by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Howdy! Equities are down this morning after the jobs report soundly beat expectations, Today’s Comment begins with an overview of the recent sell-off in the U.S. dollar and what it means for financial markets. Next, we discuss the U.S. government’s efforts to resolve tensions with unions and the EU. Lastly, we explain the risk the war in Ukraine poses to equities abroad.

Dollar Peaking? The recent retreat in the greenback is significant, but it isn’t clear if it will last, as evidenced by its recovery today in the wake of the payroll data.

• Although the U.S. dollar is one of the best-performing assets in 2022, it has begun to turn. The greenback has dropped more than 7% from its September peak. Its descent was driven by a combination of speculation that the Fed is almost done hiking and greater positivity about the global economy heading into 2023. The CPI and PCE inflation reports both came in below expectations. Meanwhile, GDP data from Germany and optimism of China’s reopening have made a global recession next year less likely. Additionally, signs that global inflation is approaching its peak have made foreign currencies more attractive.

• The weakness in the dollar will likely make it easier for other central banks to relax monetary tightening. Due to their reliance on imports of dollar-priced commodities such as oil, central banks such as the Bank of Japan and the European Central Bank were pressured to take aggressive monetary action to contain inflation. However, their lack of aggressive action had led to dollar appreciation. As a result, the recent dollar weakness (we note that the dollar is stronger today off the payroll wage data) against peer currencies will likely mean that these banks can take less aggressive policy action to tackle price pressures. In short, a weaker dollar is a positive for international equities. For example, the recent rally in emerging market equities and bonds shows that investors are positioned to take advantage of a depreciating U.S. currency.
• Next year’s FOMC will have more hawks than in 2022. Kansas City Fed’s Esther George and Boston Fed’s Susan Collins will be replaced by hawks Fed President Neel Kashkari and Dallas Fed’s Lorie Logan. Meanwhile, Chicago Fed picked notable dove Austan Goolsbee as the next bank president. He will be a voting member and will offset the loss of St. Louis Fed President James Bullard, a bona fide hawk. Additionally, persistently high employment payroll data like the one released today also supports further tightening in the future and pushes up the dollar’s value. In short, the hawkish tilt of the committee suggests that the dollar could rebound in 2023.
  • Austan Goolsbee was the economic advisor of former President Barack Obama. In an interview with NPR, he called into question the ability of hikes alone to rein in inflation and is likely to be sensitive to economic changes.

U.S. Firefighting: The president and Congress are moving to contain flames both domestically and abroad.

• The Senate passed legislation that would prevent rail workers from going on strike. The bill is expected to be sent to President Biden’s desk to be signed into law. The passage of the bill has prevented a strike from disrupting the U.S. economy but could have political costs for Democrats in upcoming elections. Rail workers were pushing for seven days of paid sick leave, a tenet that should have left-wing support on paper. The Democrats’ decision not to support labor is an example of how the party is becoming more pro-business establishment and less union-friendly. A stricter line by government officials could ease inflation and may be preferable to equities.
  • Government and unions can have a hot and cold relationship depending on the economic environment. In an inflationary period, politicians have been known to turn on labor.
• President Biden is open to negotiating with Russian President Vladimir Putin over the war in Ukraine. This stance is in contrast with the U.S. president’s previous statement that peace talks must include Ukraine. Although there is some sign that Putin may accept the invitation, the change in Biden’s tone suggests that the West wants the war to end. Biden’s offer came after meeting with French Emmanuel Macron. In the past, Macron has criticized the U.S. for profiting from the conflict at Europe’s expense. Thus, there is a possibility that Western support for Ukraine could be fading, which should be favorable to financial markets.
• Although demand remains an important driver of inflation, there are still many supply-side factors that can support higher prices. The growing power of labor unions has given unions more leverage to negotiate higher wages and benefits from firms. Meanwhile, the uncertainty in Ukraine suggests that commodity prices will continue to fluctuate. The Fed will consider these factors when determining whether it should lower rates. That said, U.S. central bank officials have shown no intention of distinguishing demand and supply pressures when deciding policy. Thus, supply-side shocks could lead the Fed to raise rates higher and for longer than the market currently expects.

Russia Risk Rising: A string of suspicious packages sent across Europe raises new questions about the war; meanwhile, the EU continues to bicker over price caps.

• Threatening packages were sent to Ukrainian embassies in Hungary, the Netherlands, Poland, Croatia, Italy, and Austria. Packages contained varying materials, from explosives to animal parts. Although no one was harmed, Western governments believe that the boxes are a form of terrorism and intimidation. The delivery of these threatening items could be a warning that there are factions, within Russia or sympathetic to, who are willing to escalate the war outside of the Ukrainian borders. At this time, the packages do not provide present a risk but could be a warning of something worse to come.
• Meanwhile, EU members still need to settle on a price cap for Russian oil. Although the recent proposal shows a price cap of $60, some countries within the bloc would like the lid to be lower, and others prefer to do away with the price cap entirely. Countries most in danger of being invaded are pushing for a lower limit as it would deprive Moscow of needed revenues to expand its war aims. However, EU members most adversely impacted by the price limit have warned that a low cap could make it harder for countries to receive energy supplies.
  • The EU has until Monday to come to a resolution before the agreed-upon embargo is set to take effect. Failure to do so could lead to disruptions within energy markets.
• Uncertainty in Ukraine represents a prevalent risk for European equities. Despite efforts from the West to curtail Russian oil production, it has still been able to increase its shipments worldwide. OPEC’s willingness to work with Moscow to minimize the impact of Western restrictions makes the problem worse. Meanwhile, the threat of a broader conflict could escalate tensions between the West and Russia. In short, investors should be mindful that any de-escalation of the war effort will likely be taken positively by the markets, especially in Europe. In the meantime, the U.S. remains safe, a place to hide and wait.

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