by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Howdy! Equities are down this morning after the jobs report soundly beat expectations, Today’s Comment begins with an overview of the recent sell-off in the U.S. dollar and what it means for financial markets. Next, we discuss the U.S. government’s efforts to resolve tensions with unions and the EU. Lastly, we explain the risk the war in Ukraine poses to equities abroad.

Dollar Peaking? The recent retreat in the greenback is significant, but it isn’t clear if it will last, as evidenced by its recovery today in the wake of the payroll data.

• Although the U.S. dollar is one of the best-performing assets in 2022, it has begun to turn. The greenback has dropped more than 7% from its September peak. Its descent was driven by a combination of speculation that the Fed is almost done hiking and greater positivity about the global economy heading into 2023. The CPI and PCE inflation reports both came in below expectations. Meanwhile, GDP data from Germany and optimism of China’s reopening have made a global recession next year less likely. Additionally, signs that global inflation is approaching its peak have made foreign currencies more attractive.

• The weakness in the dollar will likely make it easier for other central banks to relax monetary tightening. Due to their reliance on imports of dollar-priced commodities such as oil, central banks such as the Bank of Japan and the European Central Bank were pressured to take aggressive monetary action to contain inflation. However, their lack of aggressive action had led to dollar appreciation. As a result, the recent dollar weakness (we note that the dollar is stronger today off the payroll wage data) against peer currencies will likely mean that these banks can take less aggressive policy action to tackle price pressures. In short, a weaker dollar is a positive for international equities. For example, the recent rally in emerging market equities and bonds shows that investors are positioned to take advantage of a depreciating U.S. currency.
• Next year’s FOMC will have more hawks than in 2022. Kansas City Fed’s Esther George and Boston Fed’s Susan Collins will be replaced by hawks Fed President Neel Kashkari and Dallas Fed’s Lorie Logan. Meanwhile, Chicago Fed picked notable dove Austan Goolsbee as the next bank president. He will be a voting member and will offset the loss of St. Louis Fed President James Bullard, a bona fide hawk. Additionally, persistently high employment payroll data like the one released today also supports further tightening in the future and pushes up the dollar’s value. In short, the hawkish tilt of the committee suggests that the dollar could rebound in 2023.
  • Austan Goolsbee was the economic advisor of former President Barack Obama. In an interview with NPR, he called into question the ability of hikes alone to rein in inflation and is likely to be sensitive to economic changes.

U.S. Firefighting: The president and Congress are moving to contain flames both domestically and abroad.

• The Senate passed legislation that would prevent rail workers from going on strike. The bill is expected to be sent to President Biden’s desk to be signed into law. The passage of the bill has prevented a strike from disrupting the U.S. economy but could have political costs for Democrats in upcoming elections. Rail workers were pushing for seven days of paid sick leave, a tenet that should have left-wing support on paper. The Democrats’ decision not to support labor is an example of how the party is becoming more pro-business establishment and less union-friendly. A stricter line by government officials could ease inflation and may be preferable to equities.
  • Government and unions can have a hot and cold relationship depending on the economic environment. In an inflationary period, politicians have been known to turn on labor.
• President Biden is open to negotiating with Russian President Vladimir Putin over the war in Ukraine. This stance is in contrast with the U.S. president’s previous statement that peace talks must include Ukraine. Although there is some sign that Putin may accept the invitation, the change in Biden’s tone suggests that the West wants the war to end. Biden’s offer came after meeting with French Emmanuel Macron. In the past, Macron has criticized the U.S. for profiting from the conflict at Europe’s expense. Thus, there is a possibility that Western support for Ukraine could be fading, which should be favorable to financial markets.
• Although demand remains an important driver of inflation, there are still many supply-side factors that can support higher prices. The growing power of labor unions has given unions more leverage to negotiate higher wages and benefits from firms. Meanwhile, the uncertainty in Ukraine suggests that commodity prices will continue to fluctuate. The Fed will consider these factors when determining whether it should lower rates. That said, U.S. central bank officials have shown no intention of distinguishing demand and supply pressures when deciding policy. Thus, supply-side shocks could lead the Fed to raise rates higher and for longer than the market currently expects.

Russia Risk Rising: A string of suspicious packages sent across Europe raises new questions about the war; meanwhile, the EU continues to bicker over price caps.

