by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with updated projections for global economic growth from the International Monetary Fund.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including new evidence that China has reverted to its old strategy of infrastructure investment to boost economic growth.

Global Economic Growth:  The IMF released updated forecasts yesterday showing global economic growth will slow from 3.4% in 2022 to just 2.8% in 2023.  The updated forecast for 2023, contained in the institution’s latest World Economic Outlook, is slightly lower than the 2.9% figure issued in January, reflecting the IMF’s continued concerns about high inflation, rising interest rates, increased financial stresses, and the impact of Russia’s war against Ukraine.

• The weaker forecast for 2023 is consistent with our view that the U.S. and other major economies are likely to slip into a moderate recession later this year.
• Although the upcoming recession is now widely anticipated, it still presents the risk of a renewed pullback in stock values. We therefore remain cautious on equities and other risk assets for the time being.

China:  New data shows the country’s total fixed railway investment in the first quarter of 2023 was up 6.6% from the same period one year earlier, hitting its highest level since 2013.  The big increase in railroad spending illustrates how Beijing has reverted to its traditional strategy of massive infrastructure investment to boost economic growth, even though the country is already struggling with excess industrial capacity and high debt.

• In the short term, this type of stimulus spending will likely boost economic growth and stock values in China and those countries that export to it.
• In the longer term, however, this uneconomic spending will exacerbate the Chinese economy’s deep structural imbalances, making it harder to maintain growth and raising the risk of economic and social crises.

China-India:  Imagery analysis by London-based think tank Chatham House suggests China has been building new military intelligence facilities on Myanmar’s Coco Islands, just 55 km north of India’s military installations on its Andaman and Nicobar Islands in the Bay of Bengal (see map below).  The expanded facilities include a lengthened runway and hangars for aircraft, an upgraded radar installation, and docks for supplies.  Along with China’s access to ports in Pakistan and Sri Lanka, the Coco Islands’ facilities show that Beijing is gradually tightening its military and intelligence noose around India, which will likely continue to drive New Delhi toward a closer military, economic, and diplomatic relationship with the U.S.

United States-South Korea:  More of the purported U.S. intelligence documents recently leaked on social media, which we described in our Comment on Monday, have been found to be fabricated, including much of the intelligence that had suggested U.S. spying on its key ally South Korea.  According to Seoul, the South Korean and U.S. defense ministers agreed in a phone call yesterday that much of the information had been fabricated, and that the two countries would continue to cooperate closely.  The report suggests the leak may not be as damaging as originally thought to the U.S. and its allies.

NATO-Germany:  A leaked memo from the Bundeswehr’s inspector general indicates that Germany wouldn’t be able to meet its pledge to provide a fully-equipped division to NATO in time of war by 2025.  According to the assessment, “the army will not be able to hold its own in high-intensity combat and will also only be able to fulfill its obligations to NATO to a limited extent.”  The report also contended that continued underfunding and military support for Ukraine have already led to a “clearly noticeable reduction in the army’s operational readiness.”  The revelation could potentially put more pressure on Germany to boost its defense budget in the near term.

China-Russia-Iran-Ukraine:  Diplomatic sources say China and Russia are secretly negotiating with Iran to provide it with large amounts of ammonium perchlorate, the main ingredient in the solid propellants used to power missiles.  The amounts of the chemical under negotiation would reportedly be enough to build thousands of medium-range rockets, some of which could then be exported to Russia for its war against Ukraine.

United States-Russia:  Officials yesterday revealed that the U.S. Embassy in Moscow still has not received permission from the Russian government to visit Wall Street Journal reporter Evan Gershkovich, whom the Russians have detained on charges of spying.  The U.S. officials also said Russia has given no legitimate reason for the failure to grant permission.  The breach in diplomatic and consular standards will further poison the U.S. relationship with Russia and its ally, China.

