by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a note on Russian President Putin’s decision last week to replace his defense minister with an economist. We next review several other international and US developments with the potential to affect the financial markets today, including a major taxi driver strike in Italy and signs of change in the US labor market.

Russia: After President Putin’s decision last week to replace Defense Minister Shoigu with economist Andrei Belousov, we’ve been hoping to see more evidence of what drove the move, but nothing concrete has shown up. All the same, we agree with the various Russia experts who think the move probably reflects both Putin’s concern about rampant corruption in the military and his realization that the war against Ukraine and its Western backers will be taxing on the Russian economy over the long term.

• In its respected estimates of military spending, the Stockholm International Peace Research Institute (SIPRI) believes Russia boosted its military outlays to the equivalent of about $126.5 billion in 2023, some 70% higher than in the three years right before the coronavirus pandemic (excluding price inflation).
• Based on SIPRI’s estimates, Russian military spending last year equaled 5.86% of gross domestic product. That’s Russia’s biggest “defense burden” in its modern history, and it far exceeds the current US defense burden of 3.36% of GDP.
• CIA analysis, which has been replicated by private analysts, indicates economic growth begins to falter at defense burdens above about 10% of GDP. As estimated by SIPRI, the Russian defense burden isn’t quite at that level, but if Russia has large amounts of hidden defense spending like the USSR did, it could be approaching the danger zone. At the very least, even at SIPRI’s calculated defense burden of 5.86% of GDP, we suspect Russia is facing resource constraints and inflation pressures.
• From this perspective, it makes sense for Putin to want an economist at the helm of the Defense Ministry. Chief of the General Staff Gerasimov will still run the war against Ukraine, but by installing an economist as defense minister, Putin is signaling that Russia will keep spending large amounts on its military into the future and will need a defense minister who can manage the defense industry’s interplay with the overall economy.
• Importantly, Belousov has a reputation for favoring heavy state intervention in the economy to promote economic growth and boost particular industries. He therefore could launch a new Russian industrial policy aimed at broadening and improving the country’s ability to produce high-tech weapons en masse. Such a move might convince Western countries to adopt similar measures to expand their defense industries.

Russia-Poland: The Polish government today said it has arrested nine Belarusian, Ukrainian, and Polish citizens for carrying out acts of intimidation and sabotage at the direction of the Russian intelligence services. According to Polish Prime Minister Tusk, the nine were also preparing to conduct sabotage in Lithuania, Latvia, and possibly Sweden. The arrests highlight how Russian intelligence is now on a war footing and aggressively operating across the West.

• Over the weekend, the Polish government also said it would spend about $2.5 billion to build fortifications against Russian attack along Poland’s borders with Belarus and the Russian exclave of Kaliningrad.
• Along with other countries building fortifications, Poland’s effort shows just how serious the Eastern European countries consider the military threat from Russia.

Italy: If you’re heading off to Italy to begin the summer, beware of travel chaos. The country’s politically powerful taxi drivers, who have already greatly limited the operations of ride-hailing apps, have launched a nationwide strike to protest a government minister’s meeting with representatives from Uber. Amid consumer anger over insufficient taxi service, the meeting was taken as a sign that the government may be planning to lower restrictions on firms like Uber and Lyft.

China: A review of earnings reports from top Chinese electric vehicle makers shows they have dramatically slowed their payments to suppliers in recent quarters. For example, top EV maker BYD took an average of 275 days to settle its accounts payable in 2023, versus 219 days in 2022 and 198 days in 2021. Analysts believe the drawn-out payments reflect increasing liquidity problems as EV sales slow. Importantly, weaker domestic demand raises the risk that Chinese EV makers will dump their excess output on global markets, hiking trade tensions.

• Separately, the Wall Street Journal today carries an article showing Chinese mining firms are dramatically boosting their global investment and output, pushing down prices for some minerals (such as nickel) and driving some Western producers out of the market.
• The article suggests that China’s tried-and-true strategy to grab global market share in manufacturing is now being used to grab market share in mining. Key elements of that strategy include making massive investments in new, modern facilities to gain scale and cut costs, leveraging cheap labor, and flooding the market with ultra-low cost output to put Western competitors out of business.
• If so, the strategy could make the West even more dependent on the China/Russia bloc for minerals critical to national defense and the new, more electrified economy of the future. That would be consistent with our often-stated belief that the China/Russia bloc will try to weaponize its mineral holdings against the West to achieve global dominance.

Australia: Ahead of elections next year, the ruling center-left Labor Party government has proposed a budget for the coming fiscal year that includes tax cuts and about $5.3 billion in energy rebates and rent subsidies to ease the cost of living for renters and mortgage borrowers. The fiscal help, along with stickier-than-expected consumer price inflation, is expected to preclude the central bank from cutting interest rates anytime soon.

