by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with two key developments in European Union economic policy, including a suggestion that the European Central Bank will tighten monetary policy more than expected and the passage of a new law that will ban the sale of gasoline-powered cars in the EU from 2035.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including NATO’s confirmation that Russia has launched its anticipated new offensive in Ukraine and signs that the Federal Reserve may also tighten monetary policy more aggressively than investors currently expect.

European Union Monetary Policy:  ECB board member and Irish Central Bank Governor Gabriel Makhlouf said the ECB may hike its benchmark short-term interest rate to more than 3.5% this year, from 2.5% currently, and won’t cut rates until at least 2024 as it fights to bring down inflation.  The statement is at odds with investors’ current expectations for the ECB’s terminal rate to stop rising at 3.5% and for rate cuts to begin later in 2023.  In response, the EUR is trading up approximately 0.3% today at $1.0761.

European Union Regulatory Policy:  The European Parliament approved a law today that would ban the sale of gasoline-powered cars in the bloc beginning in 2035, although vehicles that run on carbon-neutral fuels would still be allowed.

• The new law aims to accelerate Europe’s shift to electric vehicles, although it threatens to disrupt one of the EU’s key industries in the meantime.
• Indeed, Ford Motor (F, $13.09) announced today that it will lay off 3,800 workers in Europe over the next three years in order to cut costs and boost profits amid its transition to making electric vehicles.

Russia-Ukraine War:  The North Atlantic Treaty Organization (NATO) confirmed that Russia has launched a major new offensive in eastern Ukraine, as widely expected.  The announcement came as NATO defense ministers are meeting today in Brussels to discuss the provision of further support for Ukraine, including ramping up production of ammunition and other military aid in NATO countries.  Even though the Russians have started their new offensive after spending weeks replenishing their forces with newly conscripted troops and massing equipment along the front, it appears that they have made only limited gains so far, mostly to the north of the heavily embattled city of Bakhmut.

Russia-Moldova-Ukraine:  Moldova’s pro-European President Maia Sandu said she has confirmed that Russia had tried to instigate a coup over the last year that would topple her government and replace it with a pro-Russian government.  Moldova, on Ukraine’s southwestern border, has been a target of Russia in part because it is trying to join the European Union and cooperates closely with NATO.  In an apparent abundance of caution regarding possible Russian retaliation for Sandu’s announcement, the country has shut down its airspace today.

Turkey:  One day before Istanbul’s stock exchange reopens after a shutdown caused by last week’s earthquakes, President Erdoğan’s government has ordered the country’s private pension funds to boost their holdings of Turkish stocks to support the market.  The move is likely a further effort by Erdoğan to shore up his re-election chances ahead of May’s national balloting.

• Under the new rules, pension funds must allocate 30% of the funds the government contributes to match individual pension contributions to Turkish stocks, up from the previous requirement of 10%.
• The pension funds will also be allowed to increase the weighting of a single stock in their portfolio to 5%, up from 1% previously.

Israel:  Yesterday, the Knesset passed Prime Minister Netanyahu’s controversial judicial reform on its first reading, prompting a mass strike, protests by tens of thousands, and expressions of concerns by key business leaders who fear it will lead to a dictatorship and be bad for business.  The proposed law, which would give parliament the right to override court decisions with a simple majority vote, still needs to pass two more readings before it becomes law.

China:  Following on our note in yesterday’s Comment that the U.S. will restrict its citizens from direct investments in certain Chinese technology firms, reports say Singapore’s sovereign wealth fund GIC has significantly slowed its investments in China-focused private equity and venture capital funds.  The pullback by GIC evidently comes after an intense internal debate over Chinese investment prospects under the authoritarian leadership of Chinese President Xi.

• GIC is widely recognized as an astute, sophisticated investor, and it was an early adherent to the Chinese investment story. Its decision to pull back from the market is therefore an important indicator that investor sentiment toward China has deteriorated.  Indeed, beyond China’s domestic economic management, the volatile and intense geopolitical tensions between the U.S. and China (illustrated this month by the Chinese surveillance balloon crisis) raise serious questions as to whether China is truly investable anymore.
• Nevertheless, investors do seem to believe that China is still at least tradable. New data from Refinitiv Lipper shows that global investors have poured money into Chinese stock funds for five straight weeks, bringing the year-to-date total to some $2 billion.  The new investments in China appear to be driven by bets on its dismantling of COVID-19 pandemic lockdowns.

United States-China:  The U.S. military stated it has recovered important electronic components from the suspected Chinese surveillance balloon that was shot down earlier this month off the coast of South Carolina.  According to the announcement, crews have retrieved significant debris, including all the “priority sensor and electronics pieces” as well as large sections of the payload structure.

• That should help U.S. intelligence and counterintelligence analysts figure out exactly what information the balloon was designed to gather, how it operated, and whether it relied on any U.S. or allied technology.
• However, U.S. and Canadian officials say they have not yet been able to retrieve debris from the other three unidentified flying objects shot down over the U.S. and Canada in the last week.

United States-Japan-Philippines:  Philippine President Ferdinand Marcos Jr. said he wants a tripartite defense treaty between the U.S., Japan, and the Philippines to supplement the individual defense deals he has recently signed with the U.S. and Japan.  According to Marcos, stronger military relations between the three countries would help keep the peace as China becomes more geopolitically assertive in the region.

• One of Marcos’s recent deals gives the U.S. access to four additional Philippine military bases where it can conduct training, stockpile weapons, and build infrastructure to help fight a potential conflict with China. His other deal eases the Japanese military’s access to Philippine bases.
• Marcos’s embrace of the U.S. and Japan marks a sharp reversal from the policies of Former Philippine President Duterte, who tried to distance himself from the U.S. and its alliance system.

U.S. Monetary Policy:  Fed board member Bowman said the monetary policymakers are still “far from achieving price stability,” which means they will have to keep raising interest rates and hold them at a high level for a prolonged period.  The statement underlines the view of other key Fed officials and suggests that many investors are being overly optimistic as they look for an end to rate hikes and a potential pivot to rate cuts in the near term.

U.S. Fiscal and Regulatory Policy:  Various reports say President Biden will name Fed Vice Chair Brainard as his new economic policy coordinator this week.  Brainard will replace Brian Deese as chief of the National Economic Council, which advises the president on policy and personnel decisions and coordinates policy making across executive branch agencies.  That will open up her spot on the Fed’s board of governors and remove one monetary policymaker who has been more dovish on interest rates than Chair Powell.

View PDF