U.S. Monetary Policy:  Yesterday, the new leader of the Chicago FRB, Austan Goolsbee, warned that monetary policymakers should be cautious about hiking interest rates further, now that banks have already started tightening lending standards and regulators had to take over two mid-sized lenders last month.  Even though Goolsbee voted for rate hikes at the two Fed policy meetings held since he took over at the Chicago FRB in January, his speech contained no endorsement of any further rate hikes.  His presentation confirms that interest rates probably can’t be raised much more before generating pushback from the policymaking committee.

U.S. Environmental Regulation:  As we flagged in our Comment a few days ago, the Environmental Protection Agency proposed new rules today that would limit vehicle tailpipe emissions across each automaker’s entire fleet between 2027 and 2032.  The rules aim to reduce overall emissions and force automakers to transition most of their production to electric vehicles.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with key news on the global technology sector, including data showing a steep downturn in personal computer shipments and increasing regulatory pressure on the evolving artificial intelligence industry.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including signs that the new Bank of Japan leader will keep monetary policy unchanged for at least the near term.

Global Computer Industry:  Research firm International Data Corp. reported that global personal computer shipments in the first quarter were down 29% from the same period one year earlier.  In fact, shipments were even lower than in the first quarter of 2019, prior to the onset of the coronavirus pandemic, indicating the industry is now giving back much of the surge in activity it enjoyed in the midst of the pandemic.  With PC inventories expected to remain excessive until at least mid-2023, the data suggests much of the information technology sector could see soft business conditions and weak stock prices for some time yet.

Global Artificial Intelligence Industry:  Yesterday, just hours after Alibaba (BABA, $101.54) became the third Chinese technology giant to launch a generative artificial intelligence chatbot, the Cyberspace Administration of China issued a draft of rules aimed at slowing the development of AI models and ensuring they work to support Communist Party priorities.  Meanwhile, separate reporting indicates that the Biden administration is exploring whether checks should be imposed on AI chatbots in the U.S., such as the popular ChatGPT, amid growing concerns that they could be used to discriminate or spread harmful information.

• Under China’s drafted rules, AI developers would have to register their models with the CAC, submit them for security reviews before releasing them to the public, ensure that they “embody core socialist values,” verify users’ identity, and make sure that users can be tracked.
• In the U.S., the Commerce Department issued a formal public request today for comments on what it called accountability measures, including whether potentially risky new AI models should go through a certification process before they are released. The comments, which will be accepted over the next 60 days, will be used to help formulate advice to U.S. policymakers about how to approach AI.

Emerging Market Debt:  Advocacy group Debt Justice issued a report showing that for 91 of world’s poorest countries, debt service paid to non-residents this year will account for 16% of government revenues.  That would be the highest foreign debt burden since 1998, illustrating the impact of rising global interest rates and the strong dollar.

• The report suggests governments in poorer countries may increasingly struggle to fund public services ranging from defense and policing to infrastructure and anti-poverty programs. That could raise public frustrations and spark political instability in some countries.
• In turn, the high debt burdens also raise the prospect for more financial crises in less developed countries, which could adversely affect their foreign bond holders and lenders.

Japan:  Yesterday, at the end of his first weekday as the Bank of Japan’s new leader, Kazuo Ueda stated that he will maintain monetary easing and negative interest rates despite market expectations for an early policy change.  According to Ueda, returning Japanese price inflation to the BOJ’s target of 2% is a job that will take many years, and he wants to finish it.  In response, the JPY dropped 1.1% yesterday to about 133.60 per dollar, while today Japanese stocks have jumped more than 1.0%.

China-Australia:  The Chinese government said it will review the up to 80% tariffs that it imposed on Australian barley in 2020 after Canberra called for an investigation into China’s role in the coronavirus pandemic.  In return, the Australian government said it would suspend its complaint against the tariffs at the World Trade Organization.  The moves are part of a broader easing of tensions between the countries as China tries to set the stage for improved economic growth.

