by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment begins with a discussion about a possible shift in Fed policy. Next, we give an update on the latest stories surrounding artificial intelligence. Lastly, we end the report detailing the possible ramifications of the breach in the price cap on Russian oil.

Doves Take the Wheel:  After months of wishful thinking, traders are now more confident than ever that the Federal Reserve is close to ending its hiking cycle.

• Producer price data released by the Bureau of Labor Statistics on Thursday showed that supply price pressures are easing, similar to the recent report on consumer price inflation. The Producer Price Index (PPI) rose 0.24% from the prior year in June 2023, which is much lower than its peak of 12.5% in March of last year. In fact, the June report showed that supplier prices slowed to their lowest rate in nearly three years. This could lead to a slowdown in consumer price inflation, as firms will have an easier time maintaining margins without having to raise prices for their goods or services.
• Markets cheered the Federal Reserve’s apparent victory in its inflation fight. The S&P 500 closed up 0.9% on the day, while yields on 10-year Treasury notes fell to a two-week low. Additionally, speculation over monetary policy weighed on the U.S. dollar index, which fell to its lowest level in more than a year. The positive report led traders to downgrade their expectations for the number of rate hikes left for the rest of 2023. Currently, overnight index swaps are pricing in one remaining increase from the Fed, down from the two hikes forecast a week ago.

• Despite the investor reaction to the economic statistics, the Fed may still keep interest rate hikes on the table. The year-over-year change in core inflation is still well above the central bank’s 2% inflation target. Federal Reserve Board member Christopher Waller seized on this fact to justify the possibility of two additional rate hikes for the year. However, there appears to be a dovish tilt in the Fed, which is likely to worsen with the recent departure of St. Louis Fed President James Bullard. As a result, it is possible that the next rate hike could possibly be the last of the year.

Pushback Against AI: Excitement over the rapid advances in artificial intelligence (AI) is being tempered by growing concerns about its potential risks.

• The Federal Trade Commission is investigating ChatGPT over claims that it has the potential to harm consumers. The technology has been accused of generating misinformation that has caused harm, and of distributing copyrighted work without the consent of the owners. Meanwhile, China released its highly anticipated regulatory framework for AI that is designed to ensure that the chatbots are able to stay true to core socialist values. Similar to what the FTC wants to accomplish, Beijing’s restrictions look to ensure that generative AI technology is publishing reliable information. However, the Chinese government’s framework also goes further, placing restrictions on the types of topics that chatbots can discuss and the way that they can interact with users.
• In related news, there is growing concern that artificial intelligence (AI) will lead to major job displacements in the future. On Thursday, Hollywood actors joined screenwriters on strike as they advocate for greater protection against the growing use of AI technology. The backlash was in response to an AI proposal to scan and use images of actors in perpetuity. As depicted in the first episode of the most recent season of Netflix’s Black Mirror, workers in the entertainment industry fear that their likeness and work will be used without their permission. Over the last few years, AI has been used to de-age actors, help generate movie trailers, and even bring back the voices of late performers.

 (Source: Variety)

• • AI was used to digitally enhance the picture above to make Will Smith look younger.

• The recent controversy surrounding AI is a reminder of the ongoing regulatory and political threats that the technology faces in the coming months. There is a legitimate fear that AI will begin to displace workers on a massive scale, with some estimates predicting that it could replace up to 40% of jobs in the U.S. economy. AI’s disruptive potential is likely to make it a target of politicians and regulators, who may seek to implement policies that restrict its use. As a result, investors should take into account current and potential scrutiny when deciding whether to join the recent AI craze.

Price Cap Troubles: The price of Urals crude oil has breached the $60 per barrel cap set by the West, putting countries that continue to import Russian oil at risk of sanctions.

