by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with a few words on tomorrow’s election, which we still consider a coin-flip. We next review several other international and US developments with the potential to affect the financial markets today, including an OPEC+ decision not to start boosting oil production as early as planned and an outlook for the Federal Reserve’s latest monetary policy decision on Thursday.

US Elections: Election week is now upon us, and voters tomorrow will cast their ballots for president, senators, representatives, governors, state lawmakers, judges, county commissioners, referenda, initiatives, bond proposals, and probably even a local dog catcher or two. At least 65,000,000 voters have already cast advance ballots. In our view, the race for president and Congress remains too close to call and could go either way, from a landslide for the Republicans to a landslide for the Democrats.

• Our read of the situation is based on a broad, triangulated reading of the opinion polls, betting markets, analysis by reputable political observers, and insider commentary. No matter who you support in the election, we would caution against over confidence, since that could merely set you up for disappointment and anger.
• Supporting our view that the election could go either way, we note that a range of indicators point in different directions. For example, recent polls point to a rebound in support for former President Trump and betting markets suggest the odds are highly in his favor, but other data consistently shows that Vice President Harris enjoys higher enthusiasm among her supporters and out-sized support among women.
• In fact, a new poll suggests Harris could even win Iowa. The poll underscores a potential swing toward her, which has boosted bond prices, pushed down yields, and weighed on the dollar so far this morning. The benchmark 10-year Treasury yield has fallen this morning to 4.288%, and the US Dollar Index is down a sharp 0.6%.
• In any case, stock market performance has historically averaged about the same whether it was a Republican or a Democrat in the White House. The more important issue may be whether we end up with a unified or split government. Historically, the market has performed best in a split government, when one party has the White House and the other has at least one chamber of Congress. Given today’s close division of support, we believe there is a good chance that we’ll end up with a market-friendly split government.
• Finally, we note that emotions are high, and politicians and foreign agents alike appear to be prepping the ground for protests or even violence once the results are announced. We can’t discount the possibility of political and legal uncertainty, protests, or even localized violence between Election Day and Inauguration Day. As of right now, however, we think any such developments would be relatively short-lived and contained.

Global Oil Market: In a notice posted Sunday by the Organization of the Petroleum Exporting Countries, Saudi Arabia and seven other oil-producing nations said they wouldn’t implement their plan to gradually hike oil production until at least late December. The move likely reflects the current over-supply of oil amid strong US output, weak economic growth in China, and reduced demand for automotive gasoline as consumers buy more electric vehicles.

Global Wine Market: New data from the International Organization of Wine and Vine shows global wine consumption in 2023 fell to 221 million hectoliters, down a full 10.5% from 2017. The drop is the equivalent to about 3.5 billion bottles of wine per year, largely because reduced consumption by baby boomers isn’t being offset by younger drinkers. The decline has led to excess supplies of both wine and grapes, which is starting to weigh on prices.

Germany: The fragile three-party coalition government was thrown into further disarray on Friday evening when someone leaked an economic position paper by Finance Minister Lindner, who heads the coalition’s liberal Free Democratic Party. The paper argued for new tax and spending cuts, which are at odds with the policy proposals of the other coalition partners, the center-left Social Democratic Party, and the left-wing Greens. The disagreement could shatter the coalition and bring it down shortly after the US election, leading to a weak caretaker government.

United Kingdom: The Conservative Party on Saturday elected former Minister of Business and Trade Kemi Badenoch as its new leader. Badenoch, whose parents are Nigerian immigrants, has vowed to shift the party more aggressively to the right, with a focus on social issues such as further curbing immigration and combating “woke” culture. However, the more popular Labour Party is likely to remain in power until the next scheduled elections in summer 2029.

Moldova: In a run-off election yesterday, President Maia Sandu won a second term with 55.4% of the vote, beating the Russia-backed opposition candidate Alexandr Stoianoglo. The win by Sandu will help keep the small, Eastern European country oriented toward the West and focused on its effort to eventually join the European Union.