• Threatening packages were sent to Ukrainian embassies in Hungary, the Netherlands, Poland, Croatia, Italy, and Austria. Packages contained varying materials, from explosives to animal parts. Although no one was harmed, Western governments believe that the boxes are a form of terrorism and intimidation. The delivery of these threatening items could be a warning that there are factions, within Russia or sympathetic to, who are willing to escalate the war outside of the Ukrainian borders. At this time, the packages do not provide present a risk but could be a warning of something worse to come.
• Meanwhile, EU members still need to settle on a price cap for Russian oil. Although the recent proposal shows a price cap of $60, some countries within the bloc would like the lid to be lower, and others prefer to do away with the price cap entirely. Countries most in danger of being invaded are pushing for a lower limit as it would deprive Moscow of needed revenues to expand its war aims. However, EU members most adversely impacted by the price limit have warned that a low cap could make it harder for countries to receive energy supplies.
  • The EU has until Monday to come to a resolution before the agreed-upon embargo is set to take effect. Failure to do so could lead to disruptions within energy markets.
• Uncertainty in Ukraine represents a prevalent risk for European equities. Despite efforts from the West to curtail Russian oil production, it has still been able to increase its shipments worldwide. OPEC’s willingness to work with Moscow to minimize the impact of Western restrictions makes the problem worse. Meanwhile, the threat of a broader conflict could escalate tensions between the West and Russia. In short, investors should be mindful that any de-escalation of the war effort will likely be taken positively by the markets, especially in Europe. In the meantime, the U.S. remains safe, a place to hide and wait.

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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 thoughts about Wednesday’s speech by Fed Chair Powell. Next, we give an overview of China’s move away from its Zero-COVID policy. We end with international news focusing on the growing fractures within the Western alliance.

Fed Talks: Fed Chair Jerome Powell signaled that the central bank is not prepared to lower rates; however, the market is not convinced.

• The market rejoiced following suggestions that the Federal Reserve would scale back the size of rate increases. On Wednesday, Powell hinted that the central bank may moderate the pace of hikes at its December meeting but also that the Fed was not done raising rates. The S&P 500 soared over 3%, there was a bullish steepening in the yield curve, and the U.S. dollar index dropped. This market reaction indicates that investors are confident that the Fed is nearly finished with its tightening cycle. The latest Fed Watch Tools show that the market has priced in a nearly 80% chance that the Fed will raise its policy rate by 50 bps at its meeting later this month. Meanwhile, market bets predict that the Fed will begin cutting rates in the latter half of 2023.

• This bullish reaction from investors was likely not the response Powell expected when he made his comments. Fed officials have insisted that they will not stop tightening until inflation makes sufficient gains toward its 2% target. Thus, we suspect Fed Governors Michelle Bowman and Michael Barr will attempt to rein in expectations when they speak on Thursday. Additionally, stronger-than-expected employment data to be released on Friday might also reduce sentiment that the Fed is close to ending its tightening cycle. Therefore, Wednesday’s gain could be short-lived.
• Although inflation remains stubbornly high, there are signs that price pressures are starting to ease. U.S. rent prices fell for the third consecutive month in November, according to ApartmentList.com. Meanwhile, data collected from the Standard & Poor’s Case-Shiller Home Price Index shows that national home prices are also falling. Shelter prices comprise a third of the Consumer Price Index, so a drop would weigh heavily on price pressures. That said, it generally takes several months for the index to pick up changes in the housing market due to how the data is tracked.
  • There is also a risk that if the dollar weakens and OPEC+ follows through on rumored production cuts, energy prices could rise and prevent inflation from falling further.

China in Focus: Beijing is walking a fine line as it attempts to display confidence in its pandemic response while also pacifying a growingly disgruntled public.

• China hinted that it may reduce the pandemic restrictions as public anger arises after a new round of lockdowns. A top Chinese official announced that the latest variant of COVID was “less pathogenic” than previous strains. This sentiment was also reflected in the state media’s softer tone when discussing the virus. One editorial went as far as to say that people “should not be too afraid of Omicron.” Over recent weeks, the country has ramped up its vaccination efforts and has entertained the possibility of importing Western vaccines. The renewed push is likely a positive sign for Chinese equities.
• Although substantial policy changes did not follow the remarks, the market believes reopening is on the horizon. The news initially led to a sharp rally in the Hang Seng China Enterprises Index, which rose to as high as 3.7% on the day; however, most of those gains subsided as investors realized that a reopening was not expected to be smooth. Beijing will likely drop restrictions at a slow pace as it does not want to give the impression that it is caving to public pressures. Additionally, there may be some hesitancy among people still wary to leave their homes due to COVID concerns.
• The reopening of the Chinese economy provides both positives and negatives for the rest of the world. The loosening of restrictions should increase economic activity, which should then help boost global growth and relieve some supply chain pressures. However, the reemergence of the Chinese consumers will increase the demand for energy products and push up the prices for commodities. In short, the overall impact of China’s reopening is complicated, to say the least. Thus, a slow reopening will likely fare better for equities than a quick one would.

Friends or Foe:  Allies within the North Atlantic Treaty Organization are becoming frustrated with U.S. foreign and economic policies.