• The recent rise in the price of Russian oil is putting pressure on G-7 nations to enforce disciplinary actions in their efforts to cap Russian oil exports. The Western bloc imposed the cap as a way to constrain Moscow from receiving much-needed revenue for its war efforts. Recent data showed that the restrictions have been successful in limiting Russia’s ability to profit from its oil, with revenue nearly halving since last year. However, the increase in oil prices is threatening to undermine the cap’s credibility, as it suggests that Moscow may have more market power than the West realized.
• That said, it is unclear whether other countries are willing to risk sanctions to obtain Russian oil. India and China have been the biggest beneficiaries of the price target as the countries have been able to take advantage of the steep discounts. The recent breach may force buyers to consider alternatives as it is unclear whether they are willing to tolerate the headache of possible sanctions. Indian refiners are already preparing for talks with local banks over financing Russian cargoes. So far, it is unclear how China will deal with the situation.

• The breach of the $60 per barrel cap on Russian oil will provide a fresh test of the effectiveness of Western sanctions. If firms abide by the restrictions set by the G-7 countries, Moscow will need to offer steeper discounts on its oil in order to continue selling its goods abroad. This should dissuade Russia from cutting production to boost prices. If firms continue to purchase Russian oil despite the threats of sanctions, Russia could then collaborate with its OPEC counterparts to implement new production cuts, which could lead to an increase in global oil prices.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment begins with our thoughts about the better-than-expected inflation report. Next, we explain how tight policy abroad may impact domestic economies. Lastly, the report discusses how tensions within NATO may not necessarily doom the military alliance.

Inflation Cools: Investors are hopeful that the positive CPI report will convince the Fed to hold off on further rate hikes.

• The year-over-year change in the consumer price index fell to its lowest level since March 2021. According to the Bureau of Labor Statistics, the price paid for consumer goods rose 3.1% from a year ago. Meanwhile Core CPI, which excludes energy and food, rose 4.8% in the same period. The deceleration in prices has led to speculation that the Fed may be nearing the end of its hiking cycle. As a result, the dollar weakened against the EUR, JPY, and GBP. Nonetheless, Fed officials still seem wary of abandoning their inflation fight.
• Despite the positive reading, some policymakers still want the Federal Reserve to push forward with rate hikes. On Wednesday, Richmond Fed President Thomas Barkin insisted that inflation remains too high. Meanwhile, his Minneapolis counterpart, Neel Kashkari, argued that the central bank needs to succeed in bringing inflation back to target before it can declare victory. The hawkish remarks from Fed officials may explain why Fed futures contracts were virtually unaffected by the surprise in the inflation report. The CME FedWatch Tool shows that 30-day Fed futures contracts are pricing in a rate hike at the end of month.

• The path toward 2% inflation is likely to be a slow and bumpy ride. The Cleveland Fed expects headline inflation to reaccelerate in July by rising from a year-over-year change of 3.0% to 3.3%. While monthly inflation has been volatile, ranging from 0.1% to 0.5% in the first six months of the year, annualized inflation has risen at a more consistent pace of 3.5%. That said, an average monthly change of 0.16% is consistent with the Fed’s target of 2%. The central bank’s ability to achieve its target will likely be related to its ability to bring down shelter price inflation which represents nearly a third of the index and remains well above its historical average.

Everybody Else: Speculation that the Fed may be close to ending its inflation fight has led to a focus on other central banks.

• Investors expect central banks in advanced economies to take a more hawkish stance in the coming months. The Bank of Canada raised interest rates to their highest level in 22 years on Wednesday, and the European Central Bank and the Bank of England are both considering additional rate hikes. There is also speculation that the Bank of Japan will end its yield-curve-control program later this year. The expectation of a possible narrowing interest differential between the United States and other advanced economies led to a broad decline in the U.S. dollar, with the U.S. Dollar Index falling to its lowest level since April 2022 following the release of the June CPI report.
• The effects of persistent central bank tightening are starting to impact the real economy. The U.K., for example, is on the cusp of a mortgage crisis due to rising borrowing costs. Typically, British homeowners borrow at fixed two- or five-year rates and then remortgage at a fixed or variable rate afterward. Hence, the brunt of the tighter monetary policy will likely be felt by more households over the coming months. Additionally, higher interest rates in the eurozone will hinder countries from preventing an economic slowdown within the bloc. The region fell into a technical recession in Q1 of this year.

