by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Equities are starting the day strong despite another round of disappointing economic data. In sports, Texas A&M dominated Florida, bringing them closer to clinching the College World Series title. Today’s Comment will explore why Nvidia’s momentum may wane, discuss the renewed investor interest in the US dollar, and explain the latest rate decision from the Bank of England. As always, we conclude with a roundup of international and domestic news.

Hype Keeps Growing: Nvidia’s stock price keeps climbing, but there’s growing worry that the current enthusiasm might not be sustainable.

• The US chip designer overtook Microsoft as the world’s most valuable company on Tuesday. This rise is fueled by the ongoing excitement surrounding artificial intelligence (AI), which continues to captivate investors. The company’s recent strong performance is partly due to its decision to split its stock 10-to-1. This move made the shares more affordable for retail investors, increasing their accessibility. Nvidia sits at the forefront of the AI revolution, controlling an estimated 80% of the market for AI-specific chips. This takeover marks a historic shift, with the top spot last held by a non-Microsoft or Apple company being claimed by Cisco in 2000.
• While Nvidia’s stock soars, the momentum has not carried over to other AI-related stocks. Nearly 60% of the companies within the S&P 500 have seen gains this year, while more than half the stocks in Citi’s “AI Winners Basket” have seen a decline. The problem may be related to valuation. The “Magnificent Seven,” a group of prominent tech companies, trade at a significant premium compared to their large-cap peers. Their average price-to-equity ratio is a hefty 36.6, compared to 21.6 for the S&P 500 when those seven stocks are excluded.

• AI’s rising popularity is being met with increasing regulatory hurdles. The US is taking further steps to curb China’s chipmaking capabilities by limiting access to advanced chips. This week, a White House official will meet with counterparts from Japan and the Netherlands to discuss stricter chip export restrictions to China. Domestically, US antitrust watchdog and FTC Chair Lina Khan has announced her intentions to prevent large tech firms, particularly in the AI space, from further expansion. Earlier this year, she blocked the proposed Nvidia-ARM merger, which would have been the largest ever in the semiconductor industry, citing concerns that it would stifle innovation.

The Dollar Comeback: The Bloomberg Dollar Spot Index is on the verge of setting a new high for the year as investors view the US currency as being safer than its European counterpart.

• The US dollar has risen sharply since May. Investors are seeking the greenback due to rising uncertainty in the eurozone. Earlier this month, the European Central Bank cut its benchmark policy rates by 25 basis points, despite signs that inflation might be about to resurge. Meanwhile, the Federal Reserve surprised markets with a hawkish turn, despite evidence suggesting that inflationary pressures are easing. These contrasting policy moves have widened interest rate differentials, as investors rotate out of European bonds and into US Treasurys, in a sign that they are growing confident in America’s ability to control inflation.
• Political uncertainty has bolstered the US dollar, with French elections set to take place in 10 days. There is widespread concern that populist parties will win a significant number of seats, which is fueled by the rising popularity of the National Rally party and a potential coalition of left-wing populist movements that could gain control of parliament. Although French President Emmanuel Macron’s position is not on the ballot, the election may act as a referendum on his presidency, potentially rendering him a lame duck if his party suffers a serious defeat. A populist victory could see a slowdown or even a reversal of some of his pro-market reforms.

• Although the dollar has some momentum, concerns over US growth could prevent it from a breakout. The latest retail sales data suggests that consumers are starting to become price sensitive, while the labor market has shown signs of cooling. This weakness may lead investors to price in another rate cut for the year, rather than just the one that the Fed outlined in its summary of economic projections. Additionally, a less disruptive than expected election outcome could entice investors back to European markets. Consequently, the dollar may enter a holding pattern in the coming weeks as investors seek greater clarity.

No Action in the UK: The Bank of England held rates steady at its latest meeting despite inflation falling to target in May.

• The BOE kept its key policy rate at a 16-year high of 5.25%. The decision not to move was not unanimous, as two members of the committee voted in favor of a cut. While inflation did return to 2% in May, policymakers signaled concerns that service inflation and wage pressures remained a problem and could hinder the central bank’s target of maintaining price stability, while others showed that elevated components of the reports were likely temporary. That said, the committee seems to be satisfied with the level of inflation progress.
• The BOE’s cautious approach mirrors the Fed’s latest decision from earlier this month. Both central banks expressed concerns about a potential resurgence of inflation in the second half of the year during their explanations for their recent actions. The BOE’s meeting minutes stated that they believe price pressures may rise later in the year as energy prices stop acting as a drag on the inflation index. Meanwhile, Fed Chair Jerome Powell argued that the rollover impact of the core PCE price index could also cause the Fed’s preferred inflation measure to increase due to these temporary effects. However, both central banks maintained that a cut is still likely this year.