Mexico: With the ruling Morena Party in the pole position to win the July presidential election, the government is reportedly considering a tax hike on banks to rein in the surging budget deficit. Such a move could have big implications for major Spanish banks, which dominate the Mexican market. For example, BBVA reportedly gets almost 50% of its profit from its Mexican operations, while Banco Santander gets about 13% of its profit there.

US Labor Market: The Wall Street Journal carries an article today showing a big shift in the tenor of corporate job postings aimed at new college graduates. Rather than listing a litany of responsibilities and requirements, the listings now emphasize high salaries, opportunities for professional advancement, and perks. The change is consistent with the shortage of younger, relatively lower-skilled workers that we describe in our latest Bi-Weekly Geopolitical Report, “The Great COVID Labor Reform,” published yesterday.

US Housing Market: Axios today carries a useful article laying out how the disparity in new versus existing mortgage rates is handcuffing home sellers. The following chart lays out the situation in stark terms.

US Transportation Industry: The containership that rammed Baltimore’s Francis Scott Key Bridge and made it collapse in March was finally towed away from the crash site yesterday, allowing most cargo traffic in the important port to start flowing again. However, replacing the bridge will take many more months or years.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with several items related to artificial intelligence, the electrification of the global economy, and the resulting impacts on commodity prices. We next review several other international and US developments with the potential to affect the financial markets today, including new signs of economic decoupling between the US and China and several notes on the US labor market.

Global Copper Market: Copper prices today have reached yet another record high, with near futures trading at $5.0910 as of this writing. Copper prices are now up more than 30% from the start of the year, reflecting investor expectations for increased demand from electrification (especially for artificial intelligence), re-industrialization, and higher defense spending, as well as potential supply shortages. The surge in copper prices is consistent with our oft-stated view that ongoing geopolitical tensions will likely be positive for commodities going forward.

Global Artificial Intelligence: The UK-based multinational engineering firm Arup said it was duped out of millions of dollars in a sophisticated, innovative new deep-fake scam. The scam was based on a digitally generated version of the company’s chief financial officer that the criminals deployed in a video conference. The fake CFO convinced a Hong Kong employee to send the criminals more than $25 million. The incident shows how deep fakes could be used not just for political manipulation, but also for fraud against companies or individuals.

France-New Caledonia: Large-scale rioting broke out late last week in France’s overseas territory of New Caledonia, which lies in the Pacific Ocean northeast of Australia. The rioting, fueled by hardline, pro-independence leaders of the territory’s indigenous Kanak people, began after the French parliament approved a bill giving more voting rights to the territory’s nonindigenous population. Paris has sent additional police to the territory, but the rioting reportedly continued throughout the weekend.

• The tensions in New Caledonia also reflect today’s global trend toward electrification, especially the growth of the global electric vehicle market. New Caledonia has large reserves of nickel, which is important to a range of electrification technologies.
• Besides the electoral changes from Paris, the territory’s pro-independence parties have been fighting French President Macron’s proposal to lift restrictions on exporting unprocessed nickel from New Caledonia and give priority to shipments to European electric-vehicle battery factories.

China-United States, et al.: The Chinese Ministry of Commerce yesterday said it has launched an anti-dumping probe regarding polyoxymethylene copolymer, a thermoplastic widely used in the consumer electronics and automotive industries, from the US, the EU, Japan and Taiwan. The move is being seen as retaliation for recent US and EU anti-dumping probes against Chinese electric vehicles and other strategic Chinese exports. The tit-for-tat move illustrates how tensions between China and the West continue to spiral, with no easing in sight.

China-Philippines: To counter China’s effort to assert sovereignty over waters claimed by the Philippines, Manila has begun building military and civilian infrastructure on the country’s barely populated island of Pag-asa in the South China Sea. Manila also plans to maintain a support corridor running out to the island, in which it hopes frequent military and civilian operations will deter China from trying to intervene.

• The Philippine government has long used a calibrated military presence in disputed areas of the South China Sea to block China’s territorial aims. For example, it has grounded a World War II-era navy ship on Scarborough Shoal and keeps a contingent of Philippine marines there around the clock.
• With its new facilities on Pag-asa, which will reportedly include both military barracks and a civilian health clinic for the island’s 400 inhabitants, it appears that Manila is broadening its approach. By encouraging a bigger civilian presence, it could make China more hesitant about trying to attack or isolate the island but will also likely worsen tensions between Beijing and Manila.
• As we have noted before, aggressive Chinese operations against Philippine assets in the South China Sea are now probably more dangerous than the situation around Taiwan, especially given that the US and the Philippines have a mutual defense treaty. Under that treaty, the US could be required to come to Manila’s aid if it is attacked by China.

China: In a sign that General Secretary Xi’s plan to make China a “financial superpower” is being implemented, a new press tally shows 30 regulators, bankers, and other financial executives have been arrested for corruption so far this year. Under Xi’s plan, China will use tightened financial regulation to reduce risks and build a world-leading capital market that can support favored manufacturing industries and insulate China from US financial sanctions.