• That said, we currently do not see any signs of an imminent financial meltdown. The quick response by policymakers during the U.K. pension crisis in 2022, as well as the regional bank turmoil in the U.S. earlier this year has shown that central banks are better prepared than they were in the previous decade. Consequently, this may mean that central bankers are more willing to keep policy tighter for longer. If we are correct, this should lead to an increase in bond yields, especially if there is a notable increase in inflation volatility.

Intergroup Tensions: Ukraine’s recent success has not been enough to get NATO members on the same page as to the best way to tackle threats from China and Russia.

• Although there was some progress at the summit in Vilnius, NATO leaders failed to articulate a clear vision for foreign policy going forward. The meeting led to Turkey’s acquiescence to allow Sweden to proceed with its application to join NATO, and to an agreement to repair its relations with Greece. This is likely related to backroom dealings between Turkey and other NATO members and reflects Turkey’s growing importance within the alliance. Yet, the group failed to elaborate on Ukraine’s path to joining NATO. The communiqué stated that Ukraine belongs in NATO but implied that the country needs to meet certain conditions before it can be admitted.
• Strains within the NATO alliance were also made apparent outside of the summit, especially regarding China. U.K. security officials scolded their American counterparts for not adequately addressing Chinese spying. It was revealed earlier this week that Chinese hackers gained access to emails of government officials. Meanwhile, other countries within the military group remain uncertain in how to address Beijing. On Thursday, Germany released a statement acknowledging its concerns about China’s growing assertiveness in the Indo-Pacific. However, the statement did not provide any details about how Germany plans to “de-risk” from its dependence on the world’s second-largest economy. Last year, Germany’s total trade with China was nearly $300 billion.

• Strains within NATO may become worse as economies begin to slowdown, but it is unlikely that the group will fracture. The bright spot of the war in Ukraine is that it reminded members of the importance in maintaining the military bloc. As a result, we expect that there will be increased coordination and cooperation between NATO members, which could come in the form of boosted weapon sales and investment, as well as the broadening of trade relations. This should be favorable for defense and aerospace firms. So far this year, XAR ETF, which tracks aerospace and defense stocks, has outpaced the S&P 500, excluding tech, 11.48% to 8.24%, respectively.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with notes on global asset allocation strategy among hedge funds and new developments in the global race for electric-vehicle minerals.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a jump in the value of the yen and the opening of important negotiations for a new labor contract for U.S. automakers.

Global Asset Allocation Strategy:  Brokerage data from Goldman Sachs (GS, $320.88) shows hedge funds currently have their lowest exposure to the U.S. stock market since records began in 2013, while their allocation to European stocks is at a record high.  The low asset allocation to the U.S. is driven largely by concerns that many of the country’s key technology stocks are overvalued.  We share that concern, although we also think the broader U.S. economy is likely to perform better than the European economy in the coming quarters.

Global Mining Industry:  Automobile manufacturers Volkswagen (VWAGY, $16.90) and Stellantis (STLA, $18.00) have announced plans to contribute $100 million each to form a new, publicly-traded mining company producing nickel and copper in Brazil.  The plan is to join the firm with a special-purpose acquisition company run by a well-known mining executive who hopes to do more deals to build a large battery-metals company.  The deal illustrates the frenzy to find and develop electric vehicle materials and shows how the trend is pushing auto firms to vertically integrate to lock up their own supplies.

Japan:  As investors begin to focus on the Bank of Japan’s next policy meeting on July 28, they are increasingly pricing in a chance that the officials could adjust or abandon their yield-curve control policy and allow bond yields to rise.  In response, the yen so far today has strengthened about 1.0% to 138.99 JPY per dollar, meaning it has now essentially reversed all of its depreciation since early June.

