Weekly Energy Update (May 18, 2023)

Posted on May 18, 2023May 17, 2023 by Amanda Ahne

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA | PDF

Oil prices were mostly steady over the past week. Recession fears continue to stifle price movements.

(Source: Barchart.com)

Commercial crude oil inventories rose 5.0 mb compared to the forecast draw of 2.0 mb. The SPR fell 2.4 mb, putting the total build at 2.6 mb.

In the details, U.S. crude oil production fell 0.1 mbpd to 12.2 mbpd. Exports rose 1.4 mbpd, while imports increased 1.3 mbpd. Refining activity rose 1.0% to 92.0% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories. After accumulating oil inventory at a rapid pace into mid-February, injections first slowed and then declined. For the past two weeks, stock have increased, putting the current level near average.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $56.42. Although OPEC+ is trying to stabilize the market, recession worries are clearly pressuring crude oil prices.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories. With another round of SPR sales set to happen, the combined storage data will again be important.

Total stockpiles peaked in 2017 and are now at levels last seen in 2002. Using total stocks since 2015, fair value is $93.20.

Gasoline markets are tight.

The previous chart shows the number of days the current level of inventory could cover based on current demand. The latest reading is 24 days, a level we usually see in late October, well after the summer driving season has ended. As the five-year average shows, we usually have about six more days of inventory available as we swing toward Memorial Day. Barring a sharp decline in demand, we are going into the summer with unusually tight gasoline supplies, which may boost prices.

Market News:

The IEA projects that the oil market will tighten rather dramatically in the second half of this year. The forecast assumes strong Chinese demand.
Although we continue to harbor doubts this will ever occur, the DOE has issued parameters to add 3.0 mb to the SPR in August. If prices are above $70 per barrel, we doubt the order will be executed; in addition, this is a very small amount given the fact that 231 mb have been drained since the start of 2022.
There is growing evidence that the shale boom is fading. Rig counts have stalled, and some new rigs are being auctioned off at low prices. The bargain prices on rigs may simply reflect overbuilding, although rig count growth has clearly slowed.
The DOE is projecting higher natural gas prices this year.

Kazakhstan oil exports jumped 24% in March when compared to last year. The sharp rise reflects the disruptions caused by the war in Ukraine. We also note that Russian oil exports hit a post-invasion high in April, although the price for Russian oil has declined, leading to less revenue. To some extent, this was the goal of the U.S. from the outset—to maintain global supply levels for crude oil (to avoid high prices) but reduce Russia’s revenue—which it seems to have achieved. Thus, supply has remained elevated, which has kept prices lower than expected.
An El Niño event is forming quickly and the NOAA says it will be significant. This will likely mean a warm winter. So far, 2023 is setting up to be the fourth warmest April on record over the past 174 years, and heat advisories have been issued for the Pacific Northwest. This El Niño is expected to boost global temperatures past the 1.5 C mark in the next few years, which has been a target for some environmental actions.
With the EU outlawing the sales of internal combustion engine (ICE) cars by 2035, and the U.S. taking steps to advance the conversion, there is some concern that gasoline demand will decline. However, it’s important to remember that ICE vehicles have an ever-expanding lifespan, with the current average light vehicle lifespan being 12.5 years and it can be even longer for cars. That means that most ICE vehicles sold today will still be running into the mid-2030s.
- The EIA projects that EV new car sales will reach a 15% market share by 2030 but could flatten after that. If this prediction is correct, it suggests that oil will be needed well into this century.
At the same time, we note that French President Macron has called for a time out on EU environmental regulations. He is worried that European firms won’t be able to compete against foreign companies less encumbered by environmental rules.
Canadian oil prices often trade at a discount to U.S. prices due to the lack of transportation. However, as bottlenecks ease, we are seeing spreads narrow.
Argentina is preparing to use natural gas from the Vaca Muerta (“dead cow”) shale fields to offset imported gas from Bolivia.

Geopolitical News:

Iran’s economic minister is visiting the Kingdom of Saudi Arabia, providing further evidence of the diplomatic thaw between the two countries.
Iraq and Shell (SHEL, $60.13) are in a joint venture to supply gas to an electric utility that is mostly owned by an Iranian company.
The EU and G-7 have barred states in both groups from accepting natural gas from Russian pipelines. The goal is to take away any idea that Russian piped gas could return at some point, because if that hope was available, it might curtail the investment necessary to transition away from Russian gas.
Venezuela is issuing export licenses to European oil companies. The two companies, ENI (ENI, $29.02) and Repsol (REP.MC, EUR, 13.30), already plan to export LNG and other natural gas liquids. The goal now is to export oil as well. Gradually, Venezuela has seen the sanctions regime ease.
As we have noted in recent weeks, Russian oil is being processed into products and sold around the world. The EU is being pressed to stop buying these refined products to maintain sanctions on Russian oil.
One way the EU is trying to protect their industrial base from environmental rules is with a carbon tariff. The idea is that if Europe has strict environmental restrictions, then foreign nations that don’t deploy similar policies will undercut EU prices. Foreign nations often view such measures as protectionist; we note India is taking its case to the WTO with regard to these carbon tariffs.

Alternative Energy/Policy News:

