by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

While everyone else today will be talking incessantly about the solar eclipse, our Comment opens with another step in the Biden administration’s effort to strengthen its alliances in the face of China’s geopolitical challenge. We next review a wide range of other international and US developments with the potential to affect the financial markets today, including new tactics being used by Russia in its invasion of Ukraine and multiple developments regarding US interest rates and the bond market.

United States-Australia-Japan: The AUKUS defense ministers today will announce that the pact’s countries are inviting other nations to join in the grouping for its “Pillar II” projects related to technologies such as quantum computing, undersea sensors and weapons, hypersonic missiles, artificial intelligence, and cybersecurity. A key focus will be to bring in Japan, transforming the group to “JAUKUS.”

Russia-Ukraine War: The Russian military has reportedly shifted its tactics recently, launching missile and drone strikes against Ukraine’s energy infrastructure in relatively less protected regions. The attacks appear aimed at causing more long-lasting damage, since the remote facilities can’t be repaired easily or quickly. In addition, it appears the Russians are trying to force Kyiv to shift its air defense systems to areas away from the main urban centers and battle lines to make it easier for Russian forces to launch an expected new ground offensive.

Slovakia:  In presidential elections yesterday, Peter Pellegrini, an ally of pro-Russian, populist Prime Minister Robert Fico, won with approximately 54% of the vote. In Slovakia, the president has only limited power, but the result is seen as burnishing the political power of Fico at the expense of the Slovakian politicians who are more pro-Western, pro-European Union, and anti-Russian.

Ecuador-Mexico:  On Friday, the government of Ecuador’s tough-on-crime President Daniel Noboa intruded on the Mexican Embassy in Quito and arrested a former Ecuadorian vice president who had been granted asylum there from charges of corruption. The move prompted Mexico to cut diplomatic ties with Ecuador, but it is also apparently boosting the political position of Noboa as he begins positioning himself for re-election next year.

Mexico: In a debate ahead of the presidential election looming on June 2, leftist frontrunner Claudia Sheinbaum of the ruling Morena Party appeared to successfully fend off biting personal attacks from Xóchitl Gálvez, the main opposition candidate. In the latest opinion polls, Sheinbaum has had a commanding lead with support from about 59% of likely voters. The polls suggest the leftist Morena Party will likely retain the presidency and perhaps control of Congress as well. That will likely keep Mexican equity prices lower than they otherwise could be.

US Monetary Policy:  After Friday’s report showing strong labor demand and job growth in March, futures trading now suggests investors no longer expect the Fed to cut its benchmark interest rate in June. Based on the CME FedWatch Tool, investors now see a 51.9% probability that the policymakers will keep the rate in its current range of 5.25% to 5.50%. Some investors now expect the Fed to cut rates only twice this year, while others are entertaining the possibility of just one or even no cuts.

• The scenarios of just one cut or no cuts at all are probably less likely, but they are plausible if economic growth remains healthy.
• In any case, adjusting to the possibility of continued high interest rates has become at least a temporary challenge for stock investors, as reflected in the price declines seen last week.

(Source: CME Group)

US Bond Market: Looking further into the future, JPMorgan Chase CEO Jamie Dimon warned today in his widely read annual letter that US interest rates could surge to 8% or more in the coming years in response to expanding fiscal deficits, the energy sector’s “green transition,” and worsening geopolitical tensions. Dimon has been overly gloomy in recent years, but his general analysis is consistent with our view that future inflation and interest rates are likely to be higher and more volatile because of the factors Dimon cites in his letter.

US Fiscal Policy: President Biden today will unveil another sweeping plan to slash student loan debt for millions of borrowers, despite his earlier attempts being turned back by Congress and the courts. The plan marks another effort to curry favor with progressive and younger voters ahead of the November election, and administration officials say they hope borrowers will see reduced payments by the autumn. However, Republican resistance to the plan is already growing and could well thwart it.