• Naturally, Xi has argued that large, deep, corruption-free capital markets should help support industries he has identified as “new productive forces,” such as electric vehicles, batteries, solar panels, and semiconductors.
• Cleaner financial markets probably would help support Chinese stocks to some extent. However, we suspect the market will continue to struggle in the face of problems such as China’s slowing economic growth, Communist Party intrusion into the private sector, and reduced interest from foreign investors.

Iran: State media has now confirmed that President Raisi died in a helicopter crash in northwestern Iran over the weekend. Supreme leader Ayatollah Khamenei has named First Vice President Mokhber as interim leader of the government until the constitutionally required elections can be held, probably in late June or early July. In Iran’s theocracy, the president serves mostly to execute the clerics’ national strategy, so Raisi’s death isn’t likely to change Iran’s overall strategic direction.

• Even though Raisi’s helicopter went down in bad weather, there will inevitably be some suspicions in the region that Israel, or even the US, was behind the crash.
• If they arise, such suspicions could further stir up tensions in the area, which are already high because of Israel’s war against Iran-backed Hamas militants in Gaza.

Israel-Hamas Conflict: Benny Gantz, a centrist former military chief and rival of Prime Minister Netanyahu, has threatened to pull his party from the national unity government conducting Israel’s war against Hamas by June 8 if Netanyahu doesn’t develop a credible post-war plan for governing the Gaza Strip. In addition, current Defense Minister Yoav Gallant, from Netanyahu’s conservative Likud Party, has backed Gantz’s call.

• Netanyahu’s right-wing coalition alone has the majority of seats in the Knesset, so even if Gantz pulls his party out of the government, the prime minister would likely stay in power.
• However, the demands from Gantz and Gallant lay bare the growing divisions in Israel’s unity government. If Gantz pulls his party out, Netanyahu would likely become even more isolated on the world stage and even more reliant on his far-right coalition members.
• Reflecting Netanyahu’s isolation, the International Criminal Court’s prosecutor has formally requested arrest warrants for Netanyahu and other Israeli and Hamas leaders. To back up his call, the prosecutor says he has reasonable grounds to believe Netanyahu and the other leaders are responsible for war crimes and crimes against humanity.

US Regulatory Policy: New research from Axios suggests President Biden’s recent flurry of new regulations is designed to cement his agenda in government policy even if former President Trump wins re-election in November. Under the Congressional Review Act of 1996, rules that have been in place for a certain period would be much harder for Trump to kill unilaterally. Legal scholars disagree on the minimum period, but the Axios research estimates that Biden would have to institute his rules by this Wednesday or by September at the latest.

US Labor Market-Unions: The National Labor Relations Board said workers at a Mercedes-Benz plant in Alabama voted against joining the United Auto Workers by a vote of 56% to 44%. Coming just weeks after the UAW won a vote at a Volkswagen plant in Tennessee, the result suggests it will remain difficult for unions to organize workers in the South. Although today’s labor shortages have boosted wage rates and workers’ bargaining power, it appears the economy could avoid the kind of mass unionization that hamstrung the labor market decades ago.

US Labor Market-Immigration: An article in the Financial Times today compiles statements from various US business organizations and firms warning that new restrictions on immigration or mass deportations would be costly and weigh on economic growth. The statements come from organizations ranging from the Associated General Contractors of America to the National Retail Federation and the National Restaurant Association.

• The businesses have issued their warning as both President Biden and Former President Trump adopt stronger anti-immigration rhetoric ahead of the November elections.
• The businesses are concerned because COVID-era changes in the labor market have left a large “hole” in the supply of relatively less-skilled workers. We describe that situation in depth in our latest Bi-Weekly Geopolitical Report, due to be published later today.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with reports of a big new housing support program in China. We next review several other international and US developments with the potential to affect the financial markets today, including another possible election-driven tax cut in the UK and expectations for new US tariffs against foreign solar cells and panels.

Chinese Housing Market: The government today announced a large program to prop up the housing market, which was upended in 2021 by Beijing’s clampdown on excess capacity and developers’ high debts. The program encourages local governments to buy up unfinished homes now weighing on the market and convert them into affordable housing for low- and middle-income buyers. It also scraps minimum interest rates on mortgages and reduces minimum down payments by buyers.

• Excess capacity, high developer debt, and faltering home prices have become a major headwind for Chinese economic growth, so investors will be hopeful that the new program will be successful. However, Beijing hasn’t been clear so far about how extensive the program will be and how local governments will fund the home purchases. As they say, the devil is in the details.
• Despite the lack of detail in the plan, it has apparently helped give Chinese stocks a lift today.

(Source: Dow Jones)

Chinese Economic Performance: April industrial production was up 6.7% year-over-year, beating expectations for a 5.5% rise and accelerating from the 4.7% increase in the year to March. The improving output stems in large part from government support for manufacturing and exports. In contrast, fixed-asset investment in January through April was up just 4.2%, falling short of expectations and slowing from the annual growth of 4.5% in January through March. The annual growth in retail sales also slowed in April.