North Korea:  New reports say the government banned the use of foreign currency such as the Chinese yuan (CPY) and U.S. dollar this month and ordered its citizens to exchange their foreign money for the domestic won (KPW).  According to the reports, the government is confiscating any foreign currency that citizens attempt to hide from the authorities.

• The program may indicate that North Korea is preparing to fully reopen foreign trade with China and wants to have sufficient foreign reserves to pay for any imports.
• In turn, that may mean the North Korean economy is faltering so badly that the government has no choice but to reinvigorate trade with China again.

France-United States:  French President Macron has once again sparked concern about Western unity with statements about his cherished concept of European “strategic autonomy.”  During his visit with Chinese President Xi last week, Macron said in an interview that Europe shouldn’t just blindly follow U.S. policy on Taiwan or other important international conflicts so that it won’t be caught up in “crises that are not ours.”  His remarks have drawn condemnation from a range of political leaders not only in the U.S., but also in Europe.

• Without a doubt, Macron’s statements were music to Xi’s ears, given the Chinese leader’s desire to drive a political wedge between the U.S. and Europe. Because of China’s rapidly growing military power, enormous economy, and increasing diplomatic influence, the ongoing effort to thwart China’s geopolitical aggressiveness will require the U.S., Europe, and other key Western allies to maintain unity.  Macron’s call for Europe to be more independent is a threat to that.
• Nevertheless, Macron’s vision remains aspirational, just as de Gaulle’s vision of French power and glory was in the decades after World War II. The French soul laudably embraces its history— from its Napoleonic victories and its Empire to the contributions it has made to world culture in terms of political principles, diplomacy, law, philosophy, science, architecture, design, visual and performing arts, fashion, style, cuisine, and the simple art of living.  But France in particular and even Europe in general are far from having the military, economic, or diplomatic power needed to act as an independent and secure superpower.  In time of crisis, French and European vulnerabilities become clear, and the imperative of their alliance with the U.S. becomes obvious.  As such, Macron’s statements do raise tensions and weaken the Western alliance, but they are unlikely to be fatal to it.

United States-Philippines:  Today, the U.S. and the Philippines have launched their largest joint military exercises in 31 years.  The drill will include a total of 17,500 soldiers, sailors, and airmen and will even include a small contingent of troops from Australia.  The U.S. and Philippine foreign and defense ministers are also due to hold their first so-called “2+2 meeting” in seven years today in Washington.  Today’s activities come a week after the Philippines formally identified four of its military bases which it will permit the U.S. to use under the countries’ security agreements.  These activities illustrate the renewed military cooperation between the two countries as the Philippines becomes more concerned about China’s geopolitical aggression.

U.S. Military Recruiting:  New analysis by The Military Times indicates the recent big shortfalls in troop recruiting may be tied to a new medical records system adopted by the Pentagon in 2022.  Since the new system does a better job of vacuuming up an applicant’s entire medical history from multiple digital sources, military recruiters interviewed for the article said the new system has ended an applicant’s ability to gloss over or knowingly ignore minor medical issues, such as past use of ADHD meds or inhalers, before signing up.

• Some politicians and political pundits have blamed the recruiting shortfall on “woke” diversity training or out-of-shape kids. Pentagon officials have pinned the blame largely on today’s roaring civilian jobs market and bad perceptions of service fueled by negative headlines.  The recruiters blamed the new medical records system above all else.
• If the new medical system is indeed the key problem, it suggests the Pentagon could tweak the system to flag fewer problems or adopt a more flexible approach that allows more young people to enlist.

U.S. Monetary Policy:  New York FRB President Williams yesterday downplayed signs in the financial markets that investors are expecting the monetary policymakers to begin cutting interest rates later this year, despite Fed projections that they will hold rates steady once they have gotten the benchmark fed funds rate slightly above 5.0%.  According to Williams, investors may have a more pessimistic view of economic growth going into the second half of the year, or investors may not understand how hard it will be to get inflation back down to the Fed’s 2% target.  In any case, his statements are consistent with our view that interest rates will rise at least a bit more and then may stay elevated for longer than investors currently think.

