by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with the latest on the potential for a broader, more intense war in the Middle East. We next review a wide range of other international and US developments with the potential to affect the financial markets today, including downgraded debt rating outlooks for Chinese banks and a statement by Federal Reserve Chair Powell that confirms the central bank is less likely to cut US interest rates in the near term.

Iran-Israel: As the Israeli government continues to consider how and when it will retaliate for Iran’s direct missile and drone attack over the weekend, the Iranian government and military are reportedly preparing for an assault. Iranian and Iran-backed Hezbollah militants in Syria are being dispersed, while the Iranian air force is preparing for an attack on Iran itself. The Iranian navy will also escort commercial ships in the Red Sea. The moves illustrate how the war between Israel and Hamas could still broaden and escalate into a disruptive regional conflict.

• US and European officials continue to put strong pressure on Israel not to retaliate or at least to avoid any major retaliation.
• In a sign that the US and European messages may be getting through, the Israeli government has reportedly assured Arab countries in the region that its response to Iran’s attack wouldn’t endanger their security and would likely be limited in scope.
• Nevertheless, investor concern about a broader war has driven the VIX stock volatility index to its highest level since last October.

Chinese Stock Market Regulation: The China Securities and Regulatory Commission has clarified that its recent rule updates designed to make stocks more inviting for investors won’t be applied to smaller companies. The clarification comes after investors raised concerns that the new rules would discourage small companies from listing and force others to abandon their current listing. The CSRC’s move is another example of Chinese regulators clamping down on a sector, only to backtrack after going too far or scaring off investors.

• According to the CSRC, its new policy to flag companies for unsatisfactory dividends will mostly target healthy, profitable firms that pay no dividends at all or relatively small dividends over several years.
• The agency also emphasized that the “special treatment” tag applied to such firms would not necessarily be grounds for delisting.

Chinese Banking Industry:  Just days after cutting the outlook for China’s sovereign debt rating, Fitch has cut the outlook for China’s major state-owned banks from stable to negative, citing China’s slowing economic growth and the government’s more limited ability to support the institutions as fiscal challenges increase.

United States-China: President Biden today will propose more than tripling a key tariff on imports of Chinese steel and aluminum. The move will lift the tariff to 25% from its current level of 7.5%. Moreover, the higher rate would be in addition to the Trump administration’s tariffs of 25% on Chinese steel and 10% on Chinese aluminum, which Biden has kept in place. The resulting total tariffs of 50% on steel and 35% on aluminum are sure to further worsen US-China trade tensions and will probably invite some kind of trade retaliation from Beijing.

United States-Australia: Just weeks after rare-earth mining firms Lynas of Australia and MP Minerals of the US came to an impasse in their merger bid, Australian mining billionaire Gina Rinehart has amassed at least 5% of the shares in each company, raising expectations that she will serve as kingmaker to facilitate the link-up.

• China and its geopolitical bloc currently account for the vast majority of proven reserves, production, and refining capacity for rare earths, which are critical to the more electrified economy of the future.
• The Lynas-MP Minerals merger is seen as one potential way to help boost Western production of rare earths and establish a more secure supply chain for the minerals.

US Monetary Policy: At an event yesterday, Fed Chair Powell gave the strongest hint yet that the central bank expects to hold interest rates “higher for longer” because of continued high consumer price inflation. According to Powell, “Given the strength of the labor market . . . and progress on inflation so far, it’s appropriate to allow restrictive policy further time to work and let the data and the evolving outlook guide us.” The statement is consistent with our view that investors have been too aggressive in expecting near-term rate cuts.

US Labor Market: The United Auto Workers today will begin a unionization vote at a Volkswagen car plant in Tennessee, marking a key step in the union’s effort to organize workers at foreign-owned factories outside the more union-friendly areas in Michigan. Results of the vote are expected by the end of the week. With the vote, the UAW is trying to capitalize on the increased leverage workers have during today’s labor shortages and the union’s recent success in boosting pay at “Detroit Three” automakers.

US Military:  Six months into the federal fiscal year, the Army and Air Force have reported improved recruiting results compared with the previous year. The improvement reflects a number of new programs and policy changes, such as remedial training for low-scoring applicants and relaxed standards for drug use and tattoos. However, the Navy continues to lag its recruiting goals, leaving it undermanned in both at-sea positions and on-land billets.