Russia-Ukraine War: The Ukrainian government said Russian forces have advanced about 10 kilometers from the Russia-Ukraine border toward Kharkiv, leaving them just 25 km from the city. According to the Ukrainians, the Russian troops were stopped as they ran up against the first line of defense around Kharkiv. Nevertheless, the Russian advance in northeastern Ukraine illustrates how they are trying to capitalize on Kyiv’s weakness in personnel and equipment before refreshed aid from the US arrives.

Eurozone: With investors now expecting the Federal Reserve to hold US interest rates higher for longer, many US firms are boosting their euro-denominated bond issuance in Europe. Data from Bank of America shows US firms have borrowed some 30 billion EUR ($32.5 billion) via such “reverse Yankee” deals so far this year, which is on track to match or exceed the record 88 billion EUR ($95.5 billion) in reverse Yankee deals in 2019. This European issuance could help hold down US companies’ interest charges even as they roll over lower-cost debt from previous years.

United Kingdom: With the ruling Conservative Party still trailing by some 20% in opinion polls ahead of the autumn elections, Chancellor Jeremy Hunt today hinted that the government wants to again cut national health insurance contributions, this time to 6% of wages and salary income. If put into place, the Tories will have cut the insurance contribution in half, potentially creating further fiscal challenges for the UK down the road.

US Fiscal Policy: New research by the University of Washington indicates metabolism-related health issues linked to aging and obesity will continue to rise, even as infectious diseases and maternal/child health issues become less prevalent. Since metabolism-driven health issues can be chronic and expensive, we suspect that this will lead to continued spending pressure for programs such as Medicare, Medicaid, and Veterans’ health, making it even harder to cut the federal budget deficit.

US Trade Policy: Just days after announcing a range of big tariff increases aimed squarely at Chinese dumping, the Biden administration today is expected to announce a boost in tariffs on solar panels and cells that will be applied more globally. Because of China’s huge excess capacity for solar-energy manufacturing, global prices for panels and cells have fallen dramatically, boosting US imports from Asian producers such as South Korea, Malaysia, and Vietnam. The new tariffs are designed to protect US producers.

US Financial Market Regulation:  Yesterday, the Supreme Court affirmed by a vote of 7-2 that the Consumer Financial Protection Bureau (CFPB) is constitutional, overturning an appeals court ruling that the body’s funding structure was unallowable. The broad consensus on the agency’s constitutionality will likely cement its position in the nation’s financial regulatory scheme.

US Housing Market: New analysis from the Wall Street Journal shows several major cities in Texas and Florida are posting higher inventories of homes for sale and falling home prices due to strong building activity in recent years. While most of the significant cities are dealing with reduced inventories and rising prices, the situation in cities such as Austin and Cape Coral is a reminder that home values could soon start to peak and even turn negative as inventories catch up to demand.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equity markets are calmer today after yesterday’s investor enthusiasm over the inflation report cooled. In sports news, the Boston Celtics have eliminated the Cleveland Cavaliers and now advance to the Eastern Conference Finals. Today’s Comment will examine the impact that recent economic data will have on Fed policy, explain why the first presidential debate will be historic no matter who wins, and explore rising political violence in Europe as parliamentary elections approach. As usual, the report concludes with a summary of international and domestic data releases.

There Is a Chance: Wednesday’s economic data releases kept the possibility for rate cuts alive by confirming signs that demand is starting to cool.

• Inflation showed signs of cooling, while retail sales lagged. Consumer inflation eased slightly, with the Consumer Price Index (CPI) rising 3.4% year-over-year, down from 3.5% in the previous month. Core CPI, which excludes volatile food and energy prices, also slowed, increasing 3.6% year-over-year, down from 3.8% in the previous month. The slowdown may be related to weak demand. In the same month, real retail sales, which are adjusted for inflation, fell 0.3% from the previous year. Combined, the reports suggest firms may be having trouble moving volume as consumers struggle to absorb price increases.
• Weak economic data has likely kept the possibility of interest rate cuts on the table this year, making further hikes a less attractive option. Reinforcing this cautious stance, Minneapolis Fed President Neel Kashkari emphasized the need for stronger evidence that inflation is moving towards the Fed’s 2% target before policymakers would consider a rate cut. So far this year, the non-seasonally adjusted CPI data, which is never revised, is currently showing that prices are trending at a slower pace than the previous two years, but still remain above the trend of the three years before the pandemic.

• The improvement in inflation is likely a welcome sign for Fed officials but not enough for them to consider lowering rates in June. Next week’s FOMC meeting minutes may provide further clues about how committee members viewed inflation in the first quarter. Based on recent speeches, we suspect that at least one official has signaled a preference for a rate hike this year, which is unlikely to change following one month of subpar economic data and a better-than-expected inflation report. However, if this trend continues to hold over the next couple of months, sentiment could favor a September cut.

