by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with the latest on the spiraling of tensions between the U.S. and China.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including news that the U.K. will begin training Ukrainian pilots to fly modern jets and an overview of President Biden’s State of the Union address last night.

China:  The commander of U.S. Strategic Command, who oversees the country’s nuclear forces, has formally notified Congress that China now has more launchers for ground-based intercontinental ballistic missiles (ICBMs) than the U.S. does.  The Chinese launchers include both mobile vehicles and newly constructed silos that are still sitting empty.  The U.S. continues to field many more missiles and nuclear warheads than China, as well as many more bombers and submarines capable of launching strategic nuclear weapons.  Nevertheless, the notification will likely prompt increased concerns about China’s military expansion and fuel even more calls to decouple from the country and kneecap its development.

China-U.S. Spy Balloon:  Yesterday, the U.S. Navy published photos showing its sailors recovering the remains of the Chinese spy balloon shot down off the South Carolina coast.  However, it is still probably too early for any analysis of the debris to have been completed.

• That analysis will aim to establish what information the balloon was designed to gather, how capable it was, and whether it contained any U.S. or allied components. Given today’s strong bipartisan enmity toward China, any threatening findings will likely prompt further bilateral tensions, potentially catching investors in the crossfire.
• In a further sign of how the incident has worsened U.S.-China relations, new reporting says Chinese Defense Minister Wei Fenghe refused to take a secure hotline call from U.S. Defense Secretary Austin immediately after the U.S. downed the balloon on Saturday.

Russia-Ukraine War:   As Russian forces continue to ratchet up their new offensive in northeastern Ukraine, President Zelensky is visiting Prime Minister Sunak in London today.  Zelensky has scored a British commitment not only for more weapons and equipment, but also for British training of Ukrainian jet fighter pilots.  The fighter training will evidently be on British Hawk 2 trainers, but that could be a first step toward getting them up to speed on modern fighters like the U.S. F-16 that Kyiv has been clamoring for.

• Separately, the German government announced yesterday that Germany, Denmark, and the Netherlands together would donate 178 older-generation Leopard 1 tanks to Ukraine.
• Despite being an older version of the powerful and highly modern Leopard 2, the new tanks would be a significant upgrade to what Ukraine already has. The unexpectedly high number of tanks from the three countries will also likely be welcomed by Kyiv.

Turkey:  After a three-day sell-off triggered by this week’s big earthquakes, the Turkish stock exchange has suspended trading.  So far this week, Turkish stocks have lost approximately 16% of their value, although the central bank has been able to keep the value of the TRY relatively stable.  There is no word yet on when stock trading will resume.

United States-European Union:  After a series of meetings in Washington yesterday, the German and French economy ministers said that top U.S. officials promised to assuage EU concerns about the $369 billion in subsidies for domestic green technology investments in last year’s Inflation Reduction Act.  However, they didn’t secure any concrete proposals beyond an agreement on full transparency over the level of subsidies on offer under the IRA so that Europe can match them if necessary.  That will ensure that the subsidies remain an issue between the U.S. and the EU in the coming months.

U.S. Monetary Policy:  Fed Chair Powell stated yesterday that January’s surprisingly strong labor market data shows why the fight against inflation will take longer and interest rates will need to go higher than many investors have been expecting.  We continue to believe that many investors are erroneously anticipating a quick end to excess inflation and a near-term pivot to lower interest rates before the economy falls into recession.

• As one example that many investors still trust the “Fed put,” risk assets rallied strongly yesterday after an initial dip following Powell’s comments. The market moves suggest that many investors were worried that Powell’s comments might be even more hawkish.
• The jump in U.S. stocks yesterday is being followed by a jump in European stocks today.

U.S. Politics:  In his State of the Union address last night, President Biden appealed for a bipartisan approach to the nation’s challenges but also focused on selling the benefits of the various legislative victories he’s had, such as passage of his big bill on infrastructure spending and last year’s Inflation Reduction Act.  As we flagged in our Comment yesterday, Biden also offered a number of new proposals, such as quadrupling the 1% tax on stock buybacks to channel more money into capital investment and expanding the $35 cap on monthly insulin costs to those outside the Medicare system.