The Biden administration has proposed sweeping new rules on electric utilities designed to reduce carbon emissions. As we noted last week, the Supreme Court may limit the ability of agencies to make such shifts, but regardless, the White House is moving ahead despite the risks. We do note that the rules may support carbon capture, which is controversial among environmentalists. Most carbon capture activity is occurring in the natural gas processing industry. The Biden administration is boosting funding for various carbon storage projects. Politically, these projects make sense as they allow for the continued use of fossil fuels but mitigate the carbon impact. Of course, most of these carbon storage methods are untested, but if they work, they will offer a “middle of the road” approach to deal with carbon emissions.
- The White House is also trying to ease permitting regulations, which has support from both fossil fuel proponents and environmentalists. However, streamlining permitting will remove one of the key tools used by environmentalists to thwart the expansion of pipelines. In the debt-ceiling talks, the GOP is trying to streamline oil and gas permitting while thwarting the expansion of power lines, which would be needed to make wind and solar more efficient. We suspect this stance is for bargaining purposes.
- Even in oil country, there is concern about carbon capture, since safely storing tons of CO₂ underground is a new industry.
- Recent climate laws have around $11 billion in funding for rural low and zero emissions power projects. This money is designed to help co-ops deploy renewables, capture carbon, and execute other projects.
One of the conundrums that we have been watching is that the conversion from fossil fuels will require lots of mining, some of which is environmentally disruptive. As environmental groups oppose mining projects, they are creating supply issues on critical metals needed for renewable energy technologies.
Distributed power will raise costs for consumers who remain with traditional electric utilities. It may be necessary to tax those who install solar panels on their homes and businesses for equity reasons, but doing so will reduce the impact of distributed power.
As the Biden administration unveils its rules for solar power subsidies and credits, the domestic solar panel industry is disappointed in the level of Chinese content that is still allowed for subsidies and credits. A number of companies in this area saw stock gains on the news. Still, there is fear that the rules will allow China to dominate solar power.
- On the EV side, Lithium Americas (LAC, $21.80) is splitting from China’s Ganfeng Lithium Group to develop a project in Nevada. The affiliation with China was becoming an issue.
- The president has vetoed a resolution that would have prevented the Commerce Department from suspending tariffs on Chinese solar panels. The panel manufacturing industry wanted the tariffs to remain in place, while the installers wanted access to cheap Chinese solar panels.
As we have noted in recent weeks, there is interest in using less costly materials in EV batteries. One being considered is a lithium-iron-phosphate battery, which uses less nickel compared to other battery formulations. This battery tends to lose power in cold temperatures, but new developments suggest this downside could be limited.
The Inflation Reduction Act upset the Europeans as it created subsidies to build out the EV infrastructure. European firms in this industry, including automakers, are considering investments in the U.S. to take advantage of these incentives. European nations are trying to figure out if and how they can match the support of the U.S. act. Recently, Germany offered Northvolt, a private Swedish battery maker, subsidies to build a battery factory in Germany. The EU has been trying to craft a broad European response, but individual nations have started to move independently.
EV sales in Asia are rising rapidly. China is positioned to dominate the global EV market.
- China is the majority supplier of key EV components. This dominance includes both raw materials and processing. Through industrial policy, China has steered its economy toward creating the industrial structure needed for this transition.
- Other automakers are giving up on the Chinese market due to the growing prowess of Chinese firms. And it’s not just foreign firms. Chinese firms, as well, are locked in stiff competition with each other. The competition is leading to rapidly falling prices.
- For the rest of the world, there is a growing possibility that nations will either (a) import Chinese EVs at low cost to expand EV usage, or (b) exclude Chinese EVs to protect domestic industry. The consequence to the first choice is low inflation (imagine $15k new cars) and expanded EV adoption at the cost of harming domestic industry. The second choice supports domestic industry and jobs but slows the adoption of EVs and likely triggers higher inflation.
- Increasingly, automakers are being forced to buy mines to secure key metals for batteries. This vertical integration is similar to the early days of ICE vehicles.

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Daily Comment (May 17, 2023)

Posted on May 17, 2023May 17, 2023 by Amanda Ahne

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a hawkish statement by Bank of England Governor Bailey that suggests British interest rates are likely to go higher. We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a new technology-theft scandal that will probably further worsen U.S.-China relations and news that commercial office buildings are starting to be sold at fire-sale prices.

United Kingdom: Bank of England Governor Bailey warned that he is prepared to keep raising interest rates as much as necessary to fight what he called a wage-price spiral and bring consumer price inflation down to the institution’s target of 2%. Despite optimism that the Federal Reserve will now pause U.S. interest rates, Bailey’s comments serve as a reminder that “second-round” inflation pressures are probably in place around the world and could still require the major central banks to hike rates higher and keep them there for longer than currently anticipated.

China-United States-South Korea: Yesterday, the U.S. Department of Justice’s new task force focused on protecting critical technologies from being stolen by foreign governments charged a Chinese citizen, Weibao Wang, with stealing trade secrets from Apple (AAPL, $172.07). While Wang worked for Apple in California on a project related to driverless-car technology, he simultaneously took a job at the U.S. subsidiary of a Chinese company developing driverless cars. Prior to informing Apple that he was quitting, he allegedly stole thousands of documents and other information before fleeing to China. Other recent reports show Chinese firms and spy services are ramping up their effort to steal technology secrets from South Korea and other advanced countries in the West.

While many Western business elites continue to resist decoupling with China for fear of losing financial and economic opportunities, we think Beijing’s continued program of getting Western technology “by hook or by crook” will ultimately undermine their position. China’s aggressive military build-up will probably also justify decoupling.
Indeed, Western leaders in recent months have noticeably shifted their rhetoric to emphasize protecting national security over trade and investment with China.

Taiwan: The island’s largest opposition party has picked Hou Yu-ih, the popular mayor of New Taipei City, as its candidate in January’s presidential election. To contrast himself with the independence-minded ruling party, the Kuomintang party’s Hou opposes a formal breakaway from China but also doesn’t support operating under Beijing’s “One China, Two Systems” arrangement as it is applied in Hong Kong. That stance may make him more palatable than other Kuomintang politicians who want the island to be closer to China, but it remains to be seen whether it will be enough to win the election.

Indonesia: The chief executive of the country’s sovereign wealth fund said the fund will deploy some $3 billion into Indonesian infrastructure, digital assets, and other domestic opportunities in 2023, including funds from international co-investors. The announcement is being seen as a sign of Indonesia’s attractiveness as an investment destination as investors sour on China, and Indonesia positions itself as a key supplier for materials related to green technologies.

Turkey: The united opposition group that unexpectedly lost the first round of Sunday’s election to President Erdoğan accused the electoral authorities of large-scale irregularities but admitted that it would have lost the first round anyway. Since Erdoğan very nearly snagged the 50% of the vote needed to win outright, he appears to be in the driver’s seat to win the second and final round of voting on May 28. The likelihood that Erdoğan’s unorthodox economic policies will remain in place continue to weigh on Turkish assets so far this week.

Brazil: State-owned oil giant Petrobras (PBR, $11.78) said it will end its longstanding practice of pegging the domestic price of its fuels to global prices. The move appears to clear the way for leftist President Luiz Inácio Lula da Silva to keep domestic prices artificially low for his own political purposes. If that comes to pass, it could portend expensive new subsidies to be paid from the government budget. The loss of fiscal discipline would likely be negative for Brazil’s stocks, bonds, and currency.