Presidential Faceoff: Prospective presidential nominees Joe Biden and Donald Trump will have their first debate next month as they look to set the tone for the election cycle.

• This will be the earliest televised presidential debate in history since the tradition began in 1960. Notably, it was announced before some states had even held their primary elections. The decision to fast-track the debate comes at a time when both candidates want to solidify their names as the leaders of their respective parties in hopes of generating more fundraising. Despite the initial bump after the State of the Union address, President Biden’s approval ratings have significantly declined in recent polls. Meanwhile, former President Donald Trump has faced challenges in fundraising, largely due to ongoing legal expenses.
• An earlier debate should make it easier for the market to gauge which presidential candidate holds the advantage going into the election. The Republican candidate will likely capitalize on the perception that they are stronger on the economy and immigration issues, while the Democratic candidate will likely emphasize the strength of the labor market and the protection of women’s reproductive rights. Although polls currently show that former President Trump has an advantage over President Biden in most swing states, the prediction market, which was a more reliable predictor during the 2020 election, indicates a dead heat with Biden holding a 2-point electoral lead.

• This election is likely to be a toss-up, given that these candidates remain quite unpopular. This explains why both candidates are still facing a notable amount of protest votes during the primary contests. As a result, we suspect that the market is still underpricing the threat that a third-party candidate who has been excluded from the debate, Robert Kennedy, Jr., will have on the outcome of the election. His rising popularity, especially among fringe voters, has allowed him to pull votes from both sides. Currently, there is an elevated chance that the two major candidates will not reach the 270 votes needed to secure victory, which could lead to some market uncertainty.

European Violence:  Attacks on government officials have started to pick up across Europe as the bloc prepares for parliamentary elections.

• On Wednesday, Slovakian Prime Minister Robert Fico was shot after leaving a government meeting. The politician’s condition appears to be improving following the incident, although he is still considered to be in critical condition. The assassination attempt comes a week after two German lawmakers were attacked at two separate events. These violent acts have likely added another level of complexity to European elections that are set to take place June 6-9. So far, lawmakers have sought to limit the gatherings of extreme groups due to concerns that it may lead to more hostilities.
• Recent violent acts in Europe raise questions about a potential link to the ongoing tensions surrounding the Russia-Ukraine conflict. Notably, Fico has publicly supported Russian President Vladimir Putin and is closely aligned with Hungarian President Viktor Orbán. In contrast, the recently targeted German politicians belonged to a coalition government that endorsed sending weapons to Ukraine. Tensions are high following speculation that Moscow has recruited extremists to launch attacks on European infrastructure.

• The potential for rising conflict in Europe, particularly between pro-Moscow and anti-Moscow parties, has been largely ignored. These opposing sides have increasingly resorted to hostile tactics, reflecting the deep divide over Europe’s role in the Ukrainian conflict. While Ukraine’s supporters, particularly those among European leaders, remain vocal, it’s clear that Putin also has allies. As the conflict between Ukraine and Russia extends beyond two years, the situation is likely to deteriorate further. Escalating tensions could weigh heavily on the euro, potentially leading to further supply chain disruptions and raising the specter of a direct confrontation.

In Other News: President Putin and Chinese President Xi Jinping have renewed their vow to cooperate with each other in limiting the US’s influence in the world. While the agreement is nothing new, it serves as a reminder of the two countries’ unshakeable bond. Copper prices surged to a record high in a sign that the global economy may be starting to pick up.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities futures are off to a great start as the consumer price index ended its streak of disappointments. In sports news, the Denver Nuggets took a commanding 3-2 lead in their series against the Minnesota Timberwolves. Today’s Comment will explain why leaving rates unchanged was seen as bullish for investors on Tuesday, why young investors are drawn to risk assets, and why Turkey wants to restore trust that it can contain inflation. As usual, the report includes a summary of international and domestic data releases.

Fed Remains Calm: Federal Reserve Chair Jerome Powell has ruled out the possibility of a hike even as inflation continues to disappoint.

• The head of the Federal Reserve reiterated that inflation remains too high for the central bank to consider cutting rates in the near future. Speaking at the Foreign Bankers’ Association, he acknowledged that disinflation, initially expected this year, hasn’t progressed toward the central bank’s 2% target. However, he surprised markets by indicating that the Fed’s next move wouldn’t be an interest rate hike. Instead, he emphasized the Fed will likely hold rates steady while the effects of current policy restrictions work their way through the economy. This downplaying of future monetary tightening boosted market sentiment, as investors continue to price in two rate cuts starting in September.
• Powell’s comments coincide with the release of a hotter-than-expected producer price index (PPI). The index for input costs rose 0.5% in April, exceeding expectations of a 0.2% increase. Despite the concerning reading, the data offered a glimmer of hope. A downward revision of the previous month’s number, from a 0.2% increase to a 0.1% decline, tempered the impact of the hot report. Additionally, the components feeding directly into the PCE price index, the Fed’s preferred inflation gauge, showed a mixed bag, suggesting consumer inflation may still align with forecasts.