Australia: Fitch Ratings today reaffirmed Australia’s stellar sovereign debt rating of AAA, with a stable outlook. The firm praised Australia’s “high income per capita and sound medium-term growth outlook, as well as [its] strong institutions and an effective policy framework.” Still, it also noted the budget deficit would likely widen to 2.6% of gross domestic product in fiscal year 2025, up from just 0.8% in FY 2023, largely because of tax cuts and fast spending hikes.

China: The Ministry of Commerce and the China Securities Regulatory Commission have announced easier rules on Qualified Foreign Institutional Investors (QFIIs) seeking to buy Chinese “A” shares, which trade only on the mainland and can’t be directly purchased by foreign individuals. To qualify as a QFII, for example, the new rules require the institution to have capital of at least $50 million or assets under management of at least $300 million, down from the previous requirements of $100 million and $500 million, respectively.

• The move is consistent with the economic stimulus measures Beijing announced earlier in the autumn, which partly aimed to boost Chinese stock prices and give Chinese citizens a viable alternative way to build wealth as the country’s residential housing market continues to struggle.
• The eased rules are also consistent with Beijing’s newly adopted goal to make China a “financial superpower.” However, even with the new changes, Beijing will still have tight control over cross-border inflows and outflows of capital. Those controls will likely keep acting as a disincentive to foreign investors and inhibit the renminbi from becoming a more viable reserve currency.

China-Peru-United States: The head of US Southern Command, Army Gen. Laura Richardson, has warned that a new China-funded megaport in Peru could be used by the Chinese navy. The new port, due to be inaugurated by General Secretary Xi this month, is the latest example of Beijing’s strategy to build ostensibly civilian maritime facilities around the world, which it could then use for naval operations in a conflict. Since the Peru port could allow the Chinese navy to threaten the western approaches to the US, it could further worsen US-China tensions.

• On a related note, the head of US Space Force, Gen. B. Chance Saltzman, warned late last week that China is developing and launching space weapons at a “mind-boggling” pace. According to Gen. Saltzman, China and Russia are both demonstrating an ability to conduct warfighting in space, which he called “very threatening” to the US and its allies.
• To reiterate, the continued aggressive military buildup by China and Russia are likely to further exacerbate US-China tensions, creating continuing risks for investors.

US Monetary Policy: The Fed holds its latest monetary policy meeting this week, with its decision due to be released on Thursday at 2:00 PM ET. The policymakers are widely expected to cut the benchmark fed funds interest rate by 25 basis points to a range of 4.50% to 4.75%, and we agree with that assessment. However, because of the underlying strength in economic growth, relatively tight labor markets, and continued price pressures, we still think the pace and endpoint of future cuts could leave investors disappointed.

US Stock Market: Reflecting how fortunes have shifted for two of the country’s key technology giants, Dow Jones late last week announced that Nvidia, the graphics processor maker turned artificial-intelligence darling, will replace Intel, the past king of central processing chips that is now struggling to compete, in the Dow Jones Industrial Average. The change will be effective prior to market opening on Friday, November 8.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is currently processing the latest jobs data. In sports news, Carlos Alcaraz was eliminated from the Paris Masters’ quarterfinals in a surprising upset. Today’s Comment will discuss why the latest inflation figures further strengthen the Federal Reserve’s case for achieving a soft landing. We will also share our thoughts on how OPEC may respond to the US’s growing influence in the oil markets and conclude with a report on why the yen has begun to appreciate against the dollar. As always, our report includes both international and domestic data releases.

Inflation Cooling: The Fed’s preferred inflation and wage indexes both showed signs of cooling, suggesting that the central bank may be on track for a soft landing.

• The Personal Consumption Expenditure (PCE) Price Index, a key inflation gauge, increased 2.1% year-over-year in September. This represents a slight deceleration from the previous month’s 2.3% increase and aligns with market expectations. Core PCE, excluding volatile food and energy prices, remained stable at 2.7%. Meanwhile, the Employment Cost index, which tracks wage pressures, increased at an annualized rate of 0.8%, down from 0.9% in the previous quarter. The combined easing of inflation and wage growth provides further evidence that the Fed is closer to achieving its mandate.
• The Federal Reserve’s potential for multiple rate cuts remains on the table as wage and price pressures ease. Market expectations, as reflected in the CME FedWatch Tool, currently point to a near-certainty of a rate cut next week with a 70% probability of another in December. This confidence stems from the fact that inflation has shown a consistent downward trend throughout the year, with price pressures rising at a slower pace compared to the previous year. As the chart illustrates, seven out of nine months in 2024 saw a deceleration in core PCE price growth compared to the previous year.

