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 more evidence that the Russians are expecting a robust Ukrainian counterattack on the east side of the Dnipro River.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including news of mass anti-government protests in China that have sparked fears of new, draconian political crackdowns and even worse headwinds for the Chinese and global economies.

Russia-Ukraine:  Now that the Ukrainians have pushed the Russian invasion forces from the western side of the Dnipro River and are continuing to probe the eastern side, the Russian forces are apparently assuming that the Ukrainians will soon attack in force on the eastern side.  They are therefore attempting to build trenches and other fortifications to at least delay a Ukrainian advance toward Crimea.  Meanwhile, the Russians continue to attack toward the city of Bakhmut in the northeastern Donbas region of Ukraine, with little success so far.

• The Russians are continuing to stage artillery, missile, and kamikaze drone attacks against Ukraine’s civilian power and water infrastructure in an apparent effort to freeze the population into submission. However, Ukrainian authorities claim they are quickly repairing much of the infrastructure and bringing it back online, raising the question of whether the Russians are wasting their dwindling ammunition supplies on a lost cause.
• Separately, the European Union on Wednesday failed to agree on the price at which to cap Russian oil sales in order to reduce the amount of funding Moscow has available to prosecute the war. Consistent with a recent G7 agreement, most EU members were prepared to cap the price at between $65 and $70 per barrel, but Poland held out for a much lower $30 per barrel to turn the screws even harder on Russia.

Global Oil Market:  U.S. regulators stated that they would allow Chevron (CVX, $183.70) to resume pumping crude oil from its Venezuelan fields after the Socialist government and an opposition coalition agreed on a humanitarian relief program and continued dialogue on efforts to hold free and fair elections.  Improved access to the resources and expertise of Chevron could help it modestly boost production and exports going forward, which the Biden administration hopes will help bring down prices.

European Union:  EU Commission President von der Leyen issued an unexpectedly harsh judgment that Hungary has failed to adopt promised rule-of-law reforms and therefore has no right to €7.5 billion in regular EU funding and €5.8 billion in pandemic recovery grants that have been temporarily frozen over the issue.  She did recommend approving Hungary’s plan to spend the recovery funds if they are ultimately released, but only if Hungary now meets an expanded list of 27 reforms.

• The EU’s College of Commissioners will formalize the decision next week, after which the Council of the EU (consisting of national representatives) will have to approve it by qualified majority (55% of the EU countries and 65% of its population).
• Naturally, the decision will anger Hungarian Prime Minister Viktor Orbán. As he has done in the past, he will likely retaliate by holding up EU decisions that require a unanimous vote of all countries, including votes on new sanctions against Russia.  Brussels’ ongoing rule-of-law disputes with Poland and Hungary threaten to undermine the EU’s cohesion and hamstring its decisionmaking in the coming months.

European Union-United States:  EU trade ministers meeting on Friday warned that there is a rising risk of a trans-Atlantic trade war over the U.S.’s newly passed Inflation Reduction Act, which provides some $369 billion in subsidies for domestically-made high-technology products beginning in 2023.  Along with the U.S.’s better supplies of energy and labor, those subsidies have already prompted a number of major European companies to re-channel future investment plans out of the EU and into the U.S.  That is further irritating European leaders who see the U.S. as profiteering from the war in Ukraine by selling immense amounts of natural gas and weaponry to EU nations.

• Some EU members, such as France, have called for Brussels to replicate the U.S. act with a “buy European” subsidy regime of its own. German Economy Minister Habeck has also suggested increased subsidies. However, EU Trade Commissioner Dombrovskis, some other EU national leaders, and many economists oppose a big subsidy program on grounds that it would be exceedingly expensive and lead to economic distortions.  They also fear that competing subsidy programs would amount to a “trade war” that would hurt EU-U.S. ties.
• However, we note that the Biden administration, to date, hasn’t been warning the EU against such a program. Indeed, early in November U.S. Trade Representative Tai called on the EU to step up support for its manufacturers and reduce its reliance on China for strategically important products in the process.  As we reported in our Comment at the time, Tai suggested that Brussels should jointly develop a new industrial policy alongside the U.S. to counter China’s rising geopolitical threat.  This suggests that the Biden administration is actually pushing for a broad industrial policy to support key technology companies wherever they may be in the evolving U.S.-led geopolitical bloc.

