by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with an update on the Russia-Ukraine crisis, where the U.S. and other Western nations have now imposed sanctions on Russia for its deployment of troops into the Donbas region.  Those sanctions are seen by many observers to be lighter than expected, but they could still be ratcheted up if Russia takes further steps against Ukraine.  We next review other U.S. and international news that could affect the financial markets today.  We end with the latest developments related to the coronavirus pandemic.

Russia-Ukraine:  President Biden yesterday characterized President Putin’s deployment of troops into Ukraine’s eastern Donbas region as “the beginning of a Russian invasion of Ukraine” and “a flagrant violation of international law,” setting the stage for a series of steep economic punishments.  The U.S. sanctions will target two major Russian financial institutions and their subsidiaries, as well as five Russian elites and their family members with connections to the Kremlin.  The sanctions will also restrict investor purchases of any new sovereign debt issued by Russia.  Other key Western nations, and the EU, also imposed sanctions on top of Germany’s decision to freeze certification of the new Nord Stream 2 natural gas pipeline from Russia to Germany.

• In each case, however, the Western leaders held some sanctions in reserve to leave room for diplomacy and maintain leverage against further Russian aggression.  For example, the sanctions announced yesterday did not include the threatened export controls on advanced technology or the blacklisting of major state-owned industrial giants. Sanctions on Russian oil and gas exports were also not imposed in order to avoid further upward pressure on consumer energy prices.  The measured nature of the sanctions allowed the ruble to rebound yesterday, although it is probably still at risk of additional downward moves if more severe sanctions are imposed in the future.
• Separately, President Biden also has authorized additional movements of U.S. forces and equipment already stationed in Europe to help protect Lithuania, Latvia, and Estonia.  Roughly 800 U.S. troops based in Italy will head toward the Baltic states, along with eight F-35 fighter jets from Germany and Greece.  Almost three dozen Apache helicopters based in Germany and Greece will also be deployed forward, with 12 sent to Poland and 20 to the Baltics.  British Prime Minister Johnson said the U.K. would send additional defensive weapons directly to Ukraine “in light of the increasingly threatening behavior” displayed by Russia.
• In Ukraine, President Zelensky announced a national state of emergency, mobilized military reserves, and recalled contract military personnel to active duty.  He also mobilized Ukraine’s new territorial defense brigades for exercises but said he wouldn’t announce a general call-up of civilians for now.  On the non-military front, Zelensky warned Ukrainian citizens to leave Russia, while Foreign Minister Kuleba begged for the West to impose even tougher sanctions.
• More broadly, the Russian move against Ukraine continues to reinvigorate NATO and energize stronger defense efforts.  For example, Poland’s government yesterday approved a bill boosting its defense spending and launching a doubling in the size of its military to 300,000 troops.  At that level, Poland would have one of the largest armies in Europe.
• Other than the risks of direct combat damage to Ukraine and sanctions on Russia, we continue to believe the primary near-term economic and financial impacts of the conflict will come from the risk to Russian energy and mineral shipments.  Such supply disruptions would likely boost energy and raw materials prices, especially in Europe but also to some extent in the U.S., just as the world’s major central banks are planning to tighten monetary policy.  A recent European Central Bank simulation exercise showed that a 10% shortage in gas could knock 0.7% off Eurozone Gross Domestic Product, with the effects most pronounced among countries with large gas and electricity sectors and industries most dependent on gas (see chart below). As expected, the result has been additional downward pressure on equity prices, driving the S&P 500 stock price index into correction territory as of yesterday’s close.

United States:  Several winter storms are forecast to bring frigid temperatures, strong winds, and heavy snow and rain to swaths of the U.S. this week, potentially leading to disrupted travel, school closures, and other economic disruptions in some states.  The storms are expected to span from Texas to the Dakotas and as far east as Maine.

Canada:  The Finance Ministry has already told banks to unlock financial accounts belonging to individuals involved in the Ottawa truckers’ protest against COVID-19 mandates, which police shut down this past weekend.  It isn’t clear whether the quick reversal of the lockdowns was because they weren’t effective or because the government believes it already has control of the situation and wants to minimize any antagonisms caused by the action.

United Kingdom:  In its annual review of the British economy, the IMF said the government should try to limit the risk of persistently high inflation by bringing forward planned tax hikes, especially on higher-income people.  In contrast, the organization warned the Bank of England should not increase interest rates rapidly, or it could risk tipping the economy into recession.

EU Information Technology Regulation:  The European Commission has proposed new legislation that would force big technology companies to share more of the non-personal data generated by connected products like smart appliances or automobiles.

• The proposal is part of the biggest proposed expansion of global tech regulation in decades. The EU is in the final stages of settling on the texts of two new laws aimed at large tech companies.  One seeks to limit potential abuses of dominance, and the other aims to force them to take more responsibility for policing online content; significant fines back both.
• As we’ve said before, the global technology industry faces increased regulatory risks, not only in Europe but in countries such as Canada and the U.S.  Increased regulation would threaten tech firms’ profits and take even more wind out of their stock prices.

Global Energy Technology:  We’re always on the lookout for up-and-coming technologies that could not only change how we all live but also offer future investment opportunities.  In one such development, European aerospace giant Airbus (EADSY, $32.03) said it would work with France’s Safran (SAFRY, $31.94) and General Electric (GE, $94.15) of the U.S. to develop an engine that can run on hydrogen. Executives said that a converted A380 test aircraft would fly by the end of 2026 and that a zero-emissions plane could be in service by 2035.

COVID-19:  Official data show confirmed cases have risen to  428,190,863 worldwide, with 5,909,581 deaths.  In the U.S., confirmed cases rose to 78,649,877, with 939,202 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 215,006,201, equal to 64.8% of the total population.