• The Fed’s ability to navigate a soft landing hinges on its avoiding complacency. By carefully easing monetary policy and monitoring the normalizing labor market, the central bank can mitigate the risk of a reversal or hard landing. The next three months will be a critical test, as lower inflation readings are typically observed during this period. A substantial acceleration in October or November could lead the Fed to hold off on cutting rates in December. That said, a cut at next week’s meeting does seem reasonable.

Market Share or Margins: OPEC is facing challenges in developing a strategy to address the growing competition from US oil production.

• US oil production reached a record 13.4 million barrels per day in August, helping to keep prices from surging despite escalating tensions in the Middle East. The increase was driven by Texas and New Mexico, which produced 5.8 million and 2.1 million barrels per day, respectively. Recently, strong US production has boosted its share of global oil production to nearly 22% in 2023, up from 19% in 2020. In contrast, top oil producer Saudi Arabia has maintained a steady output share of around 11%.
• The US’s emergence as a major oil producer has curtailed OPEC’s ability to influence global oil prices through production cuts. Despite efforts to curb supply, the oil market remains saturated due to weakening global demand, particularly from China. As a result, Saudi Arabia, OPEC’s most influential member, has experienced declining revenue from both lower oil prices and reduced production. This has compelled OPEC to explore strategies to bolster profitability, as many of its member nations rely heavily on oil revenues to fund their governments.

• OPEC is poised to address the global oil oversupply issue at its December meeting. While production cuts to bolster prices remain a possibility, the cartel may alternatively opt to flood the market to weaken competitors and regain market share. OPEC’s decision will likely depend on its assessment of global economic growth in the coming months. A positive outlook on global growth could prompt production cuts, supporting oil prices. Conversely, a pessimistic forecast for the global economy may lead to increased production, putting downward pressure on prices.

Japanese Yen Resurgence: Speculation over monetary policy has led the yen (JPY) to strengthen and Japanese equities to fall.

• On Thursday, Bank of Japan Governor Kazuo Ueda announced that the central bank would no longer state that it can “afford time” on future rate hikes, acknowledging that fluctuations in foreign exchange rates are having an effect on domestic price pressures. His comments marked a hawkish shift from the previous day’s more general BOJ statement, which had suggested that any rate increases would depend on economic and inflation trends aligning with the bank’s forecasts. Following Ueda’s remarks on Thursday, the Japanese yen surged 1% against the dollar at its highest.
• Since September, the country’s currency has depreciated significantly against the dollar, falling nearly 7%. This sharp devaluation was likely driven by a sudden shift in global interest rate expectations, primarily due to changes in market sentiment regarding central bank policies in the US and Japan. Following the September FOMC meeting, investors have begun to price in fewer rate cuts over the next few years. Additionally, the July market turmoil caused by the unwinding of the yen carry trade has led investors to believe that the Bank of Japan will adopt a cautious approach to rate cuts.

• Ueda’s comment suggests a potential hawkish shift in the BOJ, which should help support the JPY. We suspect that as long as uncertainty persists regarding the extent of the Federal Reserve’s planned rate cuts during its easing cycle, the BOJ will be forced to be more assertive with policy. Consequently, Japanese policymakers may seek to protect the yen by adopting a monetary policy stance that diverges from the Fed’s, potentially including a more hawkish rate hike at the December BOJ meeting.