U.S. Energy Market:  The Energy Information Administration issued a report showing that U.S. gasoline consumption fell to just 8.78 million barrels per day in 2022, some 6% lower than at the peak before the COVID-19 pandemic.  The agency also forecasts that U.S. consumption will continue to decline in 2023 and 2024, reflecting more efficient cars, the growing prevalence of electric vehicles, and work-from-home arrangements following the pandemic.

• Those factors could well drive down the consumption of gasoline far into the future.
• Nevertheless, the decline is likely to be gradual, meaning large amounts of fossil fuels will still be consumed in the U.S. and worldwide. The shortfall in oil and gas investment in recent years is therefore likely to lead to supply shortages and higher prices in the future, which is one key reason we believe commodities will be an attractive asset class once we get through the impending recession.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with news that yesterday’s earthquakes in Turkey have closed a major oil exporting terminal, pushing up global prices.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including news that the next head of the Bank of Japan is likely to be just as dovish as the current chief and indications that the Republican Party may be moving toward raising taxes on big U.S. corporations.

Global Oil Supply:  Yesterday’s big earthquakes in Turkey have closed a major oil terminal on Turkey’s southern coast, pushing up global oil prices today.  The Ceyhan terminal is the main hub for oil exports from Azerbaijan (620,000 bpd of Azeri oil last month) and Iraqi Kurdistan (350,000 bpd last month).  We’ve seen no firm estimates as to when the terminal might begin operating again, but the shutdown has contributed to a jump of approximately 1.5% in global oil prices so far this morning.  Brent crude oil is currently trading at about $82.50 per barrel.

Japan:  Prime Minister Kishida’s government has reportedly asked the Bank of Japan’s Deputy Governor Masayoshi Amamiya to become the central bank’s top leader when Haruhiko Kuroda, the current governor, retires in early April.  BOJ observers widely consider Amamiya to be a continuity candidate who will maintain Kuroda’s dovish approach to policy.  In response, the JPY weakened to its lowest value since early January.

Australia:  The Reserve Bank of Australia hiked its benchmark short-term interest rate today for the ninth consecutive time, boosting it by 25 bps to 3.35%.  RBA Governor Philip Lowe said the hike was needed to bring down inflation and signaled that further rate hikes were likely.  Along with last week’s rate hikes by the U.S. Federal Reserve, the European Central Bank, and the Bank of England, the hike in Australia underscores that the major central banks in the developed world remain in rate-hiking mode and that investors looking for a quick pivot to rate cuts are probably being too optimistic.

France:  Key labor unions are launching a new nationwide strike today to protest President Macron’s proposed pension reform, which would raise the standard retirement age to 64 from the current 62.  Just as important, opposition parties in parliament have introduced a blizzard of some 20,000 proposed amendments to the legislation in order to slow its progress.  The latest polling shows that only about 35% of French citizens support the bill, raising serious questions as to whether Macron can push it through with his lack of a majority in the legislature.

Russia-Ukraine War:  Reports indicate that Russian forces have now opened new offensives in at least five places on the front lines in eastern Ukraine, but Western officials and analysts are casting doubts on Kyiv’s assertion that this is the beginning of a major strategic push that could put Ukrainian gains at risk.  The Western officials and analysts continue to believe that Russia’s depleted troops, equipment losses, and ammunition shortages will limit its ability to launch any large, effective combined operations in the near future.

• The war also continues to pressure the West’s defense industry, as it tries to rapidly ramp up the production of weapons and ammunition in support of Ukraine.
• The pressure on producers is being exacerbated by lingering supply chain bottlenecks after the coronavirus pandemic, a lack of production capacity, and a shortage of critical raw materials for some explosives, which is holding back efforts to increase output.

