by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! The S&P 500 is off to a decent start, 10-year Treasury yields are up, and Republican contenders failed to make a spark at last night’s debate. Today’s Comment will cover the rising dollar, several unions’ fights against AI, and Russia’s waning influence over neighboring regions.

Fed Lifting the Dollar: The U.S. dollar has hit a 10-month high against its peers as investors accept the Fed’s “restrictive for longer” narrative.

• Bolstered by stronger-than-expected economic growth and hawkish monetary policy from the Federal Reserve, the dollar index is poised for its eleventh consecutive week of gains, outperforming its G-10 peers. Meanwhile, Fed policymakers have shown a greater willingness to tighten policy than their counterparts at the ECB and BOJ who have both maintained a preference for keeping rates at their current levels at least for the rest of 2023. Earlier this month, Fed Governor Michelle Bowman and Boston Fed President Susan Collins called for further tightening to address rising inflation. However, Minneapolis Fed President Neel Kashkari has cautioned that economic disruptions, such as a government shutdown or union strikes, could lead FOMC members to hold off on another rate increase.
• The USD is likely to remain strong in the near term due to expectations of higher interest rates and faster economic growth in the U.S. than in other major economies. Interest rate swaps suggest that U.S. policy rates will rise faster than most other advanced economies in the coming three months. At the same time, GDP growth is expected to accelerate in the U.S. from an annual rate of 2.2% to 4.9% in the third quarter. In contrast, nowcasts show that the eurozone economy will contract an annualized 0.9% from July to September, and Canada’s economy will expand by a scant annual rate of 1.2% in the same period.

• Despite its current strength, the dollar is likely to face some headwinds in 2024. This is because Fed officials expect to cut interest rates at least once next year, while other central banks may keep rates steady or even tighten. As this chart above shows, U.S. policy rates generally rise and fall faster when compared to other advanced economies. The divergence in monetary policy could lead to a period in which other currencies start to gain on the dollar. This may make foreign stocks more attractive, especially as countries start to exit the trough phase of the business cycle.

Unions Against AI: The new labor contract for screenwriters may provide a roadmap of how labor unions can protect themselves against AI.

• Hollywood screenwriters have ended their five-month strike against studios and are expected to return to work this week. Under the new agreement, studios are required to disclose whether material given to them has been sourced from AI, either partially or in full. AI cannot receive a writer’s credit, and AI cannot be used to rewrite scripts. These new rules are the first time that guardrails have been established for this burgeoning technology, and similar agreements are expected to follow. Not long after the agreement, Hollywood video game actors announced their own strike, seeking further limits on AI.
• The movement to combat the threat of AI is likely to spread to other industries, as workers across the globe become concerned about its potential to displace them. A recent study from Goldman Sachs suggests that over 300 million jobs may be at risk, and a Pew Research study found that 27% of jobs that require a bachelor’s degrees may also be vulnerable. This rising fear has led to increased political scrutiny, as governments seek to understand and mitigate the potentially negative impacts of AI. In order to alleviate concerns, President Biden is expected to release an executive order on AI in the coming weeks.

(Source: Pew Research Center)

• Despite its growing significance, the labor struggles against AI have, so far, flown under the radar. During Wednesday’s Republican debate, there were few references to the new technology. This is likely to change during the election season, as candidates will be forced to discuss how they plan to mitigate the impact of AI on the job market, while still incentivizing firms to innovate as the U.S. looks to maintain its lead on China in that area. Although AI is likely to offer a lot of productivity gains and make firms more profitable, regulatory uncertainty still makes investment in the space relatively difficult, especially at current valuations.

Russia’s Waning Influence: An ally of Moscow was forced to cede territory to a rival after a tumultuous conflict.

• The self-governing Nagorno-Karabakh, an Armenian enclave within a territory internationally recognized as part of Azerbaijan, surrendered to Azerbaijan following a military clash last week, and announced it will dissolve on January 1, 2024. Many Armenian residents were allowed to leave, but some were forced to stay, including billionaire Ruben Vardanyan, who has close ties to the Kremlin. The region, which many believed was under Russian protection, now faces accusations of ethnic cleansing, as locals fear retaliation from their Azerbaijani captors. This situation reflects Russia’s inability to enforce the ceasefire that it brokered with Azerbaijan in 2020. 
• Russia’s reluctance to get involved in conflicts outside of Ukraine may be due to budget constraints. As a result of Western isolation and sanctions, the Kremlin has had trouble funding its expenditures and has been working to reduce its debt burden. The government has been able to lower its debt by around $128 billion since the start of the war, as it adapts to a changing environment. The recent rebound in oil prices has offered the country some relief, but domestic shortages have forced the country to ban exports of certain fuels.