Virology

• In the U.S., data continues to suggest that the highly transmissible Omicron mutation is in retreat.  The seven-day average of people hospitalized with a confirmed or suspected COVID-19 infection fell to 62,464 yesterday, down 44% from two weeks ago.
• Despite the downward trend in Omicron infections and hospitalizations in the U.S. and many other countries, scientists say a more transmissible subvariant of the mutation, designated BA.2, has surged to account for more than a third of global COVID-19 cases sequenced recently and could extend the current infection waves.  Nevertheless, we still believe most developed countries will continue to ratchet down their economically disruptive pandemic restrictions because of Omicron’s reduced morbidity, a better understanding of how to live with the disease, and voter fatigue with social distancing measures.
• As Hong Kong continues to grapple with its big infection wave with draconian testing and lockdown measures, the municipal government said it would give spending vouchers of HK$10,000 (US$1,280) to 6.6 million adult residents in order to help preserve demand and support the economy.

 Economic and Financial Market Impacts

• While U.S. life insurers saw a jump in COVID-19 deaths last year, as anticipated, they also faced higher payouts because of an unexpected rise in non-coronavirus deaths.  Industry executives and actuaries believe many of these other fatalities are tied to delays in medical care as a result of lockdowns in 2020, and later, people’s fears of seeking out treatment and trouble lining up appointments.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

On this historic day, as the post-Cold War global order hangs in the balance, our Comment opens with an update on the Russia-Ukraine crisis.  Events on the ground are developing rapidly, but as of this writing, the key developments are that President Putin has ordered Russian troops into Ukraine’s breakaway Donetsk and Luhansk regions and issued a lengthy statement questioning the rest of Ukraine’s independence and legitimacy.  Following our update on Russia-Ukraine, we cover a range of U.S. and other international developments.  We close with the latest on the coronavirus pandemic.

Russia-Ukraine:  Over the long Presidents Day weekend in the U.S., a series of false-flag attacks and a manufactured refugee crisis in Donetsk and Luhansk culminated in President Putin’s signing of documents recognizing the breakaway Ukrainian regions as independent states and establishing mutual aid commitments between them and Russia (see map below).  Press reports have emphasized Putin’s subsequent decision to order Russian troops into Donetsk and Luhansk as “peacekeepers.”  We think the more significant story is Putin’s long speech yesterday reiterating his view that Ukraine is an integral part of Russian culture that can’t legitimately be independent of Russia.  That signals that Putin will probably try to take control of the entirety of Ukraine, at least eventually.  Such a move would be consistent with the current deployment of Russian forces along the entire northern and eastern borders of the country, and it is also consistent with top U.S. officials’ statements that Russia will even attack the capital city of Kyiv in western Ukraine.

• The latest commercial imagery intelligence shows Russian forces along the border have now left their bases and garrisons and have been deployed throughout the countryside in attack formation.  Those forces can’t reasonably be kept in such positions for more than a few days, so it appears that a large-scale offensive is imminent.  Some reports so far this morning say columns of Russian troops have already entered Donetsk and Luhansk.
• Meanwhile, we continue to note more small deployments of U.S. military units to Europe beyond transferring of 6,000 or so troops that has been widely reported.  For example, a dozen F-35A Lightning II fighter jets and 350 airmen from Hill Air Force Base in Utah have been sent to Germany, eight F-15E Strike Eagles from Johnson Air Force Base in North Carolina have gone to Poland, and six KC-135 Stratotankers based in the U.K. have been deployed to Ramstein Air Base, Germany.  Separately, Defense Secretary Austin said the U.S. is examining whether to send additional forces to the Baltic countries.
  • At first glance, the small scale of these little-reported deployments may not seem to make sense.  However, it could be the U.S. and its NATO allies are trying to ramp up their capabilities slowly enough to avoid triggering a further Russian mobilization in response.  It’s also important to remember that modern U.S. and NATO military equipment is so advanced that small numbers of aircraft and ships still represent significant firepower, especially against an old-school, heavy-armor oriented ground force like Russia’s.  That goes for infantry troops as well.  A U.S. Army brigade today might have the firepower and capabilities of an entire division in World War II.
  • Beyond that, it’s important to remember that in the event of a major Russian attack on Ukraine, a major risk would be that China takes advantage of the situation to seize Taiwan.  Today’s U.S. military is much smaller than during the Cold War, so U.S. military leaders must keep a significant part of their force in reserve for action in the Asia-Pacific.
• On the political front, Ukrainian President Zelensky said he is considering severing diplomatic ties with Russia and begged for Western nations to punish Russia quickly with severe sanctions.  Indeed, the U.S., the U.K., and the EU all appear ready to issue additional sanctions against Russia today, although they are likely to hold back their toughest measures until Russia actually sends troops into Ukraine.  Japan has also signaled it would join the U.S. in imposing sanctions on Russia.  The U.K. has summoned Russia’s ambassador to London and may inform him of the British sanctions at that meeting.
• The immediate economic and financial implications of a Russian move into Ukraine are obvious.  Global equities pulled back before stabilizing this morning in hopes that the situation won’t worsen much further.  Safe-haven assets like precious metals and government bonds are appreciating sharply, and oil and grain prices are surging.  Energy prices in particular have risen on fears about the impact of Western sanctions that will now surely be imposed on Russia.  German Chancellor Scholz has even announced that the newly finished Nord Stream 2 natural gas pipeline from Russia to Germany will not be certified, at least for the time being.  Those trends could continue as long as the crisis lasts.  Importantly, if the crisis leads to weaker economic activity around the globe, the major central banks could even be forced to abandon their current plans to hike interest rates.
• There is also some risk of longer-term social fracturing from the crisis.  Since today’s right-wing populists often seem given to appeasement, if not outright fealty, toward Russian-style authoritarianism, it will be interesting to see if they emerge as vocal opponents to U.S. leadership against Russia’s actions in Ukraine, or even worse, as a kind of fifth column supporting Russia here at home.  After eight decades in which hundreds of thousands of Americans have shed their blood in the defense of freedom, democracy, and peaceful prosperity, such a domestic movement would mark a dangerous new cleavage in U.S. society.