• After years of falling short of recruiting goals, Army Secretary Christine Wormuth says her service is now about 5,000 contracts ahead of where it was at the same point last year. She also said the Army is on track to meet its goal of 55,000 new recruits for the whole fiscal year, in large part because of a new, 90-day soldier prep course that helps low-scoring applicants meet the Army’s academic and fitness standards.
• In the Air Force, recruiting has been strong enough for the service to hike its goal for the year to 27,100, compared with its original goal of 25,900. According to service officials, the improvement mostly reflects easier tattoo rules, bonus increases, and expanded efforts to recruit lawful permanent residents.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with an examination of China’s latest economic growth, which will have a big impact on global markets. We next review a wide range of other international and US developments with the potential to affect the financial markets today, including new signs that the Russian military is regaining momentum in its invasion of Ukraine and a major new antitrust suit being prepared in the US.

China: After stripping out price changes, first-quarter gross domestic product was up 5.3% from the same period one year earlier, beating expectations and accelerating slightly from the 5.2% rise in the year ended in the fourth quarter of 2023. However, the country’s growth is looking increasingly lopsided. In the year to the first quarter, most of the economic expansion came from corporate investment, industrial production, and exports, while consumer spending and housing investment remained tepid.

• The data is consistent with official plans to encourage massive new investment in higher-technology production, such as electric vehicles, batteries, and solar panels to make up for the weakness in consumption and the steep correction in residential building. The problem is that domestic demand isn’t strong enough to absorb all that new production, so Chinese firms are increasingly dumping excess output at fire-sale prices on the world market, further stoking trade frictions.
• So long as the government refuses to stimulate consumption spending or allow another spurt of housing investment, and so long as Western countries keep clamping down on Chinese dumping, the strategy will likely lead to further excess capacity in the economy. Indeed, other data today showed Chinese industrial capacity utilization falling in March to just 73.6%. Excluding the pandemic period, that was the lowest since 2016.

Japan:  The yen depreciated further yesterday, closing at 154.37 per dollar, its lowest level since 1990. Given the Japanese government’s recent warnings that it will intervene in the currency markets if the currency weakens much further, the likelihood of intervention has probably risen sharply.

• More broadly, last week’s unsettling report on US price inflation and yesterday’s report of strong US retail sales have pushed foreign stock markets sharply lower today.
• Since the data adds to concerns that the Federal Reserve may be even more reluctant to cut US interest rates, the dollar has surged against a number of currencies and forced foreign investors to consider a prolonged period in which capital will be drawn to the US and out of Europe and Asia.

Iran-Israel: The Israeli war cabinet today continues deliberating whether or how to respond to Iran’s big missile and drone attack against Israel over the weekend. As discussed in our Comment yesterday, domestic political dynamics are likely to push the Israeli government to launch some kind of response. The key question is how big and destructive such a response could be. A bigger response would raise the risk of a significant expansion of the current war between Israel and Hamas and threaten Middle Eastern energy supplies.

Russia-Ukraine: As warmer weather returns and dries out the ground, making it easier for Russia’s armored vehicles to maneuver, the Ukrainian military says Russian forces are now attacking more intensively along the front lines. Kyiv has rushed forces to try to plug the gaps in the line, but residents of front-line cities and towns are fleeing, and it is looking increasingly like the Russians could gain new offensive momentum and re-seize significant territory across Ukraine.

• To the extent that the Russians retake territory in Ukraine, it will have negative security implications for Western Europe. In such a scenario, the Europeans would likely have even more incentive to try to coalesce politically and boost their defense spending.
• If the Russians conquer huge new swaths of Ukrainian territory, it could also have an important political implication in the US, as the Democrats would likely pin the blame on those Republicans who have blocked further US military aid to Kyiv in recent months.

US Antitrust Regulation: The Justice Department is reportedly preparing to file an antitrust suit against concert promoter and ticket vendor Live Nation, alleging it has leveraged its dominance in a way that undermines competition for ticketing live events. The company has long been criticized for exorbitant ticket fees and poor customer service. In any case, the potential suit is another example of the Biden administration’s effort to toughen antitrust enforcement, which creates increased regulatory risk for investors.

US Energy Industry: In a little reported development last week, the Biden administration has announced an increase in the royalties paid and bonds posted to drill for oil on federal land. Royalties paid to the government will rise from 12.50% to 16.67%, marking their first increase since 1920. Bonds posted will rise from $10,000 to $150,000, for their first increase since 1960.