• Russia’s waning influence in the Caucasus and Central Asia could create a power vacuum that could be exploited by other actors and potentially lead to increased conflict. Countries such as Georgia and Kazakhstan are likely vulnerable to heightened tensions given the lack of a Russian counterweight. At this time, it appear that China and the U.S. are looking to fill the void left by Moscow, but it isn’t clear whether either side can offer the same level of security commitments. An outbreak of violence, particularly in the countries surrounding the Caspian Sea, could further exacerbate commodity uncertainty and drive up oil prices, as the region supplies over 20% of global oil and 26% of global gas supplies. Investors should pay close attention to tensions in this part of the world.

Other stories that made us think:

• Why Hasn’t the Gold Price Fallen Further?– Bloomberg
• Oil Prices Are Rising. Shale Isn’t Coming to the Rescue– Wall Street Journal
• Rising headwinds threaten US economy’s resilience– Financial Times

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with the latest on the prospects for a partial shutdown of the U.S. government starting this weekend due to budget gridlock.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including an improvement in British Prime Minister Sunak’s approval ratings after he eased the U.K.’s climate-stabilization policies and a few words on U.S. antitrust policy.

U.S. Government Shutdown:  The Senate last night advanced a bipartisan stopgap spending bill that would keep the federal government funded at today’s levels from the expiration of the current fiscal year on Saturday until November 17.  The bill is designed to give Democrats and Republicans more time to negotiate and pass the needed full-year appropriations bills.

• However, Republicans in the House said they wouldn’t consider the Senate’s bill.
• Instead, they voted to clear the way for debate on just four of the 12 appropriations bills, i.e., those for the Departments of Defense, Homeland Security, Agriculture, and State.
• While setting up debate on the four spending bills is a win for House Speaker McCarthy, final passage of the four bills before fiscal year-end on Saturday would still leave the departments that rely on the remaining eight bills unfunded.
  • Since those departments are often top budget-cutting targets, many right-wing Republicans would probably try to drive a very hard bargain before passing their funding bills.
  • Their approach could well include refusing to pass a stopgap spending bill, setting the stage for a partial government shutdown.

China-Philippines-United States:  After China installed floating barriers to keep Philippine fishing boats out of a contested shoal in the South China Sea, as we reported in our Comment on Monday, the Philippines has taken the risky step of removing the barrier and now plans to step up military, coast guard, and administrative patrols of the area.  It is still not clear how Beijing will respond to Manila’s new self-assertiveness, but because of the U.S.-Philippines mutual defense treaty, the action probably raises the risk of increased tension or conflict between the U.S. and China.

China-Australia:  Although bilateral relations have improved under Australian Prime Minister Albanese, with China lifting its punitive import restrictions on Australian coal and barley, the country is still struggling with Chinese punitive import tariffs on Australian wine.  New data shows Australia now has about two billion liters of excess wine in storage, equal to about 859 Olympic-sized swimming pools.  Albanese reportedly urged the end of wine restrictions when he met with Chinese Premier Li Qiang this month, but in the meantime, the glut of supply suggests there may be some good bargains on Australian Shiraz, Cabernet Sauvignon, or other varietals in your local supermarket.

China:  The government’s China Integrated Circuit Investment Fund, known as the “Big Fund,” is reportedly having trouble raising new money from its target investor base of state-owned enterprises and local governments.  The fund, which has been instrumental in developing China’s semiconductor industry since it was established in 2014, raised the equivalent of about $20 billion and $28 billion in its first two funding rounds, but it is falling short of its goal to raise an additional $41 billion in the current round.

• The shortfall in funding reflects China’s sharp slowdown in economic growth and the increased debt loads faced by state-owned firms and local governments. The country’s finance ministry could step in to make up the shortfall but appears reluctant to do so.
• The funding shortfall not only could temper the further development of China’s technology industry, but it also illustrates the potential that sluggish economic growth and high debt have to slow China’s military buildup over time.
• On the other hand, if President Xi senses that a prolonged growth slowdown and debt burden will limit future military investments, he could potentially be tempted to launch his long-desired takeover of Taiwan earlier rather than later.