Iran:  As anti-government protests continue, especially in eastern Iran, the commander of the Islamic Revolutionary Guard Corps traveled to Sistan-Baluchistan’s capital of Zahedan, where he threatened more crackdowns and alleged that the protesters were being manipulated by foreign powers.  The protests continue to threaten social stability and the government’s hold on power.

China:  The latest wave of COVID-19 pushed many local governments to impose further lockdowns, sparking mass protests against the government across the country.   Although it now appears that the government has taken control of the situation and suppressed the protests, there is no denying the fact that they were big enough to threaten the social stability and political power that President Xi prizes so dearly.  The lockdowns and protests are also weighing heavily on stocks, commodities, and other risk assets so far this morning.  Interestingly, the dollar is also down today as investors continue to focus on a hoped-for slowing in the Federal Reserve’s interest-rate hikes.

• To address the weakening economy, on Friday the People’s Bank of China announced a cut in the bank reserve requirement ratio to 7.8%, down 25 basis points from the previous RRR and roughly in line with expectations. The modest cut, which will take effect December 5, will mean that banks can lend roughly $70 billion more than before.
• The small boost to banks’ lending capacities will probably have only a very modest positive impact on Chinese economic prospects this winter. Along with weakening foreign demand and President Xi’s crackdowns on key parts of the private sector, the latest COVID-19 lockdowns and resulting protests are expected to be a big headwind to Chinese economic growth in the coming months.

United States-China:  On Friday, the U.S. Federal Communications Commission voted 4-0 to ban the marketing or importing of new telecom and surveillance equipment made by several Chinese companies, based on national security concerns.  The ban affects a number of Chinese telecom heavyweights that were already under restrictions, such as Huawei, ZTE (000063.SZ, CNY, 23.94), and Hangzhou Hikvision (002415.SZ, CNY, 30.90).  The order doesn’t require U.S. equipment buyers to remove items that they have already purchased, nor does it remove authorizations for electronics models that already exist.  However, it apparently does allow the FCC to take those steps in the future.

• The FCC action is the latest U.S. move aimed at thwarting China’s strategy of using advanced telecom technology to carry out mass spying on U.S. citizens, conduct secret influence campaigns in the U.S., and sabotage critical U.S. infrastructure in times of conflict. Illustrating the seriousness of the issue, the move is the first ever in which the FCC has voted to prohibit the authorization of new equipment on national security grounds.
• The FCC’s move comes on the heels of the administration’s draconian new restrictions on semiconductor technology exports and services to China, the recent Congressional hearings into the national security implications of Chinese social media app TikTok, and a broader range of barriers against Chinese imports that began under the Trump administration. Together, the never-ending rise of U.S. restrictions show how the U.S. government, with strong bipartisan support, is taking ever-tougher steps to constrain China’s ability to compete with the U.S. and its bloc. Naturally, that presents ongoing regulatory risks for Chinese assets.

U.S. Economy:  Reports suggest that the traditional kick-off to the holiday shopping season on Friday started off relatively well, with a further rebound in store traffic and continued gains in online buying.  According to shopping data firm RetailNext, store visits on Black Friday were up about 7% from the previous year.  However, there are also signs that consumers are exercising caution in the face of rising prices and interest rates.  The same report showed in-store sales rose just 0.1%, and the average shopper spent less per visit than last year.

U.S. Housing Market:  Real estate analysts report that as home prices remain high and interest rates continue to surge, more individuals who had hoped to buy are now renting single-family homes instead.  The trend is creating new opportunities for larger developers and real estate funds that are pivoting toward building and buying more single-family homes to rent.

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