• The market reversal appears to stem largely from a statement by BOJ Deputy Governor Shinichi Ushida last week.
• According to Ushida, the BOJ is now seeking “a balanced decision [on yield-curve control] with an eye on monetary interventions and market functions.”
• An adjustment to the yield-curve control policy is also more likely now that BOJ Governor Ueda has been in his position for three months. Ueda indicated at his appointment that he would more slowly and cautiously on any change in policy, but the longer he is in his position, the freer he would likely feel to move forward.

North Korea-Japan:  North Korea today fired an intercontinental ballistic missile that flew approximately 600 miles before splashing down in the waters between the Korean peninsula and Japan.  Besides being the latest example of North Korea’s belligerence, the launch is a reminder of the kinds of destabilizing events that could periodically transpire between Russia and Ukraine if their war eventually cools into a Korean-style “frozen conflict,” as we think is likely.

China-Mexico:  Mexican President Andrés Manuel López Obrador said his government is considering whether to impose tariffs against Chinese shoe imports to slow their proliferation in the country and protect local manufacturers.  The move underscores an important dynamic between China and the other so-called emerging markets—once China’s ultra-low-cost producers gained access to the global market in the early 2000s, they tripped up many other developing countries’ industrialization efforts and forced them to focus on more volatile, less profitable commodity production.

China-United States:  Researchers at Microsoft (MSFT, $332.47) said Chinese hackers have broken into email accounts at more than two dozen organizations, including some U.S. government agencies, in what appears to be a major new espionage effort.  Officials said the hackers didn’t gain access to classified information, but they continue to investigate whether sensitive information was stolen.

U.S. Antitrust Regulation:  A federal judge yesterday said Microsoft (MSFT, $332.47) can move ahead with its acquisition of videogame maker Activision Blizzard (ATVI, $90.99), ruling against the Federal Trade Commission’s contention that the merger would hurt competition.  The FTC may continue a separate administrative effort to block the acquisition, and regulators in the U.K. are looking at the deal as well.  Nevertheless, the judge’s decision shows how the Biden administration’s effort to tighten big-tech antitrust regulation has had only spotty success so far.

U.S. Labor Market:  Officials from Ford (F, $15.23), General Motors (GM, $39.97), and Stellantis are meeting with the United Auto Workers union this week to work on a new labor contract to replace the one that expires September 14.  By all accounts, the new leadership at the UAW is intent on winning back the cost-of-living adjustments its workers lost following the Great Financial Crisis and protecting jobs as the automakers shift toward producing less-labor-intensive electric vehicles.

• Ahead of the elections in 2024, the pro-union Biden administration is also likely to put outside political pressure on the negotiators to strike a deal favorable to workers, despite concerns that high wage growth is boosting consumer price inflation.
• In any case, there is a considerable chance that the negotiators will fail to strike a deal and the UAW’s 400,000 could go out on strike, as they did at the last contract expiration in 2019.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens, understandably, with our observations on the rebellion in Russia over the weekend.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a sharp drop in the value of the renminbi as the Chinese economy slows and expected details today on tens of billions of dollars in new subsidies for high-speed internet infrastructure in the U.S.

Russian Rebellion: The world this morning continues to digest the short-lived rebellion in Russia that was called off on Saturday.  As we have often noted in our Comment, financier and oligarch Yevgeniy Prigozhin has had considerable success wielding his Wagner Group mercenaries in support of Russia’s invasion of Ukraine, but he had increasingly come into tension with the leadership of the formal Russian military, most notably Defense Minister Shoigu and Chief of the General Staff Gerasimov.  In recent weeks, President Putin appeared to throw his support more toward Shoigu and Gerasimov, leading to a presidential directive that would have brought the Wagner troops under their control starting July 1.  In an apparent preemptive strike, Prigozhin and thousands of his soldiers on Friday launched a “march for justice” toward Moscow with the professed aim of removing Shoigu and Gerasimov.  As Prigozhin and his troops took control of the headquarters of the Russian armed forces’ Southern Military District, Putin denounced the march as “treason” and called for Prigozhin’s arrest.  However, with the Wagner troops almost two-thirds of the way from Ukraine to Moscow, Belarussian President Lukashenko mediated an agreement in which Putin lifted the arrest warrant and agreed to let Prigozhin escape to Belarus, while Prigozhin ended his march and agreed to allow at least some Wagner troops to be absorbed into the Russian military.  The latest press reports indicate the Wagner troops are indeed returning southward.

