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 the main news focuses on fighting around a major nuclear power plant and Russian preparations to hold a sham referendum on annexing the territories it occupies to Russia.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today.

Russia-Ukraine:  Over the weekend, there was little change in the overall disposition and activity of the Russian and Ukrainian forces in theater.  The Russians made only very limited territorial gains in Ukraine’s northeastern Donbas region, while they continued trying to reinforce their positions to defend against a slow-moving Ukrainian counteroffensive designed to retake the city of Kherson, which the Russians have held since early in the war.  Meanwhile, in a development that highlights the broader risks of the war, shelling near the Zaporizhzhia nuclear power plant in eastern Ukraine severed some high-voltage power lines serving the facility, forcing engineers to shut down one of its six reactors over the weekend.

• Separately, reports indicate that Russian occupation authorities are accelerating their plans for a pseudo-referendum in occupied territories on annexation to Russia.  Facing limited cooperation from Ukrainian citizens and partisan threats to any officials that might help legitimize a Russian annexation, the Russian authorities are reportedly planning to dispense with polling places and have the Ukrainians “vote from home,” i.e., have Russian troops visit each home and survey each voter at gunpoint.
• In his regular video address last night, Ukrainian President Zelensky vowed that if Moscow holds referendums on joining Russia in occupied areas of his country, there could be no chance that Kyiv and its Western allies would hold peace talks with Russia.

China-Taiwan:  The People’s Liberation Army has continued its aggressive military exercises around Taiwan, despite saying last week that the maneuvers would end on Saturday.  The continued exercises suggest Beijing might intend to keep pressuring Taiwan over time to punish it for House Speaker Pelosi’s visit to the island last week.

• With China’s maneuvers already disrupting sea and air access to Taiwan, continued exercises could amount to a “soft” blockade of the island, raising a thorny dilemma for the U.S. and the island’s other allies.
• Such a soft blockade would force Taiwan’s allies to make the tough decision of whether and how to break it.  Whatever strategy they would adopt could potentially lead to greatly increased tension or military conflict, with massive impacts on the financial markets.

China:  In data over the weekend, China’s July trade surplus expanded to a seasonally adjusted $101.26 billion, beating expectations and marking a rise from the surplus of $97.90 billion in June.  The expansion came mostly in exports as trading and logistics firms continued to catch up from the disruptions of China’s mass pandemic shutdowns during the spring.

• The country’s July exports were up a robust 18.0% year-over-year, accelerating from a 17.9% year-to-date gain.
• In a significant note of caution, however, the country’s July imports were up just 2.3% from the same month one year earlier, after a weak annual rise of 1.0% in June.  The import figures suggest that China’s domestic demand continues to grow tepidly, with negative implications for the global economy and financial markets.

Israel:  The Israeli government and the Gaza militant group Islamic Jihad agreed to a ceasefire yesterday after three days of fighting that killed more than 40 Palestinians and sent rockets flying deep into Israel’s heartland.  The exchange of fire had been the most intense since an 11-day conflict between the Israelis and the military group last year.

Colombia:  Gustavo Petro, a former leftist guerilla and longtime congressman, was inaugurated as president yesterday.  In his inaugural speech, Petro pledged to lower poverty and hunger in Colombia and secure peace by engaging in talks with several armed groups.  He also laid out a platform to redistribute wealth, modernize the countryside, and adopt environmentally friendly economic policies.

Greece:  Prime Minister Mitsotakis is facing a major political scandal after local media reported that the phone of Nikos Androulakis, a European Parliament member who is the leader of the opposition socialist PASOK party, had been bugged by the Greek intelligence service.  The prime minister’s chief of staff (who is also Mitsotakis’s nephew) and the head of the intelligence service resigned on Friday.

Eurozone Monetary Policy:  According to the Financial Times, the ECB in June and July used €17 billion of maturing bonds in its emergency pandemic relief fund to buy Italian, Spanish, and Greek government obligations, while allowing its portfolio of German, Dutch, and French debt to fall by €18 billion.  The transactions illustrate the ECB’s “anti-fragmentation” effort to keep bond yields from blowing out in the Eurozone’s weaker economies.

• The reinvestments under the pandemic relief program are separate from the ECB’s new “Transmission Protection Instrument” (TPI), which can be used in case the pandemic relief program reinvestments fail to keep spreads under control.  The TPI allows the ECB to buy the bonds, at unlimited scale, of any country it deems to be facing market pressures outside the economic outlook.
• In any case, the reinvestments show that the ECB had already embarked on the controversial anti-fragmentation effort before early this summer.  Nevertheless, there is still some risk that the central bank will run into difficulties in both raising interest rates and trying to control yields in the Eurozone.

U.S. Fiscal Policy:  The Senate yesterday passed President Biden’s “Inflation Reduction Act,” consisting of hundreds of billions of dollars of income tax increases on large, profitable companies to cut the federal budget deficit, partially offset by increased spending on a range of healthcare and climate-stabilization programs.  The bill will now go to the House, where it is likely to be approved on Friday before being sent to President Biden to be signed into law.

• Among its major provisions, the bill would:
  • Impose a minimum corporate income tax of 15% and a 1% excise tax on stock buybacks.  It would also boost funding to the Internal Revenue Service in order to reduce tax evasion.  Of the funds raised, the bill sets aside approximately $300 billion to reduce the budget deficit.
  • Among its key spending provisions, the bill would provide new tax incentives for investments that reduce carbon emissions, extend health insurance subsidies under the Affordable Care Act, and allow the federal government to negotiate pricing for some drugs covered by Medicare.
• Politically, final passage of the bill would mark an unexpected and improbable string of legislative victories for Biden, although it remains to be seen whether the White House political team can finally get that message out and reverse what is still likely to be massive losses in the November midterm elections.  Despite the name of the legislation, a wide range of analysts expect the bill will have very little impact on bringing down inflation, especially in the near term.  Biden’s unlikely tally of legislative wins to date, along with their spending totals, include:
  • American Recovery Act: $1.9 trillion
  • Infrastructure Investment and Jobs Act: $550 billion
  • Chips and Science Act: $280 billion
  • Inflation Reduction Act: ≈$700 billion
  • NATO Enlargement to include Sweden and Finland
  • Gun Safety Legislation
  • Veterans’ Burn Pit Healthcare Legislation

U.S. Labor Market:  Despite the strong headline numbers in the July employment report, released last Friday, some major employers are reporting that it’s getting easier to hire and keep workers.  That’s consistent with our view that the July report probably overstated the actual strength of the labor market, in large part because of challenging seasonal adjustment issues.  While it does appear that payrolls increased in July, the true pace is probably moderating.

• All the same, the labor market remains tight as the pool of available workers continues to grow sluggishly.
• Importantly, the strong headline numbers in the July report and continued inflation pressures suggest the Fed will continue to hike interest rates aggressively in the coming months.

U.S. Coronavirus Vaccines:  Pfizer (PFE, 49.27) and partner BioNTech (BNTX, 183.11) said they will soon start clinical trials for a COVID-19 vaccine designed to block the BA.4 and BA.5 variants of Omicron.  If the trials are successful and the vaccine is approved, the shot could become available as early as October.

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