• Turkey’s bullheadedness leads to more uncertainty in the Middle East and is straining U.S. ties. On Wednesday, the U.S. warned Ankara against further escalation in Kurd-controlled areas of Syria due to the danger it poses to U.S. military personnel. Tensions between the two countries have been brewing after Turkish President Recep Tayyip Erdoğan blamed Kurdish groups for a November bombing in Istanbul. The ongoing row between the two NATO allies may complicate coordination efforts for their considerable roles in supporting Ukrainian war efforts.
  • Outside of Syria, Turkey has also backed Azerbaijan in its ongoing dispute with Iran. Tehran’s military presence along its shared border with Azerbaijan has angered Anakara. In response to Tehran’s actions, Turkey suggested that it may consider military actions if tensions escalate further.
• European countries continue to rail against the U.S.’s new climate law. French President Emmanuel Macron is the latest European leader to express his frustration. In a speech yesterday, he stated that the Inflation Reduction Act threatens to divide the West. The point of contention between the two sides relates to tax breaks for components used in renewable energy technologies like electric cars. Europe sees it as an opening salvo in a trade war. In our view, the Inflation Reduction Act was designed to convince Europe to prioritize its own industries over China through subsidies of its own. This is supported by U.S. Trade Representative Katherine Tai’s insistence that Europe create its own subsidy program.
• Differences between the U.S. and its allies over trade and foreign policy have yet to lead to a complete fracturing of ties. This is evident in the European Commission’s recent decision to follow through on a price cap on Russian oil, a measure pushed by the Biden Administration. However, that does not mean that things are all fine and dandy. If Washington fails to keep its Western and NATO allies onside, it could lead to a multi-bloc world led by Europe, the U.S., and China as opposed to a two-bloc world led by just the latter two. A fragmented world will likely complicate supply chain efforts, which could harm earnings for companies with foreign exposure.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning on this last day of November.  Risk markets are trending higher this morning, and a key component to the rally in commodities and equities (especially the former) is a weakening dollar.  For most of the year, the dollar has been on a tear, despite the fact that on most valuation measures, it was already richly valued.  Divergences in monetary policy due to the Fed conducting tighter policy than the rest of the world, was behind the strength.  However, as the markets anticipate at least a slowing of tightening in the U.S., the dollar has begun to roll over.  We still suspect that the expectations of easing are overly optimistic, which could mean that the dollar will at least make a recovery in the coming weeks.  However, over next year, our expectation is that the dollar will decline, which will be supportive for commodities and equities.  On the topic of the Fed, we get the Beige Book today and Chair Powell will speak on the economy.  The markets are watching for any hints of a slowing of tightening.

In today’s Comment, our coverage begins with China news.  Economics and policy are up next.  An update on the Ukraine War follows, and we close with international news.

China news:  The government’s Zero-COVID policy is evolving, and former General Secretary Jiang has died.

• In the past, when China’s leaders implemented unpopular policies, a common response to popular opposition to the policies is to blame local officials for “misunderstanding” the policy. By doing this, leaders in Beijing can soften the policy without losing face.  It appears President Xi is deploying this well-worn playbook again, but that doesn’t necessarily mean that the CPC is easing the policy.  Instead, the policy appears to be evolving.
  • Elements of the policy include deepening surveillance, arresting leaders, and stifling less committed protesters. Security officials are systematically looking for participants to the protests, likely to either arrest or intimidate them, and “flooding the zone” with police to discourage gatherings.  The response does appear to be working, as protests seem to have declined.
  • At the same time, the leadership does seem to realize that the lockdown policies are probably no longer workable. The harm they bring to the economy is significant and public support is waning.  So, how does China open without triggering a mass infection event?  The plan emerging looks like it will focus on mass vaccinations, especially of the elderly.  China continues to use its own vaccines, which are less efficient than Western-developed ones, which will slow the process.  However, to avoid an expansion of infections, vaccination looks like the primary tool.
• Analysts are still sorting out the long-term ramifications of what increasingly looks like a massive policy failure. One element of the failure is the damage it has brought to President Xi as a leader.  Is Xi in trouble?  What we watch for are divisions at the top such as does dissention among the party leaders increase?  So far, we have seen no signs of such divisions, but we also note that (a) the CPC is good at hiding such divisions and (b) Xi has mostly sidelined the powerful who opposed him.
• The other major issue is that tensions are not just due to Zero-COVID policy. Youth unemployment in China is terrible, with reports of 20% unemployment rates.  As China’s economic growth slows, the promise of a future to young Chinese appears to be falling away, leading to rising tensions.  The Zero-COVID policies have been a catalyst, but broader worries are notable as well.
• Jiang Zemin, the former General Secretary, has died at the age of 96. He came from the coastal regions of China and was seen as an economic liberalizer.  There has been some speculation that protesters might use his demise to expand protests, perhaps at his state funeral.  If his burial turns out to be a “private” affair, it might be a sign of the level of concern the current regime has over the protests.
• China, facing increasingly tight restrictions on semiconductor imports, is attempting to build out its own semiconductor industry. A key of this development is to convince European lithography firms to defy U.S. restrictions and export chip-building equipment to China.  Although these firms would like to continue to export their wares to China, the U.S. can inflict harsh punishments on those who defy American policy.  This is an area we monitor closely, but we don’t expect the Europeans, in the end, to continue exporting banned products to China.
• NATO is holding its first talks focused on China’s threat to Taiwan. The Pentagon warns that China has designs on more than just Taiwan in its neighborhood.
• As the world evolves into blocs, there will be nations that straddle the divide. Switzerland was such a nation during the Cold War.  Chinese companies are increasingly betting on Singapore to play a similar role as the U.S. and China steadily separate.
  • Although we do note that the Commerce Secretary doesn’t believe that the U.S. wants to decouple from China. That will be “music to the ears” of multinational firms, but in our reading of U.S. politics, it is widely out of step with political trends.
• The Vatican says Beijing violated its deal with the papacy. Who would have guessed?