• Under the plan, individual borrowers who earn $120,000 or less and married couples who make $240,000 or less would be eligible for forgiveness of the entire amount that their current loan balance has increased beyond the principal.
• The plan would essentially cap accrued interest at the amount of the original principal.

US Industrial Policy: In the latest announcement of subsidies to boost advanced semiconductor manufacturing in the US under the CHIPS and Science Act of 2022, the Commerce Department said it will give $6.6 billion in grants, plus up to $5 billion in loans, to Taiwan Semiconductor Manufacturing Corp. for its effort to build three new fabrication facilities in Arizona.

• Under the deal, TSMC has agreed to start producing its most advanced 2-nanometer chips in the new facilities.
• According to the Commerce Department, that would put the US on track to produce 20% of the world’s advanced computer chips by 2030.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities are giving back gains after a surprisingly strong jobs report. In college athletics news, Caitlin Clark, the Iowa star, secured her second straight Player of the Year award. Today’s Comment discusses why the Fed’s tolerance for inflation might be higher than investors anticipate, analyzes the surprising strength of US banks following the one-year mark of the Silicon Valley Bank collapse, and delves into the resilience of European equities despite a stagnant European economy. As usual, our report includes a roundup of international and domestic economic releases.

Not 2%, But Close Enough: The S&P 500 trimmed gains after a Fed president downplayed rate cuts, but signs suggest a Fed policy shift might still be coming.

• The Federal Reserve’s monetary policy stance is in flux. In a recent LinkedIn event, Neel Kashkari, president of the Minneapolis Fed, admitted his prior projection of two rate cuts in 2024 might need to be revised. Wary of inflation proving more persistent than anticipated, Kashkari signaled a possibility that the Fed may not cut rates at all this year. This shift follows hotter-than-expected inflation data in January and February, impacting both consumer and producer prices. However, Loretta Mester, president of the Cleveland Fed, remains optimistic, believing inflation will cool enough to allow for a rate cut as planned.
• The threshold for a rate cut may be lower than most investors realize. The latest FOMC projections showed that the committee expects three rate cuts and inflation to fall to 2.5% by year-end. This suggests policymakers may be comfortable with a slower-than-expected pace of inflation reduction as long as the progress is consistent. Even so, the conflicting inflation data may complicate their decision. In February, the Consumer Price Index (CPI), a common inflation gauge, rose 3.8% from the prior year, while the Fed’s preferred measure, the Personal Consumption Expenditures (PCE) price index, currently sits at 2.8%.

• The timing of any policy easing could hinge on which inflation indicator policymakers prioritize, or even if they consider both. Despite policymakers preferring to use core PCE as their tool to evaluate inflation, they have been known to react to changes in core CPI. This is evident in their recent references to persistent inflation, primarily based on the month-to-month change in the CPI data in March, which overshadowed a noticeable deceleration in core PCE. If they prioritize the CPI, they might hold rates for longer than expected. Conversely, if they focus on the PCE price index, they could be open to a rate cut as early as June.

Slow Moving Train: More than a year after the Silicon Valley Bank collapse, the financial system shows signs of recovery, though some skepticism lingers around regional banks.

• This week, Federal Reserve Vice Chair of Supervision Michael Barr sought to reassure the public about the financial system’s health, while acknowledging potential risks in commercial real estate. At a National Community Reinvestment Coalition event, he declared banks to be “sound” and “resilient,” highlighting improved liquidity. However, he balanced this optimism by acknowledging “pockets of risk” due to firms holding “significant unrealized losses” on their books and having a high concentration of commercial real estate. Instead of an immediate crisis, Barr likened the situation to a “slow-moving train” with potential problems surfacing over several years.
• Despite lingering concerns about the health of the banking system, US banks have surprised analysts with a strong start to 2024. Large-cap bank stocks have surged 11% year-to-date according to a UBS index, significantly outperforming the S&P 500’s gain of just 8.5% over the same period. This robust performance can be attributed to two key factors. First, large banks capitalized on opportunities last year by acquiring struggling but profitable regional banks, which has bolstered their earnings. Second, net interest income has remained healthy due to the Federal Reserve’s decision to keep interest rates elevated.