U.S. Monetary Policy: Consistent with our earlier comments on the Bank of England’s policy, Cleveland FRB President Mester yesterday warned that she hasn’t seen enough evidence that U.S. inflation pressures have eased to the point where the Fed should stop hiking interest rates. However, Chicago FRB President Goolsbee and Atlanta FRB President Bostic both signaled they want to hold rates steady now to avoid over-tightening and potentially sparking a financial crisis. We continue to believe the Fed is at least close to the end of its tightening cycle, if it’s not there already, but continued inflation pressures mean rates in the U.S. and in other developed countries could still go higher.

U.S. Energy Industry: Data from Baker Hughes (BKR, $27.44) confirms that U.S. oil and gas exploration has suddenly cooled since the beginning of the year. The figures show the number of oil and gas drilling rigs in operation has fallen some 6% so far in 2023 to just 731. The drop in exploration likely reflects multiple factors, including lower energy prices, investors demands that energy companies exercise capital discipline, and concerns about regulation and the green-energy transition. As we noted in our Comment yesterday, the fall-off in global output comes at a time of rising energy demand in China and other developing countries, which could spark a rebound in prices later in the year.

U.S. Commercial Real Estate Market: Several sizable office buildings around the country have recently been sold at fire-sale prices, suggesting the work-from-home movement and high interest rates are causing increasing stress in the commercial real estate market. Importantly, building owners now appear to have capitulated to the idea that weak prices are here to stay. Distressed sales are expected to keep increasing in the coming months.

Of course, some firms are starting to insist that workers pare back their WFH time. For example, giant asset manager BlackRock (BLK, $633.83) yesterday told its employees that they will only be allowed to work remotely one day per week starting September 11.
Despite such efforts, however, employee resistance and today’s tight labor market will likely keep office usage much lower than before the pandemic. Any significant rebound in office occupancy, rents, and building values seems a long way off.

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Daily Comment (May 16, 2023)

Posted on May 16, 2023May 16, 2023 by Amanda Ahne

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with new forecasts showing global crude oil demand in 2023 will likely rise more than expected, potentially boosting prices later in the year. We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a range of disappointing economic indicators out of China and signs of weakening small-business hiring in the U.S.

Global Oil Market: In its monthly report, the International Energy Agency boosted its forecast for global crude oil demand in 2023 to 102.0 million barrels per day (mbpd), up from 101.9 mbpd in last month’s forecast. The new forecast, driven by stronger-than-expected demand in China and other developing countries, represents an increase of 2.2 mbpd when compared with demand in 2022.

In contrast, the IEA expects global supply to grow only weakly because of recent cuts by the Organization of the Petroleum Exporting Countries and its allies, capital discipline among drillers, and regulatory and energy-transition headwinds.
Even though oil prices have recently pulled back because of concerns about weakening demand in the advanced countries, the IEA’s forecast indicates some risk that higher demand in the developing countries could boost prices later in the year.

China: Despite China’s stronger-than-expected oil demand in the IEA oil market report, several data releases today provided more evidence that the country’s post-pandemic economic rebound is running out of steam. For example, April retail sales were up 18.4% year-over-year, but that was largely because of the big pandemic lockdown in Shanghai in April 2022. The annual rise was weaker than expected, and sales last month were only slightly higher than in March. The April unemployment rate fell to 5.2%, but that masked a record jobless rate of 20.4% for people aged 16 to 24. Fixed-asset investment and factory production also disappointed.

China-South Korea: Chinese police on Friday arrested Son Jun-ho, a 31-year-old who plays in China’s top-tier soccer league and has appeared for the South Korean national team, on suspicion of accepting bribes. The arrest marks another in a series of detentions of high-profile foreigners from countries that have been working more closely with the U.S. to build their national defense capabilities and crack down on technology flows to China.

Along with Beijing’s recent clamp down on foreign consulting and information businesses in China, the arrests are probably retaliation for the U.S.’s dramatic and internationally coordinated restrictions on selling advanced semiconductors and related equipment and services to China. Those restrictions were first announced October 7, 2022.
The arrests and harassment of Western firms in China have already added to the disincentives for foreign companies to operate in China. That may seem counterproductive for Beijing. However, it’s important to remember that the Chinese Communist Party ultimately wants to end the country’s reliance on foreign providers for any high-value goods or services. The new arrests and harassments may signal that the party sees China as strong enough to push those foreign providers out now.

China-United States: Yesterday, the U.S. Department of Justice announced that it has arrested Litang Liang, 63, of Brighton, Massachusetts, on charges of acting as an unregistered foreign agent for China. Liang, a U.S. citizen, allegedly provided officials at the Chinese consulate in New York City with information about Boston-area individuals and organizations that oppose Chinese policies. He also organized counter-protests against anti-Beijing activists in the area and suggested the names of ethnic Chinese people that Beijing’s spy services should try to recruit.

Naturally, the arrest of Liang will further spoil U.S.-China relations.
The arrest also provides more evidence that China is running a large, aggressive program of spying, influence operations, and extraterritorial policing on U.S. soil.

Japan: As global investors plow into Tokyo’s stock markets, the country’s key indexes today have reached their highest levels in 33 years. We agree that Japanese equities look attractive on several counts, including valuations, corporate performance, geopolitical trends, and the prospect for a decline in the value of the dollar, which typically boosts returns for foreign stocks.

Brazil: Arthur Lira, the speaker of the Brazilian Congress’s lower house, vowed in an interview with the Financial Times that he will block any effort by leftist President Luiz Inácio Lula da Silva to roll back the business-friendly laws of the previous conservative President Bolsonaro. The statement is being seen as a shot across the bow of the Lula administration, since it does not command a majority in congress and must rely on Lira’s center-right bloc in order to pass bills.

U.S. Monetary Policy: Richmond FRB President Barkin yesterday said the Fed shouldn’t be afraid to keep raising interest rates to bring down inflation even if doing so raises the risk of financial instability. Barkin effectively argued that bringing down inflation was a higher priority, and that “steady” rate hikes would help lower the risk of a financial crisis.

U.S. Fiscal Policy: President Biden, House Speaker McCarthy, and other congressional leaders will meet face-to-face again today in an effort to reach a deal on raising the federal debt limit. Biden expressed optimism yesterday that Democrats and Republicans can reach an agreement that would avoid a federal debt default. Press reporting suggests the evolving deal might be built on fixed caps on federal spending for some period of time, clawing back unused pandemic relief funds, and tightening work requirements to receive certain federal benefits.

Continued signs of progress in the talks will likely buoy stocks in the short term, at least until investors focus again on the likelihood of a recession starting soon.
Nevertheless, many individual investors appear to be dumping the shortest-term Treasury bills as they prepare for the worst. One-month bill yields have shot up in response.