Source:  New York Times

U.S. Monetary Policy:  Federal Reserve Governor Michelle Bowman yesterday said she had an open mind over whether the central bank should kick off interest-rate increases next month with a larger half-percentage-point rate rise.  That’s in contrast with statements late last week by other senior Fed officials that downplayed the need for such a large rate hike.  Since investors remain highly concerned about the prospect of tighter Fed policy, the Bowman statement could provide a headwind for equity values today.

U.S. Financial Market Regulation:  After a slow start, financial firms are starting to settle on the Secured Overnight Financing Rate, or SOFR, as the new interest-rate benchmark to replace LIBOR.  New data show SOFR has gained traction since a December 31 deadline that prohibited U.S. banks from issuing new debt tied to LIBOR.

• The data show that U.S. companies in January sold 61 leveraged loans tied to SOFR, totaling over $66 billion.
• That is up from only about $3.9 billion raised across four deals in December.

United States-Iran:  The U.S., Iran, and other world powers are reportedly nearing a deal to revive the 2015 agreement limiting the Iranian nuclear program.  Officials involved in the talks say a revised deal could be finalized in the next couple of days.

• The terms of the new deal would be almost identical to the 2015 pact.  However, because of the expertise Iran has gained through its nuclear work since the U.S. pulled out of the deal in 2018, the country’s breakout time to amass enough nuclear fuel for a bomb could fall to as little as six months compared with about one year in the original deal.
• Any new deal would involve the U.S. lifting many economic sanctions on Iran.  Although the new agreement could still falter, the prospect that Iran could once again have greater scope for its oil exports will probably put some downward pressure on global oil prices, though not necessarily enough to offset the impact of the Russia-Ukraine crisis.

China:  State-owned banks have cut their mortgage interest rates in Shanghai and Guangzhou.  The rate cuts apparently aim to help arrest the fall in the country’s housing market since the government started clamping down on real estate developers’ debt levels.

Canada:  Police have now completely cleared the massive truckers’ protest against COVID-19 mandates in the capital city of Ottawa, although smaller demonstrations have temporarily disrupted other big cities in the country and at least one U.S.-Canada border crossing.

• In Ottawa, police said have filed 389 criminal charges related to the protests, made 191 arrests, and towed 79 vehicles to clear downtown streets.
• The protests have revealed the presence of a potentially destabilizing populist movement in Canada, as in many other major developed countries.  However, the government’s disciplined and largely violence-free approach to ending the demonstrations may provide a template for how officials can take the wind out of those movements going forward.  Importantly, the Canadian government was able to maintain popular support for its effort to end the protests, with the latest polls showing some 70% of Canadians wanted officials to step in and stop the protests.

Global Inflation:  Recent data suggests consumer price inflation is finally accelerating in some Asian countries that had previously seemed immune to the problem.  For example, inflation has now reached 6.0% in India and 3.2% in Thailand.  Because of soaring pork costs, at least one Thai restaurant owner says he has substituted crocodile meat!

COVID-19:  Official data show confirmed cases have risen to  426,339,418 worldwide, with 5,897,563 deaths.  In the U.S., confirmed cases rose to 78,529,492, with 935,992 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 214,745,073, equal to 64.7% of the total population.

• In the U.S., data continues to suggest that the highly transmissible Omicron mutation is in retreat.  The seven-day average of people hospitalized with a confirmed or suspected COVID-19 infection fell to 65,861, down 43% from two weeks ago.
• U.S. health regulators are looking at potentially authorizing a fourth dose of a COVID-19 vaccine in the autumn, according to people familiar with the matter.  The planning is still in the early stages, and authorization would depend on ongoing studies establishing that a fourth dose would shore up people’s molecular defenses that waned after their first booster and reduce their risk of symptomatic and severe disease.
• In Britain, Queen Elizabeth has been diagnosed with COVID-19.  The 95-year-old monarch, who is believed to be fully vaccinated, has only “mild, cold-like symptoms,” and her life is not considered to be in danger.
• Even as the Omicron wave continues to peter out in many developed countries, it continues to wreak havoc in Hong Kong.  Reported infections yesterday reached a new record of over 7,500 cases.
  • In addition, an 11-month-old baby became the city’s youngest coronavirus-related fatality, the third such death of a young child in the past fortnight.
  • With infections rising, the government plans to impose further social-distancing rules later this week, including vaccine passports and a rule that restaurants will be limited to just two diners per table, unlike currently where some venues could have up to four people seated together.
  • The city’s top official said all schools would have enforced early summer holidays to run from March to mid-April, with campuses used for testing, isolation, and vaccination as an unprecedented coronavirus outbreak spreads through the city.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

In today’s Comment, we open with an update on the Russia-Ukraine crisis, where most of the optimism generated earlier in the week has now dissipated.  Government officials and investors seem increasingly resigned to the possibility of war, as reflected in yesterday’s activity in the financial markets.  We next review U.S. news with the potential to affect the markets today, followed by a discussion of various international developments.  We wrap up with the latest on the coronavirus pandemic.