United States-China:  Several U.S. Navy warships, with divers and FBI counterintelligence officials on board, continue to comb the Atlantic Ocean off the coast of South Carolina for the remains of the suspected Chinese spy balloon shot down on Saturday.  If landing in the water kept the balloon’s instruments relatively intact, U.S. officials could figure out what the Chinese were looking for, better understand Chinese surveillance technology, and determine whether their sensors use any computer chips or other high-technology components from the U.S. or its allies.  Those findings could worsen the spiral of tensions between the two countries and create further risks for investors.

U.S. Tax Policy:  In an interview with the Wall Street Journal, the new Republican chairman of the House Ways and Means Committee, Jason Smith of Missouri, vowed to champion tax policies that prioritize the interests of farmers, small businesses, and working-class voters, rather than the big corporations his party has often favored in the past.  He also warned that he may launch investigations into the economic ties between big corporations and China.

• Smith’s shift in priorities is consistent with our view that the Republican Party, under the increasing influence of populists on the right wing of the party, is becoming less friendly toward big, international businesses. If the Republicans continue to strengthen, that could eventually translate into big tax increases and other populist attacks on multinational corporations.
• In contrast, the Democratic Party is becoming increasingly identified with big business, especially in sectors such as information technology, financial services, communications services, and media.

U.S. Politics:  President Biden will deliver his State of the Union address tonight at 9:00 pm ET.  In the speech, he is expected to tout his legislative wins last year and lay out policy priorities for the coming year.  Biden’s new policy priorities are expected to include a quadrupling of the 1% tax on stock buybacks that took effect in January and expanding a recent $35-a-month cap on insulin for Medicare recipients.  He is also expected to call for a  reduction in the federal budget deficit  “through additional reforms to ensure that the wealthy and the largest corporations pay their fair share.” Finally, Biden may lay out some tough new measures against China, given that he is facing political pressure to retaliate against the country for sending a spy balloon over the U.S. last week.

U.S. Power Grid:  Two Neo-Nazi activists have been arrested on charges that they conspired to damage electrical substations in the Baltimore area to cause mass energy outages.  Recent attacks on substations elsewhere have raised concerns about sabotage from Russia, China, or other state actors, but the arrests are a reminder that the electrical grid may be more vulnerable to homegrown terrorists.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with a few words on last week’s Chinese spy balloon incident and Chinese support for Russia’s war in Ukraine, which together are likely to worsen the spiral of tensions between the U.S. and China and put investors at risk.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including the latest on the Russia-Ukraine war and how it is creating new energy opportunities for Algeria.

United States-China-Russia:  Customs records obtained by national security nonprofit C4ADS show that Chinese defense companies have been providing Russia with a range of dual-use civilian/military goods needed by the Kremlin to prosecute its invasion of Ukraine.  The products supplied include semiconductors, navigation equipment, jamming technology, and fighter-jet parts.  We suspect the report will spur the U.S. to impose sanctions on more Chinese firms, exacerbating U.S.-Chinese tensions even beyond that of the impact of Saturday’s U.S. shoot-down of the Chinese surveillance balloon identified early last week.

• U.S. defense officials now say the Chinese had previously sent several other spy balloon over the U.S. beginning in the Trump administration.
• Such a visible, easily understood incursion of the nation’s airspace is likely to energize U.S. political and popular feelings against the Chinese, prolonging the spiral of escalating bilateral tensions. As the U.S. and China continue to clamp down on their mutual trade, capital, and technology flows, investors remain at risk of getting caught in the crossfire.

Russia-Ukraine War:  While the front lines from northeastern to southern Ukraine remain mostly static, the Russians finally appear close to encircling the eastern city of Bakhmut.  The new Russian gains partly reflect the availability of tens of thousands of new troops mobilized in President Putin’s September call-up.

European Union-Algeria:  With Algeria emerging as one of the key natural gas sources available to replace Russian exports to Europe, U.S. energy giant Chevron (CVX, $169.45) has revived talks with the Algerian state-run company Sonatrach to investigate natural-gas opportunities in the country’s vast shale formations.  The potential for reinvigorated shale development illustrates how the Russia-Ukraine war has shifted global energy markets and created new opportunities for some countries.