• The industry naturally has complained that the moves will weigh on domestic energy exploration and production. However, it’s important to remember that only about 10% of US oil output comes from federal land.
• In all likelihood, Biden’s move aims to placate supporters on the left wing of the Democratic Party, many of whom have been disappointed by his energy policies.

US Electric Vehicle Industry:  Premium EV maker Tesla yesterday said it is laying off more than 10% of its workforce to deal with the worldwide slowdown in demand for fully electric cars. In response, Tesla’s stock price fell some 5.6%, bringing its year-to-date loss to more than 33.0%. Tesla’s layoffs and stock decline illustrate the sharp reversal in fortune for EV makers since last year — a trend that could get even worse as Chinese producers look to dump their excess production on world markets at fire sale prices.

US Commercial Real Estate Industry: New data shows that technology firms have sharply curtailed their purchases and leases of office space in coastal markets, despite strong demand for the companies’ products. The drop-off in technology office demand marks yet another blow to the commercial real estate industry. The trend has reportedly boosted sublease listing, driven down lease rates and building values, and hurt office owners.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities are off to a slow start today as investors await key bank earnings reports. In a separate development, NFL fans are buzzing after quarterback Tom Brady hinted at a possible return. Today’s Comment examines the contrasting monetary policies of the ECB and the Fed, explores the reasons behind gold’s recent surge in investor interest, and analyzes the potential impact of South Korea’s parliamentary elections on its stock market. As always, we conclude with a summary of key domestic and international data releases.

Taking Different Paths: The ECB and the Federal Reserve are diverging on monetary policy, with both looking to loosen restrictions without abandoning their goals.

• The FOMC minutes unveiled on Wednesday provide valuable insights into the Federal Reserve’s strategy for balance sheet reduction. FOMC policymakers have signaled an openness to initiating this process, with a primary focus on scaling back the pace of US Treasury roll-off while maintaining mortgage-backed securities unchanged. While a specific start date isn’t confirmed, May or June are possible targets. Chair Powell stressed a gradual approach to control the process. This aims to reduce reserves from “abundant” to an as yet to be defined “ample” level, with the hopes of preventing disruptions similar to the 2019 short-term funding market issues.
• The European Central Bank (ECB) is taking a contrasting approach. The ECB is maintaining its current pace of balance sheet reduction, continuing to unwind its asset purchase program, and stopping the reinvestment of bonds from its pandemic program by year-end. This last step will significantly accelerate the shrinking of the ECB’s balance sheet. This faster drawdown aims to both limit new money entering the financial system and counteract any stimulus from potential future rate cuts, aligning with the ECB’s mission of ensuring the return of price stability within the market.

• The central banks are taking different approaches to monetary policy based on their economic concerns. The Fed’s measured pace of balance sheet reduction suggests a focus on preventing financial instability, possibly due to rising liquidity concerns. In contrast, the ECB’s preference for rate cuts suggests policymakers are worried about rising defaults, hoping lower rates will allow businesses to refinance debt more easily. That said, these adjustments by central banks may not signal a return to loose monetary policy, but rather a moderation of previous tightening measures. Investors should therefore remain cautious about excessive risk-taking.

Gold Bugs in Charge: The bullion has surged in recent months as central banks have looked to acquire the metal as a hedge against the dollar.

• Several factors are driving the gold surge, including heightened demand from central banks in emerging economies, such as China, that are seeking alternatives to the dollar. Investors are also increasingly drawn to safe havens due to rising geopolitical risks and uncertainty surrounding Fed policy rates, which could erode the value of US Treasurys. Additionally, consumers are actively seeking alternative assets to safeguard their savings amid sustained inflationary pressures. As a result, gold has been a star performer in 2024, outperforming the S&P 500 with a year-to-date return of 16.0% compared to 9.6%.
• Traditionally, gold and stocks have moved in opposite directions during uncertain times. But over the past five years, a surprising trend has emerged of a strong positive correlation, with both assets rising in tandem. The five-year moving correlation has jumped to +0.84, significantly above its historical norm of +0.22. This breakdown of the usual inverse relationship suggests a more complex market environment. While economic optimism typically fuels stock prices, with investors betting on growing companies, rising gold prices might indicate underlying anxieties about the high valuation of tech companies.