• Large banks have thrived this year, but regional banks remain a cloud of concern for investors. The KBW regional bank index is currently in negative territory, reflecting investor wariness of smaller banks due to anxieties about their commercial real estate exposure. The recent misstep at New York Community Bank further fueled these apprehensions. Still, it’s important to note that the closure of the Fed’s Bank Term Funding Program hasn’t triggered signs of an imminent regional banking crisis. If this situation continues, it will further add to optimism that the economy may avoid a downturn this year.

Silver Lining in Europe: European equities are showcasing resilience amidst prevailing economic headwinds and Germany’s weakened state.

• The STOXX Europe 600 (SXXP) has soared to new highs in 2024, fueled by a strong performance from large-cap stocks, particularly in banking and car manufacturing. The banking sector has witnessed its best showing in six years, surging 34% year-over-year. This rise is attributed to the banks’ ability to maintain financial health and capitalize on recent interest rate hikes by the European Central Bank (ECB). The recent shift by automakers away from electric vehicles due to perceived slowing demand, though, has also found favor with investors worried about declining profit margins and potentially lower sales.
• Despite a strong stock market performance, the eurozone economy faces ongoing challenges. The region narrowly averted a recession, technically defined as two consecutive quarters of economic decline. Recent data paints a concerning picture, with retail sales dropping 0.5% in February and the March purchasing managers’ index indicating a further contraction in construction activity. Germany, a key eurozone player, appears particularly vulnerable. Its manufacturing sector, a traditional engine of growth, continues to drag. German industrial orders rose a meager 0.2% in February, far below expectations of 0.8%.

• The strong stock market performance may be short-lived if economic conditions continue to deteriorate. Downturns historically lead to credit tightening, making it harder for companies to borrow and potentially hindering their ability to remain profitable. However, the ECB’s planned interest rate cut in June could help ease the situation by making credit more affordable. In the current economic climate of uncertainty, European blue-chip stocks could be a viable option for investors seeking a safe haven. These companies are resilient to major financial fluctuations, while also maintaining relatively attractive valuations compared with their US peers.

Other News: Bank of Japan Governor Kazuo Ueda signaled a possible rate hike in the second half of the year; the comment led the yen to strengthen against the dollar. Argentinian President Javier Milei seemed to retract his commitment to distancing the country from China by indicating that Beijing still wields considerable influence in South America. Treasury Secretary Janet Yellen has underscored the impracticality of the United States severing ties with China, solidifying a persistent trend of simmering tensions between the world’s two largest economies.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities are off to a great start after initial jobless claims data came in higher than anticipated. In sports news, the St. Louis Cardinals, considered by many to be World Series contenders, kick off their home opener today. Today’s Comment explores three key market concerns: the impact of future policy rate uncertainty on market jitters, how the AI rally might diverge from the dotcom bubble, and whether Swiss inflation data offers clues about global inflation trends. As usual, our report includes a summary of domestic and international data releases.

Shifting Sands: The Fed’s uncertainty about inflation’s trajectory is muddying the policy path, prompting markets to reassess their interest rate forecasts.

• Fed Chair Jerome Powell reiterated the importance of patience in considering rate cuts for the Federal Reserve. Speaking at a panel discussion at Stanford University, Powell highlighted the significant influence of supply-side factors in curbing inflation since the onset of the pandemic. While he avoided giving a specific rate forecast, he indicated the latest data hasn’t “materially changed” the Fed’s view on inflation. This aligns with San Francisco Fed President Mary Daly, who still favors three rate cuts this year. In contrast, Raphael Bostic has reduced his forecast from two cuts to one.
• Conflicting economic data is further muddying the Federal Reserve’s decision on interest rates. The Institute for Supply Management’s (ISM) latest manufacturing PMI shows prices paid have surged to their highest levels since 2022, indicating persistent inflation. However, the non-manufacturing PMI shows service sector prices at a four-year low, suggesting a potential easing of price pressures in that sector. This surge in manufacturing prices likely reflects rising commodity costs, while the low service-sector prices could signal easing wage pressures, which aligns with the decline in the non-manufacturing employment component. The negative response to manufacturing data and positive reception of service data highlights the market’s current volatility.