In Other News: Canadian ports are bracing for strikes starting Monday, which are expected to cause supply chain disruptions across the country. Additionally, Iran has threatened to retaliate against Israeli attacks through proxy groups, resulting in a rise in oil prices. Furthermore, China sanctioned the largest US drone maker to signal its potential response to further trade restrictions imposed by the US.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Happy Halloween! Markets are currently digesting the latest inflation data as investors gauge the Federal Reserve’s next move. In sports news, the Los Angeles Dodgers clinched a World Series victory over the New York Yankees. Today’s Comment will delve into a detailed analysis of the recent GDP data, explore the challenges faced by Big Tech companies in scaling data center infrastructure to meet AI demands, and provide a brief overview of the UK’s recent budget. As always, the report will conclude with a roundup of international and domestic data releases.

GDP Resilience: The robust economic growth observed in the third quarter has complicated the Federal Reserve’s decision-making process regarding potential interest rate cuts.

• US GDP expanded at an annualized rate of 2.8% in the third quarter, marginally missing the projected 3.0%. Strong consumer spending and government expenditures were the primary growth drivers. Consumer spending accelerated from 2.8% to 3.7% annualized, led by a surge in nondurable goods purchases. Additionally, increased defense spending contributed nearly 20% to overall growth. However, investment, particularly residential spending, contracted from the previous quarter as elevated interest rates continue to act as a drag to economic output.
• While third-quarter growth was robust, its sustainability remains uncertain. Precautionary spending, likely driven by concerns over a potentially prolonged port worker strike on the East and Gulf Coasts, may have pulled forward much of the anticipated consumption for the coming quarter. Additionally, the surge in defense spending, largely driven by escalating tensions in Ukraine and the Middle East, may be a one-time event. Consequently, the latest report may still provide a complicated picture for the Fed when it is deciding whether it is appropriate to adjust policy rates.

• The Federal Reserve’s decision on whether to cut rates will likely hinge on Friday’s jobs report. In its previous meeting, the Fed revised its year-end unemployment rate expectation upward from 4.1% to 4.4%. Given that the unemployment rate has since declined from its 2024 peak of 4.3% to 4.1%, a significant rate cut this month is highly improbable. However, a pause in rate hikes remains a distinct possibility, especially if the unemployment rate continues its downward trend, given the recent strength of economic data.

Data Centers on the Rise: The limited supply of data centers is preventing tech companies from being able to capitalize on the rising demand for AI.

• Microsoft and Meta have recently warned that their limited data center capacity could hinder revenue growth in their cloud businesses. This outlook has dampened investor sentiment towards both companies, as it implies a need for increased capital expenditures to expand their infrastructure. Consequently, both companies experienced a decline in their share prices, despite reporting relatively strong revenue growth in the third quarter. Investors are concerned about the long-term profitability of these companies, given their consistently upward revised spending forecasts that have outpaced revenue guidance.
• Building out data center capacity has proven challenging, as construction projects have faced significant pushback from local communities. These communities often cite concerns about noise pollution, land use, and limited job creation. Many towns across the country have been reluctant to approve data center construction projects. Additionally, the energy intensity of these facilities has become a concern, as utility companies struggle to build out the necessary infrastructure to meet the demand. These challenges will limit tech companies’ ability to expand their data center capacity.

• While the demand for data centers continues to grow, the ability to build them at scale is facing significant challenges. This could hinder the growth of major tech companies as they seek to expand their infrastructure. Although this may not entirely derail revenue growth, it suggests that the path to profitability may be more arduous than many investors anticipate. Given that the future profitability of large tech companies is already largely priced into their stock prices, we believe investors may find more attractive opportunities in other sectors, particularly those with limited exposure to AI.

UK Budget: The Labour Party delivered its budget proposal to mixed fanfare.

• The new budget proposal aims to generate nearly $52 billion in additional tax revenue by the end of the decade. Over half of this revenue would come from an increase in the National Insurance payroll tax, with additional taxes levied on inheritance and capital gains. The budget also seeks to boost long-term growth through increased spending on infrastructure and research and development. While the market’s initial reaction was negative, it was far from a panic. On Wednesday, the 10-year UK gilt yield rose 18 basis points, and the pound sterling (GBP) modestly weakened by 0.4% against the US dollar.
• While the recent budget averted another “Liz Truss Moment,” it has raised concerns about the UK’s economic growth outlook for the coming quarters. The National Insurance payroll tax levy, in particular, has drawn significant criticism. A left-leaning think tank estimates that this tax increase will limit the real weekly wage to approximately $17 higher by the end of 2028, compared to two decades ago. However, this projection assumes that businesses will pass on the tax burden to consumers and workers to protect their profit margins.