Russia-Ukraine:  It now appears more certain that Russia is not pulling back its troops from their positions near Ukraine, as Russian officials said early this week.  Moreover, it’s starting to look like President Putin may have decided to justify an invasion on false assertions that Ukraine is persecuting ethnic Russians in and around the breakaway provinces of Donbas and Luhansk in far eastern Ukraine.

• At the United Nations yesterday, Russia formally leveled allegations that Ukraine is pursuing a “genocide” against Russian speakers. At the same time, Russian separatists in Donbas and Luhansk have continued to increase their shelling of areas controlled by Kyiv, as we noted in our Comment  That shelling seems designed to spark a military response from Ukraine that Russia could say requires intervention.  The Ukrainian government said today its troops have been issued orders to exercise restraint when responding to artillery fire to not give Russia a pretext to invade.
• For good measure, Russia yesterday also expelled the second-ranking diplomat at the U.S. Embassy in Moscow, probably hoping for a more-than-proportionate response from the U.S. that would provide a further pretext for a conflict. However, the Russian military also announced that its strategic missile forces would conduct an exercise involving multiple test launches of intercontinental ballistic missiles (ICBMs) and cruise missiles, the type used in a nuclear war.  Those exercises are actually not unusual for Russia, but they are usually held in the autumn.  Announcing they will be held now, in the midst of the crisis, is likely intended as a reminder of the ultimate risk if the U.S. and NATO choose to fight Russia.
• More broadly, the Russians replied negatively to the recently written messages from the U.S. and NATO, saying they would not accede to the Kremlin’s demands for a legally binding commitment never to admit Ukraine to the alliance and roll back NATO’s eastern expansion. In sum, the Russians are, once again, threatening to take military measures if their demands are not met.
  • As we’ve mentioned before, the Russian demands seem to be backfiring on them, as the threat to Ukraine has reinvigorated NATO and again been able to show its value.
  • In fact, at a meeting of NATO defense ministers yesterday, the alliance discussed plans to deploy rotating joint forces to Romania, similar to those now regularly deployed to Lithuania, Latvia, Estonia, and Poland. In a more specific show of support for Ukraine, the U.K. government said it would ease visa requirements for some Ukrainians trying to flee the country.
  • Separately, European Commission President Ursula von der Leyen briefed EU national leaders yesterday on a sanctions package, which is now ready to be applied if Russia invades.
• In a last-ditch effort to avoid a conflict, Secretary of State Blinken requested an urgent meeting with Russian Foreign Minister Lavrov, and U.S. officials said that meeting is scheduled for late next week. Nevertheless, President Biden sounded resigned to hostilities yesterday, saying, “Every indication we have is they’re prepared to go into Ukraine . . . My sense is this will happen within the next several days.”

U.S. Fiscal Policy:  The Senate yesterday passed a stopgap spending bill to keep the federal government funded until mid-March and avoid a partial shutdown at midnight Friday.  Passage of the bill now frees appropriators to put their full attention on hammering out a deal on an omnibus spending bill to fund the government through the remainder of fiscal 2022.

U.S. Housing Market:  According to mortgage-finance giant Freddie Mac, the average rate for a 30-year, fixed-rate loan rose to 3.92% for the week ended Thursday, compared with just 3.69% one week earlier. Driven by rising Treasury yields and expectations for a series of interest-rate hikes by the Federal Reserve, the latest rate is the highest since May 2019.

• Coupled with the sharp rise in home prices over the last year, the increase in mortgage costs is soon likely to start cooling the red-hot home market.
• If home values really do start to moderate, it will likely make many consumers feel less affluent and could take some of the wind out of consumer spending.  In turn, that would help pull down inflation.

Canada:  Police have begun arresting the truckers and other people who have been staging disruptive protests against the government’s COVID-19 rules in the capital city of Ottawa.   The arrests so far don’t seem to be producing any violence.  It appears the government will take control of the situation soon; the protests nevertheless have revealed a potentially destabilizing populist streak in Canadian society similar to that which has developed in the U.S. and other major democracies.

China:  The National Development and Reform Commission and 13 other government agencies issued a joint statement that authorities would guide online delivery-platform operators toward lowering the fees they charge to restaurant owners.  The initiative ostensibly aims to reduce restaurants’ operating costs, but it also represents another step by President Xi to rein in the country’s powerful, fast-growing technology firms.  The move has sparked another steep drop in Chinese technology stocks so far today.

European Union-China:  The EU is taking China to the WTO for patent infringements costing companies billions of euros as part of what officials in Brussels claim is a “power grab” by Beijing to set smartphone technology licensing rates.

• Smartphone makers have agreed on global standards for telecommunications networks, and in return, technology manufacturers must license their patents to others. If they cannot agree on a price, they go to court to set it.
• Chinese courts generally set prices at half the level of those in the west, meaning their companies pay less for the technology from overseas providers.
• In August 2020, China’s Supreme People’s Court decided Chinese courts can impose “anti-suit injunctions,” which forbid a company from taking a case to any court outside the country. Those that do are liable for a €130,000 daily fine, and the judgments of courts elsewhere are ignored.
• Although many European countries are reluctant to spoil their economic relationship with Beijing, the WTO complaint indicates they increasingly see the economic risks involved and are now more willing to push back.  The move may help preserve European technology and help technology firms, but the risk is that EU countries could eventually face retribution from China.

France:  The French government said it would pump €2.1 billion into state-controlled electricity utility EDF (ECIFY, $1.84) to help make up for production outages at several nuclear plants.  The funding, via a rights issue, would also help ease the financial stress caused by the government’s cap on electricity bills for households and businesses amid Europe’s surging energy prices.  The move illustrates the financial cost for European countries that try to shield consumers from the worst of the energy crisis.