• While the crisis has apparently been defused for the moment, it is not entirely clear that it is over for good. As of this writing, it appears that Shoigu, Gerasimov, and Prigozhin have still not made any new public appearances.  It is also not entirely clear what the Putin-Prigozhin agreement entailed.  We’ve seen at least one report saying that Prigozhin will be paid an enormous sum of money to go away, but it’s entirely possible he has merely made a tactical retreat.  Another report today suggested he still might be prosecuted for the insurrection.
• In very broad terms, the rebellion weakens Russia and probably helps Ukraine by undermining Russian troop morale. Below, we take a first cut at the losers and winners in the crisis, intertwined with some investment implications:
  • Russian President Putin: Strong Loser. The president’s quick about-face in lifting his arrest warrant for Prigozhin, and his military’s inability to stop the Wagner column from advancing northward, will likely weaken Putin severely.  To the extent that the power-hungry clans around him smell blood in the water, Putin will now be more likely to face further political threats in the future.  For investors, it’s important to remember that Putin could well be replaced by an even more aggressive, nationalist leader, which would be negative for global assets.
  • Defense Minister Shoigu and Gen. Gerasimov: Losers. The price for Prigozhin’s capitulation could well be that Shoigu and/or Gerasimov will be replaced in the near future.  Whoever replaces them could notably shift Russia’s approach to the war in Ukraine.
  • Wagner Chief Prigozhin: Modest Loser. Prigozhin’s apparent cold feet and his acquiescence to allowing some of his troops to be brought under control of the formal military probably weakens him politically.  He is also now possibly at elevated risk of being poisoned, pushed out of a window, or otherwise assassinated by Putin, Shoigu, Gerasimov, or their supporters.  On the other hand, Prigozhin probably benefits if Shoigu and Gerasimov are indeed replaced.  Prigozhin also benefits in terms of popular support.  After all, it’s notable that he and his troops apparently faced no popular opposition during the rebellion.  Indeed, in video of his withdrawal from the Southern Military District headquarters, local citizens mobbed him like he was a rock star – a scene that will be most uncomfortable for Putin.
  • Chinese President Xi: Modest Loser. As we’ve written many times before, Russia has become the junior partner in the evolving China-led geopolitical and economic bloc.  After declaring a “no limits” partnership, President Xi now must face facts that Putin is a problem child that reflects poorly on China and could spark instability on China’s northern border.  On the other hand, a weakened Russia makes it easier for Xi to increase China’s influence over the resource-rich states of Central Asia.
  • Ukrainian President Zelensky: Modest Winner. Putin’s weakness and Prigozhin’s complaint that the invasion was made under false pretenses play into the hands of Ukraine and President Zelensky.  Not only could the chaos of the rebellion offer an attractive opportunity to strike at the Russian invasion troops, but Zelensky will also be able to milk it for more political and military support from the West.
  • Belarussian President Lukashenko: Winner. After several years when he was especially dependent on Russian support against his domestic political foes, Lukashenko’s service in brokering the truce will probably make him a bit less subservient to Putin going forward.
  • NATO: Winner. This new, dramatic example of Russian instability will probably further improve cohesion among the NATO members.  Importantly, President Orban of Hungary and President Erdogan of Turkey may be forced to temper their sympathetic policies toward Russia.  Erdogan could even become more inclined to lift his veto on Sweden’s accession to NATO.
  • Oil Prices: Winner. Political chaos in a major oil producer such as Russia is likely to heighten concerns over the stability of supplies.  In turn, that’s likely to boost global oil prices.  So far this morning, Brent crude is trading higher by approximately 0.5% to $74.41 per barrel.