• Governments worldwide are increasingly recognizing the need to generate additional tax revenue to offset pandemic-related spending. While some countries may be able to increase funding through robust economic growth, others, like the UK, may need to rely on higher taxes to balance their budgets. The recent UK budget proposal indicates that the government does not believe that growth alone will suffice to close the fiscal gap. While we expect the new proposal to have long-term benefits, we believe that long-term bonds could present an attractive investment opportunity if the plan is successful.

In Other News: Factory activity in China strengthened for the first time in six months, in a sign that the economy is starting to show signs of life. Volkswagen is demanding that its workers take a 10% pay cut as it looks to avoid having to make layoffs. North Korea conducted its longest ever ballistic missile test flight time in a sign that the country is looking to assert itself no matter who wins the US election in November.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is still processing the latest earnings data from Alphabet. In sports news, the New York Yankees managed to avoid being swept by the LA Dodgers. Today’s Comment will discuss why consumers remain content despite a cooling labor market. We will also review the latest earnings report from tech companies and explain why the EU is starting to get tough on trade. As usual, our report will include a roundup of international and domestic data releases.

The Job Market: As a precautionary measure against additional layoffs, employers are beginning to reduce the number of job postings.

• The Bureau of Labor Statistics reported a surprising decline in job openings to a three-year low in September. Last month, job postings fell from 7.861 million to 7.443 million, significantly below the consensus estimate of 7.990 million. Despite this decrease, the report also contained some positive news — hiring actually increased from 5.43 million to 5.55 million. The combination of fewer openings and an increase in hiring suggests that the labor market may be cooling but remains relatively tight.
• Even as job openings decline, consumers’ confidence in their job prospects has seen a significant uptick, reaching its highest point since March 2021. The Conference Board’s Consumer Confidence Index rose from 99.2 to 108.7, primarily fueled by consumers’ growing optimism about their present situation given the overall economy and the strength of the labor market. This positive sentiment is further underscored by the widening gap between those who perceive jobs as plentiful and those who believe jobs are scarce, a trend not observed since January.

• The data on job openings and consumer confidence aligns with our view of a resilient economy. While the decline in openings indicates cooling labor demand, it also reinforces our belief that firms are hesitant to lay off workers. This sentiment has likely translated into increased job security for consumers. However, a key question remains: How will this impact wage growth? If wages continue to rise above historical trends, it could exert upward pressure on inflation. Conversely, if wage growth moderates, it may alleviate price pressures and potentially prompt the Fed to ease monetary policy.

AI Is Back: After concerns about overspending on AI, Google’s parent company Alphabet demonstrated that its investments may be paying off.

• On Thursday, the tech giant exceeded expectations for both profit and revenue, driven by strong growth in its cloud business. The company has faced significant pressure due to concerns about excessive spending to compete with Microsoft following its partnership with OpenAI. Despite increased capital spending in the third quarter, Google’s cloud division saw a 35% growth in revenue year-over-year. Additionally, the company has been able to reduce the cost of its search engine business by over 90% in 18 months.
• Alphabet was the second of the Magnificent 7 companies, after Tesla, to report stronger-than-expected third-quarter earnings. This robust performance is likely to bolster investor optimism for the broader index further, as investors seek signs that mega-cap tech companies can sustain their momentum despite concerns about AI-related overspending that have plagued other companies within the index. While the Magnificent 7 index has surged nearly 50% year-to-date, Nvidia and Meta have been the primary drivers, accounting for over 60% of the gains.

• Alphabet’s strong performance bodes well for other mega-cap tech companies. Last quarter, Google, Microsoft, Meta, and Amazon increased their AI investments, betting on significant untapped demand for these services. Increased capital spending reflects their belief in the potential for future revenue growth. If other companies report similar sales growth this quarter, investors may take a closer look at the Magnificent 7 stocks, especially if interest rates rise. However, we believe that other non-tech sectors offer more long-term value.