• The ISM report, though not directly influencing policymakers, exposes the market’s hair-trigger sensitivity to economic data, as evidenced by contrasting reactions. Uncertainty regarding rate cuts will hang in the air until the Fed’s June meeting, where their updated economic projections will shed light on their path forward. Committee members, especially the hawkish ones, are paying attention to payroll data. A significant drop in March or April jobs could trigger a dovish pivot towards rate cuts this summer. Conversely, persistently strong job reports could lead to a reduction, or even a complete halt, in planned rate cuts for the year.

Tech Moves: Soaring valuations prompt tech companies to seek new income sources to satisfy their investors.

• Tech giants like Google are exploring premium features on select products behind paywalls, creating new revenue streams. This could fund continued development of these enhancements while maintaining their free, ad-supported core offerings. Meanwhile, Apple’s foray into home robotics signals a potential pivot away from their electric vehicle project. These moves, though not finalized, highlight the growing pressure on tech companies, particularly the Magnificent Seven (M7), to diversify income and justify high valuations in a changing market. The recent drop in Tesla stock following weak deliveries exemplifies how investor sentiment can quickly turn after negative news.
• The recent surge in the M7’s stock prices evokes comparisons to the dotcom boom of the late 1990s. However, a crucial distinction lies in the companies’ financial health. The dotcom bubble was fueled by speculation on unprofitable startups with minimal revenue and high debt. In stark contrast, the M7 are established powerhouses generating substantial profits. Their impressive free cash flow of $309.2 billion in 2023, a staggering $100 billion increase year-over-year, demonstrates their financial strength. This massive cash cushion positions them as far more resilient than the fragile dotcom companies, providing a buffer during periods of economic uncertainty.

• While there’s confidence that the large-cap rally will spread to other sectors, the M7’s future path remains uncertain. The upcoming Q1 2024 earnings season will be critical, potentially shaping the rally’s direction as it reveals these mega-caps’ abilities to maintain profitability. However, unlike the dotcom bubble, the size and scale of the M7 provide a buffer. Even if the AI boom weakens, these companies have the resources to explore alternative revenue streams, fostering a more resilient position. This doesn’t necessarily guarantee a complete avoidance of a correction, but investors should be prepared for a more measured market response compared to the dramatic downturns of the dotcom era.

The Swiss’s Dovish Surprise:  March’s lower-than-anticipated inflation data supports the central bank’s decision and raises the possibility of additional stimulus measures.

• Swiss consumer prices have risen just 1% since March 2023, falling short of expectations for a 1.3% increase. This comes on the heels of the Swiss National Bank’s (SNB) decision in March to cut borrowing costs, marking the first such move by a G-10 central bank since November 2020. The SNB’s pivot aimed to curb the Swiss franc’s appreciation against the dollar. A recent study suggests the SNB would require an additional $30 billion alongside a commitment to keeping interest rates low for the next three years to prevent a mere 1.1% appreciation of the Swiss franc’s real effective exchange rate.
• Although a single month’s data shouldn’t be over-emphasized, recent CPI figures offer early signs of potential global inflation moderation. For instance, preliminary data from the eurozone shows core inflation dipping below 3.0% for the first time since March 2022. Similarly, both Japan and Canada have experienced a notable slowdown in inflation over the past several months. If this trend continues throughout the developed world, it is possible that the central banks will likely follow through on plans to reduce their policy rates this year.