• A key factor influencing gold’s price momentum hinges on the Federal Reserve’s ability to achieve a soft landing – controlling inflation without stalling economic growth. Recent comments from Boston Fed President Susan Collins and Fed Governor John Williams suggest policymakers are cautious about cutting rates given the current elevated inflation levels. If policymakers continue to hold rates higher than the market is expecting, it may encourage more investors to purchase gold in order to hedge against a possible hard landing or an unexpected acceleration in inflation.

Yoon in Trouble: South Korea’s parliamentary election results dealt a severe blow to the ruling Conservative party, raising doubts about its ability to hold the government together.

• In Wednesday’s parliamentary elections, the liberal opposition in South Korea achieved a resounding victory, securing 175 out of 300 seats in parliament. Although the opposition fell short of the 200 seats required for a supermajority, its win holds significant implications. This strong opposition suggests that President Yoon Suk Yeol will need help enacting his agenda. He may be forced to compromise with the opposing side, which could significantly weaken his proposals. Following the crushing defeat, the prime minister and other senior officials tendered their resignations, which paves the way for the president to reshuffle his cabinet in response to the election results.
• The election outcome raises questions about the planned reforms designed to enhance the appeal of South Korean equities. President Yoon had pledged to eliminate the planned capital gains taxes on financial investment income before the election. He also proposed a program to address the issue of Korean companies trading at lower valuations relative to their global peers, a phenomenon known as the Korea discount. Despite some hope that the reforms would survive in a weakened form, the uncertainty surrounding their implementation is likely weighing on investors and contributing to today’s decline in the KOSPI.

• South Korea’s recent political situation exemplifies the challenges in making its equities more attractive. However, the country’s booming semiconductor industry, especially with its strengthened ties to the US, Japan, and Taiwan for chip security, offers a potential bright spot for investors seeking exposure beyond a weakening China. Investor confidence hinges on lawmakers’ ability to encourage companies to prioritize shareholder value alongside other considerations during decision-making. Unfortunately, the recent parliamentary shift makes achieving this reform more difficult, potentially dampening hopes for a rally similar to the one experienced by the Japanese stock market in recent years.

In Other News: Iran has signaled a limited response to Israel, easing fears of wider conflict in the Middle East. China’s exports fell more than expected in March, raising concerns about its economic slowdown. Meanwhile, former Fed Chair Bernanke unveiled revamped economic models for the BOE in a sign that central bankers are adapting to a changing world.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities are mixed after the weaker-than-expected PPI report. In a Champions League upset, Barcelona edged past PSG in Paris, and took a 1-goal lead into the return leg. Today’s Comment examines how rising inflation (CPI) impacts interest rates, explores the increase in defense spending due to growing geopolitical tensions, and analyzes the hints of possible easing by the ECB as part of a wider trend among developed central banks.

Rate Cut Expectations: Stronger-than-expected March inflation and hawkish FOMC meetings have led to a rethink on rate cuts.

• Inflation surged in March, exceeding forecasts, and year-over-year consumer prices jumped to 3.5% (up from 3.2% in February). Core CPI, excluding volatile food and energy, also climbed to 3.8%, driven by rising costs in housing, healthcare, and car insurance. This robust report dampens hopes for the Fed achieving its 2% target, as indicated in recent meeting minutes. The minutes also reveal a divided committee, where some members fear geopolitical tensions and relaxed financial conditions could further inflate prices. In contrast, others see the potential for downward pressure from technological advancements and continued immigration.
• Recent data exposes unexpected inflation trends. Despite the Federal Reserve’s anticipation of falling housing costs, shelter inflation remains stubbornly high. The three-month annualized rate rose to a worrying 7.11% in March, a significant departure from the expected disinflation. Furthermore, inflation isn’t limited to housing. Core services, excluding rent, have also seen substantial increases, rising 9.3% at an annualized rate over the past three months. This unexpected increase in core services, which are sensitive to wages, suggests a tight labor market, which could fuel broader inflationary pressures.

• March CPI data complicates the Fed’s policy decisions. Their preferred gauge, core PCE inflation, is near their target (2.78% vs 2.50% target range). However, headline CPI inflation, the more widely followed measure, remains above 3.5%. This divergence creates a challenge. The higher CPI number suggests the Fed may now need to hold interest rates steady for a longer period than initially anticipated to avoid accusations of partisanship in an election year. Although a summer rate cut isn’t entirely off the table, its likelihood has diminished significantly.

Defense Spending Splurge: Rising global tensions are prompting governments to ramp up defense spending in a bid to deter potential adversaries.