United Kingdom Politics:  Following Prime Minister Sunak’s decision last week to delay or jettison some of the government’s climate-stabilization regulations, a new poll suggests that the move will be a political winner.  According to the poll, public approval for Sunak’s Conservative Party has risen by eight percentage points since the announcement, cutting the Labor Party’s lead to 16 percentage points from 24 previously.  The results suggest governments in Europe may continue to water down their green-energy policies as households begin to push back against their costs and inconveniences.

United Kingdom Regulatory Policy:  The Financial Conduct Authority, the U.K.’s top financial regulator, said it will open an investigation into asset valuations in private markets.  The probe reflects growing concerns in the U.K. and elsewhere that valuations on private assets are often overly rosy, potentially setting up financial volatility in time of crisis or falling valuations.

Greece:  The right-wing government of Prime Minister Mitsotakis yesterday said it will grant legal status to as many as 300,000 illegal immigrants to help ease the country’s labor shortages in agriculture, tourism, and construction.  Similar to the scandal in which Poland’s right-wing, anti-immigrant government was discovered to be selling immigration visas, the new policy in Greece illustrates the tension between conservative governments’ rhetoric against immigration and the opportunity for immigrants to ease labor shortages in the developed world.

U.S. Antitrust Policy:  Yesterday, the Federal Trade Commission and 17 states filed a long-expected antitrust complaint against Amazon (AMZN, $125.98), alleging the online retailer illegally wields monopoly power that harms its competitors and keeps prices artificially high.  Nevertheless, FTC Chairwoman Khan has had a spotty record with her antitrust suits, so it isn’t clear at this point whether the company would really be convicted and forced to change its operations.

U.S. Labor Market:  The Writers Guild of America said its members can go back to work today under the union’s tentative new labor contract with the major movie studios, streamers, and television networks.  However, members won’t vote to give formal approval of the new contract until a poll that will run from October 2 to October 9.

• According to the WGA, its initial proposal in the negotiations would have had a value of $429 million annually, while the Alliance of Motion Picture and Television Producers made an initial offer worth just $86 million per year.
• The WGA estimates that the tentative deal will be worth $233 million per year. That’s just 54% of its initial ask, but it’s 2.7x what the employers initially offered.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a new report from the International Energy Agency that could further discourage needed investments in fossil fuel supplies and could help drive energy prices even higher in the coming years.  We then review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including additional confirmation that the European Union intends to clamp down on its trade with China and signs of preparations for a partial shutdown of the U.S. government which could begin on Saturday.

Global Climate Change Policy:  The International Energy Agency has issued a new report estimating that global use of fossil fuels would have to fall 25% by 2030 in order for nations to meet their goal of net-zero greenhouse gas emissions and realize their hopes of limiting global temperature increases.  The report comes amid intensifying pushback against the IEA from the world’s oil and natural gas industry, which is accusing the agency of being too alarmist and too reckless in discouraging the fossil energy investments needed to fuel the world until greener technologies are ready for wider use.  We have also noted that many governments around the world, especially in Europe, have started to step back from their most aggressive climate-stabilization policies amid pushback from voters.

• While the report also called for faster deployment of green energy technologies, it warned they may not be ready soon enough. Therefore, “Prolonged high prices would result if the decline in fossil fuel investment in this scenario were to precede the expansion of clean energy.”  In the IEA’s view, an orderly transition is “far from guaranteed.”
• Coupled with potential supply disruptions associated with the U.S.-China geopolitical rivalry, we think the regulatory and financial-market headwinds against fossil-fuel exploration and development will likely crimp supplies going forward. That’s a key reason why we think mineral commodities will be in a prolonged bull market in the coming years, once we get past the soft growth or recession that seems likely in the near term.

Saudi Arabia:  Energy Minister Prince Abdulaziz bin Salman told the annual conference of the International Atomic Energy Agency that the Kingdom of Saudi Arabia will adopt a strict “Comprehensive Safeguards Agreement” with the agency that will allow IAEA inspectors to monitor Saudi nuclear activities.  The move provides more evidence that Saudi Arabia is pushing hard to win a U.S.-run nuclear processing facility as part of its price for normalizing relations with Israel.  Besides the nuclear processing facility, the Saudis are also seeking security guarantees from the U.S.