• The possibility of rate cuts in late summer or early fall remains on the table for both the BOE and the Fed. The chart above shows that when inflation is adjusted for comparison with other countries (harmonized inflation), UK inflation is roughly in line with US inflation. However, it’s important to note that recent declines are largely due to falling energy prices, which may not reflect the underlying trend in other parts of the economy. Reflecting this concern, the Bank of England may consider a cut in August, while the Federal Reserve will likely wait for data releases, particularly inflation reports from July and August, before deciding on a September rate cut.

In Other News: In a move to counter isolation by the US, Russia signed a mutual defense treaty with North Korea. This highlights Russia’s efforts to forge alliances with countries opposing the West, potentially to bolster its war effort in Ukraine. Meanwhile, Dutch Prime Minister Mark Rutte was selected as the new head of NATO, and his seamless transition will likely help the military alliance maintain unity as it looks to take on threats from Russia and China.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Note: There will be no Daily Comment tomorrow due to the holiday.

Our Comment today opens with a new World Gold Council survey showing global central banks are likely to keep buying large amounts of gold, supporting prices for the yellow metal. We next review several other international and US developments with the potential to affect the financial markets today, including unexpected business support for the far-right party ahead of France’s June 30 parliamentary election and several notes on US political and economic developments.

Global Gold Market: According to a new World Gold Council survey, 81% of central bankers think reserve managers will continue to increase their gold holdings in the coming year. That share is the highest since the group’s 2019 survey and reflects growing interest in gold reserves as a hedge against geopolitical and economic risks and as a source of good investment performance. The figures are consistent with our positive outlook on gold and our view that central bank buying is more than offsetting the headwinds from high interest rates.

China: In its latest review of global nuclear arsenals, the Stockholm International Peace Research Institute (SIPRI) highlighted how China is now expanding its arsenal of nuclear weapons faster than any other country. According to SIPRI, China built some 90 new nuclear warheads last year, bringing its total arsenal to 500. It is also rapidly expanding its fleet of intercontinental ballistic missiles to deliver those warheads, and it may have started deploying its weapons at a higher state of readiness.

• The SIPRI figures regarding China’s growing arsenal are consistent with the estimates we made in our Bi-Weekly Asset Allocation Report from April 15, 2024, where we attempted to calculate the incremental global demand for uranium related to weapons.
• Not only is China’s rapid nuclear buildup an unheralded reason for the recent jump in spot uranium prices, but it is also likely to intensify tensions between China and the West. As more Western leaders and voters come to appreciate the growing nuclear threat from China, we think there is a good chance that they will push for stronger defense spending.

China-Philippines: The Chinese government yesterday accused the Philippines of trying to deliver construction materials to the Sierra Madre, a Philippine navy ship grounded on a disputed shoal in the South China Sea to assert Manila’s claims to the area. In turn, Manila denied the accusation and said a Chinese coast guard ship rammed a Philippine vessel during the incident. The worsening Chinese-Philippine tensions remain a key risk for investors, as discussed in our Mid-Year Geopolitical Outlook, published yesterday.

France: As the June 30 parliamentary elections draw closer, business leaders are racing to embrace the surging far-right National Rally (RN), both to express their support and to influence the party. The development is a reaction against the far-left New Popular Front (NFP), which has issued a radical tax-and-spend agenda and is RN’s main competitor in the race.

US Foreign Policy: In a new poll by the Ronald Reagan Institute, 54% of respondents said US leaders should be more involved in international affairs, up from only about 40% in each of the previous three years. The share saying the US should be less engaged internationally remained at 33%, close to where it has been for the last several years.

• We continue to believe US voters have become weary of the costs of global hegemony over the last decade and a half, leading to increased populism, isolationism, and “America First” attitudes. One key question is whether those attitudes will continue to strengthen and ultimately force the US to give up its global leadership role, or whether the resulting challenge from China/Russia geopolitical bloc will spur a recommitment to international engagement.
• Now that US hesitation on the global stage has encouraged the authoritarian states of the China/Russia bloc to become more assertive, the Reagan Institute poll suggests US voters may indeed be embracing a stronger international stance again. If so, it will likely lead to even more tensions between the US bloc and the China/Russia bloc, as well as continued increases in US defense spending.

US Immigration Policy: President Biden has announced a new program that will give legal status to the spouses of US citizens who are in the country illegally, provided that they have been in the US for at least a decade and meet other criteria. The program is expected to help up to several hundred thousand people get work permits, deportation protection, and a path to citizenship. The announcement comes just two weeks after the president imposed a blanket ban on illegal immigrants claiming asylum after crossing the southern border.

• The apparently contradictory goals of the spousal program and the blanket asylum ban reflect the contradictory political and economic environment for immigration policy.
• Politically, large numbers of Americans want the government to clamp down on the flow of new immigrants and the lack of control over migration at the southern border, but there are still many in Biden’s Democratic Party base who prioritize immigrant rights and the ability of immigrants to bring family members to the US.
• Economically, as we mentioned in our Bi-Weekly Geopolitical Report from May 20, 2024, the post-pandemic labor shortages, especially in lower-skilled jobs, have been an important driver of consumer price inflation. Giving more immigrants the right to work would likely help fill those labor shortages and cap wage rates, bringing down price pressures.