• The Middle East simmers with escalating tensions as the US and Israel ramp up collaboration on missile defense. This follows recent threats from Iran vowing retaliation after a strike in Syria killed a high-ranking Iranian general. The simmering conflict raises fears of a wider regional war, with US officials warning of potential targeted missile attacks by Iran. In a defiant move, Israel issued a stark warning, promising a forceful response on Iranian soil if its borders are breached. Adding to the regional turmoil, two major disputes threaten to ignite further chaos: Ukraine and Russia, as well as Armenia and Azerbaijan.
• While a wider Middle Eastern conflict remains a major concern, the drone revolution is another threat to global stability that shouldn’t be underestimated. Iran’s cheap, combat-proven drones are captivating developing nations, bolstering defenses and aiding militaries like those in Ukraine and Sudan. Their global production network, spanning South America and Central Asia (including some US parts), raises questions about the effectiveness of sanctions. Meanwhile, Ukraine’s experience exposes limitations in US drone capabilities, prompting Ukraine to explore Chinese alternatives for reconnaissance. This highlights how any nation, regardless of size, can exploit niche strengths, reshaping the modern military landscape.

• The intensifying tensions in both the Middle East and Asia emphasize the critical importance of resilient supply chains. Recognizing the emerging alliance between Russia, China, and Iran, US allies are joining forces to bolster their military capacities, aiming to deter potential aggression. This collaborative effort is yielding early successes, as shown in the groundbreaking military drone radar developed by a notable French defense company. As geopolitical rifts deepen, the imperative for security investment grows, underscoring the importance for countries to support global defense companies in safeguarding collective defense interests.

 ECB’s Cautious Pivot: The European Central Bank decided to hold rates steady as it prioritizes economic growth over the inflation fight.

• The ECB Governing Council voted to hold interest rates steady for the fifth consecutive meeting. The main refinancing rate remains at 4.5%, and the deposit rate stays at 4.0%. While the central bank’s updated policy statement hinted at a future easing of monetary restrictions, it provided no concrete timeline. However, there are strong indications that a rate cut could come as early as June. The ECB also plans to continue its balance sheet reduction program and will reinvest principal payments from its pandemic bond purchases until the end of 2024.
• In a sign of shifting tides, the ECB’s decision to hold rates steady reflects a growing global trend towards a pause in interest rate hikes. This follows the Swiss National Bank’s surprise rate cut last month, the first among G-7 central banks. Similarly, the Bank of Canada has hinted at a possible June cut as it looks to ease its rate by 100 bps by the end of the year. This cautious approach comes as inflationary pressures, which peaked in the summer 2022, have begun to show signs of moderation, and economic growth has become more of a concern.

• Global monetary policy is in uncharted territory as central banks are deviating from the Federal Reserve’s cautious approach. This divergence, coupled with ongoing doubts about the need for US rate cuts given its economic resilience and robust labor markets, could significantly strengthen the dollar. A stronger greenback could pose a double challenge for economies reliant on dollar-priced imports as it would exacerbate inflationary pressures, forcing them to reconsider planned rate cuts. Additionally, a robust US economy might lead their central banks to maintain higher interest rates than desired, potentially hindering domestic growth.

Other News:  Manhattan rent dips hint at a stabilizing market, but high housing costs remain a hurdle for the central bank in achieving its 2% inflation target. Facing a persistent Russian offensive, Ukraine confronts growing challenges in maintaining momentum. Switzerland will hold a peace conference to mediate the Ukrainian/Russian crisis.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a major new speech by a top European Union policymaker that calls for greater US-EU coordination to counter China’s unfair trade practices — a call that is likely to anger Beijing and fuel greater tensions between the West and China. We next review a wide range of other international and US developments with the potential to affect the financial markets today, including a new downgrade to the outlook for China’s credit rating and an Arizona Supreme Court ruling that could have an important impact on the US elections in November.

United States-European Union-China: In a major speech yesterday, European Commission market competition chief Margrethe Vestager called for the US and the EU to team up and present a more systematic, coordinated approach against China’s unfair trade practices. To protect their key industries of the future, Vestager outlined a strategy in which the US and EU, working together, could convince the Group of 7 countries to erect trade barriers against subsidized Chinese products being sold in the West at artificially low prices.