• Slower economic growth in some countries is tempering inflation, but rising commodity prices threaten this progress. The robust US economy, with strong wage growth and a tight labor market, might prompt the Federal Reserve to maintain its current stance before easing monetary policy. This could lead to a stronger dollar as the interest rate differential between the US and other countries widens. Consequently, import-dependent nations may face challenges due to higher costs for dollar-denominated goods. This divergence in monetary policy could dampen global interest rate reductions, potentially falling short of market expectations.

Other News: Germany is undertaking military reforms in response to a perceived increase in global hostility. An Israeli cabinet member’s call for early elections highlights the current political instability in Israel.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with new signs that global consumer demand for electric vehicles isn’t growing as fast as previously thought, with major implications for the global economy and policymakers. We next review a wide range of other international and US developments with the potential to affect the financial markets today, including news of a major earthquake in Taiwan and the latest statement from a Federal Reserve policymaker pointing to US interest rates remaining “higher for longer.”

Global Electric Vehicle Market:  Adding to the evidence that global demand for electric vehicles is slowing sharply, EV giant Tesla yesterday stated that its first-quarter deliveries were down much more sharply than expected. The company said it delivered just 386,310 vehicles in January through March, down 8.5% from the same period one year earlier and far below the anticipated rate of about 457,000.

• Even though top Chinese EV makers reported even steeper delivery declines, leaving Tesla as the world’s top seller, the news nevertheless pushed Tesla’s stock price 4.9% lower for the day, leaving it down about 33% for the year-to-date.
• If the delivery shortfalls really do reflect a saturated market or waning demand, it suggests there will be an even greater profit bloodbath as China’s excess capacity leads it to try to dump even more vehicles on the world market.

Taiwan: An earthquake with a magnitude of 7.4 struck the country’s east coast this morning, killing at least nine people and damaging infrastructure and buildings. Of course, a key question for the global economy is the fate of Taiwan Semiconductor Manufacturing Company’s fabs on the island, which produce most of the world’s advanced computer chips. The firm said damage to its plants has been minimal and workers are already returning to their jobs, but the quake will nevertheless refocus attention on the security of chip supply chains.

European Union-China: Just weeks after signaling the EU wouldn’t intervene to help European solar panel makers survive the onslaught of cheap Chinese imports, the European Commission today announced it will investigate whether two Chinese producers are using state subsidies to engage in unfair competition. The probe will utilize a new anti-subsidy law passed by the EU last July. The about-face on solar panels illustrates how political winds are increasingly forcing Western governments to take a tough stand against Chinese military and economic threats.

Eurozone: The March consumer price index was up just 2.4% from the same month one year earlier, coming in a bit better than expected and slowing from the rise of 2.6% in the year to February. The slowdown in inflation mostly stemmed from weaker price growth for food, energy, and other goods, while service inflation remained steady. Despite the sticky service inflation, the figure is likely to increase expectations that the European Central Bank can cut its benchmark interest rate in June.

• With the US’s healthy economic growth and sticky overall price inflation increasingly convincing investors that the Fed will move only slowly in cutting its benchmark interest rate, the prospect of near-term rate cuts by the ECB has been weighing on the euro.
• Even though the EUR is slightly higher today, trading at 1.0783 per dollar, it is still down some 2.5% against the greenback for the year-to-date.

US-China Diplomacy:  Yesterday, during their first phone call in two years, President Biden and President Xi reportedly had a “candid” and “constructive” conversation about a range of issues between the two countries. However, Xi warned Biden that China “will not sit idly by” if the US continues what he called efforts to suppress Chinese economic and technological development. In turn, Biden said he will keep taking what he called limited steps necessary to ensure US national security.

• While it’s probably good that Biden and Xi are talking again, the tit-for-tat exchange on economic and technological relations should serve as a reminder that tensions look set to continue spiraling.
• The US-China relationship continues to show signs of being a “Thucydides Trap,” where the reigning hegemon (i.e., the US) faces a rising power (i.e., China). Some foreign affairs scholars, such as Harvard professor Graham Allison, argue that to avoid war in such a situation, the US should accommodate China’s rise. However, both Democrats and Republicans in Washington continue to show signs that they’re willing to stand up to China in an effort to preserve the US’s dominance in geopolitics and the global economy.