U.S. Weather Conditions:  New data shows that drought has now taken hold in about two-thirds of Florida, up from about one-fifth of the state a year ago.  The drought is creating challenging economic conditions for ranchers and farmers and creating a higher risk of widespread wildfires.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with the latest on the big leak of classified U.S. intelligence documents that was discovered late last week.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including increased military tensions surrounding Taiwan, big new strikes in the U.K., and news that the EPA will soon propose strict new emissions rules for U.S. vehicles.

U.S. National Security Leak:  U.S. officials continue to investigate the big leak of classified Pentagon documents onto social media sites late last week.  Over the weekend, additional documents were posted, some dealing with topics beyond the U.S. efforts to help Ukraine defend itself against Russia’s invasion.  The FBI is now investigating who had access to the leaked documents, which appear to be briefing slides prepared for the Joint Chiefs of Staff.  The postings on social media show the hard-copy documents were folded and unfolded before being photographed, which would suggest that they were secretly taken out of a secure location.  Although at least one of the photographs was altered to put Russia in a better light, identifying markings on the documents could help identify the culprit.  One possibility is that there is a Russian mole at the Pentagon.  Another possibility is that the culprit is a Russian sympathizer with access to officials high up in the Pentagon bureaucracy, or perhaps someone opposed to certain aspects of U.S. foreign policy, such as providing more aid to Ukraine.

• One document shows that the U.S. was secretly listening in on communications between top South Korean national security officials late last year when President Yoon Suk-yeol was considering whether to sell 155-mm artillery ammunition to the U.S. to replenish supplies that Washington had sent to Ukraine.
• The report showed Foreign Secretary Yi Mun-hui warned his boss, National Security Adviser Kim Sung-han, that if the ammunition were later re-sold to Ukraine, it would violate official South Korean policy not to provide lethal military goods to countries in active hostilities. Yoon ultimately approved the sale on the condition that the U.S. military would be its “end user.”
  • Both Yi and Kim later resigned for unclear reasons, suggesting they may have been forced out for pushing back against the deal.
  • If so, it would suggest Yoon went out on a limb politically to support the U.S. In turn, that would underline how much Yoon has prioritized cooperation with the U.S. as he seeks to further cement South Korea into the evolving U.S. geopolitical bloc and prepare for a potential conflict with China.

China-Taiwan-United States:  China has launched a series of military drills near Taiwan to express its anger at Taiwanese President Tsai’s visit to the U.S. and her talks with House Speaker McCarthy in California last week.  The Chinese military said on Saturday that the drills would aim to test its ability to “seize control of the sea, air and information” in the area, and that they would involve a wide range of naval, air, missile, and electronic-warfare assets.  Nevertheless, the drills appear to be somewhat smaller and less threatening to Taiwan than the exercises China launched last summer after former House Speaker Pelosi visited the island itself.

China:  Ten Chinese companies had their initial public offerings today, marking the first batch of IPOs under a new set of listing rules for Shanghai and Shenzhen.  The average first-day gain for the new stocks was 96%, suggesting the rules still aren’t producing an efficient market for new listings.

Saudi Arabia-Yemen:  A Saudi delegation has arrived in Yemen to begin negotiations with that country’s Iranian-backed Houthi rebels.  The development is one result of the recent Chinese-brokered rapprochement between Saudi Arabia and Iran.  Saudi Arabia’s involvement in ending Yemen’s civil war could also help ease tensions between Riyadh and Washington.

United Kingdom:  The British government continues to face big, disruptive strikes by public sector workers who are seeking higher pay.  Tomorrow, junior physicians plan to launch a four-day walkout across England for a 35% pay hike.  Meanwhile, passport workers last week launched a five-week strike, and additional strikes are feared in education after teaching unions recently rejected the government’s offer of a 4.5% pay rise and a £1,000 one-off payment.