European Protectionism: The EU has started to crack down on Chinese dumping as it looks to protect its own domestic industries.

• The EU will impose tariffs on Chinese electric vehicles (EV) on Thursday, as negotiations to resolve trade disputes between the two sides have failed. These tariffs aim to prevent China from dominating the region’s EV market. EU regulators have accused Beijing of unfair trade practices, such as providing substantial subsidies, which have allowed Chinese EVs to undercut prices of domestically produced cars. The rapid growth of Chinese EV sales is evident, increasing from a mere 3.9% of the market in 2020 to a significant 25% in 2023.
• The decision to impose tariffs comes as the West’s efforts to develop its own green technology industry have faced significant headwinds. The region has struggled to nurture domestic firms, unable to compete with the lower prices of Chinese imports or the generous incentives offered by the US to boost clean-tech manufacturing. For instance, since the passage of the Inflation Reduction Act, US solar investments have surged from $200 million to over $2 billion, while EU investments have declined to $141 million, despite starting from a similar level.

• The EU tariffs on Chinese electric vehicles sends a clear signal that the EU intends to bolster its domestic clean-tech industry. This move could also foreshadow potential retaliatory measures by the EU against the US if the next administration imposes tariffs on EU goods. While the EU may seek to retaliate, it is also likely to pressure the US to reduce tax incentives and subsidies for foreign firms building factories domestically. While a trade war between the US and EU may not be desirable for either party, it is something that could be an issue as it is unclear which side will back down.

In Other News: Israeli Prime Minister Benjamin Netanyahu has expressed interest in negotiating a short truce with Hamas. The German economy unexpectedly grew in the third quarter in a sign that the worst of the downturn may be behind it. Russia has fined Google $2.5 decillion for not allowing propaganda on its YouTube platform.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is currently awaiting the latest earnings reports from several mega-cap tech companies. In sports news, Rodri from Manchester City has been awarded the Ballon d’Or for the 2023/2024 season. Today’s Comment will address rising concerns about financing the US deficit, explore the efforts to increase restrictions on US investments in China, and provide an update on Russia’s use of North Korean troops in its war against Ukraine. As usual, our report will include a roundup of both international and domestic data releases.

Treasury Supply Unease: US bond yields have increased due to a disappointing Treasury auction and concerns about financing the federal deficit.

• The US Treasury Department forecasts borrowing $546 billion in the final quarter of the year, which is a $19 billion decrease from the previous quarter’s estimate. This projection assumes a year-end cash balance of $700 billion. While the decrease in borrowing was a welcome sign, markets are still grappling with how to absorb the substantial debt. Monday’s weak auctions for two- and five-year Treasurys underscore these worries as investors have started to price in the possibility of rising inflation expectations and less dovish Fed policy.
• Bond yields on Wednesday are expected to respond to the Treasury Department’s guidance on debt financing for the upcoming year. Investors anticipate that the quarterly refunding announcement will indicate a need for around $125 billion, consistent with May’s announcement, which maintained auction sizes for the next few quarters. With auction sizes at record highs — particularly for the 10-year Treasury — any increase above this level could drive yields higher, while a reduction might prompt a retreat. Additionally, a miss could further lead to a decline in US government bond liquidity.

• The nation’s debt remains a persistent challenge, as neither presidential candidate has offered a specific plan to tackle the deficit. Instead, their proposals rely on general and potentially contentious measures such as tax hikes and spending reductions. This absence of a clear fiscal strategy is anticipated to drive up bond yields. However, if inflation continues to moderate or the job market weakens, this upward pressure could diminish. Recent estimates from the Cleveland Fed suggest that core PCE inflation may stabilize in the near term, while unemployment rates are expected to remain at 4.1%.

Chip Wars: The White House has unveiled new restrictions on US investments in Chinese companies, aiming to curb the development of critical technologies that could potentially be used by the Chinese military.