Markets, Economics and Policy:  Congress moves to prevent a rail strike and the “lame duck” session heats up.

• As a senator, Joe Biden built a narrative of his support for union workers. Holding stances as a senator rarely has ramifications, though,  as a senator is simply part of a larger body and holding dissent positions doesn’t really matter all that much.[1]  With the potential for a paralyzing rail strike looming, the president called on Congress to prevent a strike by taking away the union’s most powerful tool to extract revenue from capital.  Although the decision is understandable, it will likely have political costs.
• With the seating of the next Congress, the U.S. will have a divided government. This prospect is triggering rather frenetic legislative activity to pass as much as possible before early January because once the government is divided, the likelihood of passing anything will become quite difficult.  The biggest surprise is that the existing House and Senate leadership appear to be moving quickly to pass an omnibus spending bill.  The Pentagon is worried that in the absence of a new spending bill, the government will fund itself with a continuing resolution which would mean that defense spending would not grow in a period where spending demands are elevated.  In fact, the GOP is insisting that defense spending grow faster than other spending, and if the Republicans get their way, it may be supportive for the Defense sector.
• As we noted above, Chair Powell speaks today, and the regional banks will report on their local economies. We have seen a parade of Fed officials speaking recently and there is evidence of a growing hawk/dove divide.  Such divisions shouldn’t be a complete surprise; in fact, these sorts of divides are common.  Policy was so easy that for most of this year, there was near unity that tightening was needed.  With divergences emerging, however, Powell’s position becomes increasingly important.  Simply put, we need to know which side he favors, and his speech today may offer some clues.
• European inflation, although still elevated, did fall last month, triggering hope that inflation has peaked. European markets celebrated.  Europe has had a run of good luck recently.  Ukrainian forces have been doing well, the weather has been very mild, easing fears of energy shortages, and with inflation perhaps rolling over, sentiment is improving.
  • The idea that inflation has peaked in the U.S. has triggered a rally in high-yield bonds. Widening credit spreads is usually a feature of recessions.  However, we are still early in this expansion and credit practices have not had enough time to become lax.  Thus, the chances of a spike in yields are less likely as defaults should be manageable.
• Yesterday, it was reported that home prices fell. We are now seeing a rapid decline in home prices, which is usually consistent with recession.

• On the housing market, the government will now offer mortgage guarantees on mortgages of more than $1.0 million, a reflection of recent price escalation.
• One of the ways that companies deal with higher costs is through “shrinkflation” which is the practice of holding the price steady but packaging a smaller quantity. Edgar Dworsky is the go-to guy on this issue.

War in Ukraine:  Is Crimea going to revert to Ukraine?  And Germany recounts its errors.

• Although it looks to us a bit farfetched that Ukraine could retake Crimea, in the peninsula there is increasing evidence that the locals are expecting a direct conflict. If Crimea were threatened, an unconventional response from Russia would become more likely.
• German Justice Minister Marco Buschmann admitted that Germany’s policy of cozying up to Moscow contributed to Russia’s invasion of Ukraine. We note that Buschmann is a member of the Free Democrats, whereas the Social Democrats have been the most supportive of Russian/Soviet engagement going back to the 1970s.  The Free Democrats are part of the ruling coalition along with the Greens.  One of the tensions within the German government is that the dominant SDP continues to support engagement to some extent, but that is not at all in sync with the Greens or the Free Democrats.
• The U.S. is considering labeling the Wagner Group as a terrorist organization.
• Russia is asking India for specific products that have become scarce due to sanctions. This action would require India to break sanctions.  So far, the U.S. has tended to give India a pass on its relations with Russia, wanting to keep India “on side” in containing China.  So, India’s reaction to the request bears watching.

International News:  Orbán is isolated, and “corn wars” are developing.