Brazil:  Now that leftist President Luiz Inácio Lula da Silva is back in power, a radical agrarian rights group known as the Landless Workers’ Movement said it expects to step up its use of “land invasions,” where it illegally occupies rural land to assert control over it and push out private owners.  Increased land invasions would be a threat to Brazil’s important agribusiness sector and could touch off increased political tensions within the country.

U.S. Environmental Regulation:  Next week, the Environmental Protection Agency reportedly plans to propose extensive new limits on vehicle tailpipe emissions in order to push U.S. auto makers toward making and selling more electric-vehicles.  The stringent new rules are expected to apply to model years from 2027 to 2032.

U.S. Manufacturing Industries:  New analysis shows U.S. manufacturing capacity last year grew at its fastest rate since 2015, driven by the extensive new construction of factories and related facilities.  The increase in factory construction is consistent with our belief that deglobalization, the fracturing of the world into relative separate geopolitical and economic blocs, and increased international tensions will all tend to drive a new period of re-industrialization in the U.S.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Happy Maundy Thursday! Today’s Comment starts with our thoughts about tomorrow’s job report. Next, we discuss possible substitutes to the equity and futures markets to gauge investor reaction to the labor market data. Lastly, we review the latest development in the conflict between the U.S. and China.

 Good Friday? Markets will be closed tomorrow when the March employment numbers are released by the Bureau of Labor Statistics, but investors will still be on high alert.

• Signs of a cooling labor market could pave the way for a Fed pause or pivot. On Wednesday, private payroll data from ADP showed U.S. firms added 145,000 jobs last month, well below the consensus forecast of 210,000. The slowdown in hiring was also reflected in the manufacturing survey reported by the Institute for Supply Management and BLS data that showed a sharp drop in job openings in February. The Federal Reserve has consistently pointed to the tight labor market as evidence that it still has room to raise interest rates. Thus, a weak BLS jobs report could pressure the central bank to conclude its hiking cycle before the end of the year.
• Despite Wednesday’s data supporting a more dovish monetary policy, investors are worried about the state of the economy. The service activity index tracked by the ISM showed a sharper-than-expected drop. The index came in at 51.2, well below expectations of 54.5, and the previous month’s reading of 55.1. The subpar economic number weighed on equities as investors looked to lock in temporary gains made earlier in the week. Led by tech stocks, the S&P 500 fell 0.25% on Wednesday, while the NASDAQ sank 1.1% in the same period.
• A disappointing jobs number may convince the Fed to rethink its interest rate strategy. Over the last few weeks, Fed officials have appeared less committed to raising rates. Regional Fed President Neel Kashkari and Thomas Barkin have both been reluctant to advocate for another rate hike in the May meeting. Meanwhile, Cleveland Fed President Loretta Mester has emphasized that the central bank must be “judicious” as it conducts policy going forward. The shift in tone may be related to uncertainty regarding the economy following the downfall of Silicon Valley Bank (SIVB, $106.04) and Signature Bank (SBNY, $0.16) in March. As of this writing, the market has priced in a 67% chance that the Fed will stop hiking rates by June.

Still Open Most Hours: Equity markets may not be open on Friday; however, currencies and bonds will still be trading.

• With it trading until 5 PM EDT on Friday, the forex market will likely be a great place to see reactions to the jobs number. The U.S. Dollar Index shows that the greenback is down 1.5% against global currencies for the year. Its steady decline has been driven by concerns that a looming recession will force the Fed to halt and possibly reverse its policy stance. If the jobs number is softer than expected, global currencies will likely rally against the greenback. However, strong employment data could see the opposite or no reaction at all. Although the DXY Index is based on futures contracts and thus won’t be traded on Friday, movements in the EUR, GBP, and JPY will likely reflect a broader decline in the U.S. dollar relative to its peer currencies.
• Although hours will be limited, fixed income will be another market to gauge investors’ perceptions of the U.S. labor market. The yields on two-year Treasuries have fallen 132 bps since March 7 of this year, while 10-year Treasuries have decreased by 77 bps in the same period. Similar to the DXY Index, the normalization of the yield curve shows that the market believes the central bank is just about finished with its hiking cycle. Additionally, fixed-income securities have been noticeably more sensitive to changes in Fed interest rate expectations. As a result, a strong jobs report may be bearish for bonds, while a weak report may be favorable.
• Fixed income and currencies will give hints to how the market may open on Monday. This year, risk assets have generally rallied whenever data supported a possible moderation in central bank policy. Investors’ increased risk appetites explain why Bitcoin has surged 69% since the beginning of the year. Thus, a lower-than-expected jobs number could lead to an overall surge in equities on Monday. In the meantime, barring a significant event, we expect that markets will be relatively tame on the final trading day of the week.