• The new restrictions, set to take effect on January 2, will limit US investment in Chinese semiconductor and artificial intelligence companies. Additionally, investors will be required to report certain other forms of assistance to regulators. While the US has already imposed export controls on specific technologies, these new measures aim to prevent US investors from holding equity in companies with ties to the Chinese military. This move comes as a recent report revealed that American investors participated in 17% of global transactions involving Chinese AI companies.
• The restriction on US investments into China comes as Beijing looks to shore up its domestic industry. In recent years, China has aggressively sought to develop its domestic semiconductor industry through substantial investments and the acquisition of advanced manufacturing equipment. Simultaneously, China has imposed export controls on critical minerals essential for chip production, aiming to secure a reliable supply for its domestic industry and potentially limiting access for the US and other Western nations. Although China still trails the US in advanced chipmaking, it is steadily narrowing the gap.

• The escalating semiconductor rivalry is creating headwinds for US tech firms. Apple, for instance, is facing obstacles in launching Apple Intelligence in China due to stringent AI regulations. This could prompt other US AI companies to form partnerships with Chinese firms, despite increased US regulatory scrutiny. To mitigate supply chain risks, Apple has invested in India to diversify its manufacturing base. However, ongoing trade tensions remain a significant challenge for mega-cap tech companies, prompting investors to consider opportunities in other sectors.

The Korea Problem: The prospect of North Korean troops being deployed in Ukraine has raised the likelihood of a broadening war.

• The Pentagon estimates that over 10,000 North Korean troops have been deployed to Russia. While it remains unclear if these soldiers have engaged in combat, US intelligence indicates a significant presence in Russia’s embattled Kursk region, which borders Ukraine. In response to these reports, Ukraine has pressed Western allies to supply weapons capable of striking deep within Russia. Such a move, according to Russian President Vladimir Putin, would be seen as direct NATO involvement in the conflict.
• The potential involvement of North Korean troops in Russia’s war against Ukraine has raised serious concerns about further destabilizing Europe and could have broader implications for the Indo-Pacific region. Following these reports, there have been renewed calls for deploying EU troops to Ukraine. This idea, initially suggested by French President Emmanuel Macron, was previously rejected by German Chancellor Olaf Scholz. In response to the growing threat posed by North Korea, South Korea has agreed to share intelligence with NATO to coordinate a more effective response.

• The ongoing conflict in Ukraine underscores the increasing importance of military cooperation, even as geopolitical tensions drive global decoupling. Russia’s strengthened trade ties with Iran, North Korea, and China, coupled with Beijing’s increased export allocation to the region, have enabled these countries to mitigate the impact of Western sanctions. This growing economic and geopolitical alliance could lead to further collaboration on initiatives beyond Ukraine, potentially including actions on the Korean Peninsula or regarding Taiwan.

In Other News: US natural gas prices plummeted 11% on Monday, driven by expectations of warmer-than-usual autumn temperatures, increased domestic production, and easing geopolitical tensions. There is growing skepticism as to whether the Fed will be able to cut rates two more times this year as the economy proves to be very resilient in spite of elevated interest rates.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with the aftermath of Israel’s airstrikes on Iran over the weekend. The bottom line is that both countries are showing signs of restraint, which has reduced the risk of a broader regional conflict and therefore pushed global energy prices down so far today. We next review several other international and US developments with the potential to affect the financial markets today, including an electoral loss for Japan’s ruling party and a new US directive to focus on artificial intelligence in the military.

Israel-Iran: Over the weekend, Israel launched a large number of airstrikes against Iran to retaliate for Tehran’s big missile attack on October 1. However, all reports suggest both the Israelis and the Iranians are pulling their punches and trying to avoid escalating the conflict. For example, the Israelis only targeted military-related facilities, and reports say Tel Aviv secretly warned Iran of the upcoming strikes via intermediary countries. Meanwhile, Iranian officials have avoided dramatizing the strikes and took care not to threaten a near-term response.

• For now, it appears Israel and Iran will keep a lid on their confrontation. That should help reduce the risk of the conflict widening into a regional war. For example, if Israel would have attacked Iran’s oil or nuclear infrastructure, Tehran might well have retaliated by striking Saudi Arabia’s oil facilities, disrupting global energy supplies, and forcing Riyadh to strike back. So far today, global oil prices are down about 5.5%.
• Despite Israel’s discipline in the attacks over the weekend, they probably weren’t inconsequential. Some reporting suggests that by striking Iran’s missile production facilities, Israel has crimped Iran’s ability to produce new replacement missiles, which could discourage it from launching new large-scale attacks against Israel.