US Apartment Market: While overall apartment rental rates in the US are nearly unchanged from the previous year, new data shows a surprising upswing in rents outside the Sunbelt. Brokers and property owners say the rent hikes in places such as Kansas City and Washington, DC, reflect a dearth of new supply and renters’ inability to buy a home because of sky-high prices and elevated interest rates.

• The figures suggest US rents have already reached a bottom and may be turning up again. Since apartment rents have a big weight in the key gauges of consumer price inflation, any upswing in rents could keep inflation from falling to the Federal Reserve’s target.
• In turn, that would likely force the Fed to keep interest rates higher for longer.

US Electric Vehicle Market: The number of US electric-vehicle startups that have filed for bankruptcy has now risen to three after Fisker threw in the towel yesterday. Fisker’s filing follows the earlier bankruptcies of truck maker Lordstown Motors and bus maker Arrival. While press reports indicate the failures stemmed largely from operational and financial problems specific to the failed companies, they also reflect unexpectedly soft demand for EVs in the US market.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with new data confirming the growth of US and European defense businesses as global military budgets rise. We next review several other international and US developments that could affect the financial markets today, including more evidence of a potential trade war between China and the European Union and signs that the Biden administration may release more oil from the Strategic Petroleum Reserve to hold down US gasoline costs ahead of the November elections.

Global Defense Industry: New research by the Financial Times shows top US and European defense contractors have tens of thousands of job openings and are trying to hire at the strongest pace since the Cold War. Based on a survey of top defense firms, the data shows that the companies are looking to boost their workforces by about 10%. The figures are consistent with our oft-stated belief that global defense spending is likely to rise persistently in the coming years in response to the growing tensions between the US and China/Russia geopolitical blocs.

European Union: The leaders of the 27 members of the EU today are expected to endorse Ursula von der Leyen for a second term as president of the European Commission, the region’s executive body. Although some EU leaders had floated other names (including Mario Draghi, the former chief of the European Central Bank), they have apparently decided to prioritize stability and von der Leyen’s tough approach to foreign affairs.

• If approved at a more formal meeting of the EU leaders in the coming weeks, von der Leyen would also have to be approved by a simple majority of the newly elected European Parliament.
• If von der Leyen is successfully installed for a second term, a key implication is that the EU would continue to toughen its approach to Chinese economic predations and boost its defenses against the rising threat from Russia.

China-European Union: Beijing yesterday said it is probing whether the EU has dumped pork products on the Chinese market at unfairly low prices. The antidumping investigation is widely seen as retaliation for the EU’s recent probe and imposition of antidumping tariffs against Chinese electric vehicles. The Chinese probe is designed to put maximum political pressure on Brussels, as any tariffs against EU pork products would disproportionately hurt influential farmers in countries such as Belgium, the Netherlands, Denmark, Germany, and Spain.

China-Australia: In a new sign of the rebounding China-Australia relationship, Australia’s total trade with China (the value of exports plus imports) rose to a record $125 billion in 2023, beating the pre-pandemic record of about $112 billion in 2019. China had imposed strict barriers against key Australian exports from 2020 to 2022 in retaliation against Canberra’s call for a probe into China’s role in the coronavirus pandemic. Over the last year, however, Beijing has loosened those restrictions, giving a boost to Australian exports and economic activity.

China-Philippines: On Saturday, the Chinese government again accused the Philippines of provocative activity in the South China Sea, after Manila sent coast guard boats on Friday to land at islets in the area that are claimed by Beijing but internationally recognized as part of the Philippines. The new accusation came just a day before the start of a new Beijing rule allowing the Chinese coast guard to detain foreigners and their vessels that stray into the disputed areas.

• As we note in our “Mid-Year Geopolitical Outlook,” due to be released later today, the growing Chinese-Philippine tensions represent what is perhaps the world’s most dangerous confrontation through the rest of 2024. Although we don’t necessarily think the two sides will come to blows, there is an elevated chance that they could.
• If China and the Philippines do come to blows, the US-Philippine mutual defense treaty could force the US to come to Manila’s aid, leading to a direct US-China conflict.

China: May new home prices were down 4.3% from the same month one year earlier, versus a 3.5% decline in the year to April. The value of home sales in January through May were down a whopping 30.5% year-over-year, reflecting both weaker prices and reduced transactions. Even though some homebuilders have seen an uptick in sales over the last couple of months because of the government’s new program to ease mortgage rules and support home purchases, the data shows that the key property sector remains a major drag on Chinese economic growth.