COVID-19:  Official data show confirmed cases have risen to  420,166,191 worldwide, with 5,865,242 deaths.  In the U.S., confirmed cases rose to 78,269,887, with 931,742 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 214,474,721, equal to 64.6% of the total population.

 In the U.S., data continues to suggest the highly transmissible Omicron mutation is in retreat.  The seven-day average of people hospitalized with a confirmed or suspected COVID-19 infection fell to 78,213 yesterday, down 40% from just two weeks earlier.

• As the Omicron wave surges through Hong Kong, the Chinese government is struggling to make sure it doesn’t spill into the mainland and spoil President Xi’s “zero-COVID” goals.  Authorities are especially worried about illegal border crossings from Hong Kong to China.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Once again, we open the Comment with the latest developments in the Russia-Ukraine crisis.  As we warned earlier in the week, it increasingly looks like Russia was lying when it said it was starting to pull back its troops.  Just as important, there has been a spike in artillery fire from the Russia-backed separatists in eastern Ukraine, which has the potential to spark an invasion.  Following that discussion, we examine the minutes of last month’s Federal Reserve meeting on monetary policy.  We then review some other U.S. and international news that could potentially move the markets today.  We end with the latest on the coronavirus pandemic.

Russia-Ukraine:  Despite the Russian government’s statements this week that it has withdrawn some of its troops from their menacing positions near the Ukrainian border, U.S. and NATO officials say those assertions were false.  In fact, they say the latest intelligence actually shows a continuing net buildup of forces.  That assessment is also being echoed by private satellite imagery firms and experts.  Meanwhile, the Ukrainian army this morning said Russian forces controlling the breakaway far eastern regions of Ukraine shelled a kindergarten in a Kyiv-controlled area, injuring two civilians. It later said the shelling was happening in more than 20 separate locations in what may be an effort to provoke a Ukrainian response that could justify a full-scale invasion.  Finally, press reports say senior Chinese leaders, including President Xi, are struggling to decide how and how much to support Russia in the crisis without damaging their own interests.

• Even though President Xi has expressed support for President Putin’s demand that NATO pull back from Russian borders, deeper support or helping Russia evade any resulting sanctions would fly in the face of China’s traditional insistence that one country can’t invade or interfere with another country’s internal affairs.
  • Chinese leaders also fear that closely aligning China with Russia on European security issues would risk alienating Europe more and pushing countries on the continent further into the orbit of the U.S.
  • At the most basic level, the Chinese want to protect their own economic and security interests in regions that could be under threat from the Kremlin. Notably, Ukraine is a member of Xi’s signature Belt and Road Initiative, the vast infrastructure lending and construction program designed to put China at the heart of trade from Southeast Asia to Europe.
• Out of deference to Xi and the Chinese, Putin may now hold off on attacking Ukraine until the Beijing Winter Olympics conclude this weekend, which was the original assumption of many observers, including ourselves.  In the meantime, the lack of evidence that Russia is de-escalating and incidents like the shelling in eastern Ukraine mean the financial markets are likely to get dicey again.  We’re already seeing some evidence of that today, with equity futures pulling back modestly, safe-haven Treasury obligations and gold being bid up, and the Russian ruble trading down.

U.S. Monetary Policy:  In the minutes from last month’s FOMC meeting, released yesterday, Fed officials gave no indication that they would hike their benchmark fed funds interest rate by 50 basis points next month, as some investors have started to fear and as St. Louis FRB President Bullard suggested on Monday.  The omission helped salvage what had been a decidedly down day for the financial markets, allowing equities to close essentially flat.  All the same, we caught numerous hawkish elements to the minutes that investors may start to focus on in the coming days.

• When it comes to the size of the Fed’s balance sheet, investors have focused much more on the pace at which the policymakers will slow and end their asset purchases.  Less attention has been paid to the prospects that the Fed will actively sell off assets.  The minutes indicate that at least some FOMC members felt that the Fed’s balance sheet has become so large that “a significant reduction in the size of the balance sheet would likely be appropriate.”
  • Although the Fed’s main monetary policy tool is the fed funds rate, a rapid selloff of the Fed’s bond portfolio could be disruptive to the financial markets.
  • Even if the Fed reduced its overall portfolio gradually, the minutes add to market speculation that it may run down or sell off its mortgage-backed securities more rapidly, potentially disrupting residential mortgage markets.
• When it comes to the FOMC members’ assessments of the economy and thoughts on the fed funds rate, the minutes provided an updated view of the current balance between hawks and doves.  In general, the participants noted the strong momentum in U.S. economic growth and the recent surge in inflation, which “many” appeared to tag on the tightening labor market.  In contrast, the minutes say only “a couple” of members still felt there was slack in the labor market.  Similarly, only “a few” members thought longstanding structural factors like demographics and technological innovation would eventually bring inflation back down to the low levels seen before the pandemic.
• Overall, the minutes point to an FOMC that might have an itchy trigger finger.  Although the minutes don’t specifically point to any discussion about a 50-basis point hike in the fed funds rate, it is probably on some members’ minds.  The minutes certainly point to a period in which the policymakers hike interest rates at each and every meeting, essentially every six weeks.  As that possibility hits home with investors, there will be a continuing risk of market volatility going forward, even if the Russia-Ukraine crisis is resolved peacefully.

U.S. Inflation and Growth:  While it’s a bit technical, this Financial Times opinion piece argues that corporate capital investment in the U.S. has recently been much higher than official figures suggest.  If true, the increased productive capacity would promise to help bring down inflation, boost economic growth, and increase corporate profits in the coming years.