US-China Capital Flows: Reflecting the bipartisan effort to rein in China, Democratic and Republican lawmakers in the House of Representatives have introduced a bill that would bar index funds from investing in Chinese companies. According to the bill’s sponsors, the proposed No China in Index Funds Act is justified because index funds do not research the firms they hold and therefore can’t uncover the unique risks inherent with Chinese companies.

• The bill was introduced by Rep. Brad Sherman, a Democrat from California, and Rep. Victoria Spartz, a Republican from Indiana.
• Sherman and Spartz have also introduced a number of other anti-China bills that would “end tax breaks for Chinese equities, restrict sanctioned Chinese companies’ access to US capital markets, increase transparency on risks to American corporations, and reduce exposure to these risks for retail investors and other Americans saving for retirement,” according to a statement from the lawmakers.

US Monetary Policy: In a speech yesterday, Cleveland FRB President Mester said the continued fundamental strength in the US economy has convinced her that interest rates will settle at a higher level than she previously thought, even after the Fed finishes its impending rate-cutting cycle. Over the long term, Mester said she now expects the benchmark fed funds rate to settle in a range of 2.5% to 3.0%, rather than the flat 2.5% she assumed previously.

• Mester’s view of higher future interest rates is consistent with our view that geopolitical tensions and structural changes in the global economy will lead to increased inflation and interest rates going forward. In our view, inflation and interest rates are also likely to be more volatile.
• Separately, Mester also poured cold water on the idea of any rate cut at the Fed’s policymaking meeting in May. She hinted that a cut was still possible at the June meeting, but only if in-coming inflation data clearly supports it.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with increasing geopolitical tensions after an apparent Israeli airstrike killed senior Iranian military commanders in Damascus, Syria. We next review a wide range of other international and US developments with the potential to affect the financial markets today, including a growing likelihood that the Japanese government will intervene in the currency markets to support the weakening yen, and new signs that investors are giving up on the likelihood of a Federal Reserve interest-rate cut in June.

Israel-Hamas-Syria-Iran:  In an indication that Israel’s war against Hamas in the Gaza Strip threatens again to escalate, the Syrian government yesterday claimed Israel was behind a missile strike on an Iranian diplomatic post in Damascus. The strike reportedly killed several high-level Iranian military leaders. It also marked at least the fourth Israeli strike on Iranian military forces in Syria this year, potentially aimed at provoking Iranian proxy forces in the area to fight back so that they can be targeted. The risk is that such an incident could draw Iran directly into the conflict.

• Separately, an Israeli airstrike has killed seven workers from World Central Kitchen, the aid group established by celebrity chef José Andrés that first rose to fame by providing food aid to Ukrainians displaced by the Russian invasion of their country. After the UN, World Central Kitchen is reportedly the largest food-aid group operating in Gaza.
• Israel today claimed the airstrike was unintentional, but the killing of aid workers is likely to further undermine global support for Israel’s attacks on Hamas in Gaza.

Russia-Ukraine War:  Britain’s defense intelligence agency has issued a dire warning that a key Ukrainian defensive line west of Avdiivka is beginning to collapse as Russia pours new troops, equipment, and munitions into the area. The report suggests that Russian forces may be starting to build sufficient momentum to overcome Ukrainian resistance, especially now that Kyiv’s forces are facing severe resource constraints.

• Any additional Russian momentum will likely cause greater angst in Western European capitals regarding future threats from President Putin.
• In turn, that could spur additional European aid to Ukraine and even more commitment to boost European defense spending.

United Kingdom:  S&P Global said its March purchasing managers’ index for manufacturing rose to a seasonally adjusted 50.3, beating both the flash estimate of 49.9 and the February reading of 47.5. Like most major PMIs, this one is designed so that readings over 50 indicate expanding activity. With the rise in March, the index suggests Britain’s factory sector is now growing again for the first time since July 2022.