• Hungarian President Orbán has been on the outs with the EU for some time. His anti-immigration and social policies are seen as out of step with the EU.  For the most part, Orbán has avoided severe penalties because Poland has similar policies and has supported Hungary.  The EU has tended to avoid making both nations upset, so it has mostly not enforced strict constraints on Hungary.  However, that situation does appear to be unwinding.  Poland, a stanch opponent of Putin, opposes Hungary’s support of Russia and therefore isn’t coming to Hungary’s aid.  This is allowing the EU to threaten a material funding reduction.
• Mexico is one of the world’s largest corn importers. It uses the grain for both cattle feed and for subsidized tortillas.  The AMLO regime wants to ban GMO corn which is mostly grown in the U.S.  Washington is threatening to enforce the USMCA to prevent Mexico from banning the GMO sales.
• Pakistan’s former head of its spy agency has been appointed to the head of the army. The military is very powerful in Pakistan, so General Asim Munir is essentially the head of state as well.
• It’s India’s turn to head the G-20, and it plans to make the most of it.

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[1] This is why, in our analysis of politics, we usually have less regard for senators who become presidents.  Senator’s positions often don’t matter; instead, we prefer people who have actually had to make decisions for which they are responsible.  In this regard, we believe that governors tend to be better candidates.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with an update on the Russia-Ukraine war.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a hawkish statement on the Eurozone’s monetary policy by ECB President Lagarde and a request from President Biden that Congress take action to thwart a threatened railroad strike.

Russia-Ukraine:  As the Ukrainian military continues to press its counteroffensive in the country’s northeast, east, and south, the Russian military is reportedly planning a new wave of artillery, missile, and kamikaze drone strikes against Ukraine’s civilian infrastructure in an effort to freeze the Ukrainian population into submission.  As we have mentioned previously, that effort has failed so far, raising the question of whether Russia is wasting its remaining precision-weapons inventory for little gain.

• Separately, as Western Europe continues scrambling to replace natural gas supplies cut off by Russia in retaliation for its support of Ukraine, Germany has signed a small-scale deal to import gas from Qatar for 15 years beginning in 2026. The emirate is one of the world’s largest gas exporters, but this will be its first long-term deal to send supplies to Europe.  All the same, the deal will do nothing to help Western Europe regain its gas supplies this winter or, perhaps more crucially, next winter.
• French President Macron arrives in Washington today for a four-day state visit in which he is expected to discuss the joint U.S.-European approach to the war. Macron will likely air a range of European grievances involving the belief that the U.S. is profiteering from the conflict by selling enormous volumes of gas and weapons to Europe at high prices.

Eurozone:  Yesterday, European Central Bank President Lagarde said that in spite of encouraging signs that Eurozone inflation may be set to moderate, the ECB is not yet finished raising interest rates and still “has a long way to go” in tightening monetary policy.  The hawkishness of Lagarde’s statement suggests that the ECB may not be as ready to slow the pace of its rate hikes as the Federal Reserve is, which probably goes far in explaining the euro’s strength against the dollar in recent days.

China:  Although new COVID-19 infections remain near record highs, health authorities today have begun downplaying the risks in an apparent effort to quell concerns about widespread new lockdowns.  As we reported in our Comment yesterday, it also appears that Chinese police and security forces have suppressed the extraordinary wave of anti-government protests that began late last week.

• So far this morning, those developments have sparked a sharp rebound in Chinese stock values as investors bet that the crisis will force the government to loosen its highly disruptive Zero-COVID policies.
• However, investors should take note of how quickly China’s police and security forces gained control over the weekend protests. That could well encourage President Xi to keep his Zero-COVID policies in place, especially since he had already allowed a modest loosening of the policies in recent weeks.

China-Djibouti:  A new report from the World Bank indicates that Djibouti has suspended its debt repayments to China as it faces major economic difficulties.  Djibouti has received $1.5 billion of funding from China, largely as a part of President Xi’s “Belt and Road” initiative that seeks to fund roads, ports, and other trade infrastructure in mostly developing countries.  In return, China had hoped to build political influence and support, and it had even secured a military base in Djibouti.  In recent years, however, China has had to face the fact that its loans won’t necessarily be repaid or be spent wisely, putting a damper on new lending under the program.

China-United States:  The People’s Liberation Army claimed that it warned away a U.S. Navy warship that had entered waters near the Spratly Islands in the South China Sea on Tuesday in what was apparently a “freedom of navigation operation.”  Like previous such incidents, this one highlights the continuing and growing geopolitical tension between the U.S. and China, which has already had negative impacts on Chinese stocks.

U.S. Monetary Policy:  New York FRB President Williams warned yesterday that the Fed has no choice but to continue raising interest rates and tightening monetary policy to bring down high inflation.  In fact, he said he didn’t expect the Fed to start cutting rates again until 2024.  As a consequence, he warned that the U.S. unemployment rate could rise to between 4.5% and 5.0% by the end of 2023.

• Although U.S. monetary officials are intent on continuing to hike rates, they do look like they will soon shift to smaller hikes of 50 basis points at a time.
• Williams’ expectation for higher unemployment is consistent with our view that the U.S. economy is likely to slip into recession in the first half of 2023. One key reason to expect a recession next year is that the U.S. long-term bond yields are now at their deepest inversion relative to shorter-term yields since 1981.  Inverted yield curves are often a harbinger of an economic downturn.