U.S. Energy Industry:  Amid weak deliveries of natural gas from Russia to Europe and a resulting spike in prices that drew in U.S. shipments, the U.S. has surpassed Qatar as the biggest LNG exporter in the world for the first time. In the following month, the U.S. supplied almost half of the record 11.7 million metric tons of LNG delivered into Europe.  The data underline the current strong operating environment for many energy firms, despite dimmer future prospects as world energy policies discourage fossil fuels.

China:  Dozens of bidding and procurement documents seen by the Financial Times indicate China has spent almost double its budget for the Beijing Winter Olympics.  The Chinese government has been secretive about the true cost of the games, but the documents show it has already spent about $8.8 billion on them in an effort to project China’s power and success.

France-Mali:  France and its European and West African allies have announced they will shift the focus of their anti-terrorism campaign in Africa eastward to Niger and south to the Gulf of Guinea after being pushed out of Mali by an uncooperative military junta.  The move marks a setback in the effort to keep al-Qaeda and ISIS on the run.  Over time, it means the terrorists may be able to regroup enough to launch socially and economically disruptive attacks on developed Western countries.

Turkey:  As expected, the central bank held its benchmark short-term interest rate unchanged at 14.0% for a second consecutive month, citing increased geopolitical risks (likely a reference to the Russia-Ukraine crisis).  The central bank’s unorthodox rate cutting in the face of high inflation triggered a chaotic slide in the lira’s value last year, but the recent stability in rates has helped slow the depreciation.  So far today, the lira is trading only slightly lower.

COVID-19:  Official data show confirmed cases have risen to  418,235,287 worldwide, with 5,853,246 deaths.  In the U.S., confirmed cases rose to 78,173,320, with 928,519 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 214,218,580, equal to 64.5% of the total population.

Virology

• In the U.S., data continues to suggest the highly transmissible Omicron mutation is in retreat.  The seven-day average of people hospitalized with a confirmed or suspected COVID-19 infection fell to 81,822 yesterday, down about 49% from an all-time high seven-day average above 159,000 reached on January 20.  Importantly, new deaths related to the coronavirus have also started to drop.
• New Census Bureau data released yesterday show the number of people who were out of work because they were sick or caring for someone who was sick fell sharply to 7.8 million in late January and early February from almost 8.8 million in early January.

The figures contribute to the evidence that the Omicron wave of the mutation is now in full retreat.

• In Japan, the government today said it would reopen its border to a limited number of overseas students, workers, and business travelers after a three-month ban.  The ban has been popular among voters and helped Prime Minister Kishida maintain healthy poll ratings during the Omicron infection wave, but it has been unpopular with foreigners and international businesses.

 Economic and Financial Market Impacts

• Japan is also facing increased living costs, just like other countries facing higher inflation.  But is that prompting Japanese firms to boost salaries?  No.  A recent poll shows over two-thirds of Japanese firms don’t plan to raise base salaries at this year’s labor talks.  They do plan to boost pay in the form of one-time bonuses that may not kick-start household spending.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

In today’s Comment, we open with an update on the Russia-Ukraine crisis, where there still seems to be no concrete evidence that Russia is really pulling back its troops.  We next cover several developments in U.S. economic policy, including a statement by the Biden administration that it is open to temporarily suspending the federal gas tax in order to reduce inflation.  We then discuss a few international developments.  We close with the latest news on the coronavirus pandemic.

Russia-Ukraine:  Following the Russian government’s statements yesterday and today that it had withdrawn a small number of troops from the Ukrainian border, U.S. and European officials said they have seen no evidence of a significant pullback.  Indeed, NATO Secretary General Stoltenberg today said alliance intelligence indicates Russia is still building up its forces close to Ukraine, and President Biden yesterday warned that an invasion is still “distinctly possible.”  Officials in Ukraine voiced skepticism that Russia’s position was softening and said it was unclear what signals Moscow intended to send.  As if to justify the continued caution, yesterday, the Russian parliament passed a resolution urging President Putin to recognize two Russian-backed separatist republics in eastern Ukraine as independent states. And, the Ukrainian government said a suspected cyberattack hit the country’s Defense Ministry and two state banks.

• Although it’s still not clear that Putin really is backing down, he will soon be constrained by the calendar.  The Russian way of war emphasizes heavy armor, and as the weather starts to warm and the Ukrainian soil begins to thaw, Russian vehicles will find it hard to travel.  If you have any doubt of that, check out this video of Russian tanks stuck in the mud during exercises just north of the Ukrainian border.
• Until there is concrete evidence one way or the other regarding any Russian de-escalation, global financial markets will be caught in limbo.  We continue to monitor a wide range of information sources to gauge where the crisis might be headed.

U.S. Fiscal Policy:  The White House yesterday said it is open to temporarily suspending the federal gas tax after a high-profile group of Democratic lawmakers proposed scrapping the levy until at least next year in an effort to curb inflation.  According to a White House press secretary, “Every tool is on the table to reduce prices.”  The openness to the idea comes as the Biden administration continues to have no luck trying to convince Saudi Arabia to pump more oil in order to bring down prices.

• With gasoline prices currently averaging approximately $3.50 per gallon, eliminating the federal gas tax of 18.4 cents per gallon would amount to a price cut of about 8%.
• However, gas station operators may not pass all the savings on to their customers.  While gas prices are highly visible to consumers, explaining the political benefit of reducing them, they are also just one part of the typical household budget.  The overall impact on inflation would probably be only modest.
• Of course, there is also a political downside to the administration’s efforts to lower the price of gasoline.  Those efforts directly contradict the administration’s commitment to reduce U.S. global warming emissions.  Indeed, the gas-tax proposal is already generating pushback from both Congressional Republicans and some Democrats.

U.S. Monetary Policy:  Republicans in the Senate yesterday refused to attend a committee vote on President Biden’s nominees to the Federal Reserve, delaying the reconfirmation of Chair Powell and the initial approval of all four of the other picks.