Turkey: The central bank yesterday eased its “security maintenance requirement,” which requires banks to hold lira-denominated securities to back up their foreign-currency deposits.  As one of President Erdogan’s many unorthodox economic policies, the security maintenance requirement had aimed to discourage demand for foreign currencies and support the lira.  The easing of the requirement is consistent with the way Erdogan’s new finance minister and central bank chief have started to shift Turkish economic policy toward a more orthodox stance to help bring down inflation and stabilize the economy.  We think the improvement in policy will be positive for Turkish assets going forward.

Greece: In parliamentary elections yesterday, the conservative New Democracy Party of Prime Minister Mitsotakis won an outright majority in parliament with 40.6% of the vote.  Preliminary results suggest the left-wing opposition party Syriza came in second with 17.8% of the vote, which will probably prompt its leader, former Prime Minister Aléxis Tsípras, to resign.  The center-left Pasok Party finished third with 11.9% of the vote.  The results confirm that right-wing parties are now in the ascendency throughout much of Europe.

Guyana-OPEC: After recent discoveries of a huge oil field under their tiny nation on the northeastern coast of South America, officials in Guyana are reportedly fending off pressure to join the Organization of the Petroleum Exporting Countries (OPEC).  The officials say their goal is to pump as much oil as quickly as possible in case electrification and green policies push down oil demand in the future.  They fear that being a member of OPEC could require them to hold back output in order to boost prices.

• Major international oil companies already have more than $40 billion in oil projects planned for Guyana. Five of those projects alone are expected to pump more than one million barrels per day combined by the end of the decade.
• In contrast, a recent survey by the Dallas FRB showed that U.S. shale drillers are rapidly cutting their planned near-term expansions based on fears of falling commodity prices as the economy slows. In confirmation of that trend, other recent data show a decline in the number of drilling rigs operating in the U.S.

China: The renminbi today has fallen to a seven-month low versus the dollar, reflecting continued concerns about faltering Chinese economic growth.  Slowing growth has already prompted the People’s Bank of China to cut some key interest rates, even as the major developed country central banks keep hiking rates.  So far this morning, the currency is down 0.7% to 7.2307 per dollar.

U.S. Defense Budget: In a letter to Defense Secretary Austin, several founders and investors in defense-focused technology companies warned that the Pentagon must improve how it procures high-technology systems from private firms to avoid falling behind U.S. adversaries such as China.  The signatories propose a series of recommendations, such as providing $20 billion in additional spending toward corporate research and development projects and the creation of a $250 million bridge fund to help companies further develop technology that has been proven to work.  The letter serves as a reminder that the long-term uptrend in defense budgets that we expect will benefit not only traditional defense contractors, but also software and other technology firms.

U.S. Broadband Subsidies: The White House today is expected to announce how much each state will receive out of the 2021 infrastructure bill’s $42.5 billion in subsidies for broadband development.  As required by the law, the disbursement plan will be based on a new, more accurate map of where high-speed internet service is missing.  Funds are expected to start flowing to states and territories early next year and could fund projects as soon as mid-2024.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment begins with a discussion about the growing hawkishness of central banks in advanced economies. Next, we give our thoughts on the disappointing economic data coming out of Europe. Finally, we’ll explain how the rivalry between the U.S. and China is leading countries to change their trade relationships.

Keeping Up the Fight: Markets are learning to accept that rates will be higher for longer.