• Saudi-U.S.-Israeli negotiations toward normalization are continuing.
• In the meantime, it is increasingly clear that the Saudis are holding down crude oil production to boost global energy prices and heap additional pressure on President Biden for concessions.
• Along with the recent dearth in new fossil fuel development, the cut in production by Saudi Arabia and its allies continues to boost global oil prices. So far this morning, Brent crude is trading down 0.7% at $91.29 per barrel, but that’s still up dramatically from only about $71.75 in early summer.
• The rise in energy prices has also increased worries that consumer price inflation will prove stickier than earlier thought, prompting the Fed to keep interest rates higher for longer. As a result, the yield on the benchmark 10-year Treasury note closed yesterday at a multi-year high of 4.541%.

European Union-China:  During a speech in Beijing, EU Trade Commissioner Dombrovskis warned yesterday that China’s “lack of reciprocity and a level playing field [in trade], coupled with wider geopolitical shifts, has [sic] forced Europe to become more assertive.”  Coming so soon after EU Commission President von der Leyen’s recent announcement of an anti-subsidy probe into Chinese electric vehicle exports, and shortly before Dombrovskis was scheduled to meet Chinese Vice Premier He Lifeng, the trade commissioner’s statement helped confirm that the EU has swung around to a more protectionist stance regarding trade and investment with China.

• Dombrovskis also warned today that the EU’s anti-subsidy investigation would include vehicles made by Western companies in China.
• Although Chinese-made EVs currently account for only a modest share of European sales, their rapidly advancing quality and lower costs are expected to help them capture a huge amount of market share in the coming years.
• Almost all of the Chinese-made EVs currently sold in Europe are from Chinese-owned European brands such as Britain’s MG, owned by China’s SAIC (600104.SS, CNY, 14.86), or from joint ventures between European and Chinese companies.

South Korea:  Lee Bok-hyun, governor of the Financial Supervisory Service, said he thinks South Korea has now met most of the conditions to be included in the FTSE Russell World Government Bond Index.  The index managers are expected to meet soon to decide on any changes in index constituents.  If they decide to include South Korea, the country is expected to account for up to 2.5% of the index, which would likely translate into around $65 billion of additional purchases of the country’s government bonds.

United States-South Pacific Islands:  President Biden yesterday hosted the leaders of 16 different South Pacific nations at the White House as part of an effort to keep them from falling for China’s recent diplomatic, military, and economic overtures.  At the meeting, Biden announced several new embassies and aid programs for the region.  However, Solomon Islands Prime Minister Sogavare failed to show up for the meeting, illustrating his increasing alignment with Beijing.

U.S. Government Shutdown:  Some lawmakers are reportedly working on an emergency bill to protect active-duty troops from losing their pay in the event of a partial government shutdown which could start on Saturday.  As during the shutdown of October 2013, the legislation would aim to protect troop morale and avoid imposing financial difficulties on military families.  However, unlike the legislation in 2013, this bill would also apply to members of the Coast Guard.

• Even if troop pay is protected, more than half of the Defense Department’s large civilian workforce would likely be furloughed.
• That illustrates how the economy could face a large hit to demand in the event of a partial shutdown. In addition, Moody’s (MCO, $322.81), the last major credit assessment firm with a AAA rating on Treasury debt, warned yesterday that it would consider a shutdown to be “credit negative” for U.S. obligations.
• As we argued in our Comment yesterday, a shutdown could potentially have a big impact on today’s “slow bicycle economy,” which has likely lost enough momentum to become more susceptible to recession even if there is only a modest hit to demand or confidence.

U.S. Electrical Vehicle Industry:  Ford Motor (F, $12.58) announced it will pause construction of a controversial factory in Dearborn, Michigan, where it planned to make electric vehicle batteries using technology from Chinese green-tech giant Contemporary Amperex Technology, or CATL (300750.SZ, CNY, 206.27).  Ford said the pause was caused in part by the on-going United Auto Workers’ strike, but it also cited unspecified other issues.  That could mean the company has gotten cold feet after being criticized for relying on Chinese technology and seeing how many governments around the world are stepping back from their climate-change regulations.