• The Republicans said they still have concerns about Sarah Bloom Raskin, the nominee for Fed Vice Chair for Supervision, primarily because of her past comments that bank regulators should promote the transition away from fossil fuels.
• At this point, it isn’t clear how long the dispute will delay confirmation of the officials or if Bloom Raskin or any of the other nominees will have to give up.  In any case, we would still expect the Fed to start raising its benchmark short-term interest rate in March, although we continue to believe rates won’t ultimately be raised as fast or as far as most investors currently seem to think.

European Monetary Policy:  In an interview with the Financial Times, ECB executive board member Isabel Schnabel said the central bank must consider the “unprecedented” rise in European house prices when assessing the high level of inflation and deciding how fast to tighten monetary policy.

• Unlike the U.S., the Eurozone does not include the cost of owner-occupied housing in its consumer price index.  According to Schnabel, including it would have added 0.6% to the Eurozone’s third-quarter core inflation of 1.4%.
• Schnabel is an influential hawk on the ECB board, so her arguments are likely to bolster the minority of board members who are pushing for faster monetary tightening.  If and when the Russia-Ukraine crisis recedes, investors would likely return their attention to the prospect of tightening monetary policy in the Eurozone and beyond.  In other words, financial markets could well remain volatile even with peace in Ukraine.
• Separately, the Bank of England is likely to face continued pressure to keep raising its benchmark interest rate after the U.K.’s January Consumer Price Index (CPI) showed a year-over-year increase of 5.5%.  As shown in the chart below, that marks the country’s highest inflation rate in almost three decades.

European Union Politics:  The European Court of Justice approved a new EU budget mechanism that allows Brussels to withhold funds from member countries that don’t meet EU legal standards.  Brussels will now be free to use the mechanism to punish Poland and Hungary for their violations of EU rule-of-law principles.

Global Digital Currencies:  The Financial Stability Board, which makes recommendations to the G20 nations on financial rules, today warned that cryptocurrencies are a growing risk to global financial stability.  The report argued that policymakers must act quickly in crafting rules covering the digital asset market, given the tightening link with the traditional financial system.

COVID-19:  Official data show confirmed cases have risen to  415,769,578 worldwide, with 5,839,809 deaths.  In the U.S., confirmed cases rose to 78,039,888, with 925,560 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 214,104,148, equal to 64.5% of the total population.

 In the U.S., data continues to suggest that the highly transmissible Omicron mutation is in retreat.  The seven-day average of people hospitalized with a confirmed or suspected COVID-19 infection fell to 85,086 yesterday, down some 38% from just two weeks earlier.

• The Biden administration yesterday asked Congress for an additional $30 billion to fund its coronavirus response.  The request includes $17.9 billion for medical countermeasures like antivirals, $4.9 billion for testing capacity, and $2.7 billion to combat future variants.
• In San Francisco, voters seem to have ousted three of the city’s school board members in a recall election yesterday.  Recall organizers began the effort in part out of frustration over the 13-month closure of city schools during the pandemic, arguing that the board had given priority to social-justice issues over a safe return to classrooms for the district’s 51,000 students.
• As the Omicron wave starts to overwhelm Hong Kong’s hospitals, Chinese President Xi ordered the city government to “mobilize all possible forces and resources” to protect the health of residents and maintain social stability.
  • Ominously, Xi’s directive explicitly indicates that controlling the outbreak should “take priority over everything else.”
  • The directive raises concerns about even more draconian measures that could hammer the Hong Kong economy and affect its financial markets.  Those measures could also be a harbinger of how Xi would react to a worsening outbreak in mainland China.
• In contrast, things appear to be moving in a better direction in Japan, allowing the government to plan for further restriction easing.  The government will shorten the quarantine period for all international arrivals—both Japanese and foreign nationals—from the current seven days to three days, starting in March when it opens the border for travelers other than tourists.  For some arrivals, the government is considering dropping the quarantine period entirely.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Today’s Comment begins with tantalizing news that Russia may be pulling back its military forces from the Ukrainian border, although it’s important to stress that the move is not confirmed, and anything can still happen.  Given that our discussion of the Russia-Ukraine crisis is quite detailed, we next cover only the most significant developments in the U.S. and abroad.  We wrap up with the latest news on the coronavirus pandemic.

Russia-Ukraine:  In a potential sign that President Putin is backing down from his threatening stance toward Ukraine, a spokesman for the Russian Ministry of Defense said units from the country’s southern and western military districts have completed their “training exercises” and have begun returning to their bases.  Of course, there can be no assurance that the statement is true.  It could easily be a ruse to get the U.S. and its NATO allies to let their guard down while Putin proceeds with an attack.  Besides, the statement came as German Chancellor Scholz was about to meet Putin in an effort to defuse the crisis.  The announcement could simply be aimed at weakening German resolve in resisting Putin’s designs on Ukraine.  The Ukrainian government has already expressed skepticism that Russia is really pulling back, and NATO General Secretary Stoltenberg has said the alliance has still not seen any concrete evidence of a Russian stand down.  It may well take several days before commercial and government imagery or other intelligence confirms a Russian move to de-escalate the situation.  Until then, we can only be cautiously optimistic.

