by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment opens with our update on the Russia-Ukraine war, where Russian forces are now consistently making some small territorial gains in eastern and southern Ukraine.  There are also increasing signs that the war may be spreading into Moldova, which lies on Ukraine’s southwestern border, and even into Russia itself.  We next review a range of international and U.S. developments with the potential to affect the financial markets today.  Finally, we have the latest news on the coronavirus pandemic.

Russia-Ukraine:  Russian forces continue to probe and advance slowly into the Donbas region of eastern Ukraine, suggesting they have learned a few lessons from their disastrous rush to take Kyiv in western Ukraine early in the war.  Russian troops also continue to attack Ukrainian defenders in Mariupol, including the Azovstal Steel Plant, despite Russian President Putin’s claim there is no more fighting in the city.  Finally, the Russians are apparently ramping up their false-flag operations in the Transdniestria region of Moldova, along with efforts to destabilize the country (see map below).  As we have mentioned before, a growing body of evidence suggests Putin plans to take over not only Ukraine but also Moldova.  On the Ukrainian side of the war, new reports suggest the Ukrainian military has launched more small-scale air attacks against Russian military supply lines throughout the country’s border region.  Apparent attacks were reported today near the Russian cities of Kursk, Voronezh, and Belgorod.  So far, Ukraine has not officially claimed responsibility for the attacks.  A Ukrainian presidential advisor today ascribed them to “karma.”  Separately,

Source:  Financial Times

• Russian natural gas giant Gazprom (OGZPY, $1.10) said it would halt gas flows to Poland and Bulgaria starting Wednesday.  It marks the first time it has followed through with President Putin’s threat to cut off countries that don’t pay for their gas in rubles.
  • The decision will have little effect on Poland, which was already set to become independent of Russian gas by the end of this year. It’s a much bigger deal for Bulgaria, which gets over 75% of its gas from Russia and has few immediate options to replace it fully.
  • The Russian decision to cut off only Poland and Bulgaria while sparing major customer Germany (so far) is probably an attempt to undermine Europe’s unity against the war.  Germany’s responses to Russia’s invasion have been reluctant, at best, and now that Poland and Bulgaria see what a Russian energy shutoff really looks like, German leaders may be even more tempted to appease Putin.  On the other hand, cutting off Poland and Bulgaria shows Russia to be an unreliable supplier, or even an “energy imperialist,” and that could help swing more Germans against Russia.  In what may be just a show of bravado, German Economy Minister Habeck yesterday said his country could end its reliance on Russian oil “within days.”  Time will tell.
  • More broadly, the move introduces the possibility that Russia could eventually target more European economies, which deeply depend on Russian gas.  In response, European gas prices rose as much as 20% earlier today before pulling back to levels about 10% higher than yesterday.
    • As of this writing, the euro has fallen to a five-year low of $1.0588.  The currency’s value has now declined 6.9% so far in 2022, and it has depreciated 12.4% from its level one year ago.
    • Concerns about the war and Europe’s vulnerability to energy shortages hurt the euro.  It is also hurt by muted economic growth and the European Central Bank’s relative reluctance to hike interest rates compared with the U.S. and some other major central banks.
• According to oil traders, Russian oil giant Rosneft (OJSCY, $3.00) found no takers for almost 40 million barrels of crude oil it put out to bid last week.   The problems with the sale give an early indication that European sanctions targeting Rosneft, and due to kick in on May 15, are starting to disrupt Russia’s ability to move crude from oil fields to overseas buyers.
  • Since Russia has relatively limited oil storage capacity, the inability to sell could quickly require producers to shut in their wells.
  • Once wells are turned off, they can be hard to turn back on to their previous capacity.  If that leads to long-lasting production declines in Russia, it could contribute to persistently high oil prices and faster inflation out into the future.

Global Commodity Markets:  In its annual Commodity Markets Outlook, the World Bank said commodity prices would remain elevated for years to come as supply disruptions like the war in Ukraine alter how commodities are traded, produced, and consumed around the world.

• The institutions forecast that energy prices will soar 50.5% this year from last, after nearly doubling in 2021. Energy prices are then expected to fall 12.4% in 2023.  Food prices are projected to rise 22.9% this year before declining 10.4% next year.
• The forecasts dovetail with our expectations that even if inflation moderates over the coming year or two, it will probably settle at rates well above those of the last decade.  The analysis suggests commodities may be well placed to provide good returns.

European Union:  Despite the ECB’s relative reluctance to tighten monetary policy as aggressively as the Fed, investors increasingly bet the dam will eventually break, and the central bank will accelerate its interest-rate hikes.   Many investors now think the ECB will take its deposit rate, which currently stands at -0.5%, into positive territory by the end of this year and to more than 1.0% next year.