U.S. Railroad Strike:   After four major railroad unions recently rejected a contract compromise proposed by the administration, threatening to strike in the coming days, President Biden yesterday called on Congress to pass legislation that would avert the shutdown by imposing a contract between the workers and the railroad companies.  House Speaker Pelosi said the lower chamber of Congress will vote on the legislation this week.

• Under the Railway Labor Act, Congress can make both sides accept an agreement that their members have voted down. Lawmakers can also order negotiations to continue and delay the strike deadline for a certain period, or they can send the dispute to outside arbitrators.
• In any case, a full-blown rail strike could be a big blow to the economy by disrupting supplies of key commodities and driving up prices. A strike would therefore likely be negative for U.S. equities.

U.S. Cryptocurrency Market:  In yet more fallout from this month’s failure of crypto exchange FTX, major crypto lender BlockFi yesterday filed for bankruptcy protection.  BlockFi attributed its problems mostly to falling cryptocurrency prices and its ties to FTX.  As one of a long string of crypto bankruptcies this year, BlockFi’s bankruptcy illustrates the major problems that the industry is now working through.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with an update on the Russia-Ukraine war, including more evidence that the Russians are expecting a robust Ukrainian counterattack on the east side of the Dnipro River.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including news of mass anti-government protests in China that have sparked fears of new, draconian political crackdowns and even worse headwinds for the Chinese and global economies.

Russia-Ukraine:  Now that the Ukrainians have pushed the Russian invasion forces from the western side of the Dnipro River and are continuing to probe the eastern side, the Russian forces are apparently assuming that the Ukrainians will soon attack in force on the eastern side.  They are therefore attempting to build trenches and other fortifications to at least delay a Ukrainian advance toward Crimea.  Meanwhile, the Russians continue to attack toward the city of Bakhmut in the northeastern Donbas region of Ukraine, with little success so far.

• The Russians are continuing to stage artillery, missile, and kamikaze drone attacks against Ukraine’s civilian power and water infrastructure in an apparent effort to freeze the population into submission. However, Ukrainian authorities claim they are quickly repairing much of the infrastructure and bringing it back online, raising the question of whether the Russians are wasting their dwindling ammunition supplies on a lost cause.
• Separately, the European Union on Wednesday failed to agree on the price at which to cap Russian oil sales in order to reduce the amount of funding Moscow has available to prosecute the war. Consistent with a recent G7 agreement, most EU members were prepared to cap the price at between $65 and $70 per barrel, but Poland held out for a much lower $30 per barrel to turn the screws even harder on Russia.

Global Oil Market:  U.S. regulators stated that they would allow Chevron (CVX, $183.70) to resume pumping crude oil from its Venezuelan fields after the Socialist government and an opposition coalition agreed on a humanitarian relief program and continued dialogue on efforts to hold free and fair elections.  Improved access to the resources and expertise of Chevron could help it modestly boost production and exports going forward, which the Biden administration hopes will help bring down prices.

European Union:  EU Commission President von der Leyen issued an unexpectedly harsh judgment that Hungary has failed to adopt promised rule-of-law reforms and therefore has no right to €7.5 billion in regular EU funding and €5.8 billion in pandemic recovery grants that have been temporarily frozen over the issue.  She did recommend approving Hungary’s plan to spend the recovery funds if they are ultimately released, but only if Hungary now meets an expanded list of 27 reforms.

• The EU’s College of Commissioners will formalize the decision next week, after which the Council of the EU (consisting of national representatives) will have to approve it by qualified majority (55% of the EU countries and 65% of its population).
• Naturally, the decision will anger Hungarian Prime Minister Viktor Orbán. As he has done in the past, he will likely retaliate by holding up EU decisions that require a unanimous vote of all countries, including votes on new sanctions against Russia.  Brussels’ ongoing rule-of-law disputes with Poland and Hungary threaten to undermine the EU’s cohesion and hamstring its decisionmaking in the coming months.

European Union-United States:  EU trade ministers meeting on Friday warned that there is a rising risk of a trans-Atlantic trade war over the U.S.’s newly passed Inflation Reduction Act, which provides some $369 billion in subsidies for domestically-made high-technology products beginning in 2023.  Along with the U.S.’s better supplies of energy and labor, those subsidies have already prompted a number of major European companies to re-channel future investment plans out of the EU and into the U.S.  That is further irritating European leaders who see the U.S. as profiteering from the war in Ukraine by selling immense amounts of natural gas and weaponry to EU nations.