European Union-Indonesia-Malaysia:  The impending approval of a new EU law against importing products linked to deforestation has spurred Indonesia, Malaysia, and other East Asian countries to threaten cutting off palm oil exports to the bloc in protest.  Other emerging markets are likely to be affected and could protest as well, given that the law could affect a wide range of products, such as cattle, cocoa, coffee, palm oil, soya, wood, and rubber.

United Kingdom:  Over the weekend, Former Prime Minister Truss launched a concerted effort to rehabilitate herself politically with a 4,000-word essay in The Telegraph, a newspaper widely read by members of her Conservative Party.  In the article, Truss lashes out at a number of enemies, arguing that her proposed program of massive tax cuts was brought down by disloyal Conservatives and the “economic establishment.”  Truss may find a sympathetic audience among some Conservatives, which will complicate matters for incumbent Prime Minister Sunak as he struggles to deal with Britain’s current wave of strikes and rising financial pressures.

Israel:  Violence continues to escalate between the Israeli government and militant Palestinians.  Earlier today, Israeli forces said they killed five Palestinian militants during an operation targeting Hamas members near Jericho.  It was the second such deadly raid in a little over a week as violence escalates in the occupied West Bank.

Turkey:  At least two major earthquakes struck southern Turkey this morning, killing at least 1,000 and probably many more.  The quakes, which registered 7.8 and 7.5 on the Richter scale, were Turkey’s strongest in some 80 years.  The loss of life, economic disruptions, and future government response could potentially affect President Erdoğan’s re-election prospects at the next balloting in May.

U.S. State Fiscal Health:  In another sign that any recession this year is likely to be moderate, the National Association of State Budget Officers said state governments have about $136.8 billion set aside in financial reserves, a record high of 0.53% of GDP.  County and city governments also appear flush with cash, which should limit how much they will have to tighten their spending in the event of an economic downturn.

U.S. Labor Market:  Despite the surprising growth in overall payrolls reported on Friday, the information technology and real estate-related industries continue to shed workers.  Earlier today, Dell Technologies (DELL, $42.24) announced it that would lay off 5% of its workforce, which will equate to about 6,600 employees.  The company blamed the move on “eroding” market conditions.

• Despite the continued layoffs in technology and real estate, other employers’ panicked scramble for workers and rising wage offers could spur the Federal Reserve to keep raising interest rates even beyond what it had previously signaled.
• The risk that wage growth will keep buoying inflation and interest rates not only weighed on financial markets last Friday, but it continues to affect the markets today. So far this morning, stock futures are falling, bonds are in retreat, and the dollar is strengthening.

U.S. Childcare Industry:  One industry that hasn’t been able to hire back all the workers it lost during the COVID-19 pandemic is childcare.  According to the most recent data, there are now about 58,000 fewer daycare workers in the U.S. compared with February 2020, just before the pandemic took hold.  The worker shortage is limiting daycare availability and driving up costs.

U.S. Housing Industry:  Now that mortgage interest rates have fallen back to around 6% from their peak of 7% last November, real estate professionals report there is some thaw in the housing market.  However, it is still too early to know whether the market will continue to improve from here, especially given that the tight labor market could keep the Fed hiking interest rates beyond what investors had recently been expecting.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning! Today’s Comment begins with our concerns about the market’s dovish interpretation of the remarks from the central banks. Next, we discuss why poor Q4 earnings may not lead to a weak performance in the stock market. We end the report by discussing how rising tensions with Russia and China may lead to increased defense spending in the West.

Mixed Signals: Perceived dovishness from the central banks has lifted risk assets, but more questions still need to be answered to know if the upswing will last.

