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.  We next review other international and U.S. developments with the potential to affect the financial markets today.  We wrap up with the latest news on the coronavirus pandemic.

Note:  Because COVID-19 has become more endemic and in most countries isn’t disrupting the economy or politics as much as it did previously, we will drop our dedicated COVID-19 section beginning July 1.  We will continue to cover pandemic news as needed within our main text.

Russia-Ukraine:  As Russian forces slowly gain enough territory to threaten the last major concentration of Ukrainian forces in the eastern Donbas region, in and around the city of Lysychansk, reports indicate the Ukrainians have begun a fighting retreat designed to make the Russians pay dearly for any territory they seize.  Meanwhile, the Ukrainians continue to pin down Russian forces in the southern part of the country along the Black Sea coast.  Both sides continue to face steep losses of personnel and equipment, although it appears the Russians will ultimately have the more difficult time replacing them with combat-competent forces.

• Separately, the Biden administration has placed five little-known Chinese companies on an export blacklist for violating sanctions by allegedly providing support to Russia’s military and defense companies before and during the invasion of Ukraine.  The action essentially prohibits U.S. firms from exporting to the companies.
• In a new sign that President Putin’s energy warfare is putting cracks in European unity, the U.K. government is testing an emergency energy plan that would cut off natural gas exports to mainland Europe in the event of a major shortage, such as the type that would be caused by a bigger Russian embargo. European officials are warning that the plan could backfire by triggering a cutoff of gas exports to the UK when it typically needs them in the dead of winter.
• All the same, even if the Western allies tire of the conflict and put pressure on Ukrainian President Zelensky to cede land and reach a deal with the Russians, new polling suggests he would keep fighting.  The poll, by The Wall Street Journal-NORC, indicates that 89% of Ukrainians think it would be unacceptable to reach a peace deal with Moscow by ceding Ukrainian territory that Russian forces have seized in their invasion this year.  The poll also found that 78% of Ukrainians support Zelensky’s management of the war so far.

NATO Summit:  In one of the most important outcomes of the NATO summit so far, the Turkish government yesterday dropped its opposition to Sweden and Finland joining the alliance, clearing a path for the two Nordic countries to become members in the coming months.  The accession of Sweden and Finland will vastly expand NATO’s territory right up to the Russian border and transform the Baltic Sea into a virtual NATO lake, illustrating how badly President Putin’s invasion of Ukraine has backfired on him.

• President Biden today also outlined specific steps the U.S. would take to help strengthen NATO in accordance with its updated “strategic concept,” which we described in our Comment yesterday.  The new U.S. commitment will include a permanent headquarters for the U.S. Army V Corps in Poland, additional troops, and additional air, air defense, and naval assets in several countries.
• Other NATO leaders will announce their additional commitments later today.

Eurozone:  In a speech this morning, ECB chief Lagarde is expected to provide more details on the central bank’s evolving “anti-fragmentation” program aimed at capping government bond spreads in the Eurozone as the ECB stops buying new assets.  As we mentioned in our Comment yesterday, the program would likely involve preferential ECB purchases of government bonds from Italy, Spain, Portugal, Greece, and other weaker Eurozone economies.

• In an interview this week, Lagarde offered no new details on how the program would work, other than insisting it will be separate from the ECB’s main policy framework.
• Even if Eurozone leaders can agree on such a program, we suspect it would essentially work at cross purposes with the ECB’s tightening policy.  We therefore think it would probably be negative for the euro.

United Kingdom:  Scottish leader Nicola Sturgeon announced plans aimed at holding a fresh referendum on independence in October 2023.  The new effort follows a failed referendum in 2014, which Prime Minister Johnson says is the last word on the matter.  The new effort reflects intense dissatisfaction with Brexit throughout Scotland and could create a sense of political uncertainty in the U.K., which would likely be a further headwind for its economy and financial markets.