• Regarding the strike, today both President Biden and Former President Trump will visit the UAW picket lines in Michigan to show their support for the workers. Biden’s visit will mark the first time a sitting president has ever joined the strikers on a picket line.
• Of course, the visits by such high-stature politicians are likely to further encourage the strikers. Despite the UAW being happy with some recent concessions by Ford in the negotiations, it doesn’t look like the work stoppage will end anytime soon.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with the latest on Canada’s allegations that India assassinated a Canadian citizen in British Columbia in June.  The resulting strain on Canadian-Indian relations could have big implications for the U.S.’s effort to use India as an economic and geopolitical counterbalance to China.  We next review a range of other international and U.S. developments that could affect the financial markets today, including an effort by China to boost its stock market by limiting insider share sales and a tentative deal to end the U.S. screenwriters’ strike.

United States-Canada-India:  Reports over the weekend said U.S. intelligence helped Canada conclude that Indian agents were involved in the June assassination of Sikh separatist leader Hardeep Singh Nijjar near Vancouver.  The U.S. information included not only the regular reports provided to Canada as a member of the “Five Eyes” intelligence-sharing partnership that includes the U.S., the U.K., Canada, Australia, and New Zealand, but it also included additional reports specifically aimed at providing further context for the reports related to the assassination.

• Despite the U.S. assistance, the reports indicate that Canada’s conclusion about India’s involvement relied mostly on Canada’s own communication intercepts.
• Nevertheless, the U.S. role could complicate the Biden administration’s effort to draw India closer to the U.S.-led geopolitical and economic bloc as a counterweight against China’s growing power.

China-Philippines:  China’s coast guard and maritime militia forces have installed a 300-meter floating barrier to keep Philippine fishing boats out of a disputed shoal in the South China Sea just 140 miles from the Philippine coast.  The development is additional evidence that China is ratcheting up its harassment of Philippine interests in the area as punishment for Manila’s recent move to rebuild its security alliance with the U.S.

China:  In a further move to bolster China’s flagging stock market, authorities in Beijing have reportedly banned controlling shareholders of listed companies from selling their stock if their firm hasn’t paid a dividend for the last three years or if the company is trading below its initial public offering price or net asset value.  The new rules reportedly apply to more than half of the 5,000 or so stocks listed on Shanghai and Shenzhen.  The rules have also already led to the cancelling of insider share sales at more than 200 companies.

Russia-Ukraine War:  On Saturday, the New York Times revealed that the U.S. Army’s Landstuhl Regional Medical Center in Germany is treating a small number of Americans who were wounded in Ukraine after volunteering to help fight the invading Russians.  According to the report, the Defense Department last summer authorized the hospital to treat up to 18 members of the Ukrainian armed forces at a time, but a substantial percentage of those treated have been Americans who had previously served in the U.S. military or had served as former soldiers of other NATO allies.  The report has the potential to be seen as further evidence of creeping U.S. involvement in the war.

• Separately, Ukraine continued its recent missile and drone attacks on Russian-occupied Crimea over the weekend, forcing Kremlin-allied authorities there to issue air raid warnings. The attacks appear designed to disrupt Russia’s ability to launch its own air attacks against Ukraine’s grain exports and energy infrastructure.
• Importantly, Ukraine has stepped up use of its newly declared safe corridor for food shipments out of its southeastern ports. Last week, two ships laden with Ukrainian wheat successfully used the corridor, and three more ships are expected to use it to carry Ukrainian food exports in the coming week.  Continued Ukrainian food exports would help preclude a spike in global grain prices.

Japan:  Start-up pharmaceutical company Toregem BioPharma said it’s preparing to start clinical trials for a new drug that would spur the growth of new teeth in people who have lost both their baby and adult teeth.  The drug, which the firm hopes to have on the market by 2030, could help take a bite out of a problem many older people have in aging societies like Japan.

U.S. Economic Data:  As a “heads up,” the Bureau of Economic Analysis will issue updated and corrected figures on Thursday for gross domestic product, price inflation, corporate profits, and other key indicators for the last ten years, along with its third regular estimate of second-quarter GDP growth.  There is a significant chance that the revisions will show recent GDP growth has been weaker than initially reported.  Just as important, the figures for consumer inflation as measured by the price index for personal consumption expenditures could be revised upward, which would likely affect how policymakers at the Federal Reserve approach monetary policy in the coming months.