The Saga Continues: The Washington and Beijing feud continues despite growing momentum for peace talks between Russia and Ukraine.

• A senior Ukrainian official has expressed his country’s openness to holding talks with Russia to end the territorial conflict. Prior to these comments, Ukraine President Volodymyr Zelenskyy dismissed the potential for talks until Russia removed all of its forces from his country, including Crimea. The change in sentiment is related to rising confidence that the Ukrainian military will be able to retake land along the administrative border of Crimea. The possible de-escalation of tensions between the two countries will be welcomed by Europe, who feared that Ukraine might overplay its hand if it tries to retake Crimea.
• Meanwhile, China is broadening its influence in the Middle East as Beijing positions itself to decouple from the U.S. On Thursday, government officials from Saudi Arabia and Iran met in Beijing for the first time since the countries agreed to restore diplomatic ties. The Chinese-brokered agreement reflects Beijing’s strategic pivot toward the Middle East and Africa as it looks to maintain its access to key raw materials. At the same time, U.S. Vice President Kamala Harris concluded her trip to Africa this week. She had one message to her African counterparts: America is your friend, and China is not.
• It is too soon to say whether the war between Russia and Ukraine is close to a conclusion. Both sides have much to lose if the conflict ends without a decisive victory for their respective side. That said, the end of the conflict could help ramp up the competition between the U.S. and China. The European Union’s deep trade ties with China have made it reluctant to completely sever ties with America’s top rival. French President Emmanuel Macron’s pestering of his Chinese counterpart to mediate tensions between Russia and Ukraine reflects Europe’s eagerness to maintain strong ties with China despite pressure from Washington. Hence, if Beijing is able to use its influence to end the war in Ukraine, EU countries may be less inclined to support U.S. trade restrictions.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with the latest signs and implications of worsening U.S.-China tensions, including an important admission by a top U.S. business leader that China poses major economic threats to the U.S. and must be confronted.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a surprisingly aggressive interest-rate hike in New Zealand, hawkish statements by a key Federal Reserve official, and evidence that the Fed’s own policies are helping draw deposits out of the U.S. banking system.

United States-China:  The U.S. Department of Defense stated in a recent report that China is now, for the first time ever, keeping at least one of its six Jin-class ballistic missile submarines on patrol in the South China Sea on a 24/7 basis.  According to the report, the subs are also now carrying China’s new JL-3 missile, which can deliver multiple independently targeted nuclear warheads all the way to the U.S. mainland.  The enhanced operating tempo suggests that the Chinese sub force is making important strides in communications, command and control, logistics, and other operational skills.  Even though the Jin-class subs are relatively noisy and therefore easy to detect, keeping them in China’s well-protected South China Sea bastion could help them survive any initial conventional or nuclear attack from the U.S., giving China an enhanced ability to launch a retaliatory second strike.  That will likely force the U.S. to increase the deployment of its nuclear hunter-killer attack subs, surface ships, and sub-hunting aircraft to the region to track the Chinese vessels and prepare to destroy them if needed in time of conflict.  In turn, that will presumably further increase the current strain on the U.S. military and defense industry and worsen U.S.-China tensions.