• Vestager also announced that the EU is launching an anti-dumping probe into Chinese wind turbines, just as it previously announced an investigation into the likely dumping of low-cost Chinese electric vehicles on the EU market.
• According to Vestager, “We saw the playbook for how China came to dominate the solar panel industry . . . We see this playbook now deployed across all clean tech areas, legacy semiconductors, and beyond, as China doubles down on a supply side support strategy to address its economic downturn.”
• The new anti-dumping probe is certain to generate complaints, pushback, and perhaps even retaliation by Beijing. Indeed, some European officials are likely to push back against the probe out of fear that China will retaliate by imposing new restrictions on their trade or investment flows. In the past, those concerns have limited the EU’s actions against China. However, faced with yet another onslaught of subsidized Chinese goods, the EU may ultimately impose tougher restrictions this time, as Vestager calls for.
• In any case, Vestager’s tough speech is a sign that economic tensions between the West and China aren’t going away anytime soon. They actually look set to worsen, since the Chinese government is likely to retaliate in one way or the other and shows no sign of wanting to shift away from its investment/export economic development strategy toward a consumption-led model.

Japan-China:  In a new survey by Japanese news firm Yomiuri Shimbun, 92% of respondents said China is a threat to Japan’s national security, versus 86% who said the same in 2023 and 81% who said so in 2022. The responses help explain Tokyo’s enthusiastic support for the US effort to strengthen allied defense efforts against China’s increased geopolitical aggressiveness in the Indo-Pacific region. The results also suggest tensions between China and the westernized liberal democracies will continue to increase going forward.

China: Reflecting China’s slowing economic growth, slumping property market, and rising fiscal deficit, Fitch today maintained its A+ rating on the country’s sovereign debt but cut its outlook from stable to negative. The move follows a similar one by Moody’s in December, in which that company maintained its A1 rating on China’s long-term debt but also cut its outlook from stable to negative.

• China’s burgeoning public sector debt stems mostly from fiscal shortfalls at the provincial and local government levels. The central government has begun to issue its own new debt to rescue some of those lower-level governments, but that is putting new fiscal pressures on Beijing.
• The rising debt challenges compound other structural economic challenges that have come to light in recent years, such as excess industrial capacity, weak consumer demand, poor demographics, decoupling by foreign countries, and the disincentives from the Communist Party’s increasing intrusions into the economy.
• Not only are China’s debt and other structural economic problems creating headwinds for the country’s own economy and financial markets, but they are also holding down growth in some other countries.

Australia: The government said today that it will toughen the country’s corporate merger rules amid concerns that increased market concentration is stifling competition and boosting prices. Under the plan, the government will give the Australian Competition and Consumer Commission added powers to scrutinize mergers above certain value and market-share thresholds. The ACCC would also be given authority to stop small serial acquisitions that could reduce competition over time, bringing Australia’s rules in line with those of most other developed countries.

Eurozone: Big US money managers are reportedly shifting their bond purchases from US Treasuries to eurozone obligations in hopes that the European Central Bank could begin to cut its benchmark interest rate sooner and faster than the Federal Reserve will cut US rates. The improved outlook for eurozone bonds reflects Europe’s much weaker economy and rapidly falling inflation. In contrast, strong economic growth in the US is keeping price pressures high and threatening to delay the Fed’s interest-rate cuts.

US Politics: Responding to the US Supreme Court decision in June 2022 that rolled back federal protections for abortion, the Arizona Supreme Court yesterday ruled that a nearly total ban still on the books from Arizona’s territorial days must be reinstated. The move follows a recent Florida Supreme Court ruling that also allowed tighter restrictions, even as it approved a referendum on abortion rights in the November election.

• Although the rulings will have no discernible impact on the US economy or financial markets, they have the potential to affect the upcoming elections.
• Given that Democrats have shown they can exploit the June 2022 ruling that overturned Roe v. Wade, the rulings could help the party in Arizona, Florida, and even in other key swing states, despite current polling showing greater support for former President Trump than for President Biden.

US Postal System:  The US Postal Service has requested permission to boost the price of a first-class stamp by an additional 5 cents. If approved in the coming weeks by the Postal Regulatory Commission, the cost of a stamp would rise on July 14 to $0.73, up 10.6% from one year earlier.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with some observations on gold prices, which hit a record high yesterday. We next review a wide range of other international and US developments with the potential to affect the financial markets today, including more signs of a Western trade war against China over its dumping of excess production on world markets and another indication that US commercial real estate prospects may be on the verge of improving.