• Even with Powell downplaying the possibility of a rate hike, the threat remains significant. Historically, the Fed has tended to manage market expectations; thus, consistent inflation readings exceeding investor forecasts could force them to act. A positive sign is that core PCE has largely met market expectations and may still fall within the range of the 2.5% terminal rate outlined in the Fed’s summary of economic projections. So far, our worst-case scenario is no rate change at all this year. However, if inflation continues to run hot, we may revise our forecast to include a possible hike at the beginning of 2025.

Meme Rally Back: In an attempt to close the wealth gap with other generations, some younger investors may be turning to riskier assets in hopes of higher returns.

• The return of Roaring Kitty has led to another frenzy in the markets. The social media icon helped lead a charge of retail investors to squeeze hedge funds looking to profit from shorts. He has become a cult figure following the GameStop fiasco and the movie documenting it called Dumb Money. This return has led investors to flock to GameStop and AMC, with those stock prices each rising 30% on Tuesday. Despite the attractive yields offered by traditionally safe assets like Treasurys, Roaring Kitty’s return highlights that risk appetite remains relatively high among investors.
• Limited savings, coupled with rising interest rates and home prices, may be pushing some investors, particularly millennials, towards riskier assets. The stock market appears to be an attractive option for faster financial growth, since it offers an alternative to traditional homeownership, which has become increasingly difficult to achieve for millennials. Supporting this trend, a 2023 National Association of Realtors survey shows the average first-time homebuyer is 35, while a World Economic Forum survey reveals that 70% of retail investors are under 45. Thus, preference for risk assets may be a generational trend.

• While Roaring Kitty’s return might be a temporary market ripple, his influence highlights the ongoing investor appetite for stocks as a store of value. The lack of savings suggests younger generations may be more willing to take on risk to build their retirement funds. This could lead to less sophisticated investors having a greater impact on market prices compared to in the past. While strong fundamentals remain the key to sustainable growth, investors should be aware that bubbles may still form even in a rising interest rate environment.

Turkey’s Inflation Fight:  The country is looking for ways to win back investor confidence as it tackles surging inflation.

• On Tuesday, Turkish Finance Minister Mehmet Şimşek hinted that the government may be willing to implement tough fiscal measures to restore price stability. During an interview at the Qatar Economic Forum, he implied that President Recep Tayyip Erdoğan may be willing to tolerate slower growth as he looks to place the Turkish economy on a sustainable path. His comments come a day after investors shrugged off the government’s announcement of a series of cuts to public spending of about 100 billion liras (TRY) ($3.1 billion) over the next three years. The response was due to doubts that the government would tolerate such a hit to its economy.
• The country’s move to rein in its deficit stems from a decision to return to conventional economic policy. In the past, Erdoğan dismissed the idea that lower interest rates could bolster inflation, suggesting it might actually have the opposite effect. His logic hinged on the notion that higher rates would put more money in the hands of government bondholders, potentially leading to increased spending. To ensure that policymakers would follow his direction, he sacked and replaced the members of the central bank to get the policy that he desired. As a result, the annual change in inflation that year accelerated from 36% to over 80%, leading to a significant depreciation of the TRY.

• Despite concerns over inflation, Turkey continues to boast one of the world’s best-performing stock markets. The MSCI Share Price Index for Turkey is up nearly 40% year-over-year. The rally has been driven by investors seeking to protect their cash holdings from debasement, leading them to invest in stocks. However, this doesn’t necessarily mean that containing inflation won’t have benefits. Foreign investors still believe there may be opportunities if the country can get its fiscal house in order. As a result, it may be worth keeping an eye on Turkey as it may still have a lot of upside.

In Other News: The US announced additional funding for Ukraine in a sign that the war is likely to continue for the foreseeable future. Additionally, there is speculation that China may allow local governments to enter the housing market by purchasing homes, in a bid to reverse the country’s property slump. President Biden is set to provide $1 billion in new arm sales to Israel, as tensions between him and Israeli Prime Minister Benjamin Netanyahu deepen.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equity futures are off to a slow start due to a hotter-than-expected PPI report. In sports news, the Boston Celtics were able to snatch a 3-1 lead in the series against the Cleveland Cavaliers. Today’s Comment will explore why white-collar workers are facing a tough job market, explain the rise in demand for used electric vehicles despite weakening overall demand, and discuss China’s potential economic stimulus measures ahead of its July Politburo meeting.

Labor Losing Leverage: While the labor market remains tight for the broader population, there are signs that certain sectors are struggling.