• Separately, Chief of Naval Operations Admiral Michael Gilday said this week that the U.S. Navy’s updated force structure analysis will probably show that it needs even more ships than its current target of 373 to carry out its global responsibilities and counter the growing threat from China. The Navy’s actual current inventory is only 296 ships.  The updated force structure analysis is due to Congress by mid-June.
• Additionally, Jamie Dimon, CEO of JPMorgan Chase (JPM, $128.42), warned in his widely followed annual letter to shareholders that China is now in a position to disrupt the supply of critical commodities and products to the U.S. and its allies, and that it must not be allowed to do so.
  • In Dimon’s words, “China, using subsidies and its economic muscle to dominate batteries, rare earths, semiconductors or [electric vehicles], could eventually imperil national security by disrupting our access to these products and materials. We cannot cede these important resources and capabilities to another country.”
  • Dimon’s comments are notable because he, like many other top U.S. business leaders, had previously been a champion of tighter U.S.-China economic relations. Dimon’s about-face suggests that business leaders may finally be swinging around to the consensus view that China is an increasingly dangerous military, economic, and diplomatic threat to the U.S. and should be countered.

United States-Taiwan-China:  Taiwanese President Tsai Ing-wen meets House Speaker McCarthy in California today.  The meeting is expected to prompt strong responses from China, including at least accusations that the U.S. is abandoning its “one China” policy and probably some sort of aggressive, retaliatory military exercises around Taiwan in the coming days.  If those drills happen, they will raise the risk of an accidental conflict.  At the very least, they would worsen U.S.-China tensions, potentially putting investors in the cross-fire.

New Zealand:  The Reserve Bank of New Zealand announced an unexpectedly big increase in its benchmark short-term interest rate to 5.25% from 4.75% previously.  The hike was especially surprising because recent data has shown that New Zealand’s economy is weakening and may be on the verge of a recession.  The aggressive rate hike also marks a contrast with the Fed and the Bank of England, which have slowed their rate-hiking campaigns.  The Bank of Canada and the Reserve Bank of Australia have both recently paused their rate hikes.

Mexico:  The Mexican government said it has reached a deal to buy most of the electricity-generating assets owned in the country by Spanish utility Iberdola (IBDRY, $50.15) for $6 billion.  The deal marks a victory for leftist President Andrés Manuel López Obrador, who had long pressured Iberdola to sell as part of his “new nationalization” program.  As such, the deal also illustrates the government’s strong nationalist and left-wing populist bent, which has prevented Mexico from taking full advantage of the trend of “near shoring” production to be closer to the U.S.

U.S. Monetary Policy:  Cleveland FRB President Mester today warned that consumer price inflation remains too high and stubborn, and that it could take until 2025 to bring it down to the Fed’s 2% target.  Mester stressed that the Fed will continue to focus on inflation despite the need to address the recent mid-sized bank crisis.  The statement reinforces our view that the Fed is probably not yet ready to stop tightening monetary policy, although it is probably getting close to that point.

U.S. Banking Crisis:  Concerns about sudden bank runs have dissipated, and analysts (including those at Confluence) are now focusing on the new risk that banks are facing—a slow-motion loss of deposits as individuals and businesses look for higher-yielding places to store their funds.  One place these depositors are shifting to are money market funds, which are putting increasing amounts of money to work in the Fed’s “reverse repo” facility.

• In turn, that’s generating concern that the Fed itself is exacerbating the outflow of deposits from banks because of the relatively high interest rates it pays to money market funds in the reverse repo facility.
• More broadly, the outflow of deposits from banks could eventually help prompt the Fed to begin cutting its benchmark fed funds interest rate.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with some good news on global lithium prices and the prospect of lower costs for batteries and electric vehicles.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including the Australian central bank’s decision to pause its long campaign of interest-rate hikes and new signs of weakness in the U.S. commercial real estate market.