U.S. Labor Market: A survey by the Wall Street Journal showed that the share of small-business owners who expect to expand their workforce over the next year was below 50% for the second month in a row in May, hitting the lowest level since June 2020. The fall in hiring intentions is another hint that the economy is slipping toward recession, even if the main economic indicators don’t show it yet.

At the same time, the country continues to face longer-term imbalances in the labor market, in part because of the prospect for “re-industrialization” as geopolitical tensions and new government industrial policies encourage firms to invest more in domestic manufacturing.
Many of the new factories being built are in technology-intensive sectors like semiconductors, defense, and clean energy. Because of a shortage of U.S. workers with top-notch skills in science, technology, engineering, and mathematics, a number of tech and clean-energy executives have called for the government to urgently loosen immigration rules to let in more highly-skilled workers from abroad.
At the same time, the Biden administration has begun to stress that its signature laws which boost infrastructure investment and subsidize factory development will create many new jobs that don’t require a college degree. Once the economy has moved past the expected recession, the new re-industrialization could produce a long-lasting shortage of workers in areas like construction and construction trades, welding and metalworking, and machine-tool operating.

U.S. Stock Market: Berkshire Hathaway (BRK-B, $323.53) revealed in a regulatory filing yesterday that it has opened a new position in credit-card issuer Capital One (COF, $89.12). Because of CEO Warren Buffett’s reputation as a star investor, the news looks set to give a boost to Capital One when the market opens today. The filing also revealed that Berkshire has recently increased its holdings in Apple (AAPL, $172.07) and Bank of America (BAC, $27,65), which could help buttress near-term buying in those names as well.

The company eliminated its position in at least two regional banks, consistent with the recent crisis in U.S. medium-sized and smaller lenders.
It also eliminated its position in Taiwan Semiconductor Manufacturing (TSM, $85.66), which perhaps should be no surprise given Buffett’s recent concerns about growing geopolitical tensions between China and the West.

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Bi-Weekly Geopolitical Report – Opportunities and Risks in a Tripolar Nuclear World (May 15, 2023)

Posted on May 15, 2023May 11, 2023 by Amanda Ahne

Patrick Fearon-Hernandez, CFA | PDF

Some 30 years into China’s development boom, it’s no longer controversial to say that tomorrow’s global investment environment will be shaped by Beijing’s effort to displace the United States as the world’s dominant country. China remains focused on building its various sources of power, whether they be political, economic, technological, or military. We have examined those sources of power and their implications for investors in various publications. This report dives deeper into one aspect of China’s growing military power: its new effort to expand its arsenal of strategic nuclear weapons and the means to deliver them against the U.S.

China’s nuclear buildup will result in a scarier, less stable world. Many investors and investment managers will be tempted to close their eyes to this uncomfortable risk. Here at Confluence, we think it’s better to understand this important trend and incorporate the resulting opportunities and risks into our investment strategies. It may seem strange to mention opportunities in relation to a potential nuclear arms race, but history shows that riches are often made during times of war or international tension. Although nuclear war is unthinkable and unwinnable, preparation for a conflict will require investment and economic allocation. Portfolios should take this spending into account. In discussing the investment implications of China’s nuclear buildup, we therefore identify both the opportunities and the risks that may arise.

Read the full report

Don’t miss the accompanying Geopolitical Podcast, available on our website and most podcast platforms: Apple | Spotify | Google

Daily Comment (May 15, 2023)

Posted on May 15, 2023May 15, 2023 by Amanda Ahne

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a major mining merger that underscores our oft-stated view that global commodity markets are set to enter a prolonged boom period once we get past the expected recession. We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including an unexpectedly strong performance by President Erdoğan in Turkey’s elections over the weekend and upbeat comments by Treasury Secretary Yellen regarding the negotiations over the U.S. federal debt limit.

Global Commodity Markets: Canadian gold miner Newmont (NEM, $45.94) has agreed to buy Australian miner Newcrest (NCMGY, $18.81) in a move that will expand Newmont’s access to minerals such as copper, which are expected to be in high demand as the world transitions to electric vehicles and other forms of electrification.

More generally, Newmont’s move is consistent with our view that global fracturing and insufficient investment will boost prices for a range of mineral commodities in the coming years. Even automakers are looking to get into mining in order to control prices for key mineral inputs.
Separately, the World Platinum Investment Council issued a report forecasting that global platinum demand will jump 28% this year to 8.2 million ounces. However, the report also warned that sporadic electricity production in South Africa, the main producer, will leave a deficit of almost one million ounces. The deficit is expected to further buoy platinum prices in the near term.

Turkey: In yesterday’s presidential election, President Recep Tayyip Erdoğan and opposition leader Kemal Kılıçdaroğlu came in first and second, respectively, but it appears neither won the required 50% to avoid a run-off ballot. That ballot will take place on May 28. Separately, Erdoğan’s alliance appeared to be on track to maintain its majority in parliament after clinching 323 of the 600 seats in the National Assembly, compared with the opposition alliance’s 211 seats.

Erdoğan’s tally in the presidential election was better than recent polling suggested, which could prompt destabilizing allegations of fraud.
In any case, the president’s better-than-expected results could lead to disappointment among investors looking for a return to more orthodox economic policies in Ankara and renewed cooperation with the West. Indeed, Turkish stocks are falling on the news so far this morning.

Greece: In happier news from the same neighborhood, S&P recently assigned a “positive” outlook on Greece’s sovereign credit rating. That sets the stage for the country to possibly regain an investment-grade rating if the winner of the May 21 elections commits to continuing favorable economic policies. S&P currently rates Greece’s foreign debt at BB+/B, one step below investment grade.

Greece was the poster child for Europe’s fiscal troubles during the Great Financial Crisis more than a decade ago.
Now, however, economic growth in Greece is skyrocketing and government economic policies have improved markedly.
Regaining an investment-grade credit rating would lower the government’s interest payments just when rapidly rising rates are becoming a greater headwind.

Russia-Ukraine War: After months of slowly pulling back as Russian forces advanced through the eastern city of Bakhmut, Ukrainian forces have not only caught the Russians unawares with a small counterattack, but some reports suggest they may now be trying to surround the city. If that’s the case, the Ukrainians could trap the Russian troops, ammunition, and equipment deployed there. Such an event, which would probably be distinct from the expected large-scale Ukrainian counterattack, would further weaken the Russian military and be a major embarrassment for President Putin.