U.S. Fiscal Policy:  The House of Representatives has again failed to start passing the funding bills needed to avert a partial government shutdown this coming weekend.  Top Republican and Democratic lawmakers yesterday warned that time is running out to pass the appropriations bills that would keep operations funded after the current fiscal year ends on Friday.  Several House Republicans who are insisting on deep spending cuts are the key holdups.

U.S. Labor Market:  The Writers Guild of America and the major Hollywood studios have struck a tentative deal on a new labor contract, potentially ending the screenwriters’ strike that has hobbled movie and television production for months.  The negotiators are still ironing out the final details of the three-year contract before putting it to a vote by the union members, but it looks like the workers will win a number of concessions, such as increased royalties, minimum staffing levels, and protections related to artificial intelligence.  In turn, those concessions would likely encourage the still-striking Screen Actors Guild to hold out for a better deal.

U.S. Energy Market:  Data last week showed the average price for regular unleaded gasoline has reached $3.88 per gallon, up more than 25% from the start of the year.  The increase in cost reflects a recent surge in global crude oil prices stemming from strong demand, low inventories, and production cuts by countries such as Saudi Arabia and Russia.

• The jump in energy costs is especially concerning given that U.S. economic growth is already moderating in response to the Federal Reserve’s interest-rate hikes. When growth is slow, it may only take a small hiccup in demand to push it into recession.
• We call this the “slow bicycle economy,” since it’s so similar to the situation where it becomes very hard to keep your balance on a bike when you slow down too much.
• For all of today’s talk among investors about a hoped-for soft landing (in which growth slows enough to bring down consumer price inflation), that would also be something like a slow-bicycle economy where activity could be at risk if energy prices rise too much, if there is a partial government shutdown, or if there are some other hits to demand.

Global Artificial Intelligence:  If you think the wonders of artificial intelligence are simply divine, you’re going to love this.  Clerics in Iran’s theocracy are reportedly exploring the use of AI to write fatwas, or religious edicts.  Even the country’s supreme leader, Ayatollah Khamenei, has urged the clergy to pay more attention to the possibilities of AI, saying he wants Iran to be “at least among the top-10 countries in the world in terms of artificial intelligence.”

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment is divided into three sections: 1) Why the BOJ may not change policy anytime soon; 2) How the media narrative may either help or hurt strikers; and 3) Why improved relations with Saudi Arabia and Israel may help the U.S. fend off China.

Yen Under Pressure: One year after the Bank of the Japan surprised markets when it intervened to protect its currency, it is currently on standby to do so again following its recent rate decision.

• The Japanese central bank kept interest rates unchanged at their current levels. Following the Bank of Japan’s decision, central bank governor Kazuo Ueda vowed to maintain negative interest rates as a means to support the economy. Despite Japan’s economy experiencing relatively high inflation, GDP growth has failed to exceed 2.0% for eight consecutive quarters. Although Governor Ueda acknowledged that inflation has consistently exceeded the central bank’s target, he said that policymakers are not yet prepared to change their current monetary stance. He added that the BOJ does not foresee inflation sustainably reaching 2%, due to both downside and upside risks.
• The BOJ’s policy decision comes amid concerns that inflation is getting out of control. Last month, Japan’s core inflation index, which excludes fresh food and energy, rose 4.3% from the previous year. It also surpassed U.S. core inflation for the first time since 2014. Rising inflation has sapped investor confidence in the JPY, sending the real exchange rate to an all-time low against its peers. To avert a potential currency crisis, the Bank of Japan has signaled its willingness to intervene in currency markets and is working closely with the U.S. Treasury to prevent major swings in exchange rates.

• Although the central bank has maintained its ultra-accommodative monetary policy stance, economists expect it to hike rates starting around March 2024, according to a Reuters poll. This transition is poised to result in a strengthening of the JPY against the U.S. Dollar. Furthermore, this policy shift may exert an influence on yields for long-term U.S. Treasuries. The weaker JPY has benefited Japanese automakers by allowing them to increase car exports to the United States due to improved terms of trade. Japanese automakers’ stocks, such as Mazda (MZDAY, $6.00), Honda (HMC, $35.30), and Toyota (TM, $188.39), have outperformed the market, returning 30.0% in USD over the past six months.

Labor Comeback: One union strike appears to be nearing its end, while another is escalating.