Global Gold Market:  Gold prices hit a new all-time record yesterday, closing at $2,357.80 per ounce despite investors’ realization that the Federal Reserve isn’t likely to cut interest rates as aggressively as previously thought (gold prices have historically been hurt by high real interest rates). In our view, the anomaly reflects a broad commodity rally, geopolitical tensions, and especially strong buying by central banks.

• Gold has long been seen as a “safe haven” asset that can hold its value in the face of currency debasement, rising price inflation, and wars or other geopolitical tensions.
• More recently, it’s become clear that gold is a safe haven even to foreign governments and their central bankers, especially in the rival China-led geopolitical bloc. As those governments and central banks digest how the West has essentially frozen or seized reserves held by countries like Afghanistan, Iran, and Russia, they’ve become much more intent on holding their reserves in hard assets such as the yellow metal.
• The process of central banks shifting their reserve holdings toward gold, silver, or other physical commodities could well continue for some time. Therefore, it’s possible that gold’s current uptrend will continue.

European Union-China: New reports say waves of imported autos are piling up at European ports, reflecting not just the onslaught of mostly Chinese-made vehicles but also a shortage of truckers to move them out and a slowdown in demand among European consumers. We think the situation will only make it more likely that the EU will formally impose anti-dumping tariffs or other trade barriers against China once its current investigation of the issue is completed.

European Union-Russia: Yesterday, the European Commission’s top diplomat, Josep Borrell became the latest high-level European official to warn of an impending war with Russia. In a speech in Brussels, Borrell warned that “Russia threatens Europe . . . War is certainly looming around us, and a high-intensity, conventional war in Europe is no longer a fantasy.” Consistent with our outlook for bigger military budgets around the world, Borrell urged the creation of a joint EU financing mechanism to boost the bloc’s defense industrial capacity to prepare for war.

Eurozone: The European Central Bank said its first-quarter survey of commercial banks revealed a substantial decline in corporate loan demand. The fall in demand for credit apparently reflects weaker investment plans, so the data may more strongly prompt the central bank to signal the beginning of interest-rate cuts when it holds its policy meeting later this week. At this point, investors largely expect the ECB to start cutting rates in June.

Turkey-Israel: Under domestic political pressure to do more to stop Tel Aviv’s war against Hamas in Gaza, the Turkish government today said it will restrict the export of 54 different products to Israel. The restrictions will affect exports ranging from construction machinery and metal products to fuels and oils. The move reflects how Israel’s war on Hamas and the resulting civilian casualties are increasingly isolating the country politically and economically, with potentially long-term consequences.

Japan: In testimony before parliament today, Bank of Japan Governor Ueda said the central bank will keep monetary policy accommodative for now, despite its decision to end its negative interest-rate policy last month. Ueda did say that the policymakers might reduce the amount of accommodation if consumer price pressures worsen, but he offered no firm guidance on when interest rates might rise again. The testimony suggests Japanese rates will rise only slowly and remain relatively low for the time being, keeping downward pressure on the yen.

United States-China: In her visit to China this week, Treasury Secretary Yellen has delivered a tough warning that the US will respond if Beijing keeps pushing unwarranted investment that leads to more excess capacity and increased dumping of cheap Chinese goods on the world market. However, Chinese officials have pushed back on the criticism, claiming that excess capacity is normal, and that China is merely trying to develop its economy appropriately.

• Yellen’s tough message and Beijing’s pushback point to further US-China tensions.
• As we have noted many times before, the increasing tensions threaten to catch investors in the crossfire going forward.

US Bond Market: Treasury yields across the maturity spectrum rose to their highest levels since November, with the benchmark 10-year rate closing yesterday at 4.422%. So far this morning, the higher yields appear to be enticing some investors to buy bonds again, pulling yields a bit lower. Nevertheless, as we noted in our Comment yesterday, investors are likely to remain skittish about buying fixed income in the face of sticky consumer price inflation and a Federal Reserve that is less likely to cut interest rates than earlier thought.

US Commercial Real Estate Market:  Private investing giant Blackstone yesterday said it is buying Apartment Income REIT, known as AIR Communities, which owns 76 upscale apartment communities mostly in coastal markets such as Miami and Boston. The $10-billion buy comes after a period in which Blackstone was being cautious in the face of high interest rates, rising commercial real estate vacancies, and falling building values. The deal, therefore, could signal an upturn in the sector’s fortunes and a potential rebound in commercial real estate values.

View PDF