the war and stated Kyiv had assembled an international legal team to lodge claims against Moscow.

U.S. Energy Policy:  To help bring down energy prices that have been boosted in part by the Russia-Ukraine war, the Biden administration said it would temporarily allow the sale of gasoline with high ethanol content.  The decision will allow gasoline with 15% ethanol to be sold between June 1 and September 15.  Normally, only a 10% ethanol blend can be sold during that time period in the summer to reduce smog caused by the 15% blend’s higher volatility.

• According to officials, allowing fuels with a higher ethanol content will lessen reliance on oil, give drivers more options, and save drivers as much as 10 cents per gallon.
• However, oil-industry officials have questioned whether such moves would lower prices. Higher ethanol blending can sometimes raise prices on refiners. Corn prices, like oil, have also seen sharp increases this year because of Russia’s invasion of Ukraine.
• Overall, the announcement reflects how the administration is desperately grasping at straws—any straws—to bring down inflation and salvage its political prospects ahead of the November mid-term elections.  Considering the political constraints facing the administration and the limited tools at its disposal, it does not look like it will be able to cut inflation meaningfully in the near term.

U.S. Monetary Policy:  Chicago FRB President Evans provided further evidence that the Federal Reserve will hike interest rates aggressively at its early May policy meeting.  Although Evans isn’t a voting member of the policy committee this year, he argued at a speaking event in Detroit that a 50-basis-point hike at the May 3–4 meeting “is obviously worthy of consideration, perhaps it’s highly likely.”

• The statement is in line with comments by many other policymakers reflecting their panic over inflation and their intent to demonstrate inflation-fighting cred by jacking up interest rates and cutting the Fed’s balance sheet aggressively.
• As investors mull over the implications of the Fed’s aggressive tightening plans, the yield curve has steepened considerably again after inverting last week.  At day’s end yesterday, the yield on the 10-year Treasury note had reached a three-year high of 2.827%, while the yield on the 2-year Treasury note rose to just 2.549%.
• We continue to believe the policymakers will uncover financial or economic fragilities relatively soon and will not be able to tighten policy as far or as fast as most investors expect.  Still, even if the officials have to curtail their tightening early, the damage from high inflation and rising interest rates may already be done.  At this point, we already see an elevated risk of a sharp economic slowdown or recession starting in 2023.

Japan:  An additional complication for Fed policymakers will come from Japan.  The rapid depreciation of the yen over the last week is raising hedging costs for Japanese investors and making it harder for them to buy U.S. bonds.  Decreased demand from Japan could make it harder for the Fed to implement its planned sell-off of assets held on its balance sheet without disrupting the bond market.

France:  Working to solidify his status as the frontrunner in the April 24 presidential run-off election, President Macron climbed down from an earlier campaign pledge to raise the French retirement age from 62 to 65 by 2030.  Courting left-leaning voters who might otherwise be tempted to support right-wing populist Marine Le Pen, the president said he would consult unions and other political parties over the pace and timetable of reform.  He also hinted that he might be willing to submit the reform to a popular referendum.

• In the latest opinion polls, Macron is currently supported by 52.8% of the electorate, while 47.2% support Le Pen.  Macron’s support has improved slightly since his better-than-expected performance in the first round of voting last Sunday.
• Nevertheless, the election remains fraught with danger for Macron, France, and Europe in general.  Le Pen has softened her hard-edged populism going into this year’s election.  Her policy goals, if elected, would probably still include steps like clamping down on Muslim rights within France, restricting immigration, pulling France out of the NATO military command structure, and undermining European Union powers over its member states.

Sri Lanka:  Amid a financial crisis touched off by the coronavirus pandemic, surging commodity prices, and political tensions, the government announced that it would suspend all bond payments, including debt service on some $35 billion of foreign sovereign bonds.  The government will also request help from the IMF.

• The crisis is one example of the financial and political instability that can be touched off by high global commodity prices, as we’ve written about many times.
• The debt default also could have geopolitical ramifications.  Sri Lanka’s biggest foreign creditor is China, and Western analysts have long worried that aggressive Chinese lending would give it leverage over the country.

COVID-19:  Official data show confirmed cases have risen to  499,748,065 worldwide, with 6,181,560 deaths.  In the U.S., confirmed cases rose to 80,449,398, with 985,826 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 218,430,663, equal to 65.8% of the total population.

• In the U.S., the seven-day average of people hospitalized with confirmed or suspected COVID-19 came in at 14,940 yesterday, down 17% from two weeks earlier.  Nevertheless, new cases of the Omicron BA.2 variant continue to surge in the Northeast.
• Because of increasing Omicron BA.2 cases, officials in Philadelphia said they would reinstate a citywide indoor mask mandate.  Residents and visitors will be required to wear masks in public spaces indoors, including schools, starting next week.
• The Omicron BA.2 waves continue to worsen in parts of Asia and Europe, with China being hit particularly hard by the government’s draconian “zero-COVID” policy.  The U.S. State Department has now ordered all nonessential employees out of its consulate in Shanghai, responding to the government’s stringent lockdown there.  Even though the municipal government modestly eased its strict lockdown rules yesterday, Shanghai remains largely shut down for the time being.
• Two new, peer-reviewed studies found that the risk of inflammatory heart conditions after receiving a COVID-19 vaccine was similar to the risks after receiving other popular vaccines and lower than the risk after contracting COVID-19 itself.  Since the relative risk of a COVID-19 vaccine is middling, researchers hope the findings will encourage more people to get vaccinated or boosted.

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