by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a couple of quick notes on the war in Ukraine and Russia’s relationship with the United States.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including the death of Italian right-wing firebrand Silvio Berlusconi and a preview of this week’s policy meeting at the Federal Reserve.

Russia-Ukraine War:  The latest reporting suggests the Ukrainian counteroffensive remains in its probing and feinting phase, with some thrusts being stopped but others managing to gain some territory.  So far, it appears that Ukraine’s losses have been moderate for this type of operation, including the loss of some advanced Western tanks and other equipment.

Russia-United States:  Moscow police have arrested a U.S. citizen living in Russia and charged him with dealing illegal drugs.  Travis Leake, a 51-year-old musician, has been living in Russia since 2010 and had refused to leave despite State Department warnings that U.S. citizens should get out of the country.  His arrest will probably be a new point of friction between Russia and the U.S. and could morph into another prisoner exchange like the one in December that freed WNBA star Brittney Griner.

Italy:  Former Prime Minister Silvio Berlusconi died today, creating a leadership vacuum in his conservative Forza Italia Party and likely taking some of the energy out of Italy’s right-wing political forces.  The most immediate issue is who will take over Forza Italia, which is a member of current Prime Minister Meloni’s three-party coalition.  More broadly, since Berlusconi was sympathetic to President Putin, his death could help ensure that Meloni’s government has a free hand to keep supporting Ukraine as it tries to defend against Russia’s invasion.

United Kingdom:  Former Conservative Party Prime Minister Boris Johnson resigned from his seat in parliament on Friday after seeing a new Privileges Committee report that accuses him of lying to the Commons about holding illegal parties during his government’s pandemic lockdown.  At least two of Johnson’s allies have also resigned, setting the stage for three by-elections that will be a challenge for current Prime Minister Sunak’s government to defend.  As a result, political instability looks set to continue in the U.K. in the near term.

• Separately, former Scottish First Minister Nicola Sturgeon, who resigned in February, was arrested yesterday by police officers investigating the finances of her Scottish National Party (SNP).
• The SNP’s focus is gaining independence for Scotland. The arrest of Sturgeon and the investigation into the SNP will likely take the wind out of that effort for the near term.

Turkey:  Late last week, newly re-elected President Erdoğan named Hafize Gaye Erkan as the new chief of the central bank.  Erkan, a Princeton-educated economist who used to be a banker at Goldman Sachs (GS, $336.02), is a specialist in building complex financial models to uncover the risk in bank balance sheets.  That classical skillset suggests she will take a traditionalist approach to policy, much as Erdoğan’s new finance minister seems to be doing.

• Taken together, the appointment of the two officials suggests Erdoğan will tone down his loose, unorthodox economic policies now that he has been safely re-elected.
• If monetary and fiscal policy do shift toward a more orthodox stance, it would likely be a positive for Turkish assets going forward.

China-South Korea:  The South Korean government has arrested a former executive of Samsung Electronics (005930.KS, KRW, 71,000.00) on charges that he illegally stole the chipmaker’s manufacturing technology with the intentions of building an entire copycat factory in China.  We suspect the near miss will force South Korean officials to confront the risk that the country’s most important technology secrets could flow to China, or be acquired by China, which would eventually harm South Korea’s leading tech companies.  In turn, that will likely force a clampdown on trade, investment, and technology flows with China, bringing South Korea more in line with the policies of the U.S. and the rest of the evolving U.S. geopolitical bloc.

United States-China:  The Biden administration has requested that the U.S. be reinstated as a member of the United Nations Educational, Scientific, and Cultural Organization (UNESCO) so that it can start pushing back against China’s dominance of the group which began after President Trump’s withdrawal in 2017.  Reinstatement would require the U.S. to pay several hundred million dollars in arrears on its membership dues, but the administration sees that price as worth it to reduce Beijing’s impact on UNESCO’s work on issues ranging from press freedoms to artificial intelligence.

U.S. Monetary Policy:  Officials at the Fed begin their latest two-day policy meeting tomorrow, with their decision due to be released on Wednesday at 2:00 PM EDT.  Market indicators suggest investors now expect the policymakers to pause their interest-rate hikes and keep the benchmark fed funds rate steady within a range of 5.00% to 5.25%.  The officials are also expected to signal an option to resume their rate hikes in the future if consumer price inflation doesn’t moderate as expected.

• In a Financial Times opinion piece today, former PIMCO bond guru Mohamed El-Erian argued that the more prudent course would be to hike rates again this week, since pausing until July wouldn’t give the Fed much additional data on the impact of previous hikes and since recent economic data has been strong enough to justify a June hike.
• On the other hand, El-Erian argues that a pause, potentially followed by cuts, could be in order if the global supply side of the economy has changed to the point where the Fed’s 2.0% inflation target is too low. Such a pause could also help reduce the risk of more financial instability like the bank crisis this spring.

U.S. Military:  As China’s military buildup and increasing aggressiveness create a need to beef up U.S. deterrence, independent auditors at the Government Accountability Office said the Navy’s submarine contractors can’t find enough workers to meet their planned schedule of building one Columbia-class ballistic missile submarine and two Virginia-class fast attack submarines each year.  According to the report, staffing for the attack subs is about 25% below what would be necessary to meet the planned schedule.  The staffing problems and construction delays are expected to produce significant cost increases for the new subs.

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