• Walmart, the country’s largest employer, is set to lay off hundreds of corporate jobs and ask many of its work-from-home staff to return to the office. This shift aligns with a broader trend within the company. In April, the company announced that it plans for 65% of its stores to be serviced by automation by the end of 2026. Last year, it closed three of its tech hubs, requiring workers to relocate to other hubs in the country. This shift comes as the firm looks to shrink its workforce as a way to cut costs and improve its profitability.
• The recent cooling of the labor market has been unusual in that it has disproportionately impacted the services sector. Hiring for white-collar jobs is up 0.6% from the previous year, while the overall job market is up 1.8%. The reason for the slowdown may be related to costs. Proprietary data from Vanguard shows that the greatest demand for workers comes from jobs that pay less than $55,000 a year. This preference for low-wage workers may be related to some firms’ reluctance to hold onto higher-paid workers whose skills are not essential for their current needs.

• The selectivity of the labor market may complicate the Federal Reserve’s ability to balance its price stability and maximum employment mandate. Since many of these roles are relatively high-paying, laid-off workers may rely on savings before turning to government assistance. This could delay their appearance in unemployment figures and potentially raise the chance that the Fed may keep rates higher for longer than the economy can tolerate. While a hard landing is not our base case for this year, we do believe the risks are elevated given the signs of sticky inflation.

Renewable Comeback: While electric vehicle (EV) sales are hurting the bottom lines of major automakers, the used car market is seeing an uptick in the sales of EVs.

• A report from used car retailer Carvana showed that demand for EVs has more than doubled from the previous year. The demand rose by 4.8% in the last quarter, which is more than double the rate observed in the same period of 2023. The increase in sales comes amidst a surge in supply in the used car market, which has helped push the price of EVs down, making them more accessible to the typical consumer. According to the sales data, the difference in selling price for an EV and an internal combustion engine has dropped from $13,000 to $7,000.
• The rising demand for EVs comes at a time when automakers are struggling to contain a drop in profitability. Major US automaker Ford announced that it is losing $100,000 on every EV it sells, while a Kelley Blue Book report showed that new EV sales were down in the first quarter of the year. This weakness in the sector is likely driven by two factors: a surge of new EVs entering the market and waning demand from consumers. Consumers who cannot afford the high sticker price or who don’t see the need for an EV due to relatively low gasoline prices are contributing to the slowdown.

• The improved affordability of EVs will likely serve the US’s needs both geopolitically and domestically. The US government is promoting a switch away from combustion vehicles as a way to wean households off their reliance on energy sources increasingly dominated by countries with hostile governments. At the same time, the drop in used car prices has been a major contributor to the decline in overall inflation. As the world fights for market share in the green energy space, we can expect volatility in the electric vehicle market.

China Boom: Beijing may use fiscal and monetary policy to help boost the economy in time for the Third Plenum.

• On Monday, China’s Ministry of Finance announced plans to raise over 1 trillion CNY ($138 billion) in its fourth such issuance of long-dated bonds in 26 years. The new funds will be used to finance national strategies, including improvements to its defense capabilities and the semiconductor industry. Additionally, there is speculation that the People’s Bank of China (PBOC) could use its tools to improve market liquidity by buying and selling bonds. The recent collaboration between the central authority and monetary policymakers paves the way for improved policy coordination as Beijing seeks to reassure skeptics that it can address the country’s ongoing economic challenges.
• China’s first-quarter economic growth surpassed expectations, but challenges persist. The prior quarter witnessed a slowdown in consumption and investment spending, fueled by a reluctance to lend by banks. The PBOC has required banks to have the capacity to absorb 16% of risk-weighted assets by 2025 and 18% by 2028. This requirement is designed to protect the broader economy from the ongoing property market meltdown and prevent it from leading to a broader financial crisis. However, this change is likely behind the unprecedented contraction in aggregate financing seen in April.

• The lack of lending by banks may explain why the government is taking a more proactive role in stimulating the economy. It likely needs to take the lead until banks improve their balance sheets. The increases in bond issuance may be a prelude to a much larger announcement at the Third Plenum. While the exact nature of the announcement remains unclear, there is a strong possibility that the government could use the funds to help stabilize the real estate market. If true, this may help give the economy an extra jolt but could also weigh on the yuan.

In Other News: The US and China are set to meet to discuss AI as the two sides look to prevent a possible miscalculation. The return of Roaring Kitty has led to a surge in GameStop shares, a sign that retail investors are still willing to take on risk.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equity futures are higher as investors await this week’s economic releases. In sports news, the Indiana Pacers were able to tie up the series with the New York Knicks. Today’s Comment explores why declining consumer sentiment may spell bad news for some companies and why small-cap companies are eager for a Fed pivot. We also provide an update on the war in Ukraine. As usual, our report ends with a summary of the latest international and domestic data releases.

Feeling the Squeeze: May saw the biggest one-month drop in consumer sentiment since 2021; however, the pain was not evenly spread.