Israel: Following the resignations of centrist politicians Benny Gantz and Gadi Eisenkot last week, Prime Minister Netanyahu has dissolved the unity war cabinet he formed after Hamas’s October 7 attack on Israel. The move does nothing to undermine Netanyahu’s power, but it could mean that Israel’s war against Hamas will be prosecuted without the input of more moderate voices. In turn, that could potentially lead to a longer, more intense conflict that might further isolate Israel politically and weigh on its economy and financial markets.

Russia-United States: The Kremlin announced the espionage trial of Wall Street Journal reporter Evan Gershkovich will be held in secret, beginning next week. The US government and the newspaper vehemently deny that Gershkovich was involved in spying, so the secret proceedings are likely to further strain ties between Russia and the US going forward.

US Corporate Governance: Days after Tesla shareholders approved a $56-billion pay package for CEO Elon Musk, new data shows the median pay for CEOs in S&P 500 companies in the first four months of 2024 was up some 14% from the same period one year earlier. That compares with an average increase of 4.1% for the average worker. That disparity could help explain the increasing concern about US income inequality and the rise of populism.

US Energy Policy: Amos Hochstein, President Biden’s top energy advisor, said the president would release more oil from the Strategic Petroleum Reserve to cap any surge in gasoline prices during the summer driving season. Such a move would be on top of the massive oil releases Biden already ordered in 2021 and 2022, as prices began to rise following the pandemic and Russia’s invasion of Ukraine. Such a move would also be further evidence that presidents facing re-election will try to curry favor with voters by bringing down energy costs.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Equity futures have moderated as investors await a reaction to the May inflation data from Federal Reserve officials. In sports news, the Florida Panthers have taken a commanding 3-0 lead against the Edmonton Oilers in the NHL Finals. Today’s Comment will delve into the potential impact of letting the Saudi Arabia-US petrodollar agreement lapse, discuss what the latest PPI data tells us about consumer inflation, and examine why investors are reluctant to hold the Mexican peso. As usual, the report concludes with a summary of international and domestic economic releases.

End of the Petrodollar?: Saudi Arabia allowed the agreement with the US to price its oil exclusively in dollars lapse last Friday as the two sides work on a new defense pact.

• The decline of the petrodollar system likely signals a shift away from the dollar-based global financial regime. The agreement was the result of then President Richard Nixon’s controversial decision to suspend the gold window in 1971. Upset by this move, Saudi Arabia considered pegging the price of oil to a basket of currencies, effectively severing the link to the dollar.  In 1974, the US agreed to provide Saudi Arabia with military aid and weapon sales, in exchange for Riyadh’s commitment to recycling its excess dollars back into the US Treasury market.
• Saudi Arabia’s recent move regarding the petrodollar system can be seen as another sign of a shifting global landscape. By avoiding a definitive stance on ending the dollar’s dominance in the oil trade, the kingdom appears to be strategically navigating the growing tensions between the US and China. China’s rise as a major oil importer for Saudi Arabia, coupled with the US shale industry’s emergence as a competitor in Europe, suggests that economic realities are driving Saudi Arabia’s cautious approach. After all, China is now Saudi Arabia’s second-largest customer after Russia and has shown a preference for diversifying away from holding excessive US dollars and toward holding more gold.

• The potential end of the petrodollar system may be more calculated than it initially appeared. Earlier this year, Saudi Arabia delayed its BRICS membership bid while negotiating a potentially transformative security pact with the US. This pact, if finalized, would be more comprehensive than the previous agreement and reportedly could include a stronger US commitment to Saudi Arabia’s defense. While progress has been made, details remain under discussion, but it does feel as if both sides are close to an agreement. This strategic maneuvering suggests the petrodollar’s demise might be premature, as the US-Saudi relationship remains a key factor.

Another Inflation Surprise: Wholesale price inflation gave investors another reason to be optimistic that the Fed will cut more than once this year.

• Producer prices unexpectedly declined in May, marking their largest monthly drop since October 2023. The Bureau of Labor Statistics reported that the overall producer price index (PPI) fell by 0.2%, significantly lower than consensus estimates of a 0.1% increase. This decline was widespread, with core PPI, which excludes volatile food and energy prices, holding steady compared to the previous month. Additionally, the cost of processed goods used in production, a measure of input costs, dropped 1.5%, suggesting that businesses are seeing lower costs to build their inventory.
• Following the release of the report, the 10-year Treasury yield dropped below 4.3%, as investors believe a September cut is still possible. The report provided confidence that factors within the PPI index that contribute to the Personal Consumption Expenditures (PCE) price index, the Fed’s preferred inflation gauge, were relatively tame. This evidence suggests that core inflation may not reaccelerate this year as members of the Fed expect. In April, the PCE price index rose by 2.75% compared to the previous year, which was below the Fed’s year-end expectation of 2.8%.