Japan:  Finance Minister Suzuki warned today that he is watching trends in the currency market with a “high sense of urgency” and that his ministry would address any “excessive movements” in the yen (JPY). That marks the latest in a string of government warnings that it might intervene in the market to keep the yen from weakening further.

• Despite the Bank of Japan’s recent move away from negative interest rates, investors have been dumping the yen on concerns that the central bank doesn’t intend to keep hiking rates. In contrast, investors increasingly think that continued good economic growth in the US may prompt the Federal Reserve to slow or even abandon its plan to start cutting its current high interest rates.
• So far this morning, the yen is trading essentially flat at 151.65 per dollar ($0.0066), its weakest level in approximately 34 years and is down 7.1% for the year-to-date.

US Monetary Policy:  Against the backdrop of strong US economic data and signs of sticky price inflation, investors continue to ratchet down their expectations for interest rate cuts from the Fed. In a little-noticed development, trading in interest-rate derivatives now indicates only a 56.8% chance that the policymakers will implement their first rate cut at their policy meeting in June; trading suggests there is a 49.1% chance that they will keep the benchmark fed funds rate unchanged until at least their July meeting.

US Stock Market Regulation:  In an exclusive report by the Wall Street Journal today, US regulators are examining whether big money managers such as BlackRock and Vanguard are truly acting passively when their index funds amass more than 10% of the shares in major banks. To date, the regulators have exempted the index providers from some rules that treat investors as active when they surpass 10% ownership. The new probe reflects bipartisan concern that the index funds are using their big ownership stakes to push ideological causes, from climate-change policies to pay equity.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with yet another warning from a top European leader of a potential war with Russia. We next review a wide range of other international and US developments with the potential to affect the financial markets today, including several key economic reports out of Asia and various notes on the US economy and markets.

European Union:  In an interview last week, Polish Prime Minister Donald Tusk became the latest high-level EU official to warn of an impending war in Europe. According to Tusk, “I know it sounds devastating, especially to people of the younger generation, but we have to mentally get used to a new era. We are in a pre-war era. I don’t exaggerate. This is becoming more and more apparent every day.” In his interview, Tusk said it is essential for the EU to stand by Ukraine and make sure it is not overrun by Russia’s invasion forces.

Turkey:  In local elections yesterday, incumbent Istanbul Mayor Ekrem İmamoğlu, one of President Erdoğan’s top critics, appears on track to win reelection with about 50.8% of the vote.  Opposition candidates also look set to win in other major urban areas, potentially setting up a major embarrassment for Erdoğan and his conservative Islamist political party.

Japan:  The Bank of Japan said its “Tankan” index of optimism among large manufacturers fell to 11 in the first quarter, slightly beating expectations but still coming in weaker than the reading of 13 in the fourth quarter. The index is designed so that positive readings point to more manufacturers seeing positive business conditions rather than seeing negative conditions. Even though the decline in the first quarter was the first since the beginning of 2023, the positive reading therefore still suggests Japan’s factory sector is in good condition.

South Korea:  The country’s exports, a bellwether for global trade, showed a total value of $56.56 billion in March, up 3.1% from the same month one year earlier. The increase was a bit weaker than expected, and it marked a slowdown from the 4.8% rise in the year to February. Nevertheless, South Korean exports have now risen on a year-over-year basis for six straight months, suggesting that global economic activity is picking up after some softness in 2023.

• According to the data, exports to the US were up a healthy 12.0% in the year to March, reflecting the country’s continued strong economic performance.
• In contrast, exports to China were up just 0.4%, reflecting that country’s continued lethargy as it faces a slew of structural economic headwinds.