China-United States: The Chinese government said it has sentenced a U.S. citizen to life in prison for espionage. The U.S. citizen, 78-year-old John Shing-wan Leung, also has permanent-residency status in Hong Kong. He was arrested in April 2021. The case could further strain ties between China and the U.S. despite recent government-to-government meetings aimed at reducing tensions.

Separately, some Chinese students in the U.S. are pushing back against the Chinese Communist Party’s effort to control their activity even when they’re thousands of miles from home.
The small group of Chinese students studying at George Washington University in Washington, DC, has announced the establishment of an Independent Chinese Student Union to give young local Chinese a platform to organize and express political ideas free from the party’s prying eyes.
The students say their aim is to protect students from the CCP and the Chinese Students and Scholars Association that the party directs. They also aim to convince the university to fully divest from “companies complicit in the Uyghur genocide and which enable the CCP.”

China-Vietnam-Philippines: In a new stand-off over control of the South China Sea, the Chinese government has dispatched coast guard ships and ostensibly private fishing vessels to an area where Vietnam said it would expand oil drilling. Reports indicate the Chinese coast guard ships have provocatively cut off Vietnam’s coast guard vessels sailing near an existing oil well. Separately, the Philippine government has attempted to assert its sovereignty over areas of the South China Sea by placing navigation buoys in its exclusive economic zone near the disputed Spratly Islands. China so far has not responded to the placement of those buoys.

Thailand: In elections over the weekend, two opposition parties took the lion’s share of the 500 seats in parliament. The progressive Move Forward Party was the top vote-getter, earning a projected 151 seats, while the populist Pheu Thai Party earned 141 seats. However, the ruling military junta will have the ultimate say in who forms the next government, a process that could take weeks.

Argentina: The government today will unveil a series of tough economic measures designed to avoid a big currency devaluation ahead of October’s elections. The measures reportedly will include a 600 bps rise in interest rates, increased central bank intervention in the currency markets, and the elimination of tariffs on food imports to help bring down inflation. The measures apparently don’t address the key causes of Argentina’s economic problems, such as its big budget deficit.

U.S. Fiscal Policy: Over the weekend, Treasury Secretary Yellen said administration officials and congressional Republicans were making progress in their negotiations over an increase in the federal debt limit. According to Yellen, the negotiators “have found some areas of agreement” that could lead to a deal that would avoid having the government default on its debt. Reports suggest one potential area of agreement is to temporarily cap federal spending, rather than institute outright cuts, while another is to claw back unused pandemic relief funds. Any deal that removes the risk of a government debt default could prompt a relief rally in financial markets. However, any such rally could be short-lived as investors start to focus again on the likelihood of a recession.

U.S. Municipal Economies: Conference and hotel demand in North America finally surpassed 2019 levels in the fourth quarter of 2022, according to the Events Industry Council, an organization consisting of convention trade groups. Rebounding convention business will likely give a welcome boost to downtown areas in many cities and help bolster municipal tax bases.

U.S. Weather: The Pacific Northwest has been hit with a record-breaking heat wave, with temperatures reaching the high 80s in Seattle and the mid-90s in Portland. If they last longer than anticipated, the high temperatures could raise the risk of flooding, worsened drought, and a more dangerous forest fire season.

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Daily Comment (May 12, 2023)

Posted on May 12, 2023May 12, 2023 by Amanda Ahne

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment starts with our thoughts about this weekend’s presidential election in Turkey. Next, we explain why the recent drop in the British Pound Sterling (GBP) against the U.S. dollar may not hold. Lastly, we discuss how the controversy in South Africa may give investors insights into how the U.S. may respond to countries that don’t comply with sanctions.

Turkish Election: Turkish President Recep Tayyip Erdoğan is facing his toughest election test on Sunday as he looks to extend his nearly 20-year rule.

President Erdoğan’s rival, Kemal Kılıçdaroğlu, is the favorite to win the election this weekend. On Thursday, third-party candidate Muharrem İnce withdrew from the contest after an alleged indiscretion surfaced earlier this week. His exit is expected to support Erdoğan’s rival Kemal Kılıçdaroğlu, who is representing a six-party coalition. Several surveys show that Erdoğan lags in the polls, but the race is still too close to call. Despite İnce’s departure, his name has not been removed from the ballot, so it is possible that the election may still head to an unprecedented second round on May 28.
Anticipation about the voting result has led to increased market jitters as traders brace for a shift in the country’s unconventional monetary policy. Erdoğan’s insistence that higher interest rates lead to increased inflation has led the country’s central bank to loosen monetary policy and slash its benchmark policy rate by more than half in less than two years despite annual inflation hovering above 40%. Capital restrictions have prevented currency holders from hedging against rising inflation. That said, the country will face significant currency devaluation no matter who wins the presidential race as the government will not have the tools needed to maintain tight currency controls for much longer.

Sunday’s election has been closely watched by investors as the outcome may have geopolitical implications. Turkey is located between Europe and the Middle East and has control of the strategically important Black Sea and has the second largest army in the NATO military alliance. There has been friction between Turkey and its NATO allies, however, mostly because of President Erdoğan’s reputation for being an unreliable partner due to his tendency to play both sides of an international conflict. Hence, his ouster will likely improve relations between Turkey and the West. Additionally, a new Turkish President could pave the way for more traditional economic policy.

U.K. Confidence: Better-than-expected economic data has led the Bank of England to reassure investors that it has room to raise rates further.

The U.K. central bank lifted its benchmark interest rate on Thursday by 25 bps to 4.5%, its high level since 2008. Additionally, the BOE revised its economic outlook by removing any prediction of a recession within the year. Despite the optimism, British policymakers insist that inflation remains too high and have warned that food prices would fall more slowly than they had anticipated. The 10.1% annual inflation in the U.K. is higher than in the U.S. and the European Union. As a result, BOE Governor Andrew Bailey vowed that the central bank would continue to work to get inflation down to its 2% target.
The GBP is the best-performing G10 currency this year, but it weakened following the announcement. On Thursday, the GBP fell 0.9% from the previous day. Its weakness is related to concerns that the BOE may have oversold the health of the economy as investors doubt that the country can tolerate additional rate hikes. Unlike American homeowners, borrowers in the U.K. face significant interest rate risk as loan rates have short-term expirations. Thus, investors fear that the BOE may trigger a recession as it looks to restore price stability. Equities were little changed following the rate decision as interest futures are not convinced that policymakers will maintain their inflation fight.