• Hollywood writers are nearing a deal with studios on a new labor contract, after holding marathon talks for 10 hours on Thursday. While a final agreement was not reached, there are rumors that a deal is in sight, and the sides are expected to meet again on Friday. Meanwhile, tensions are rising in the auto worker dispute, after leaked messages from a top aide to UAW president Shawn Fain provided fresh fuel to critics of the union’s strike strategy. The leaked messages reveal that union leaders had long planned a protracted and disruptive dispute with automakers, suggesting that they were not negotiating in good faith.
• Labor disputes are often settled in the court of public opinion, rather than behind closed doors. As Robert Schiller points out in his book Narrative Economics, the drop in support in the 1960s and 1970s coincided with the fall of Teamster leader Jimmy Hoffa, who was sent to prison for jury tampering, mail fraud, and bribery. While the current leader, Shawn Fain, might reap the benefits of a resurgence in union support, he could also face heightened scrutiny for quoting controversial civil rights leader Malcolm X. That said, this dispute is far from over as the UAW is considering expanding the strike to Ford’s Chicago assembly plant on Friday.

• The rise in labor union popularity is related to a shift in economic preferences away from efficiency and towards equality. This shift will benefit workers through stronger wage increases and better working conditions, but it is likely to come at the expense of higher inflation, as firms may be encouraged to cut back production or increase prices. The transition to a more equitable economy will not be fast or smooth, and it will probably face many hurdles. However, firms with monopoly power may prosper from this shift, as they are likely to be better positioned to make adjustments in the changing landscape.

Saudi Arabia-Israel Normalization: Diplomatic normalization talks between the two major Middle Eastern powers are gaining momentum.

• Saudi Arabia’s Crown Prince Mohammed bin Salman (MBS) has expressed optimism that his country and Israel can overcome their differences and build a more cooperative relationship. This potential breakthrough comes on the heels of a visit to Washington by Israeli President Benjamin Netanyahu, where he mended ties with his American counterpart, Joe Biden. The potential arrangement between Saudi Arabia and Israel includes a possible security guarantee similar to the one between Japan and South Korea, a show of support by Israel for the development of a Saudi uranium enrichment program, and concessions to the Palestinians. The arrangement will be a major win for Biden but is far from certain.
• Lawmakers are likely to be hesitant to accept the proposed terms of the Saudi-Israeli peace deal for a number of reasons. Democrats have long raised concerns about Saudi Arabia’s human rights record, especially following the 2018 killing of Washington Post journalist Jamal Khashoggi. Meanwhile, the Republican Party remains divided on the issue of security guarantees for other countries, with some conservatives advocating for a more Jeffersonian approach to foreign policy, in which the military is less involved in the affairs of other countries. The contentious nature of the proposed Saudi-Israeli peace deal could complicate negotiations and make a final agreement less certain.

(Source: Chinamed.it)

• The potential security guarantee between the U.S. and Saudi Arabia could undermine China’s efforts to draw Saudi Arabia into its sphere of influence.
• A diplomatic relationship between Saudi Arabia and Israel would benefit the United States in its competition with China for influence in the Middle East. While China often uses its economic clout to win friends, it is less willing than the United States to make security commitments. Therefore, the deal would likely prevent Saudi Arabia from completely aligning itself with China, as some feared following Riyadh’s talks with Beijing regarding a petroyuan and its invitation to the BRICS group. Additionally, it could provide a blueprint for how the United States plans to win over emerging countries without offering access to its consumer base.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment is split into three sections: 1) How the Federal Reserve’s latest rate decision will impact its policy for next year; 2) Why governments may be forced to moderate some of their climate goals; and 3) Why support for Ukraine may face more resistance as the war rages on.

Hawkish Pause? The Fed held rates steady at its September 19-20 meeting but signaled the possibility of another hike before the year’s end.

• The Federal Open Market Committee (FOMC) kept rates unchanged at 5.25%-5.50% at its September 19-20 meeting, pausing its aggressive rate-hike campaign. Fed Chair Jerome Powell said the committee will look at the data before deciding whether to adjust policy. The latest FOMC dot plots showed that policymakers are divided on whether to hold rates at their current level or increase them again. Traders, though, are optimistic that the Fed has ended its tightening cycle, projecting a nearly 54% likelihood of a pause in rates, according to the latest forecast from the CME FedWatch Tool.
• Policymakers are more optimistic about the economy in 2024, revising up their June projections for GDP growth from 1.1% to 1.5% and the unemployment rate down from 4.5% to 4.1%, according to the Summary of Economic Projections (SEP). However, the Fed statement acknowledges that it expects the tighter financial conditions on households and businesses are likely to weigh on economic activity and hiring. During the press conference, Powell suggested that the central bank’s goal is a soft landing and implied that the committee may adjust policy if conditions change. This cautious optimism may explain why officials left inflation expectations largely unchanged for 2024.

