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, including a new statement by Ukrainian President Zelensky that he is open to peace talks with Russia, subject to tough conditions.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a series of speeches by policymakers at the European Central Bank that indicate they will continue to hike interest rates aggressively.

Russia-Ukraine:  The Ukrainians continue to slowly and methodically press their counteroffensives in the northeastern Donbas region and in the southern region around Kherson.  Meanwhile, the Russians increasingly look like they are preparing to defend Kherson, although perhaps with only a blocking force of minimally trained, recently mobilized troops.  The Russians also continue to attack civilian infrastructure targets throughout Ukraine using air, missile, and kamikaze drones.  However, Ukrainian intelligence officials say that Russia has now run through some 80% of their modern, high-precision missiles, which could mean their campaign against the Ukrainian infrastructure will soon slow enough for the Ukrainians to get much of their energy grid back into operation.

• President Zelensky stated that he was open to peace negotiations with Russia if they are focused on safeguarding Ukraine’s territorial integrity, compensating Kyiv, and bringing perpetrators of war crimes to justice. The U.S. and other allies have been pressuring Zelensky to say he is open to talks in order to firm up international support for Ukraine.  However, Russia is unlikely to accept Zelensky’s tough terms, at least for now.
• Separately, Zelensky said his government has used its wartime powers to temporarily take control of five “strategic” companies owned by the country’s oligarchs.
  • The nationalized companies include Ukraine’s top oil producer, its top oil refiner, and a key manufacturer of engines for airplanes and helicopters.
  • Importantly, some of the nationalized firms were previously owned by Igor Kolomoisky, an oligarch who backed Zelensky’s presidential bid in 2019 and who is now facing probes into the insolvency of PrivatBank, another of his previous businesses. That suggests that Zelensky may be using his wartime powers to carry out his program of weakening the country’s corrupt oligarchs.

Eurozone Monetary Policy:  Pushing back against politicians and investors hoping for a “dovish pivot” toward stabilizing or even falling interest rates soon, several senior policymakers at the ECB today insisted that the fight against price inflation will require them to keep hiking interest rates, even beyond the point at which they constrain demand and weaken growth.  The well-coordinated statements signal that the ECB will continue to hike rates aggressively, even as it tries to keep a lid on longer-term bond yields in the bloc’s weaker economies.

Pakistan:  Supporters of Former Prime Minister Imran Khan have blockaded roads around the capital of Islamabad in an effort to topple the government following an attempted assassination of Khan last week.  The protestors are angry at what they see as the government’s reluctance to investigate allegations that current Prime Minister Sharif and senior civilian and military officials conspired to kill Khan.

China:  The latest figures show that new COVID-19 infections nationwide have topped 5,400 cases per day for the first time since May.  Although there are now multiple conflicting reports about whether the government will end its disruptive Zero-COVID policies in the coming months, the current surge suggests that the government could impose new lockdowns in the coming days.  As we have discussed before, such lockdowns have been challenging for the Chinese economy, the broader global economy, and global financial markets.

United States-China:  In another example of how the world’s technology industry is finding work-arounds to the strict new U.S. restrictions on selling semiconductor technology, equipment, and services to China, Nvidia (NVDA, $143.01) announced it has developed a new graphics chip for advanced Chinese companies that can be exported to China without restriction.

• According to Nvidia, the new chip has the same computational performance but a narrower interconnect bandwidth, i.e., the capacity of the chip to send and receive data from other chips, which is crucial for training large-scale AI models or building supercomputers.
• Nvidia hopes the new chip will allow it to retain hundreds of millions of dollars of revenue from China that otherwise would be lost.
• Nevertheless, it appears that the new, restricted chip will help meet the U.S. goal of further suppressing the overall computational capacity of China and the Chinese military.

U.S. Labor Market-Impact of COVID-19:  Even though new COVID-19 infections have fallen sharply, pandemic restrictions are practically gone, and life in many respects is approaching normal, new research indicates that the disease continues to impede labor force participation and productivity growth.  In turn, the resulting labor shortages are contributing to upward pressure on wages and inflation.

• According to the new studies, the number of workers who missed at least one week of work because of illness in any given month is now up 630,000 from the average levels before the pandemic.
• At least 500,000 more workers have dropped out of the labor force because of the lingering effects of a previous COVID-19 infection.
• In a Census Bureau survey in October, 1.1 million people said they hadn’t worked the week before because they were concerned about contracting or spreading the virus.
• The pandemic’s lingering suppression of the labor force has forced many firms to keep payrolls higher than they otherwise would in order to ensure adequate personnel for operations. That means those firms are now operating less efficiently than they would have before the pandemic.  The resulting drop in productivity per worker hour has raised labor costs and fed into inflation.

U.S. Labor Market-Impact of Recession:   Recent layoff announcements by major employers suggest that middle managers may be particularly at risk as the economy slips into recession.  Skilled production workers and other non-supervisors are typically the first to be let go as firms trim their labor costs going into a downturn, but today’s massive shortage of such workers means firms will probably be loathe to let them go.  Rather, the economy may be slipping into a “white collar recession.”

U.S. Real Estate Market:  New data shows developers are slowing their major office projects already under way and shelving new projects as they face soaring interest rates and high office vacancy rates after the COVID-19 pandemic.

• Reduced office construction will help slow the economy and push it into recession, but it could eventually help bring the supply of office space down to the lower, post-pandemic level of demand. In time, that could help stabilize office rents.
• The boom-and-bust cycles in property development can be difficult for investors, but they also hold out the promise that excess space and low rents today can eventually reverse.

U.S. Elections:  Voters across the U.S. go to the polls today for mid-term elections in which all seats in the House of Representatives and one-third of the seats in the Senate will be contested.  The latest polls suggest that the summer swing of voting intentions toward the Democrats has now largely dissipated, raising the chance that the Republicans could take control of both chambers.

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