A recession will have a negative impact on the currency, but we still foresee the GBP outperforming the greenback this year. In our view, the Federal Reserve will end its hiking cycle before the BOE. The latest CME FedWatch Tool predicts that there is a high likelihood that U.S. policymakers will pause at their next meeting. Meanwhile, Gilt futures suggest that the BOE may institute another two rate hikes before it is finished. The differences in interest rates should put downward pressure on the dollar and may offer some support for British equities.

Beware of the Sanctions: South African assets are facing pressure after the U.S. accused the country of supporting Russian war efforts in Ukraine.

A U.S. ambassador has accused the South African government of supplying ammunition to the Russians. The alleged incident took place last year after a Russian vessel arrived at a dock in Cape Town. The country’s president has denied that anyone in his administration was authorized to load weapons on the ship but has launched an investigation into the matter.
The allegation comes at a delicate time as the country struggles to constrain the rolling blackouts that have led to concerns about the country’s grid. Also, electricity production in Africa’s second-largest economy has been plummeting. Despite South Africa’s robust growth over the last two decades, its electricity production is hovering near a 20-year low. Additionally, the situation puts South Africa’s preferential access to the U.S. market in jeopardy. As a result, investors do not believe the country will be able to expand its industrial activity as the country may face weaker demand for its goods.
The controversy has led to a major sell-off of financial assets as investors’ concerns about growth worsened. The rand (ZAR) dipped below 19.35 against the dollar on Thursday, beating the previous record low set during the pandemic. Additionally, the Johannesburg Stock Exchange sank 1.0% in the same period.

The situation in South Africa highlights the potential danger that countries could face when they decide to side with America’s enemies. As the world’s largest consumer market, the U.S. has the ability to use trade as a weapon to prevent countries from circumventing Western sanctions. Unlike the dollar, the use of trade cannot be remedied through the use of barter or with a simple workaround. The U.S.’s response to South Africa shows countries that America will have little tolerance for countries seeking to aid Russian war efforts. If we are correct, this may mean that countries will feel more pressure to choose sides as the world breaks into regional blocs. As a result, the incident reinforces our view that the U.S. dollar is headed toward a secular decline.

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Daily Comment (May 11, 2023)

Posted on May 11, 2023May 11, 2023 by Amanda Ahne

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment starts with a discussion about why the market reacted so positively to a subtle drop in U.S. inflation. Next, we provide our thoughts on the latest developments in debt ceiling talks and how they impact U.S. Treasuries. Lastly, we provide an update on the ongoing competition between China and the West.

Now a Pause? A key inflation indicator bolstered investor confidence that the Federal Reserve is close to ending its hiking cycle.

Consumer price data showed that the Fed is making progress in its inflation fight, despite only a modest decline in price pressures. Last month, the consumer price index rose 4.9% from the prior year. Although the increase only slightly beat consensus estimates of 5.0%, a deeper look into the data tells a different story. Non-housing core services inflation, Fed Chair Jerome Powell’s favorite indicator, declined to 5.2% last month from a peak of 8.2% in September 2022. The price indicator is viewed as a gauge of the wage pressures within the inflation data. Thus, its decline could give Fed officials the greenlight to pause in their next meeting.
Speculation about the end of the interest rate hike lifted market sentiment. The NASDAQ Composite Index rose 1.04% on Wednesday as tech stocks were favored by traders looking to take on more risk. Additionally, the market is now convinced that the Fed will pause rates in June. The latest CME FedWatch Tool projects that there is more than a 90% chance that the central bank will hold rates at their current levels. Assuming the forecast is right, this may explain the strong performance in risk assets.

At this time, there is a fundamental disagreement between the market and the Fed over the next policy steps. The market wants the Fed to cut rates as the economy slows down. In contrast, Powell insists that the FOMC should maintain rates in restrictive territory until inflation is under control. So far, there has been no sign that the Fed is ready to pivot interest rates; thus, it is still likely that it will keep rates elevated throughout the year. As a result, the market will likely see a lot of uncertainty over the next few months.

Debt Fiasco: The ongoing dispute over raising the debt ceiling is already starting to spill into financial markets.

The two major parties continue to use the threat of triggering a potential crisis as the debt deadline approaches. On Wednesday, former President Donald Trump urged Republicans to push the country into an unprecedented default unless the Democrats commit to massive spending cuts. Meanwhile, his successor has floated the possibility of using the 14^th Amendment to remove the debt ceiling. Congress has only six scheduled legislative days left, and there does not seem to be a pathway toward an agreement.
Uncertainty over whether the U.S. will default on its debts has caused disarray within the Treasury market. One-month Treasury-bill yields have surpassed three-month government yields at levels not seen since one-month Treasury bills were introduced in 2001. This divergence is related to investors’ discomfort with the political brinkmanship over raising the debt ceiling. There is growing fear that the two sides will be unlikely to come to an agreement before the debt limit’s June 1 deadline. Failure to raise the debt limit could have catastrophic consequences for the U.S. economy and will undoubtedly push the country into recession.

Congress will likely feel pressured to act on the debt ceiling when the market friction moves from the Treasury bills into equities. The lack of equity movement related to the standoff is due to market confidence that lawmakers will eventually come to an agreement even if it includes a few defections. Thus, market participants have been able to focus their attention on other market-related events. This dynamic will change over the next couple of weeks as the impasse draws more attention from investors. At this time, we suspect government officials may look for a temporary solution to avoid a default.

Beijing Pivot: As the West reduces its dependency on China, Beijing is looking to build ties with emerging market countries.

