by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment begins with a discussion about Shinzo Abe’s unfortunate assassination. We then examine central bank news from Europe and the U.S. and its impact on the euro-dollar exchange rate. Next, we provide an update on the latest development from the Ukraine war. Finally, we end the report with an overview of various stories that we believe will affect financial markets.

Attack in Japan: Former Japanese Prime Minister Shinzo Abe was shot and killed during a campaign visit to Nara. His assailant has been apprehended and is currently in police custody. The shooter claimed that the killing was not politically motivated. Shinzo Abe was one of Japan’s longest-serving prime ministers holding office from 2012 to 2020. He will be remembered for his push to rebuild Japan’s military and implement Abenomics, a strategy aimed at boosting the economy’s growth through accommodative monetary policy, fiscal stimulus, and structural economic reforms. So far, there is no sign of whether this event will delay the Japanese national elections scheduled to take place on Sunday.

 Central Bank News:  The Federal Reserve reaffirmed its commitment to raising rates. Meanwhile, the ECB struggled to articulate its policy path as it plans to raise rates this month. The hawkish tone of the Fed official and lack of policy certainty of the ECB helped drive the euro-dollar exchange rate closer to parity.

• ECB’s New Tool: The European Central Bank’s anti-fragmentation tool will not be ready by the July 21 meeting. According to the minutes released by the ECB, the bank is still working out the details of its plan to prevent financial fragmentation within the Eurozone. The specifics of the policy tool were scheduled to be released over the next two weeks, but there are still disagreements about how the central bank should implement the new tool, especially as it seeks to raise rates to contain inflation. Typically, when the ECB increases its policy rates, borrowing costs for southern European countries rise faster than northern European countries. Although a small spread is sustainable, a significant divergence in bond yields threaten to overwhelm southern governments’ debt-paying capacity. The lack of policy uncertainty suggests that the ECB may be reluctant to take aggressive action in curtailing inflation, therefore leading to weakness in the euro.
• Fed comments: Despite the recent spate of disappointing economic data, Fed officials are still pushing for a 75 bps hike in July. On Thursday, St. Louis Fed President James Bullard and Fed Governor Christopher Wallace insisted that the Federal Reserve needs to get inflation under control. Bullard argued that the Fed is in danger of losing its credibility if it does not continue raising rates. At the same time, Wallace claimed that high inflation could slow economic activity in the future. The hawkish tone from the Fed officials suggests that they remain certain that the economy can withstand additional rate hikes. Waller described market concerns of a downturn as being “overblown,” while Bullard maintained that the Federal Reserve can still achieve a soft landing.

The comments by Waller and Bullard suggest that they prioritize taming inflation over economic growth. Although both appear to downplay the notion that a recession is imminent, it is unlikely that these officials would ever admit to wanting to raise rates into a recession. Instead, officials may be trying to ensure that the Fed maintains some flexibility in its ability to raise rates in case growth remains stable and inflation is elevated. If we are correct, the Fed may wait to see solid evidence of economic deterioration before ending its tightening cycle.

Russia-Ukraine Update: The Kremlin announced that it is pausing some of its military activity to rest and prepare for new operations. Experts widely expected the pause as Russian forces sustained significant casualties in their fight to take over the Luhansk region. Although troops are expected to continue to maintain small-scale operations, Russia could be preparing for another run to take over Kyiv. In a show of defiance to Western sanctions, Russian President Vladimir Putin stated that the war in Ukraine has not even started, and challenged the West to meet it on the battlefield. Nevertheless, Putin’s provocative remarks suggest that his recent success could encourage him to take more decisive action in the war.

• World leaders gathered in Bali earlier today to discuss the war in Ukraine and its impact on the global economy. Although the Indonesian Foreign Minister urged countries to use the gathering to reduce tensions, the divide between the U.S. and Russia was palpable. While U.S. officials were looking to gain support for potential price caps on Russian oil, officials from Moscow were looking to gain reassurances from China. The competition between the U.S. and Russia over influence will probably have geopolitical ramifications. If a country sides with one, it must be prepared to isolate itself from the other. We believe that this trend reflects a broader move toward forming regional blocs, which will eventually affect how countries trade with one another.
• Russian Foreign Minister Sergey Lavrov stated that he was prepared to negotiate over wheat; however, he walked out of several meetings after criticism over Russia’s invasion. Lavrov’s exit suggests that Russia will probably continue its efforts to block Ukraine’s wheat exports.
• US. Senators Lindsey Graham (R-S.C.) and Richard Blumenthal (D-Conn.) met with Ukrainian President Volodymyr Zelensky on Friday. The two senators are looking to push legislation that would classify Russia as a state sponsor of terrorism, which should open the country to additional sanctions and trade restrictions.

Chinese News: Chinese car sales jumped in June, suggesting that the economy is seeing an improvement in consumption following the lifting of COVID restrictions. The China Passenger Car Association reported that vehicles sales rose 23% from the prior year. The increase in purchases suggests that consumers are feeling more confident about the economy.

• The Biden administration is considering reducing U.S. tariffs on Chinese goods. Although President Biden has not made a final decision, members of his administration, including Treasury Secretary Janet Yellen, have argued that tariff reduction could lessen price pressures. Meanwhile, advocates of tariffs have argued that keeping them in place will give the White House more negotiation leverage in trade talks with Beijing.

Housing market: Mortgage rates posted their steepest one-week decline since 2008. According to Freddie Mac, the average 30-year fixed-rate mortgage fell 40 bps from 5.70% to 5.30%. The sharp drop in rates reflects a broader decline in interest rates for longer-term bonds as investors are growing more concerned about a recession.

Boris Johnson Exit: The U.K. conservative party is exploring plans to expedite Prime Minister Boris Johnson’s transition from the premiership. Johnson wanted to stay on for three months while the party chose his successor. The party is currently in the process of selecting two candidates for party leader and is expected to hold a vote by early September. There is no indication that Johnson’s replacement will cause a significant shift in the country’s policy agenda.

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