• On Thursday, the Bank of England stunned investors with a larger-than-expected 50 basis point rate hike. It is the BOE’s 13^th rate hike since it began tightening its monetary policy in late 2021, and it is unlikely to be the last. Under fire due to concerns over the economic impact, BOE Governor Andrew Bailey warned that if the central bank does not get tough now, inflation could possibly get worse. Bailey’s remarks reflect a hawkish trend among central banks in the developed world, as they grapple with the challenge of taming inflation without tipping their economies into recession.
• Equities dipped on Thursday as investors grew more convinced that central banks are serious about fighting inflation. The Euro Stoxx 50 and FTSE 100 finished the day down 0.5% and 0.8%, respectively. Meanwhile, the S&P 500 Equal Weight Index fell 0.4%, reflecting weakening sentiment among investors. The poor performance in stocks is related to market fears that interest rate hikes will hinder global GDP growth. Overnight index swaps show that traders have revised their expectations up for year-end hikes. As the chart below shows, major central banks are expected to end the year with policy rates of 25 bps or higher than their current levels.

• Rising interest rates will encourage firms to be more profitable and provide investors with more value. This is because investors are increasingly prioritizing profitability over growth, as stocks now have a viable alternative in government bonds. However, growth companies are not completely out of the race. As the recent craze over AI has demonstrated, investors are still willing to buy stocks with a lot of upside potential. In the meantime, stocks should start to look more attractive over the next few months and should provide investors with opportunities in the medium- and long-term.

Recession Fears Abound: Property prices are under pressure, and economic activity is slowing in Europe.

• Higher interest rates are starting to weigh on real estate markets around the world. In Germany, the year-over-year change in housing prices fell 6.8% in the first quarter. The United States is also facing high levels of distress in commercial real estate properties, while the United Kingdom is trying to prevent a potential mortgage crisis. These problems are a reflection of the negative impact that the current monetary policy is having on the world economy, and they may be a potential sign that financial conditions are becoming too tight.
• The purchasing managers’ index (PMI) from the eurozone is on the brink of contraction. The flash reading for the June composite PMI for the euro area slowed from 52.8 to 50.3, just above the 50-point threshold that separates growth from contraction. The slowdown was driven by a steep decline in manufacturing activity. Industrial output has been struggling as demand for goods has started to weaken. The drop in manufacturing activity will contribute to the decline in the economic output and may worsen if the country’s energy supply is strained this winter.

• European central bankers are facing a difficult balancing act. They are concerned about inflation, which is well above the central bank’s 2% target. However, they also worry that raising interest rates could further damage the eurozone economy. Fears that it may cause harm to consumers have led policymakers to push banks to increase the pay savers for their deposits. The potential income effect due to higher deposit rates could encourage the central bank to tighten for longer; however, it is not clear whether banks will listen.

 Choosing Friends: The growing rivalry between the United States and China is pushing Asian and European allies to diversify their trade relationships and strengthen their security ties

• This is evident in South Korea, which has imported more goods from the United States than it has from China for the first time in almost two decades, and reflects the country’s need to protect itself from a growingly hostile China. Beijing has pressured South Korea to reduce its reliance on the U.S. and Japan, but the country is resisting these efforts. In addition to improving trade ties with the U.S., South Korea has also looked to deepen defense ties with Japan.
• As Germany weans itself off Russian gas, it has signed a deal with the United States for liquefied natural gas (LNG). This is a significant shift in Germany’s energy policy and shows how the country is looking to distance itself from Moscow following its invasion of Ukraine. The deal is also an example of the United States’ emergence as an energy-exporting power. It has been a net exporter of natural gas since 2016 and is expected to export more oil than it imports later this year. The U.S.’s growing influence in the energy space will likely play a role in its ability to keep its trade partners on its side as it looks to compete with China.

    (Source:  Joseph Politano)

• We expect that China and the United States will use a carrot-and-stick approach to win over countries. The carrot will likely come in the form of increased market access and foreign direct investment for friendly countries. In contrast, the stick may come in the form of sanctions and trade restrictions. Even though many countries will look to resist having to choose a side between the two major powers, most will ultimately have to do so. This may mean that certain countries could face some backlash. At this time, it does not appear that either Washington or Beijing is willing to use its full might against potential detractors, but that could change over the next few years.

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