Government officials in Europe are slowly distancing themselves from the world’s second-largest economy. Italy is expected to hold talks about a possible exit from China’s Belt and Road Initiative. At the same time, German Chancellor Olaf Scholz has described Beijing as being a “systemic rival” and has urged other EU countries to scale back their reliance on China. European countries’ decision to create “strategic distance” is related to concerns that China is looking to replace the global system with something that reflects its own ideology.
China has looked to developing countries to hedge against its potential decoupling from the West. On Thursday, Ecuador signed a free trade agreement with China that would boost non-oil exports. However, the deal will likely face resistance as it makes its way through the legislature. Across the Pacific, local governments in China have looked to raise capital from sovereign wealth funds in the Middle East. Officials have held talks with the Qatar Investment Authority, subsidiaries of Saudi Arabia’s Public Investment Fund, and the Abu Dhabi Investment Authority. The recent outreach in the Middle East and South America shows how China is prepared to recruit from areas within the U.S.’s sphere of influence.
Neither the West nor China wants an abrupt end to the trading relationship. Despite President Biden’s tough rhetoric, his administration has been aggressive in pushing the two Major Powers to reengage in talks. Secretary of State Antony Blinken is preparing to set up a visit to China later this year. At the same time, Defense Secretary Lloyd Austin has expressed interest in meeting China’s new defense minister Li Shangfu at an upcoming summit in Singapore. So far, China has rebuffed offers for communication as it describes Washington’s attempts at dialogue contradictory to its broader goal of Chinese containment. However, its lackluster recovery following the end of its Zero-COVID policy may force China to eventually relent to talks.
- We believe that the markets will welcome any sign of an easing of tensions between the West and China but talks alone won’t lead to an overall improvement in the relationship.

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Weekly Energy Update (May 11, 2023)

Posted on May 11, 2023May 10, 2023 by Amanda Ahne

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA | PDF

Although prices have bounced to return to the lower end of the $84/$72 trading range, recession fears continue to dominate sentiment.

(Source: Barchart.com)

Commercial crude oil inventories rose 3.0 mb compared to the forecast draw of 2.5 mb. The SPR fell 2.9 mb, putting the total draw at 0.1 mb.

In the details, U.S. crude oil production was unchanged at 12.3 mbpd. Exports fell 1.9 mbpd, while imports declined 0.8 mbpd. Refining activity rose 0.3% to 91.0% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories. After accumulating oil inventory at a rapid pace into mid-February, injections first slowed and then declined. This week there was an increase, although storage levels remain below seasonal norms.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $58.00. Although OPEC+ is trying to stabilize the market, recession worries are clearly pressuring crude oil prices.

Total stockpiles peaked in 2017 and are now at levels last seen in 2002. Using total stocks since 2015, fair value is $93.53.

Market News:

Shale oil has been mothering short of a revolution, but there are worries that we may already be past the peak in production. If so, the impact on the world economy could be profound.
The U.S. Chamber of Commerce has come out in support of streamlining the permitting process.
As oil company earnings have risen, so has talk of a windfall profits tax.
We live in divided times and there are very few topics that unite groups in America. Opposing China is one such issue that has become bipartisan, as is the recognition that local opposition to energy projects is slowing buildouts, whether they be tied to the fossil fuel industry or renewables. Congress has tried to address the issue of “red tape,” but we don’t expect this issue to be resolved anytime soon.
Usually, the focus on temperature-related energy consumption is focused on winter when cold temperatures drive the demand for heating. Increasingly, though, summer cooling demand is becoming significant as well. Last week, we noted that Southeast Asia is suffering from extreme temperatures early in the season, and hot, dry weather is triggering wildfires in Alberta, Canada. We also note that China is warning that a hot summer could lead to power shortages.
Iraqi policymakers are renewing their focus on energy with a major goal being self-sufficiency in natural gas. Iraq probably does have the resources as its associated gas flaring is the world’s second largest.
The Biden administration is floating the idea of imposing an energy tax on crypto mining. Data suggests the activity is the fourth largest consumer of household electricity.
Russian natural gas production has declined 10% so far this year.

Geopolitical News:

As China and the Kingdom of Saudi Arabia (KSA) have agreed to price oil sales in CNY, there has been a notable uptick in Chinese investment into the KSA.
- We note that National Security Advisor Jake Sullivan is in Saudi Arabia this week as part of a trip to the UAE and India. It appears that part of this visit will include a discussion on a possible U.S./KSA railway project, perhaps to compete with China’s Belt and Road Initiative.
As is often the case when sanctions are applied, firms willing to violate the sanctions (and bear the risk) can be rewarded with unusual profits. In the case of Russia, Greek firms appear to be the most active. Indian shippers are also involved.
The G-7 price cap has led the Kremlin to boost taxes on energy companies. Falling production and sales have crimped tax revenue and the state has decided to raise taxes to maintain revenues. Of course, this action will also reduce revenue for investment.
There is a raging debate underway surrounding the USD’s reserve currency status. Our take is that U.S. financial sanctions are encouraging nations that are fearful of sanctions to develop alternative international trade and financing arrangements. We doubt these arrangements will totally supplant the dollar’s deeply entrenched status. We note that Russia and India suspended talks on settling trade in INR, most likely for the simple reason that Russia has realized it would accumulate the Indian currency without a clear way to recycle the INR.
- At the same time, Pakistan says it wants to buy Russian oil with CNY. Pakistan is a major recipient of Chinese aid and investment, and thus, is likely to find it easier to secure CNY instead of USD.

Alternative Energy/Policy News:

The UAW has refrained from endorsing Biden for reelection. The union is worried about the EV movement. Since EVs have fewer parts than an ICE vehicle, job losses will be inevitable. We don’t doubt that an endorsement will eventually arrive, but it’s a warning to Biden that he may have to support the UAW which will likely mean higher prices for EVs.
The IEA notes that 15% of energy-related emissions come from oil and gas operations. Fortunately, the agency notes that existing technology exists to curb these emissions at affordable costs.
Although controversial, this graphic shows the allure of atomic power due to the fact that the energy density of uranium dwarfs all other forms of energy.
- Microsoft (MSFT, $310.52) has agreed to purchase nuclear fusion energy beginning in 2028 from a privately held firm called Helion. Although we are not sure anyone will have commercially available fusion power at scale, the fact that a large company like Microsoft is willing to forward purchase power can help boost investment and research.
Toyota (TM, $138.18) announced it will supply hydrogen fuel cells for semi-trailer trucks. Although battery technology dominates light vehicles, the batteries are too heavy to be practical for over-the-road trucks. Hydrogen offers an alternative to diesel-powered trucks. Toyota has lagged in the EV space, in part, because it has been more focused on fuel cells. In this application, hydrogen may pay off.
The GOP and nine Senate Democrats have passed a measure to overturn President Biden’s pause on solar tariffs; Biden has signaled he will veto the resolution. There has been a constant state of tension between those who want to source alternative energy production domestically (at higher costs) or leave the possibility open to import solar panels from China (the world’s low-cost producer).
- Lawmakers are also displeased with the administration’s easing of local content rules for critical minerals.
Israel unveiled a massive thermal storage operation which is expected to open by year’s end.
There is growing alarm over recent moves by nations in South America to nationalize various mineral mining operations. Moves to nationalize lithium, specifically, have raised concerns.
Eighty percent of new cars sold in Norway are EVs. The good news, so far, is that the grid has handled the change well, the cars are quieter, and pollution is much lower. The bad news is that it has hurt the established car makers and lines have developed at charging stations.
There is growing concern about the U.S.’s deficits in rare earths, which are critical for the energy transition. We note that a large rare earths deposit has been found in Wyoming.
- The Biden administration is moving to expedite a manganese and zinc mine in southern Arizona but is running into environmental opposition.
Direct carbon renewal projects are starting to operate. These are being helped by carbon-credit exchange markets. However, environmentalists are increasingly opposing these efforts, fearing that they will reduce the incentive to reduce fossil fuel usage.
Direct lithium extraction technology promises to boost production of the key mineral significantly.
China’s outbound foreign direct investment has been declining over the past decade. One bright spot, though, is China’s investment in European EV battery factories. This development could be problematic and is similar to the issues regarding solar panels. China is the low-cost producer of EV batteries, so having China build factories in Europe accelerates the energy transition. However, allowing China to build these factories makes European EV producers more dependent on and vulnerable to China.
- Glencore (GLNCY, $11.24) is planning to build Europe’s largest EV battery recycling plant.