• A growing number of monetary policymakers have moved away from hawkish rhetoric to favor language with greater flexibility. The three major central banks (Federal Reserve, European Central Bank, and Bank of England) have all offered timid support for automatic rate hikes over the next few meetings. The shift in rhetoric began when Fed Chair Jerome Powell proclaimed in a press conference that the disinflationary process had begun. This dovish sentiment was continued by ECB President Christine Lagarde and BOE Governor Andrew Bailey’s comments that their own subsequent hikes will be data-dependent. Despite each central bank’s acknowledgment that rate hikes are not guaranteed, they all insisted that keeping rates elevated is necessary to fight inflation.
• Relatively low-inflation countries are moving in the opposite direction. The Swiss National Bank and the Bank of Japan are expected to tighten policy this year. The decision to tighten comes as the countries are seeing an uncharacteristic rise in inflation. The Consumer Price Index (CPI) for Switzerland rose 2.7% from the prior year in December, while Japan had a 4.0% increase in the same period. Although their inflation remains below that of their peers, the sharp rise is well above the ten-year inflation experience within these countries. Therefore, some central banks may pause or cut this year, while others will still be hiking rates.
• Economic data can vary depending on the country and the circumstance. Just because inflation falls in one country does not mean that prices are decelerating everywhere. The latest surprise in the Spanish CPI demonstrates how price pressures can pop out of nowhere. The unpredictable changes in data may prevent central banks from halting their hiking cycle. January’s blockbuster 517k payroll number in the U.S. is a perfect example of how an economic surprise may suddenly shift sentiment. As a result, investors should remember that central bankers can be very fickle during times of uncertainty and should be reluctant to buy into dovish talk if they don’t want to be blindsided by unexpected rate hikes.

Risk On, Risk Off: Earnings reports have blunted some of the optimism for equities as firms pointed to headwinds felt toward the end of 2022; however, there is still a bright side.

• Poor results from major tech firms weighed on equities moments before the release of the nonfarm payroll numbers. Apple (AAPL, $150.82), Amazon (AMZN, $112.91), and Alphabet (GOOG, $107.74) reported a slump in sales toward the end of the year. A decline in consumer demand impacted sales for PCs, cell phones, and ads which weighed on investor sentiment. Some of the weak performance can be traced to macroeconomic factors such as the war in Ukraine and China’s Zero-COVID policies. However, much of the pullback in spending may be representative of households preparing for a recession. Amazon’s light-forward guidance also supports the view that firms are worried about a downturn.
• The disappointing figures from tech companies have mirrored economic data that came out toward the end of the year. Retail sales dropped in the final two months of 2022, and industrial production sank to a nine-month low in December. Additionally, the latest Atlanta GDPNow forecast for Q1 projects a 0.7% annualized increase in economic activity, which is a sharp drop from the 2.9% rise in the final three months of 2022. The combination of earnings reports and government data both suggest that the country may be headed toward a recession sooner than many investors realize.

• That said, this recession will likely be the most telegraphed one in our history. Toward the end of 2022, retail and institutional investors increased their cash holdings to record highs. Total net assets in money market funds rose to $4.818 trillion in the week ending January 4, surpassing the previous peak set in May 2020. As a result, the market could be primed for a strong rally later in the year. Last month, equities got off to their strongest start in over four years. Similar starts have generally been a positive sign for the rest of the year, so we believe this may be a good time to look for new opportunities.
  • According to Ned Davis Research, gains in January translate, on average, to about an 8.6% increase for the rest of the year.

Look At the Sky: The U.S. and China’s relations are back on the rocks, while the war in Ukraine enters a new phase.