• Under the plan, the Scottish government has simultaneously asked Prime Minister Johnson to approve the referendum and requested that the U.K. Supreme Court decide whether it can proceed even without that approval.
• If the court rules that the Scottish Parliament can’t proceed with a referendum without the British government’s permission, or if it declines to accept the case, then Sturgeon’s Scottish National Party would contest the next U.K.-wide elections on the question whether Scotland should be independent.

 China-United States:  According to a cybersecurity firm, a pro-Chinese government group called Dragonbridge has been impersonating environmental protectionists on social media to undermine the U.S.’s effort to build a domestic rare earths production capability.  Specifically, the group has been targeting a government-funded rare earths refinery being built in Texas that aims to cut U.S. reliance on Chinese rare earths.   The fake accounts argue that the facility would “expose the area to irreversible environmental damage” and “radioactive contamination.”

United States-Taiwan:  In another move by the Biden administration to blunt Chinese economic influence, Deputy U.S. Trade Representative and Taiwanese Minister John Deng this week held an initial round of talks aimed at boosting trade ties.  Since domestic politics in the U.S. preclude any consideration of traditional market-access provisions like tariff cuts, the talks merely center on trade facilitation, regulatory practices, agriculture, anti-corruption, small- and medium-sized enterprises, digital trade, labor, environment, standards, state-owned enterprises, and non-market policies and practices.

U.S. Monetary Policy:  In a Financial Times commentary today, bond guru Mohamed El-Erian warns that the Federal Reserve has become too reactive to economic developments, creating a risk of disruptive “stop-go” policymaking like that of the 1970s and 1980s.

• El-Erian argues that a “well-informed Fed with a credible vision for the future” would minimize the risk of disruptive financial market overshoots, strengthen the potency of forward guidance on policy, and provide an anchor of stability that would foster productive physical investment.
• In contrast, he argues that volatile, unpredictable policymaking that whipsaws between fighting inflation and boosting growth risks yet another round of undue economic damage, financial volatility, and greater inequality.
• El-Erian also says that investors are right in worrying about a near-term recession in the U.S.  As we have written, we agree that there is an increasing risk of recession, most likely in 2023.

U.S. Labor Market:  Electric vehicle maker Tesla (TSLA, 697.99) announced it will lay off about 200 workers in conjunction with closing one of its California offices to cut costs.  The layoffs are tiny compared with the overall labor market, but since Tesla is such a high-profile company, the news is likely to raise concerns that the economy is slowing rapidly in response to factors like high labor and material costs and rising interest rates.

COVID-19:  Official data show confirmed cases have risen to  545,530,847 worldwide, with 6,332,788 deaths.  The countries currently reporting the highest rates of new infections include the U.S., Germany, Taiwan, and France.  (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 have risen to 87,221,842, with 1,016,766 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 222,123,223 , equal to 66.9% of the total population.

Virology

• In the U.S., the latest wave of infections appears to be topping out, but hospitalizations are still accelerating with their usual lag.  The seven-day average of newly reported cases stands at 108,963, up 3% from two weeks ago.  The seven-day average of people hospitalized with confirmed or suspected COVID-19 came in at 32,148 yesterday, up 7% from two weeks earlier.  New COVID-19 deaths are now averaging 377 per day, up 17% from two weeks earlier.
• Separately, the Biden administration has warned Congress that the government could soon deplete its supply of a key antibody drug for treating nonhospitalized patients if pandemic funding isn’t renewed.  Should the federal government be unable to procure more doses, the drug’s manufacturer would need to sell the drug to hospitals and states directly for the treatment to remain available.
• Following yesterday’s news that officials in mainland China are easing their pandemic quarantine rules, Hong Kong’s incoming health minister said his city is also looking to ease restrictions.  As we reported in conjunction with the mainland easing yesterday, easier restrictions could remove one of the headwinds facing the overall Chinese and Hong Kong economies, although they would remain vulnerable to strict new lockdowns in the future.

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