Brazil:  In an effort to bring down the country’s sky-high credit card interest rates, which can exceed 400% APR, the central bank has launched a new regulation requiring banks to share clients’ credit and investment information, such as loan-repayment histories, with their competitors. The effort to boost competition also forces financial institutions to make their fees public, so consumers can compare costs before choosing a lender.  Lowering credit costs and spurring more consumer spending would likely be a positive for the Brazilian economy and risk assets.

China:  New reports suggest Chinese officials are at odds with each other over President Xi’s stringent “zero-COVID” policies and tough crackdown on the country’s real estate developers.  Regulators led by Vice Premier Liu He are concerned that the government is underestimating the economic impact of its policies.  Indeed, because of recent big losses, Chinese stocks are on track to mark their steepest monthly loss in six years during April.  However, other senior officials have opposed any efforts to ease the policies.

• As Xi approaches a major Communist Party conclave this autumn, where he will try to secure an unprecedented third term in office, he is likely to err on the side of policy easing to boost growth.
  • As we reported in our Comment yesterday, Xi recently ordered his economic team to ensure that Chinese economic growth this year surpasses that of the U.S.
  • Yesterday, Chinese state media said Xi called for accelerated investment in a wide range of critical infrastructure sectors; the report did not specify an amount or timeframe for the effort.
• Nevertheless, the disagreements within the Chinese government suggest that there could be continuing uncertainty and backtracking on policy.  If the disagreements stall any easing efforts, Chinese growth could slow further, putting downward pressure on global economic growth and risk assets.

China-Pakistan:  The Chinese government has demanded a thorough investigation into a van explosion in Karachi that left three of its nationals dead.  The separatist Baloch Liberation Army claimed responsibility for the attack, which killed the director of the University of Karachi’s Confucius Institute, as well as a lecturer and a volunteer.  Chinese nationals have also died in other terrorist attacks in Pakistan.  The new attack will raise tensions between these two countries.

United States-China:  The Biden administration is looking into claims that Yangtze Memory Technologies Co, a privately held Chinese semiconductor maker, has supplied chips to sanctioned Chinese telecom equipment giant Huawei in violation of U.S. export controls.  The investigation will likely further exacerbate U.S.-China economic tensions and potentially lead to further trade and capital controls between the two countries.

U.S. Monetary Policy:  As expected, the Senate yesterday confirmed Fed Governor Lael Brainard as the central bank’s new vice chairperson.  The vote was 52-43.  Since Brainard has already been serving as a Fed governor, her confirmation as vice chair shouldn’t alter the policy board’s plans to hike interest rates aggressively.

• In the coming days, the Senate should confirm nominees Lisa Cook and Philip Jefferson to the board of governors.
• It is also expected to confirm Jerome Powell to a new term as chair.

U.S. Financial Markets:  Amid growing investor appetite for commodities and products tied to the energy transition, Invesco (IVZ, $19.03) said it is launching an exchange-traded fund for metals used to build electric vehicles.  The Invesco Electric Vehicle Metals Commodity Strategy No K-1 ETF will hold futures contracts and other financial products tracking the prices of metals such as cobalt, copper, nickel, and aluminum that are in high demand for their uses in electric cars and other clean-energy projects.

COVID-19:  Official data show confirmed cases have risen to 511,086,383 worldwide, with 6,225,750 deaths.  The countries currently reporting the highest rates of new infections include South Korea, Germany, France, and Italy.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  In the U.S., confirmed cases rose to 81,101,161, with 991,959 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 219,423,356, equal to 66.1% of the total population.

 In the U.S., the Omicron BA.2 variant continues to spread, especially in upstate New York, but it is still generating relatively few serious illnesses or hospitalizations.  The seven-day average of people hospitalized with confirmed or suspected COVID-19 came in at 15,908 yesterday, up just 6% from two weeks earlier.  Because of the low level of hospitalizations and general fatigue with the pandemic, the recent outbreak is generating few new policy responses.

• A new CDC study suggests that 58% of U.S. residents had detectible, infection-induced antibodies to the coronavirus as of February 2022, up from just 34% last December.  The figure, coupled with the number of people vaccinated and boosted, it indicates a very high share of the population now has at least some immunity to COVID-19.  That should be promising news for investors, as it suggests any new waves of infection could impose minimal disruptions on the economy.
• In China, health authorities reported 17,724 new locally transmitted infections across the country, more than 95% of which were in Shanghai. Officials said Beijing had just 22 new cases, seven fewer than the previous day, but the government still plans to proceed with its massive testing and lockdown measures.

View PDF