• The University of Michigan Survey of Consumer Sentiment fell from 77.2 to 67.4, missing expectations of an increase to 78.0. This disappointing report was driven by rising inflation expectations, as households grew increasingly pessimistic about price increases moderating to pre-pandemic levels. The survey showed that consumers expected inflation to increase to 3.5% next year and eventually to moderate to 3.1% in the next five years. Although there is a lack of strong correlation between inflation expectations and indexes like CPI or PCE, the change in sentiment reflects a broadening trend of weak economic data.
• The recent drop in consumer sentiment reinforces concerns about slowing consumer spending — a trend that many companies hinted at in their latest earnings reports. Despite exceeding expectations, corporate earnings suggest executives are noticing that households are tightening their belts. This cautious spending is particularly evident among discretionary purchases, since companies like McDonald’s, KFC, and Starbucks have reported significant pushback against higher prices. The impact is felt most acutely by low-income households, while higher-income earners have shown greater resilience. In Q2, mentions of low-income consumers by companies have more than doubled when compared to the highest level seen in the past five quarters.

• Although consumer surveys suggest that households are under pressure, it is unclear whether that will lead to a broader consumption pullback. A breakdown by income shows consumer expectations remain relatively optimistic among middle and high-income households. Notably, attitudes of middle-income earners improved from the previous month. However, the sizeable decline in the overall index suggests that low-income earners are feeling less confident in dealing with rising prices. In the short term, there might be a more significant impact on the upcoming election than on the broader economy, but this trend could have long-term consequences.

Small Cap Risk: Despite attractive valuations, investors remain wary of smaller companies, perhaps until the Fed signals an interest rate cut.

• Over 75% of the debt held by companies within the Russell 2000 index needs to be refinanced within the next five years. This is a significantly higher proportion compared to the S&P 500, where nearly 50% of the debt is due at that time. These companies are particularly vulnerable to changes in interest rates because they rely more heavily on floating-rate debt compared to their larger, investment-grade counterparts. As a result, these companies have a heightened dependence on monetary policy decisions as a decrease in policy rates could drastically improve their financial performance.
• Small-cap investors stand to benefit significantly from a successful soft landing by the Fed. These companies are also highly sensitive to fluctuations in the business cycle and real interest rates. Thus, the possibility of declining borrowing costs and improved growth led these companies to outperform their large-cap counterparts toward the end of 2023, for the most part. This relationship is not just a US phenomenon. European small caps have also been able to take off this year due to interest rate cut expectations and signs of an impending economic recovery. The Stoxx Europe Small 200 Price Index has surged 7.5% year-to-date, nearing its 2023 return of 10%.

• Despite some economic setbacks, a strong case can be made for US small and mid-cap companies. Not only do these firms have better valuations when compared to their large-cap counterparts, but their strong domestic focus likely protects their revenue from being significantly impacted by currency fluctuations and geopolitical events. Additionally, while Fed Governor Bowman’s recent comments dampen hopes for a rate cut, the possibility remains for one if inflation eases and unemployment keeps climbing. Nevertheless, this week’s release of the PPI and CPI reports for April could provide crucial clues on the Fed’s path, as inflation is expected to cool from the previous month.

Next Phase in Ukraine: Russian President Vladimir Putin is seeking a new approach as his country faces growing financial pressure from the West.

• Putin replaced Defense Minister Sergei Shoigu with Andrei Belousov, an economist and former first deputy prime minister. This reshuffle highlights Putin’s attempt to re-evaluate Russia’s military strategy, as Russian forces aim to consolidate their gains before Ukraine can leverage additional Western funding. The apparent uneasiness in these moves may also be reflected in Russia’s consideration of lowering the threshold for activating its nuclear weapons and its decision to ramp up recruitment as it recently brought female convicts to serve on the battlefield. These efforts have become more pressing as Putin gets closer to taking over Kharkiv.
• The Russian need for a victory in Ukraine comes amidst growing signs that it is becoming increasingly more costly for Moscow to maintain its war efforts. The European Commission has proposed the first-ever sanctions on Russia’s liquefied natural gas industry, signaling a significant escalation in efforts to sever economic ties with Moscow. Although it would not affect imports, it would prevent EU countries from re-exporting Russian LNG. The measure would complicate purchases of Russian gas for Asian countries like China and India, which have become key buyers since the war began in February.

• Despite waning media attention, the war in Ukraine remains a critical issue, which demands close monitoring. French President Emmanuel Macron’s emphasis on the potential need to send troops to Ukraine underscores the possibility of a wider European conflict. Furthermore, the growing push by the West to restrict Russia’s ability to get help from other countries is likely to exacerbate the trend toward global fracturing and undermine supply-chain security. Therefore, the recent reprieve in gold and oil prices may not hold if European threats continue to escalate.

In Other News: China is expected to hold a major bond sale as it looks to boost its economy. This is a sign that global growth may pick up this year. Meanwhile, more Americans are eying retirement, indicating that the labor market may remain tight for some time. In Spain’s Catalonia region, the Socialist Party dominated recent regional elections. This suggests that the pro-independence movement is losing favor.

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