(Source: Bloomberg)

• The improved outlook for 2024 likely explains the Federal Reserve’s hawkish tilt in the latest dot plots. The median fed funds targets were revised upwards for 2024, 2025, and the longer-term, reflecting policymakers’ belief that the economy is still too hot for comfort. Additionally, this may suggest that Fed officials are willing to keep interest rates restrictive for longer in order to bring inflation under control as long as the economic data remains positive. It is possible that if economic conditions start to deteriorate, then the Fed may pivot. That said, Fed officials still project that rates will be 25 basis points below their current levels by the end of 2024, while the market projects a decline of 50 basis points.

Net Zero Reality: The United Kingdom walked back its climate change plans, and we suspect other countries may follow.

• British Prime Minister Rishi Sunak is delaying key green initiatives, citing concerns about over-ambitious targets. Sunak has delayed the ban on new petrol and diesel cars and oil boilers until 2035, relaxed the phaseout target for gas boilers, and abandoned efficiency rules for landlords. These policy reversals appear to be a way for him to distinguish himself from the opposition ahead of elections in late 2024 or early 2025. The Conservative Party plans to portray the Labour Party as out of touch with everyday households after the Labour Party vowed to reinstate the target once elected, despite the potential costs it will have on consumers.
• The U.K. is not alone in its reconsideration of climate change policy, particularly when it comes to electric vehicles. In the United States, Republican frontrunner Donald Trump has criticized his rival Joe Biden’s EV mandate, believing that it will kill the auto industry. Meanwhile, the countries in the European Union are struggling to cope with the influx of Chinese EVs as it aims to ban the sale of combustion engine cars in a little over a decade. To contain the fallout, the EU Commission has launched a probe into Chinese dumping claims.
• The green transition, particularly towards electric vehicles, is a key part of achieving energy independence and reducing reliance on authoritarian governments for resources. The recent production cuts by Russia and Saudi Arabia have shown the dangers of importing oil. The quickest way to reach energy independence would be to import Chinese vehicles, but this would lead to a greater dependency on another potential rival. The other alternative is to develop electric vehicles domestically, which would provide greater stability but is a slower and more arduous process. We believe that the latter option is more likely to succeed in the long term, but it will require significant political will and investment.

War in Ukraine: The ongoing row between Ukraine and several Eastern European countries highlights flaws in the West’s support for Ukraine.

• Ukraine announced that it will sue Poland, Hungary, and Slovakia over their bans on Ukrainian agricultural goods, which were imposed after the EU allowed bloc-wide restrictions to expire. The three countries claim that the bans are necessary to protect their local producers from foreign competition, but Ukraine argues that they are illegal and could undermine a key source of revenue for the country as it defends itself from Russia. In retaliation, Poland has signaled that it may halt weapons transfers to Ukraine and is considering additional protectionist measures.
• The dispute comes at a perilous time for Ukraine. Its counteroffensive has yet to achieve significant victories, and outside countries are finding it harder to justify the cost of the war as they try to control their budget deficits. The United States has given Ukraine nearly $80 billion in aid since the invasion began in February 2022, while the EU has given nearly $30 billion. Ukrainian President Volodymyr Zelensky is set to meet with Congressional leaders on Thursday to convince Republicans to back away from their demand to reduce security aid as a condition of passing a new government budget. Although Zelensky is likely to receive a warm reception, he is unlikely to sway some of the hawkish lawmakers.

• The dispute over imports is the most visible sign of disunity regarding the backing of Ukraine. Despite largely urging countries in the European Union to reverse their bans on Ukrainian products, the EU is also considering helping to defend these governments from Ukraine’s lawsuit. At the same time, U.S. policy toward Ukraine is increasingly in disarray, with more politicians urging for a more domestic shift in policy. While it is unlikely that the West will pull its support anytime soon, it is becoming evident that patience is wearing thin. A potential end to the war could lead to a boost in equities as it reduces market uncertainty over commodity prices.

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