• The latest CPI and PPI reports provide evidence that inflation is on the right track. However, investors may want to wait for the latest Fed speeches before pricing in bets for additional rate cuts. The latest Fed dot plot showed that the range of rate expectations narrowed significantly from March to June, with no policymakers supporting more than three rate cuts before the end of the year, despite that being the median estimate in the previous two meetings. Any signal that current voters on the Federal Open Market Committee have become more dovish will likely be viewed favorably by markets.

Demise of the Super Peso: Mexico’s currency plunged after a surprise landslide election victory, raising investor concerns about the country’s economic future.

• The weakness in the currency arises from concerns that the next administration will pursue judicial reforms aimed at removing checks on the ruling Morena party. Following her victory earlier this month, President-elect Claudia Sheinbaum stated that the government should focus on reforms that would replace appointed Supreme Court judges with popularly elected ones, a move likely to undermine potential challenges to the party’s agenda. While Sheinbaum mentioned that the matter should be discussed with law schools and judiciary workers, her predecessor President Andrés Manuel López Obrador (AMLO), who still holds significant influence in the party, doubled down on the necessity of this change.
• Investor uneasiness reflects concerns that the Morena party is trying to circumvent the judicial system to pass controversial legislation. Most recently, Mexico’s Supreme Court struck down a proposal that would have given the state-owned electric company an unfair advantage over private competitors. The court ruled that the proposal violated constitutional guarantees of fair competition in the power sector. Additionally, the High Court clashed with AMLO by overriding legislation that aimed to restrict the power of the National Electoral Institute. This independent body safeguards elections by enforcing rules on political campaigning by public officials.

• The recent drop in the peso (MXN) suggests investors are losing faith in Mexico’s ability to maintain stability. During his six-year term, AMLO did well at keeping spending in check, even as many countries were ramping up debt during the pandemic. Nevertheless, reforms favoring state-owned firms over foreign competition could create new tensions with their Western counterparts, especially if the government pursues the nationalization of key parts of its energy sector, which is a growing concern. That said, the country will likely remain a good investment opportunity as long as the High Court remains independent of the ruling party’s influence.

In Other News: The Bank of Japan maintained policy rates at its latest meeting but stated that it will reduce the amount of its bond purchases in a sign that the central bank is moving closer to policy normalization. Concerns over snap elections in France continue to weigh on stocks, as investors remain nervous about a potential victory for far-right candidates. Russian President Vladimir Putin proposed conditions for a possible truce, but they were rejected because they included demands for Ukrainian territory Russia doesn’t currently control. Nevertheless, this proposal shows a beginning to discussions about ending the conflict.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Investors are looking past the recent Federal Open Market Committee meeting after a bullish PPI report boosted rate cut hopes. On the sports front, the US Men’s National Soccer Team secured a draw against Brazil in their Copa América warmup. Today’s Comment will analyze the FOMC meeting, explore why the CPI report offers hope of a policy shift for the Fed, and delve into the significance of the French elections. We’ll also provide our usual roundup of domestic and international news.

Fed Raises Doubts: The latest FOMC move suggests that it is unlikely to feel confident enough to cut rates before the election.

• The central bank held its benchmark interest rate steady at a target range of 5.25% to 5.50%. However, it lowered its projected number of rate cuts for the year from three to one. This shift surprised market participants, as recent declines shown in the CPI and PCE reports suggested progress toward the central bank’s inflation target. A recent surge in the nonfarm payroll data, though, appears to have influenced this hawkish stance. During the press conference, the Federal Reserve Chair reassured markets that the Fed remains prepared to act if job growth weakens unexpectedly in the coming months.
• Job data has become paramount in the Fed’s monetary policy decisions. Fed officials have recently signaled that a significant weakening of the labor market could prompt them to ease policy. However, recent data suggests that the labor market remains tight. Since the last Fed meeting, the unemployment rate has edged up slightly, from 3.8% to 4.0%, while nonfarm payroll jobs averaged a strong 200,000. Elevated wage pressures also remain a concern. Hourly earnings remain stubbornly above 4% annually, exceeding the level policymakers view as a sustainable long-term path, which is closer to 2.5%.

• The hawkish pivot may be related to concerns about political favoritism. Recent setbacks in inflation, as evidenced by the CPI reports during the first quarter, coupled with a relatively tight labor market, have led many commentators to question the need for any rate cuts at all. This criticism may have influenced the FOMC’s decision to revise its terminal fed funds rate upward, particularly as the election nears. However, the central bank remains open to a dovish shift if labor market conditions deteriorate. Should the unemployment rate remain above the year-end projection of 4.0% (which is the current rate), it could prompt Fed officials to reassess the number of rate cuts planned for the year.

Calling the Fed’s Bluff? Despite concerns from some Fed officials, inflation is rising at its slowest pace since monetary tightening began in 2022.