• Some EU members, such as France, have called for Brussels to replicate the U.S. act with a “buy European” subsidy regime of its own. German Economy Minister Habeck has also suggested increased subsidies. However, EU Trade Commissioner Dombrovskis, some other EU national leaders, and many economists oppose a big subsidy program on grounds that it would be exceedingly expensive and lead to economic distortions.  They also fear that competing subsidy programs would amount to a “trade war” that would hurt EU-U.S. ties.
• However, we note that the Biden administration, to date, hasn’t been warning the EU against such a program. Indeed, early in November U.S. Trade Representative Tai called on the EU to step up support for its manufacturers and reduce its reliance on China for strategically important products in the process.  As we reported in our Comment at the time, Tai suggested that Brussels should jointly develop a new industrial policy alongside the U.S. to counter China’s rising geopolitical threat.  This suggests that the Biden administration is actually pushing for a broad industrial policy to support key technology companies wherever they may be in the evolving U.S.-led geopolitical bloc.

Iran:  As anti-government protests continue, especially in eastern Iran, the commander of the Islamic Revolutionary Guard Corps traveled to Sistan-Baluchistan’s capital of Zahedan, where he threatened more crackdowns and alleged that the protesters were being manipulated by foreign powers.  The protests continue to threaten social stability and the government’s hold on power.

China:  The latest wave of COVID-19 pushed many local governments to impose further lockdowns, sparking mass protests against the government across the country.   Although it now appears that the government has taken control of the situation and suppressed the protests, there is no denying the fact that they were big enough to threaten the social stability and political power that President Xi prizes so dearly.  The lockdowns and protests are also weighing heavily on stocks, commodities, and other risk assets so far this morning.  Interestingly, the dollar is also down today as investors continue to focus on a hoped-for slowing in the Federal Reserve’s interest-rate hikes.

• To address the weakening economy, on Friday the People’s Bank of China announced a cut in the bank reserve requirement ratio to 7.8%, down 25 basis points from the previous RRR and roughly in line with expectations. The modest cut, which will take effect December 5, will mean that banks can lend roughly $70 billion more than before.
• The small boost to banks’ lending capacities will probably have only a very modest positive impact on Chinese economic prospects this winter. Along with weakening foreign demand and President Xi’s crackdowns on key parts of the private sector, the latest COVID-19 lockdowns and resulting protests are expected to be a big headwind to Chinese economic growth in the coming months.

United States-China:  On Friday, the U.S. Federal Communications Commission voted 4-0 to ban the marketing or importing of new telecom and surveillance equipment made by several Chinese companies, based on national security concerns.  The ban affects a number of Chinese telecom heavyweights that were already under restrictions, such as Huawei, ZTE (000063.SZ, CNY, 23.94), and Hangzhou Hikvision (002415.SZ, CNY, 30.90).  The order doesn’t require U.S. equipment buyers to remove items that they have already purchased, nor does it remove authorizations for electronics models that already exist.  However, it apparently does allow the FCC to take those steps in the future.

• The FCC action is the latest U.S. move aimed at thwarting China’s strategy of using advanced telecom technology to carry out mass spying on U.S. citizens, conduct secret influence campaigns in the U.S., and sabotage critical U.S. infrastructure in times of conflict. Illustrating the seriousness of the issue, the move is the first ever in which the FCC has voted to prohibit the authorization of new equipment on national security grounds.
• The FCC’s move comes on the heels of the administration’s draconian new restrictions on semiconductor technology exports and services to China, the recent Congressional hearings into the national security implications of Chinese social media app TikTok, and a broader range of barriers against Chinese imports that began under the Trump administration. Together, the never-ending rise of U.S. restrictions show how the U.S. government, with strong bipartisan support, is taking ever-tougher steps to constrain China’s ability to compete with the U.S. and its bloc. Naturally, that presents ongoing regulatory risks for Chinese assets.

U.S. Economy:  Reports suggest that the traditional kick-off to the holiday shopping season on Friday started off relatively well, with a further rebound in store traffic and continued gains in online buying.  According to shopping data firm RetailNext, store visits on Black Friday were up about 7% from the previous year.  However, there are also signs that consumers are exercising caution in the face of rising prices and interest rates.  The same report showed in-store sales rose just 0.1%, and the average shopper spent less per visit than last year.

U.S. Housing Market:  Real estate analysts report that as home prices remain high and interest rates continue to surge, more individuals who had hoped to buy are now renting single-family homes instead.  The trend is creating new opportunities for larger developers and real estate funds that are pivoting toward building and buying more single-family homes to rent.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

The Daily Comment will go on hiatus beginning Wednesday, November 23, and will return on Monday, November 28. 

Our Comment today opens with an update on the Russia-Ukraine war, including news of an important new Ukrainian effort to recapture land in the southern part of the country.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including conflicting reports about whether the OPEC+ oil exporters will boost or cut production.

Russia-Ukraine:  Ukrainian forces continue to press their counteroffensive in the northeastern Donbas region and in southern Ukraine on the east bank of the Dnipro River, while Russian forces continue to attack the northeastern city of Bakhmut while simultaneously building out their defensive lines in preparation for winter.