• A surveillance balloon, suspected to be from China, threatens to undue improvement in diplomatic relations between Washington and Beijing. The spy balloon was spotted in Montana, near an area that is home to several sensitive military sites. Although Beijing claimed to be unaware of the balloon, U.S. experts are confident that it came from China. The incident comes days before U.S. Secretary of State Antony Blinken is scheduled to visit Beijing to help normalize relations between the two countries. As of this writing, the U.S. has not officially canceled the trip; however, the incident could prevent a significant breakthrough as distrust between the two sides remains elevated.
  • The discovery of the balloon suggests that any rollback of export controls on semiconductors is likely off the table.
• Russian forces are regrouping along the border of Ukraine in preparation for a new offensive. Ukrainian officials have assessed that there are over 500,000 troops ready to invade the country. Due to this renewed aggression from Russia, Ukraine has asked the West to provide it with more weapons as it looks to repel Russian troops from its country. Although Western allies have increased their arms deliveries to Ukraine, it isn’t clear just how much advanced weaponry these countries are willing to dole out. Germany was hesitant to send over tanks, while President Biden is resisting calls to send over F-16s. As a result, the new spring offensive could provide the West with another test of its unity in backing Ukrainian war efforts.
• Renewed threats from Russia and China highlight the U.S. and its allies’ need to bolster defense spending. A higher level of military expenditures will allow the West to rebuild its inventory from the war in Ukraine and maintain its lead over China in its military technology. Therefore, government investment should support defense equities in the long run. Despite these stocks not having robust performance over the last few months, it is essential to remember that “defense moves in years, while equities move in seconds.” We believe that these equities are likely more attractive than the current sentiment would suggest.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning! Our Comment begins with the latest Federal Open Market Committee meeting, including the decision to raise rates. Next, we cover the rate decisions of the European Central Bank and the Bank of England. Finally, we discuss Germany’s recent moves to position itself for a greener world.

Not Convinced: Fed Chair Jerome Powell insisted that the Fed will hold rates in the restrictive territory, but the market isn’t buying it.

• The Federal Reserve raised its benchmark interest rate by 25 bps to 4.50%-4.75%, as expected. The increase was a downshift from the previous meeting and has led to speculation that the Fed is close to ending its hiking cycle. After announcing the rate hike, Powell emphasized that the central bank plans to hike more throughout the year. He argued that core services, which exclude shelter prices, and employment remain elevated and may lead to a wage-price spiral if left unchecked. He also opined that the economy is strong enough to withstand additional rate hikes.
• Equity prices surged, and bonds rallied as investors posited that the next rate hike would probably be the last. The S&P 500 rose to an intraday high of 1.8%. Meanwhile, the NASDAQ, which tracks tech stocks, closed 2% higher than the previous day. However, the bigger news came from bonds. The yield on 10-year Treasuries dropped by 12 bps which suggests that bond traders are confident that the Fed will reverse course if inflation heats back up. The latest FedWatch tools show that 30-day fed funds futures predict another 25 bps hike in March with a 66% chance that there won’t be an increase in rates above 4.75-5.00% at the following meeting.
• The last few cycles have shown that the Fed typically uses steps when it raises rates but takes the elevator down when cutting them. Thus, Thursday’s market reaction likely reflects investors’ hopes of a Fed pivot sometime this year. If the market is correct, we could see equities flourish. However, if it is wrong and the Fed decides to hike rates, equities may stagnate or drop. The direction of inflation will likely determine where the market will go. If inflation continues to climb, the Fed could pause or possibly cut in time to prevent a significant downturn.

Not Far Behind: The European Central Bank and the Bank of England had bigger hikes than the Fed; however, neither is committed to raising rates in a downturn.

• The European Central Bank and the Bank of England both pushed up their respective policy by half a percentage point. The markets anticipated the moves as central bank officials had been hinting at the change for several weeks. Although the ECB maintained that it would stay the course of its policy, it signaled along with the BOE that future rate hikes will depend on economic data. The varying responses from these central banks highlight the pressures policymakers are under to consider the economy as they look to tame inflation.
• The EUR and the GBP were sold off as investors questioned the ECB and BOE’s commitment to fighting inflation. The markets’ reactions suggest that investors believe that the central banks could end their hiking cycle as their respective economies head into recession. The spread between 10-year government bonds for Italy and Germany, a gauge of European financial stress, narrowed as borrowing costs are less likely to rise for distressed European economies. Therefore, lending conditions could improve in the Eurozone.
• The market likely interpreted the BOE and ECB as being more dovish than they actually were. Policymakers are likely to continue pushing rates higher as long as the economy remains relatively strong. Although a recession is widely expected in both regions, stronger-than-expected GDP growth in Q4 2022 indicates that it is likely further in the future than originally thought. As a result, central bank policy may begin to tighten as these policymakers look to maintain credibility. That said, the recent comments from these banks suggest that they are not fully committed to remaining hawkish, which means that global financial conditions will likely ease throughout the year.