Global Lithium Market:  Global lithium prices are now down more than 30% for the year, partially reversing a massive two-year surge and boosting hopes that the cost of batteries and electric vehicles could come down.  The drop in lithium prices stems from weaker demand for electric automobiles, especially in China, and a decline in risk appetite as global interest rates rise.  However, given that lithium is a key mineral for electric vehicle batteries, many industry leaders believe its price will eventually rebound as the world transitions away from gasoline-powered cars.

North Atlantic Treaty Organization:  NATO foreign ministers who met in Brussels today formally accepted Finland into the alliance.  The move vastly expands NATO’s land border with Russia, makes the Baltic Sea essentially a NATO lake, strengthens the alliance’s military power, and enhances its deterrent credibility, even if Sweden’s bid to join remains held up by Turkey and Hungary.

France:  As mass protests continue against President Macron’s recent pension reform decree, police trying to get control of the situation have reportedly revived some of the tough, controversial tactics that helped them quell the country’s “yellow vest” protests in 2018.  The tactics include preventative arrests and massive police deployments even for modest-sized protests.  So far, however, it isn’t clear whether the tactics will help deflate the protests or merely add to the political fire facing Macron.

United Kingdom:  So far this morning, the British pound (GBP) has jumped to $1.2488, reaching its highest value in 10 months.  The recent surge in the GBP has been driven by better-than-expected economic performance and higher interest rates in the U.K., as well as a broad drop in the value of the USD following last month’s U.S. banking crisis.  With this surge, the GBP is now the best-performing major currency so far in 2023.

Source:  Wall Street Journal

Australia:  The Reserve Bank of Australia today held its benchmark short-term interest rate unchanged at 3.60%, after 10 straight rate hikes that lifted the benchmark by 3.50% since last May.  The central bank moved to pause its rate-hiking campaign even though Australian consumer prices have only recently begun to decelerate.  The pause could boost expectations for a similar move by the Federal Reserve in the U.S.

China-United States:  According to media reports and a Defense Department briefing yesterday, the Chinese spy balloon that traveled over the U.S. and was shot down off the coast of South Carolina in February was maneuverable enough to hover over sensitive military sites, prompting the Pentagon to take evasive steps.  The media reports said the balloon was able to transmit intelligence back to China in real time, although Pentagon officials would not confirm that in public.  The revelations could lead to renewed concern about Chinese spying and further worsen U.S.-China tensions.

U.S. Space Exploration:  Yesterday, the National Aeronautics and Space Administration announced the four astronauts who will make up the crew of the Artemis II mission that will fly past the moon in late 2024.  The NASA mission will mark the first human flight near the moon since 1972, with the goal of testing spacecraft systems needed for a future lunar landing.  The NASA crew will consist of two U.S. men, one U.S. woman, and one Canadian man.

U.S. Water Supplies:  Surveyors from the California Department of Water Resources said yesterday that the mountain snowpack near Lake Tahoe now stands at more than 126 inches, the deepest snow in four decades and some of the deepest snow recorded there over the last century.  Driven by this winter’s nearly constant precipitation, the snowpack is expected to sharply reduce the state’s drought conditions, providing a boon to industry and agriculture, but with the risk of dangerous flooding as temperatures rise.

U.S. Commercial Real Estate Market:  Blackstone (BX, $84.96) said investors asked to redeem $4.5 billion from its Breit commercial real estate fund in March, marking the fifth straight month in which the fund has faced large redemption requests that have forced it to limit withdrawals.  The big redemption requests came despite Blackstone’s conference for Breit investors last month when it argued that the recent U.S. banking crisis will create stronger long-term investment opportunities for the fund by reducing the amount of available bank loans and cutting the risk of an excess supply of properties.  The news drove Blackstone’s stock down 3.3% yesterday and put further downward pressure on real estate investment trusts (REITs).

• In another sign of the weakening market for commercial real estate, data firm CoStar Group said sales of apartment buildings in the first quarter were down a whopping 74% from the same period one year earlier. That marks the worst annual sales drop since the first quarter of 2009.
• The drop in multifamily transactions reflects the impact of rising interest rates, regional banking turmoil, and slowing growth in apartment rents.

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