• The Ukrainian activity on the east bank of the Dnipro River is reportedly focusing on taking control of the Kinburn Spit, a strategic peninsula jutting out into the Black Sea at the mouth of the river. If the Ukrainians can push the Russians out of the peninsula, they could reduce the artillery attacks on the key southern port city of Mykolaiv and gain control over the southernmost reaches of the river.
• We continue to believe that the Russian offensive around Bakhmut, led by Russia’s Wagner Group mercenaries, is designed, at least in part, to burnish the leadership credentials of Wagner Group leader Yevgeny Prigozhin as he works to boost his position in preparation to eventually challenge President Putin for power.

Global Oil Market:  Officials with the Organization of the Petroleum Exporting Countries said that the cartel and its Russia-led allies are considering a boost of 500,000 barrels per day in their crude oil production to help keep global supplies steady as the West imposes new sanctions on Russian oil.  However, Saudi Arabia and some other major exporters later pushed back on the idea and insisted that the group will follow through with its recent decision to cut output.

• Various reports in recent months have suggested that the OPEC+ group would be hard pressed to boost its output by 500,000 barrels per day. Besides, with China imposing big new pandemic lockdowns and much of the world teetering on the brink of recession, it would seem that OPEC+ would prefer to cut production and buoy prices rather than boost output and drive prices lower.
• Therefore, the statement about boosting output is being taken as a sop to President Biden now that federal officials have said that Saudi Crown Prince Mohammad bin Salman cannot be prosecuted for his role in the 2018 killing of a Saudi dissident journalist.

China:  New COVID-19 infections rose to nearly 28,000 today, close to a record and enough to raise concerns that the latest wave will weigh on the economic activity in China and beyond.  Despite Beijing’s directive to refine and water down President Xi’s draconian Zero-COVID policies, the new, widespread wave is prompting local officials to impose mass lockdowns in cities around the country.

United Kingdom:  In its latest economic forecasts, the Organization for Economic Cooperation and Development (OECD) projected that the U.K. will be the weakest G20 economy except for Russia over the next two years.  Reflecting challenges such as severed trade relationships after Brexit and the impact of high energy prices, the OECD forecasts that British gross domestic product will fall 0.4% in 2023 and rise just 0.2% in 2024.

Eurozone:  National Bank of Austria Governor Robert Holzmann, who is also a member of the European Central Bank’s governing council, backed a third straight 75 bps rise in the ECB’s benchmark interest rate at its next policy meeting in mid-December. The move, which Holzmann argued was necessary to show the ECB’s commitment to fighting inflation, would raise benchmark borrowing costs to 2.25%.

• As in the U.S., rising interest rates are creating challenges for borrowers in the Eurozone and threatening to help push the economy into recession.
• Illustrating the impact in Spain, where most mortgage borrowers have variable-rate loans, major banks and the government have agreed on a relief package for the country’s most vulnerable borrowers. The package includes reduced interest rates on mortgage loans for a five-year period.

United States-European Union:  With the Biden administration’s $369 billion package of subsidies to boost U.S. technology investment set to come into force on January 1, officials from Germany and other EU states are considering whether to launch their own subsidy program to keep firms investing on the Continent.  The officials have become increasingly alarmed at how the new U.S. program has already convinced many EU firms to shift their capital investments to the U.S.

United States-Philippines-China:  In a meeting with Philippine President Marcos yesterday, U.S. Vice President Harris reaffirmed Washington’s commitment to defending the country against aggression under a 1951 treaty.  Harris also announced a range of U.S. assistance programs and initiatives to help the Philippines deal with climate change and looming food and energy crises.

• Separately, under a 1999 “Visiting Forces Agreement” and a 2014 “Enhanced Defense Cooperation Agreement,” the U.S. has been boosting the number of troops it sends on a rotating basis to Philippine military bases.
• Despite the Philippine government’s effort to keep from antagonizing China as it steps up military cooperation with the U.S., the moves underline how much the Philippines feels threatened by China’s territorial aggressiveness in the maritime realm.

U.S. Railroad Industry:  Yesterday, one of the country’s largest railroad unions said that its members voted to reject a new wage deal brokered by the White House, raising the risk of a major labor strike as soon as early December.  That means four of the 12 major railroad unions have rejected the brokered deal, primarily over sick-leave policies.  This has triggered a cooling-off period that requires the companies and unions to go back to the negotiating table.  If the companies and unions can’t reach a deal by December 9, and if Congress doesn’t intervene to prevent it by legislation, the nation could face a crippling railroad strike that would be an important headwind for the economy and financial markets.

U.S. Housing Market:  According to data from real-estate brokerage Redfin (RDFN, $4.61), investor purchases of homes in the third quarter were down 30% from the same period one year earlier.  The big drop reflects the sudden, sharp weakening in the housing market as the Federal Reserve keeps pushing interest rates higher.  We continue to believe that the impending recession will probably be rather garden-variety, but a sharper-than-anticipated drop in the housing market could make it a more severe.

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