The German Problem: As Berlin positions its country to adapt to a new normal, it is resisting a major change in the status quo of Europe.

• Chancellor Olaf Scholz racked up two wins in his race to refocus the German economy toward semiconductors. Apple (AAPL, $145.43) announced plans to invest $1.2 billion in Germany to set up a new European silicon design center and improve research and development. The new investment will help build out the country’s 5G capabilities and enhance its wireless technologies. Additionally, American manufacturer Wolfspeed, Inc (WOLF, $83.01) agreed to produce chips for electric vehicles in Saarland. The two investments show that Germany aims to support the country’s technological shift away from traditional manufacturing and toward greener technologies.
• Despite attempts to improve its own industry, Germany has set up hurdles for other European countries to make the same transition. The European Union is expected to miss its March deadline for reforms to the Stability and Growth Pact. The changes would allow countries to offer subsidies to compete with the U.S. Inflation Reduction Act. Without these changes to the debt limit rules within the pact, countries will have to make painful budgetary adjustments if they want to offer energy incentives for green projects. Germany insists that any changes to the rules should not impact governments’ efforts to reduce debt loads. As a result, Europe’s Green Deal Industrial Plan will likely be put on hold as officials argue out the details.
• Germany will always support and put its own interests first, even at the expense of its European allies. As we have mentioned in previous reports, Berlin does not want to fully align its interests with the West since it depends on commodity imports from Russia and trade with China. Germany’s reluctance is also related to wanting a head start on its European counterparts. Thus, it will also likely use the additional time to position itself as a premier European hub for energy manufacturing.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with more good news on global price inflation.  Data today showed that the Eurozone’s consumer inflation has again cooled modestly, though probably not enough to prompt the European Central Bank to slow its aggressive interest-rate hikes.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a discussion of the Czech Republic’s controversial new president and a preview of today’s interest-rate decision from the Federal Reserve.

Eurozone:  The January Consumer Price Index (CPI) was up 8.5% from one year earlier, marking a small improvement from the 9.2% increase in the year to December.  However, much of the improvement stemmed from the recent pullback in European energy prices because of the mild winter.  Stripping out the volatile food and energy components, the January Core CPI was up 5.2% year-over-year, essentially the same annual increase as in the prior month.  The report is therefore unlikely to dissuade the ECB from implementing another aggressive interest-rate hike tomorrow as it continues to battle high inflation in the Eurozone.

Czech Republic:  Petr Pavel, the unaffiliated former leader of the Czech army and the former chief of the NATO military committee, has been declared the winner in last weekend’s presidential election.  Running on a platform embracing the EU and NATO, Pavel handily beat populist Former Prime Minister Andrej Babiš.

• Although the Czech presidency is largely symbolic and has no executive powers, Pavel’s win is being seen as an important political victory over populism and pro-Russian sympathies in the country.
• Pavel has already risked confrontation with China by taking a congratulatory phone call from Taiwanese President Tsai Ing-wen. He therefore became one of the few elected European leaders who has recently risked Beijing’s ire in such a way.  The gesture in support of Taiwan could encourage other European leaders to take a more assertive stance against China’s geopolitical aggression.
• In an interview with the Financial Times published today, Pavel was even more blunt, saying, “This is what we have to be very clear about: China and its regime is not a friendly country at this moment, it is not compatible with western democracies in their strategic goals and principles… This is simply a fact that we have to recognize.”