• There have been tantalizing hints that President Putin was setting the stage to back away from a confrontation; we think this is more likely the scenario.
  • Russian television often airs footage of highly choreographed meetings between Putin and his advisors to portray Putin as a tough leader in total control of his government or present the case for a policy initiative.  In one such meeting broadcast yesterday, Russian Foreign Minister Lavrov tells Putin that the West is ignoring the Kremlin’s core security demands but that Moscow should continue negotiations.  In reply, Putin says “Good,” raising hopes he may be signaling a desire to avoid war.
  • Kremlin spokesman Peskov yesterday said that if the Ukrainian government formally abandoned its 2008 application for membership in NATO, it would help address Russia’s security concerns.  Some Ukrainian officials have floated that possibility as a way to diffuse the crisis, but Zelensky said in his press conference with Scholz that he wouldn’t abandon Ukraine’s effort to join the alliance.
• All the same, the Russian statement is at odds with the country’s continued military buildup near the Ukrainian border.  U.S. officials say Russia has now boosted its military forces near Ukraine to 105 battalion tactical groups, up from 83 units earlier this month.  In addition, the military has moved about 500 combat aircraft within range of the country and has 40 combat ships in the Black Sea.
  • Meanwhile, the Russian Duma today will begin considering two bills recognizing the independence of Ukraine’s breakaway Russian-dominated provinces of Donetsk and Luhansk.  If approved, either bill could provide a pretext for Russia to cross into Ukraine, ostensibly at the invitation of Donetsk or Luhansk in order to protect ethnic Russians living in those regions.
  • These developments would be consistent with intelligence reports suggesting this Wednesday is a potential target date for a Russian invasion.
• If a Russian military pullback is confirmed, it would probably have a significant impact on the financial markets.  Already today, equity values are rebounding, while gold and crude oil prices are sliding.  Bonds are selling off, boosting yields again.  There could also be broader geopolitical implications:
  • A Russian pullback would offer tantalizing clues regarding what can be accomplished with reinvigorated U.S. leadership and global engagement.  As we’ve noted before, the U.S., and the Biden administration in particular, knows how to do great-power politics.  Success in diffusing the Russia-Ukraine crisis and utilizing its new information-warfare skills would likely burnish U.S. prestige and repair some of its influence worldwide.
    • In one example, the U.S. would likely pressure its NATO allies to invest more in their own defense so they can be better prepared to stand up to Russia in the future.  Indeed, after feeling the hot breath of the Russian bear on their necks, NATO countries may well be incentivized to boost their defense efforts in any case.  The Polish government has even started to ease some of its tensions with the European Union.
    • U.S. officials have said that their firm stance against Russia aims, in part, to signal that the U.S. and its Indo-Pacific allies would take a strong stance in protecting Taiwan from Chinese aggression.
  • Of course, diffusing the Russia-Ukraine crisis would also be a domestic political win for Biden, as it could help people forget about the chaotic U.S. withdrawal from Afghanistan last year.  With the administration seemingly unable or uninterested in bringing down inflation, it would probably be happy to try to turn their attention to foreign policy wins ahead of this fall’s mid-term elections.

U.S. Financial System:  The Federal Reserve Board, Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency yesterday issued a report that flagged mounting vulnerabilities across a number of sectors hardest hit by the coronavirus pandemic, including commercial real estate.

• The report shows that excessive borrowing and declining creditworthiness remained a problem in 2021.
• The fragility mentioned in the report is a key reason we think the Fed won’t be able to hike interest rates this year as fast or as far as investors currently expect.  With the fragilities that have built up in some financial sectors during the Fed’s slow pivot away from loose monetary policy, it will probably only take a few rate hikes and reduced asset purchases to expose problems and force the Fed to retreat.

United States-Mexico:  The U.S. has suspended essentially all imports of Mexican avocados until further notice after a threatening message was sent to a U.S. plant safety inspector working in the state of Michoacan, a center of drug-cartel activity.  If the import cut-off lasts too long, it would likely cause a spike in avocado prices and further feed into investor concerns about inflation and interest-rate hikes.

Canada:  A day after police cleared truckers blocking the Ambassador Bridge linking Detroit to Windsor, Ontario, Prime Minister Trudeau yesterday took the rare step of declaring a national public order emergency to end the truckers’ anti-vaccine protests in the capital city of Ottawa.

• Invocation of the Emergencies Act confers enormous, if temporary, power on the federal government, including the ability to freeze the protestors’ bank accounts.
• Although the protests have proven quite disruptive in Ottawa and at U.S.-Canadian border crossings, the government’s disciplined, measured approach so far has contained the situation.  The clearance of the Ambassador Bridge suggests the government will soon get control of the situation.  If so, its actions could serve as a template for governments struggling to contain potentially violent populist protests.

Japan:  Fourth-quarter gross domestic product (GDP) rebounded to grow by a seasonally adjusted 1.3%, equal to an annualized rate of 5.4%.  That was more than enough to offset the decline in the previous quarter, and it meant the economy avoided slipping into recession.  Given the size of Japan’s economy, the return to growth could signal momentum in the broader global economy at the end of last year, which would be positive for equities.

COVID-19:  Official data show confirmed cases have risen to  413,746,208 worldwide, with 5,827,947 deaths.  In the U.S., confirmed cases rose to 77,919,052, with 922,473 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 213,962,983, equal to 64.4% of the total population. 

• In the U.S., data continues to suggest the highly transmissible Omicron mutation is in retreat.  The seven-day average of people hospitalized with a confirmed or suspected COVID-19 infection fell to 89,158 yesterday, down some 36% from just two weeks ago.
• French liquor firm Pernod Ricard (PRNDY, 42.91) has asked its top executives in Hong Kong to temporarily relocate as the municipal government’s zero-COVID policies become increasingly onerous.
• In Japan, the situation is looking better than in Hong Kong.  The government is starting to see a decline in daily new COVID-19 cases—a major relief after infections rose exponentially in the past month—but experts say it’s still too early for people to let their guard down, especially since past waves have shown that critical cases and deaths continue to rise well after daily cases peak.

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