European Union: Reports today say automaker Volkswagen plans to shut at least three German plants, eliminate tens of thousands of jobs, and slash pay by 10%. In response, the company’s worker council has hinted that union workers might strike. The downsizing and labor woes reflect the firm’s struggles as it faces intense competition in China, slowing sales across other major markets, and a costly transition to making electric vehicles — challenges faced by auto companies across the EU.

France: Moody’s Ratings today affirmed France’s sovereign bond rating of Aa2 but cut its outlook from stable to negative. The lowered outlook reflects the splintered government’s likely inability to meaningfully cut its budget deficit in the near term. The move is consistent with other recent rating actions and economic forecast cuts by private economists. Nevertheless, the action today has had no apparent effect on the spread between French and German bonds.

United Kingdom: New data shows the fertility rate in England and Wales fell to just 1.44 births over the lifetime of the average woman in 2023, the lowest since record keeping began in 1938 and far below the 2.10 rate that is considered necessary for a stable population with no immigration. The new figure points to further population aging in the UK in the coming years, which will probably put upward pressure on government spending and debt.

Georgia: In national elections on Saturday, officials said the Caucasus country’s Russia-aligned ruling party Georgia Dream came in first with 54.2% of the vote. The results came amid multiple reports of voting irregularities and voter intimidation, following weeks of reported interference by Russia, which wants to keep the country from joining the European Union. The losing opposition parties have called for protests later today.

Japan: In national elections yesterday, the ruling Liberal Democratic Party and its much smaller coalition partner Komeito lost their parliamentary majority, winning just 215 of the 465 seats in the Diet. Since the result was much worse than anticipated for the ruling coalition, Prime Minister Ishiba is widely expected to resign in the coming days. Japan is therefore likely to enter a period of political instability, which we suspect will be negative in the short-term for Japan’s economy, stocks, and currency.

Chinese Rare Earths Industry: According to the New York Times, the last two foreign-owned rare earth refineries in China have been acquired by state-owned companies, giving Beijing even greater control over the exotic minerals that are key to technologies such as advanced semiconductors and electric vehicles. Beijing’s acquisition of the refineries comes as it also tightens restrictions on the export of gallium, germanium, antimony, and other rare earths.

• Most of the world’s commercially viable rare earth resources are in China and the rest of its geopolitical and economic bloc. Not only does that include reserves in the ground, but also production and refining capacity.
• Separately, a new report from Benchmark Mineral Intelligence warns that Chinese companies now control about two-thirds of the cobalt resources in the Democratic Republic of the Congo, which produces about 74% of the global cobalt supply. Cobalt is also a key mineral for the electrification of the global economy.
• As the US-China geopolitical rivalry intensifies over time, we continue to believe that China will increasingly weaponize its control over rare earths, cobalt, and other key mineral resources. By cutting off access to these minerals, Beijing would hope to crimp the West’s economy and drive up prices.

Chinese Demographics: New data from the Ministry of Education shows that the number of operating kindergartens in the country fell by 5.1% in 2023, while the number of enrolled students fell by 11.6%. That marks the third straight year of declining kindergarten enrollment, reflecting China’s low birthrate and the demographic threat to its economic growth going forward.

US Military: The Biden administration issued a directive late last week prioritizing defense-related artificial-intelligence projects. The directive illustrates how information processing and other advanced technologies are increasingly critical to maintaining US military dominance. The directive could also spur even greater government and industry investment in AI projects going forward.

US Immigration Policy: With just eight days to go until the elections and much of the presidential candidates’ rhetoric touching on immigration, the Los Angeles Times last week carried a useful primer on how former President Trump might approach his promise to deport millions of illegal immigrants if he were elected. The article highlights the legal and logistical challenges to mass deportation, as well as the risk that US citizens would be caught up in the program. Another risk could be a disruption to labor supply in certain industries.

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