Russia-Ukraine War:  Although the front lines running from eastern to southern Ukraine remain largely static, albeit with heavy fighting in some areas, the Ukrainian government has again warned that it has intelligence that the Russians are planning a major new offensive soon, potentially to coincide with the one-year anniversary of their invasion on February 24.  Among the signs of such a new offensive, the Ukrainians note the Russian military’s increased mobilization of resources and intensified troop training.

India:  Ahead of the next parliamentary elections in Spring 2024, the government of Prime Minister Modi has released a proposed budget for the fiscal year beginning April 1 that cuts taxes for the upper and middle classes and massively boosts infrastructure spending.  The budget assumes Indian GDP will grow between 6.0% and 6.8% in the coming fiscal year, allowing the budget deficit to decline to 5.9% of GDP from an estimated 6.4% of GDP in the current year.

United States-Russia:  In a report sent to Congress yesterday, the State Department said Russia has violated the New START treaty, which cut long-range nuclear arms, by refusing to allow on-site inspections and rebuffing the U.S.’s requests to meet to discuss its compliance concerns.  With spot checks no longer possible, the U.S. can no longer verify the weapon counts reported by Russia.  The violations, which Russia denies, raise the risk that New START, the only remaining Cold War-era arms limitation treaty still in force, will not be renewed when it expires in 2026.

• As important as the New START treaty is in limiting the U.S. and Russian nuclear arsenals, the agreement doesn’t include China at all. China’s strategic nuclear arsenal remains far smaller than the U.S. and Russian arsenals, but it is rapidly building up its inventory of nuclear weapons and could approach the numbers in the U.S. stockpile in several years.
• Abrogation of New START could therefore free the U.S. to expand its nuclear arsenal as needed to meet the new challenge of deterring a potentially combined Chinese-Russian nuclear attack.

United States-China:  In a possible retaliation for the U.S.’s stringent new controls on exporting its advanced semiconductor technologies, China is reportedly considering a ban on exporting its own advanced solar energy technologies.  If the plan is adopted, Chinese solar manufacturers would be required to obtain a license from their provincial commerce authorities to export such technologies.  If put into place, the Chinese restrictions could crimp efforts to expand solar generating facilities and solar equipment manufacturing in the U.S., Europe, and developed Asian countries in the coming years.

United States-India:  This week, the Biden administration hosted U.S. business leaders and an Indian delegation led by New Delhi’s national security advisor to discuss ways to shift key technology supply chains away from China and toward India.  The meetings are another instance of how seriously the U.S. government, with bipartisan support in Congress, is seeking to decouple from China and its evolving geopolitical bloc in terms of key technologies and commodities.

U.S. Monetary Policy:  Fed officials wrap up their latest two-day monetary policy meeting today, with their decision due to be released at 2:00 PM ET.  The officials are widely expected to slow their rate hikes at the meeting to just 25 basis points, bringing the benchmark fed funds rate to a range of 4.50% to 4.75%.  However, they are also expected to signal that they won’t be finished tightening policy until they make more progress in bringing down inflation.

• We continue to believe the continued rate hikes will help push the U.S. economy into recession in the very near future. That suggests U.S. stock prices could well turn downward again, despite their rally in recent weeks.
• The ECB and the Bank of England will hold policy meetings tomorrow, but they are expected to keep hiking their benchmark interest rates by an aggressive 50 basis points. The narrowing differential between the U.S. and European benchmark rates will probably put continued downward pressure on the dollar.

U.S. Fiscal Policy:  President Biden and House Speaker McCarthy will meet today to discuss a range of issues and, more importantly, to begin negotiating a deal to raise the federal debt ceiling.  Any lack of results could rekindle concerns about a potential U.S. debt default and spark additional market volatility.

U.S. Regulatory Policy:  The Consumer Financial Protection Bureau plans to propose a rule today that would limit the late fees credit-card companies can charge, bringing penalties down to $8 from as much as $41 currently.  The rule, which doesn’t require Congressional approval, could go into effect as early as 2024.  The expected new rule illustrates the Biden administration’s relatively more aggressive regulatory initiatives.

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