China:  The government’s official March purchasing managers’ index for manufacturing rose to a seasonally adjusted 50.8, beating expectations and marking a sharp improvement from the reading of 49.1 in February. Like most major PMIs, the official Chinese index is designed so that readings over 50 indicate expanding activity. The March reading therefore suggests that China’s factory sector is now growing again after five straight months of contraction, despite the weakness suggested by China’s lessening demand for South Korean products.

• The rebound in Chinese manufacturing may seem like a positive for the global economy and financial markets, but that isn’t necessarily the case.
• We note that the rise in the manufacturing PMI came in part from a surge in new export orders, which is consistent with the idea that Beijing is trying to re-accelerate its economy by dumping electric vehicles, batteries, solar panels, and other products on world markets. Such dumping threatens to decimate key industries throughout the developed countries.

US Monetary Policy:  After Friday’s personal income and spending report showed the Fed’s preferred measure of consumer price inflation remained above target, Chair Powell took a sanguine attitude, stating at an event in San Francisco that he still expects price pressures to keep easing, even if the road to 2.0% inflation will be “bumpy.” Nevertheless, Powell also warned that the Fed would take its time in cutting interest rates if price pressures prove sticky.

• In Friday’s report, February personal income rose by a seasonally adjusted 0.3%, slowing from a gain of 1.0% in January. Nevertheless, despite the slowdown in income growth, February personal consumption expenditures (PCE) jumped 0.8%, accelerating from their rise of 0.2% in the previous month. On a year-over-year basis, personal income in February was up 4.6%, while PCE was up 4.9%.
• Excluding the volatile food and energy components, the February core PCE price index was up 2.8% year-over-year, after two straight months in which it increased an annual 2.9%.

US Bond Market:  New data shows corporate bond issuance has already hit $606 billion so far in 2024, up about 40% from the same period last year and the highest year-to-date total since at least 1990. Reports suggest companies are rushing to market in part to take advantage of today’s low corporate yield spreads over Treasury obligations, but they may also be trying to get ahead of any potential volatility in the marketplace as the November elections draw closer. Trading in VIX futures also points to investors betting on election-driven market volatility.

US Labor Market:  According to the Wall Street Journal, new high school graduates and other members of Generation Z are increasingly eschewing college in favor of training in trades such as welding and plumbing. The report says the number of students enrolled in vocational-focused community colleges rose 16% last year to a record high. The number in construction-trades programs alone jumped 23%. The figures are consistent with our view that US reindustrialization and today’s labor shortages will help broaden the workforce going forward.

US Artificial Intelligence Industry:  Technology giant Microsoft and OpenAI are planning to jointly build a specialized data center costing up to $100 billion to boost OpenAI’s computing capacity for artificial intelligence. The data center would house a supercomputer called StarGate with millions of specialized AI processors. In return for funding the project, Microsoft would have exclusive rights to use the resulting AI systems. The project illustrates how much investment could be needed to build out AI systems in the US going forward.

• A separate report today says big AI firms will soon run out of the high-quality internet text needed to train their large language models. As a result, they may have to shift toward using synthetic text derived from videos, proprietary data, or other sources.
• The report may also help explain China’s extensive hacking of large US databases and its promotion of social media tools like TikTok, which could vacuum up immense amounts of user data. If even the internet isn’t big enough to feed modern AI models, Beijing may be surreptitiously gathering immense amounts of private data from US citizens to aid its influence campaigns and espionage efforts.

US Agriculture Industry:  After years of concern about falling honey-bee populations, new data from the Department of Agriculture suggests bee colonies are making a strong comeback. For example, the data shows that more than one million new bee colonies have popped up around the US since 2007, making them the fastest-growing type of livestock in the country.

• The rise may in part reflect inflation, since the Agriculture Department only counts bee colonies producing at least $1,000 of revenue each year.
• Nevertheless, the strong rise in counted bee colonies suggests populations are indeed rising, allaying concerns that global warming, invasive species, and other challenges are reducing the population of bees that are so critical to pollination and food production. The new data is therefore creating a buzz among environmentalists. (Sorry)

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