by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with an update on the Russia-Ukraine war, where a significant Ukrainian counteroffensive may be thwarting Russia’s effort to encircle some of Kyiv’s best troops in eastern Ukraine.  There are also more reports that suggest President Putin is preparing to make a formal declaration of war against Ukraine and launch a general Russian mobilization.  We next review a range of international and U.S. developments with the potential to affect the financial markets, especially regarding the Federal Reserve’s latest monetary policy decision coming up today.  We wrap up with the latest news on the coronavirus pandemic.

Russia-Ukraine:  Russian forces continue to make only slow, plodding advances in eastern and southern Ukraine, coupled with artillery and airstrikes against a broader set of military and civilian targets.  The Russian troops continue trying to move southeast from Izyum and westward from Donetsk in order to encircle the Ukrainian forces that have been battling Russian separatists in the Donbas region since 2014.  However, a range of reporting says the Ukrainians have launched a significant counteroffensive that pushed the Russians about 25 miles east of the major city of Kharkiv.  According to the Institute for the Study of War, the counteroffensive may allow for a broader operation to drive the Russians from most of their positions around Kharkiv. This could pose a dilemma for the Russians.  They will have to decide whether to reinforce their positions near Kharkiv to prevent the broader Ukrainian operation, potentially pulling forces away from their effort to encircle the Ukrainian troops in the Donbas, or risk losing most or all of their positions in artillery range of the city.

• Ukrainian officials reported with increasing confidence that the Kremlin will announce a general mobilization on May 9.
  • Ukrainian Main Military Intelligence Directorate Chief Budanov said the Kremlin has already begun to prepare mobilization procedures and personnel ahead of the expected announcement and has even carried out a kind of covert mobilization.
  • Ukraine’s National Security and Defense Council said high-ranking Russian officials are trying to legitimize a prolonged war effort as World War III against the West rather than the “special military operation” against Ukraine that President Putin has cited up until now.
• As expected, European Commission President von der Leyen announced the EU would phase in a ban on all imports of Russian oil, whether it be the crude or refined product, seaborne or delivered by pipeline.  Crude imports would be cut off within six months, while refined product imports would be prohibited by the end of the year.  Since Hungary and Slovakia are particularly reliant on Russian oil supplies, they would be given until the end of 2023 to comply with the ban.  The EU is also proposing cutting off more Russian banks from the SWIFT system of international money transfers as part of its latest package of sanctions against Russia.
  • Despite the concessions to Hungary and Slovakia, it is still an open question whether they will agree to the oil ban.  EU rules require the ban to be approved by all member countries, so either Hungary or Slovakia could scuttle the plan if they feel their needs aren’t being met.
  • Even though the Russian oil ban was widely expected, and Hungary or Slovakia could still hinder it, today’s formal release of the proposal has accelerated a global scramble for replacement supplies.  As of this writing, Brent crude prices have risen approximately 2.5% to $107.58.
  • As we’ve noted, the Western sanctions against Russia are becoming increasingly costly, not only by cutting off much of the EU’s trade, capital flows, and energy resources but by further boosting global energy prices and accelerating the cleavage of the world’s countries into blocs.  The crisis remains a major risk for the world economy and financial markets in the near term and long term.

North Korea:  The Japanese Defense Ministry said North Korea today launched an apparent ballistic missile that traveled 310 miles before landing in the Sea of Japan outside Japan’s exclusive economic zone.

United States-Saudi Arabia:  CIA Director Burns made an unannounced trip to Saudi Arabia last month to meet with Crown Prince Mohammed bin Salman, with officials reporting that the conversation had “a better tone than prior U.S. government engagements.”  The news suggests the Biden administration is making a concerted effort to repair ties with Saudi Arabia.  If successful, it could help lead to more cooperation with the West in thwarting Russia’s invasion of Ukraine and, potentially, increased exports of Saudi oil that would help bring down energy prices and inflation.

United States-China Sanctions:  The Biden administration is reportedly laying the groundwork to place sanctions on surveillance-technology giant Hikvision (002415 CH, CNY, 42.49) for its role in alleged human rights violations.  If implemented, the sanctions could affect a wide range of countries and customers that use the firm’s monitoring technology worldwide.  The sanctions would also add to the strained U.S.-China relations and further drive the two countries apart diplomatically and economically.

United States-China Tariffs:  Amid a legally required review of Trump-era tariffs against Chinese imports, officials in the Biden administration are reportedly split on whether to pare back the duties in order to cut consumer costs and reduce inflation.

• On one side, Treasury Secretary Yellen and Commerce Secretary Raimondo favor easing the tariffs on some of the roughly $360 billion of Chinese imports annually.
• On the other side, Trade Representative Tai and others are reluctant to relinquish U.S. leverage over China in a continuing effort to reshape Chinese economic behavior.

U.S. Monetary Policy: The Fed wraps up its latest monetary policy meeting today, with the officials expected to approve an aggressive 50-basis-point hike in the benchmark fed funds interest rate.  If the action is as expected, it will mark the first time the Fed has raised rates at back-to-back policy meetings since 2006, and it will be the first 50-basis-point hike since 2000.  The policymakers are also expected to detail a relatively quick run-off of bonds on the central bank’s balance sheet.

• We remain skeptical that the Fed can implement its entire planned program of tightening without causing financial market disruptions or contributing to a sharper-than-planned slowdown in the economy.
  • Investors have already started backing away from the riskiest corporate bonds in the U.S.  The value of junk bonds trading for 70 cents on the dollar or less, considered a sign of distress and a warning that a company may struggle to repay its debts, has climbed to $27 billion from about $14 billion at the end of 2021.
  • Amid sky-high inflation, fiscal tightening, continued supply chain disruptions, and a blow to confidence from the Russia-Ukraine war, we think the risk of a sharp economic slowdown, recession, or financial market volatility in the next 12 to 18 months remains elevated.
• All the same, central banks around the world remain in aggressive inflation-fighting trim.  The Reserve Bank of India announced an emergency hike in its benchmark repo rate to 4.40% from 4.00%.  Separately, today, an influential German member of the European Central Bank’s executive board said she could see the ECB hiking rates in July for the first time since 2011.

COVID-19:  Official data show confirmed cases have risen to  514,949,273 worldwide, with 6,241,184 deaths.  The countries currently reporting the highest rates of new infections include Germany, South Korea, 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 81,506,838, with 994,748 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 219,849,502, equal to 66.2% of the total population.

Virology

• In the U.S., the Omicron BA.2 variant continues to spread, but it is still causing relatively few serious illnesses or hospitalizations.  The seven-day average of people hospitalized with confirmed or suspected COVID-19 came in at 17,532 yesterday, up 18% from two weeks earlier.
• In Hong Kong, city officials unexpectedly announced an easing of pandemic social restrictions after new data suggested those rules led to a sharp economic contraction in the first quarter.  However, officials in mainland China continue to maintain or even tighten restrictions despite the cost to the Chinese and global economies. In Beijing, for example, officials have suspended many public transport routes and closed subway stations to curb the spread of COVID-19.  In Shanghai, millions have been under strict lockdown for more than a month.

Economic and Financial Market Impacts

• Some U.S. companies warn that COVID-19 lockdowns in Shanghai and elsewhere in China are denting sales, disrupting operations, and putting an added strain on supply chains that could be felt well into the summer.

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