• Inflation eased to a three-year low in May, according to the Bureau of Labor Statistics. Consumer prices rose just 3.4% year-over-year, down from 3.6% in April. Core inflation, a more stable measure excluding food and energy, also slowed slightly to 3.3% from 3.4%. This moderation was driven by monthly price drops in airline fares, auto insurance, and new cars. Further supporting this trend, housing costs, the index’s largest component, held steady for the fourth consecutive month. This cooler-than-expected report suggests that despite Fed concerns, policy rates are still helping relieve inflationary pressures.
• The 10-year Treasury yield plunged 9 basis points on the day, as the market cheered the CPI results and shrugged off the FOMC meeting. The market’s reaction suggests that bond investors may be discounting the Fed’s projection of a single rate cut this year, instead believing policymakers submitted their estimates prior to the release of the latest CPI figures. Data from the first five months of the year shows that non-seasonalized inflation, which is never revised, is rising at a much slower pace than in 2022 and 2023. The latest report provided even more optimism that inflation may be falling closer to its four-year average recorded before the pandemic.

• Fed officials have consistently emphasized the need for greater confidence in falling inflation before considering rate cuts this year. The next three months, which typically see lower core CPI readings, will be a critical test for the central bank. If inflation remains below 2023 levels during this period, it would be seen as evidence of easing price pressures. The bond market’s reaction reflects optimism that this will happen. However, the scenario is not without risks. A disappointing CPI report could trigger a sharp rise in bond yields in the coming months and a rethink as to whether policy rates are restrictive enough to bring down inflation.

Macron’s Gamble: The French president is hoping that the market can help spook voters into reconsidering their support for far-right parties.

• The latest opinion polls indicate that the far-right conservative party is poised to make significant gains in the upcoming election on June 30. Projections suggest that the National Rally (RN) is expected to secure between 235 and 265 seats in the 577-member National Assembly. Although this would constitute a substantial increase, they are likely to fall short of achieving an outright majority. While there have been discussions about RN aligning with the center-right Republicans, significant internal opposition within both parties hinders such a partnership. Meanwhile, far-left parties are also working on forming a united front.
• The upcoming election is likely to thrust the country’s ballooning deficit into the spotlight. Post-pandemic efforts to control the national debt have been unsuccessful. In 2023, the debt-to-GDP ratio remained at 6%, significantly exceeding the 3% threshold mandated by EU fiscal rules. Bond yields surged after the snap election announcement. Investors fear a potential RN victory could lead to higher government borrowing rather than debt reduction. Marine Le Pen, the party’s leader, has unnerved investors with her proposed sales tax cuts and push to lower the retirement age. As a result, the spread between French and German 10-year bonds widened.

• Although RN gained momentum from the recent European parliamentary elections, its success in the upcoming elections remains uncertain. Its surge over the weekend was driven primarily by frustrated voters who were more motivated to participate in an election widely regarded as inconsequential. Voter turnout for the parliamentary election was only 50%, compared to 80% in the general election. Nonetheless, a potential defeat for RN could increase pressure on Emmanuel Macron to step down, as it would be seen as a sign that the country has lost faith in his leadership. Although a leadership change in France is not our base-case scenario, it is something we will be paying close attention to.

In Other News: In a sign that conflict in Europe will likely continue, the G-7 struck a deal to offer additional funding to Ukraine for its war efforts. South Africa inches closer to a coalition government as the African National Congress Party negotiates a power-sharing deal with the pro-business Democratic Alliance.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with a new medium-term forecast of global oil supply and demand from the International Energy Agency. We next review several other international and US developments with the potential to affect the financial markets today, including a risky decision by the European Union to impose steep antidumping tariffs on Chinese electric vehicles and a proposed new US rule that would keep medical bills out of credit reports.

Global Oil Market: The IEA, in its closely watched medium-term outlook, has forecast that the world’s capacity to produce oil will far exceed demand by the end of this decade. The forecast is based on expectations of further fast supply growth in the US and elsewhere in the Americas, coupled with waning oil demand as green energy becomes more prevalent. The implication is that the supply/demand mismatch will drive down oil prices.

• The IEA now expects global oil production capacity to rise to 113.8 million barrels per day by 2029, but it expects demand to peak in that year at about 105.4 million bpd.
• Of course, the IEA forecasts are highly dependent on a continued transition to non-fossil fuels. Recent political trends and weaker-than-expected demand for electric vehicles suggests that the transition going forward may not be as significant as the IEA expects.

Global Shipping Market: Global shipping and logistics firms suffered big declines in their stock prices yesterday, reflecting the possibility of a ceasefire in the Israel-Hamas conflict. After the UN Security Council approved a US-proposed ceasefire plan late Monday and both Israel and Hamas showed signs that they are inching toward accepting the deal, hopes are rising that the Houthi rebels in Yemen would stop their sympathy attacks on shipping in the Red Sea.