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Daily Comment (May 10, 2023)

Posted on May 10, 2023 by Amanda Ahne

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with an overview of the devastating heatwave in Southeast Asia and the latest on the Russia-Ukraine war. We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including political and economic upheavals in key Latin American countries and new reports on the health of the U.S. banking system.

Southeast Asia: Countries including Vietnam, Thailand, Cambodia, and Laos have been suffering from a historic heat wave in recent weeks, leading to melted roadways, school closures, and business disruptions. The new record-high temperatures include 112°F in Vietnam’s northern Tuong Duong district and 110°F in the popular Laotian tourist destination of Luang Prabang. Since the populations in these countries are largely poor and less able to cope, the heat wave and the region’s unusually dry winter will likely have an outsized impact on the affected economies.

Russia-Ukraine War: Russian and Ukrainian officials say that at least one large Russian military unit has been destroyed in the embattled city of Bakhmut, potentially reflecting the Kremlin’s failure to provide enough equipment and ammunition to the Wagner Group mercenaries fighting there. The unit’s destruction, which apparently prompted Russian forces to pull back from part of the city, could also reflect improved resources provided by the West to the Ukrainians ahead of their widely anticipated spring counteroffensive.

Separately, the U.K. Ministry of Defense estimated that Russia’s total population declined by about two million people more than expected over the last three years because of both COVID-19 and the war in Ukraine. The ministry estimates that about 1.3 million people emigrated from Russia in 2022, including many young, highly educated people in high-value industries. In fact, about 10% of the country’s entire IT workforce left.
Finally, new reporting discusses how the war has been a boon for small, technology-oriented defense companies around the world.

Turkey: The top opposition candidate in Sunday’s presidential election, Kemal Kılıçdaroğlu, said he will reinvigorate the country’s democratic checks and balances and strengthen its role in the North Atlantic Treaty Organization if he wins. In recent opinion polling, Kılıçdaroğlu has held a slight lead over incumbent President Erdoğan but not necessarily enough to avoid a run-off election later in May.

Colombia: The country’s new finance minister, Ricardo Bonilla, said he and leftist President Gustavo Petro plan to cut Colombia’s reliance on producing mineral commodities and instead nurture basic manufacturing in areas like textiles, fertilizers, metalworking, and pharmaceuticals. Bonilla has also vowed to rein in the country’s budget deficit, but his statement on restructuring the economy suggests Petro’s recent cabinet reshuffle will push Colombian policy leftward, which could be a headwind for Colombian financial markets.

We would note that Bonilla’s plan to boost domestic manufacturing is also in sync with industrial policy trends in key developed countries, including the U.S., which in recent years has instituted more trade barriers against China and approved hundreds of billions of dollars in subsidies to help boost favored industries such as semiconductors and green technology.
Bonilla’s plan, therefore, runs counter to free-market ideology. On the other hand, it’s possible to argue that the massive boom in Chinese manufacturing since 2001, driven in part by Beijing’s subsidies and other unfair policies, unfairly short-circuited efforts by Colombia and other emerging markets to develop via manufacturing investment. One could almost say that when the Chinese economy burst onto the world stage, it forced many emerging markets off the road to manufacturing and instead pushed them onto the road of being dependent on commodity production, with all the volatility, environmental damage, and other issues associated with it. It would not be a surprise to see more developing countries adopting policies like Colombia’s in the future.

Ecuador: The national assembly yesterday voted to move ahead with an impeachment trial of President Lasso over charges of corruption. Under the constitution, however, Lasso could first dissolve congress and trigger presidential and legislative elections. In any case, the country is likely to face weeks or months of heightened political uncertainty that will likely weigh on Ecuador’s financial markets and currency.

U.S. Fiscal Policy: President Biden, House Speaker McCarthy, and other congressional leaders met yesterday in an initial effort to resolve the dispute over raising the federal debt limit, but the meeting ended with little apparent progress. After the meeting, Biden reiterated his stance that the politicians should work to cut the budget deficit, but without tying that effort to raising the debt limit. McCarthy expressed his frustration that Biden had not met with him on the issue earlier and reiterated his view that raising the debt ceiling must be accompanied by steep spending cuts. As we mentioned in our Comment yesterday, we expect the discussions, and brinksmanship, to continue in the coming weeks ahead of the June 1 deadline at which time the government may not be able to pay its bills.

U.S. Banking-Discount Window Borrowing: New data from the Federal Reserve shows that bank borrowing from its discount window plunged to $5.3 billion last week, down from more than $150 billion at the height of the banking crisis in March. The plunge in discount window borrowing last week is a welcome signal that the worst of the banking crisis has passed, although we believe banks will suffer a prolonged period of “disintermediation” as customers gradually pull their deposits to redeploy them to higher-yielding investments such as Treasury bills and money market funds.

U.S. Banking-Lending Standards: Consistent with the loss of deposits because of disintermediation, the Fed’s latest senior loan officer survey showed banks tightened lending standards for both large and small corporate borrowers in the first quarter. That merely continues a trend of stingier lending that began a year ago, but we note that the tightness is now at the levels often seen in recessions. The data suggests that if the economy isn’t in the expected downturn already, it is rapidly approaching it.

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