• Of course, the complex interplay of various actors surrounding the Israel-Hamas conflict means it could still expand to a wider, regional war. For example, Iran-backed Hezbollah militants in southern Lebanon fired a barrage of missiles today into northern Israel to retaliate for an Israeli strike that killed one of the group’s commanders.
• In any case, if the US peace deal is eventually put into place and allows the Red Sea to reopen, ships would no longer have to be re-routed around Africa, global capacity would be freed up, and freight rates would be driven lower.
• While lower freight rates would undermine shippers’ profits, they could also help bring down consumer price inflation around the world.

European Union-China: Risking a trade war, the European Union today said its antidumping probe into Chinese electric vehicles found that they are heavily subsidized and present “a threat of clearly foreseeable and imminent injury to EU industry.” In response, the EU said it will impose antidumping tariffs on Chinese EVs, on top of the current 10% tariff. The move will bring total EU tariffs on Chinese EVs from 20% to almost 50%, depending on the brand and how much the producer cooperated with the EU probe. The new tariff will apply starting on July 4.

• The EU’s move aims to protect the region’s large auto and auto parts sector, which employs a large share of the EU workforce. Nevertheless, the new tariffs are opposed by European automakers, who fear Chinese retaliation against their exports to China. Those automakers themselves also make a lot of the Chinese EVs and import them to the EU under their own brands.
• The EU’s move brings it into closer alignment with the tougher US approach to China’s geopolitical and economic challenge. That raises the prospect that China might indeed retaliate against the EU, imposing its own tariffs and other trade barriers against European goods and services.
• In sum, the EU’s new tariffs and any Chinese retaliation fits in with our often-stated view that the world is fracturing into relatively separate geopolitical and economic blocs. A few key results are likely to be higher and more volatile inflation and interest rates going forward.

China: The global fear of Chinese dumping these days stems largely from a new surge of investment in Chinese factories, leading to excess capacity, falling domestic prices, and firms exporting at fire-sale prices. Illustrating that the problem isn’t just in EVs, the chair of the Asian Photovoltaic Industry Association says China’s solar panel industry is dealing with a severe glut and falling prices, to the point where it is in an “ice age.” The official called on the Chinese government to intervene to bring supply back into balance with demand.

• Separately, China’s May consumer price index was up just 0.3% from the same month one year earlier, as anticipated. May factory-gate prices were down 1.4% year-over-year.
• The price data is consistent with continued weak domestic demand and broad excess capacity in the factory sector.

France: Ahead of the country’s snap parliamentary election on June 30, Finance Minister Bruno Le Maire has warned that a victory by the far-right National Rally could spark a debt crisis like the UK suffered during the short-lived government of Liz Truss. Le Maire’s warning smacks of scaremongering to discredit his political rivals, but market action does reflect investor concern that the surging NR’s populist program could lead to a blow-out in France’s budget deficit and debt levels. Some French debt is now trading at yields above Portugal’s.

Canada: Yesterday, the government and the Public Service Alliance representing about 9,000 of the country’s border agents reached a tentative deal on a new labor contract, averting a threatened “work to rule” strike that could have substantially disrupted US-Canadian trade starting on Friday.

US Monetary Policy: The Federal Reserve wraps up its latest policy meeting today, with its decision due at 2:00 PM ET. With price pressures still high, the policymakers are expected to keep their benchmark fed funds interest rate unchanged at 5.25% to 5.50%. They will also release their updated economic projections, including their “dot plot” of expected rate changes going forward.

• Based on interest-rate futures pricing, investors currently look for the Fed’s first rate cut to be in the autumn. The biggest uncertainty is whether the policymakers will implement further cuts later in the year.
• Because of today’s sticky inflation, we continue to believe the policymakers could keep rates “higher for longer” than investors currently believe.

US Regulatory Policy: The Consumer Financial Protection Bureau yesterday proposed a rule barring medical bills from credit reports. According to the CFPB, the rule would keep debt collectors from harassing consumers for inaccurate or false medical bills. The bureau also said its internal research shows medical bills on credit reports have “little or no value” in predicting whether consumers would repay their other debts. The CFPB said removing medical bills from a report would raise the relevant credit score by about 20 points.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with notes on eurozone monetary policy and further details on the weekend elections for the European Parliament. We next review several other international and US developments with the potential to affect the financial markets today, including a knife attack on four US teachers in China and signs of a potential dockworker strike against the US’s major East Coast and Gulf Coast ports later this year.

Eurozone: In a joint interview with European newspapers, European Central Bank President Lagarde warned that her institution may not necessarily keep cutting its benchmark interest rate after doing so last week. According to Lagarde, “We are not following a pre-determined path . . . There could also be phases in which we leave interest rates unchanged.” The statement is a reminder that persistent price inflation and the Fed’s “higher for longer” policy will limit how much the ECB can ease policy to bolster economic growth.

Germany: In another sign that Russia’s invasion of Ukraine has prompted European leaders to start seriously preparing for war, the German government has updated its wartime mobilization and civil defense plan for the first time since the Cold War. Among other measures, the “Framework Directive for Overall Defense” calls for reinstating conscription into the armed forces, forcing skilled laborers and professionals to work in certain defense-related roles, rationing food and fuel, and transforming subway tunnels into bomb shelters.

France: Following up our discussion in yesterday’s Comment about the European Parliament elections and French President Macron’s decision to call snap elections in response, we want to clarify that Macron himself will not be on the ballot, as his presidential term runs to 2027. The elections, starting June 30, will only be for the national parliament. Initial press reports suggested that the centrist-liberal Macron called the election as a reluctant response to the surging popularity of France’s hard-right National Rally party, but we see another possibility.

• National Rally won some 32% of the European Parliament votes in France, more than twice the tally for Macron’s party. However, the European Parliament has relatively limited power in European Union governance, so many French voters may have seen the balloting as a chance to register dissatisfaction without much practical impact. Macron is probably betting that French voters in the runup to the election will have to face up to National Rally’s actual agenda, potentially eroding its support and making it lose.
• Macron is probably also calculating that if National Rally wins the election and installs its leader, Jordan Bardella, as prime minister in a “cohabitation” relationship with Macron, the hard-right party for the first time will face potential voter backlash for its actual policies.
• In sum, it appears that the wily Macron is gambling that even if he can’t make National Rally lose the parliamentary election, two years of hard-right control over parliament will undermine it and ensure that it doesn’t win the powerful presidency in 2027. Of course, the risk is that the hard right doesn’t fall on its face in the campaign or in parliament, leaving it even stronger in 2027.
• Amid this risky political backdrop, French stocks and bonds continue to sell off so far today. More broadly, the euro (EUR) today is trading down another 0.3% to $1.0730.

(Source: Wall Street Journal)

Belgium: The European Parliament elections also shed further light on Belgium, which is often seen (by outsiders) as ripe for disintegration into its Flemish north and culturally French south. The center-right New Flemish Alliance retained its position as the country’s biggest party, with 25.6% of Flemish votes, while the separatist Vlaams Belang party only increased its support to 21.8%. In response, Prime Minister Alexander De Croo resigned, setting the stage for a new government that will probably be inclined to give more autonomy to Belgium’s regions.

United Kingdom: Including bonuses, average weekly wages in the three months ended in April were up 5.9% from the same period one year earlier, matching both the expected increase and the increase in the three months to March. With wage growth elevated, inflation pressures still high, and the Fed holding rates high for longer than anticipated, it remains to be seen whether the Bank of England will start cutting its benchmark interest rate in August, as many investors expect.

Australia: The May NAB business confidence index fell to a seasonally adjusted -3, compared with +1 in April, while the business conditions index fell to +6 from +7. Importantly, several price indicators in the report pointed to accelerating cost growth, despite Australia’s current weak economic growth. The report suggests that price inflation remains an issue worldwide, potentially discouraging a range of central banks from cutting interest rates.

United States-China: Four US teachers on an exchange program in the northeastern Chinese city of Jilin were stabbed in a knife attack in a public park yesterday. Video footage indicated that at least three of the teachers were seriously wounded. The incident appears to be an isolated crime, but with US-China tensions so high, we can’t discount the possibility that it will become a new issue poisoning the relationship and creating further risks for investors.

US Monetary Policy: The Federal Reserve begins its latest policy meeting today, with its decision due tomorrow at 2:00 PM ET. With price pressures still high, the policymakers are expected to keep the benchmark fed funds interest rate unchanged at 5.25% to 5.50%. Just as important, the officials will also release their updated economic projections, including their “dot plot” of expected rate changes going forward.

• Based on interest-rate futures pricing, investors currently look for the Fed’s first rate cut in the autumn. The biggest uncertainty is whether the policymakers will implement further cuts later in the year.
• Because of today’s sticky inflation, we continue to believe the policymakers could keep rates “higher for longer” than investors currently believe.

US Corporate Governance: Data from ISS-Corporate shows that through the first five months of 2024, shareholders in S&P 500 companies have forced 70 votes on measures against traditional environmental, social, and governance (ESG) initiatives, up from 30 such votes in the first five months of 2022 and just 7 in 2020. Anti-ESG moves are now the fastest growing type of proxy proposal. However, most of the anti-ESG proposals have received support from less than 2% of shares voted, and none have passed.

US Shipping Industry: The International Longshoremen’s Association has canceled talks on a new labor contract covering dock workers at the nation’s East Coast and Gulf Coast ports to protest the expanding use of automated machinery at some facilities. Canceling the negotiations with the ports raises the risk of a strike when the current contract runs out on September 30. Such a strike would disrupt the supply of many goods sold during the holiday season, boost prices, and buoy consumer price inflation.

• Separately, the Port of Baltimore’s main channel fully reopened yesterday, once again allowing full operations at one of the biggest East Coast ports.
• The reopening came 11 weeks after a container ship slammed into the Francis Scott Key Bridge, bringing it down and blocking the passageway.

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