by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

In today’s Comment, we would love to only focus on happy news like the Super Bowl or Valentine’s Day, but the world is much too tense for that.  Therefore, we open with the latest developments on the Russia-Ukraine crisis.  We then turn to a range of international news and U.S. developments that have the potential to affect the financial markets today.  We close with a short recap of the latest news on the coronavirus pandemic.

Russia-Ukraine:  Among the key developments over the last few days, President Biden had remote meetings with a large group of allied leaders on Friday, with Russian President Putin on Saturday, and with Ukrainian President Zelensky on Sunday.  The most important recent development in the meetings was that Biden reportedly told the meeting with allied leaders that the U.S. has intelligence suggesting Putin has ordered his troops to prepare to launch an attack this Wednesday, February 16.  Meanwhile, German Chancellor Scholz will meet with Zelensky today in Kyiv and with Putin tomorrow in Moscow.  Since Scholz would be the last major NATO leader to have a direct or video conference with Putin, that meeting could well be the last best chance to convince Putin to take an off-ramp and diffuse the crisis.

• We continue to believe that it is somewhat more likely that Putin will back down, and the crisis will be resolved.  In large part, that’s because of the surprising extent to which NATO countries and the U.S. political establishment have coalesced behind a strong response to the Russian threat.  In turn, that response reflects an innovative U.S. strategy to blunt Russia’s “grey zone” attacks using “information warfare.”
  • Russian grey-zone tactics have involved cyberattacks and other activities that fall short of traditional, violent warfare and are hard to clearly attribute to the Russian military.  Western leaders have, therefore, had their hands tied in taking strong action against those attacks.
  • In the current crisis, the administration is aggressively releasing U.S. intelligence on Russian preparations and grey-zone activities in order to characterize them as military aggression before they’re launched.  There are risks in the approach.  For example, there’s a chance that the U.S. releases will lead to the loss of important intelligence sources and methods.  The intelligence may also be fragmentary or otherwise unreliable, in which case it may later prove to be false.
    • Here’s one example:  During my days as a CIA analyst in the 1980s and 1990s, my computer search profile would typically send me 200 to 300 intelligence reports to review each day.  They would include everything from raw satellite imagery and communications intercepts to “finished” intelligence reports from organizations like the State Department’s intelligence group or foreign intelligence services.
    • Out of those 200 to 300 reports that would come across my computer screen, only three or four might seem reliable or connected to my “account” (Soviet/Russian military budgeting and defense industry).  I would only do a deeper dive into those reports and ignore the rest.
    • Of those three or four intelligence reports that I would examine closely, many would ultimately prove meaningless.  In the current crisis, the U.S. may be releasing these kinds of reports.  They may merely be semi-reliable hints of what the Russians are doing or planning.  While it may sound bad for the U.S. to talk up such reports, it’s probably reasonable for the administration to be using a relatively low hurdle for reliability if the release of the information closes off a potential Russian avenue for attack.
• Despite the likelihood (or hopes) that the U.S. information strategy will force Putin to back down, signs continue to accumulate that sober professionals in many industries around the world are taking seriously the possibility of a major war.
  • On Sunday, one of Ukraine’s main air carriers, SkyUp Airlines, said it suspended sales for flights this week after its insurers stopped covering aircraft in Ukrainian airspace because of an increased threat of a Russian invasion.
  • A day earlier, Dutch national flag carrier KLM said it had suspended its flights to Kyiv and wouldn’t operate flights in Ukrainian airspace.
  • Meanwhile, energy traders are starting to price in a higher risk that a Russian invasion will lead to sanctions that curtail its oil exports.  Oil prices are now approaching $100 per barrel for the first time since 2014.
  • Financial assets are also reflecting the risks.  Gold and safe-haven U.S. Treasury obligations continue to appreciate.  Bond yields are edging lower.  Stock markets continue to weaken, especially in Europe, although we’ve noted relative strength in defense stocks.  For the time being, we expect these trends to continue.
• Allied NATO military moves are also screaming, “This is not a drill.”  Among the key developments are the following:
  • The U.S. has now evacuated nearly all of its diplomatic personnel in Ukraine.  It has also removed the 160 or so Florida National Guard troops who had been in the country training Ukrainian soldiers.  The soldiers assigned to the 53rd Infantry Brigade Combat Team have been ordered to reposition elsewhere in Europe.
  • In recent weeks, four U.S. Navy destroyers normally assigned to the East Coast were deployed to the US. 6^th Fleet in the Mediterranean.  Notably, the destroyers are all configured for ballistic missile defense.
  • Late last week, a task force consisting of four U.S. Air Force B-52s was sent from Minot Air Force Base in North Dakota to RAF Fairford, U.K., for a notional three-week stay, during which they will exercise with NATO allies and partner nations.
  • Also, late last week, U.S. Air Force fighter jets were deployed to Poland and Romania to support enhanced air policing and to reassure NATO eastern flank allies.  Eight F-16s from the 52nd Fighter Squadron at Spangdahlem Air Base, Germany, deployed to Fetesti Air Base, Romania, while eight F-15s from the 48th Fighter Squadron at RAF Lakenheath, U.K., landed in Lask, Poland.
  • On Saturday, U.S. F-22 fighter jets were deployed to the United Arab Emirates, ostensibly to help the UAE thwart a recent spate of air attacks by Houthi rebels in Yemen.  However, we note those fighters would also be close enough to the Black Sea region to assist in any hostilities there.

Global Commodity Markets:  The Russia-Ukraine crisis is happening amid low inventories for a wide range of commodities beyond just energy.

• The problems are particularly acute in metals, where spot prices of several contracts on the London Metal Exchange are trading higher than those for later delivery, as traders pay large premiums to secure immediate supply.
• Even cocoa prices are rising, driven by dry weather in Africa weighing on production and cutting into inventories.  Most-actively traded cocoa futures have risen about 12% this year—and 11% in February alone—to $2,811 a metric ton, on pace for the highest monthly level since April 2018.

Canada:  Police in Windsor, Ontario, yesterday arrested anti-vaccine protesters and towed vehicles to clear access to the Ambassador Bridge linking the city to Detroit.  It’s not entirely clear when traffic on the bridge will be back to normal, but if the flow of trucks normalizes soon, it will help ease the production stoppages that the protests caused to auto manufacturing on both sides of the border.

• The truckers’ protests primarily aimed to reverse Canada’s stringent pandemic rules, but we’ve been watching them closely for any sign that the truckers, coordinating on social media, might be tempted to use such traffic blockages as leverage to pursue other goals.
• Even as a separate truckers’ protest continues in Canada’s capital city of Ottawa, the dismantling of the Ambassador Bridge blockage may reflect the limits of the truckers’ ability to wage economic warfare.  All the same, the current labor shortage and stretched supply lines probably point to continued disruptions in other areas.  In the U.S., the most important thing to watch may be the West Coast ports, where the longshoremen’s contract expires this summer, possibly setting up a major strike.

European Central Bank:  In an interview with the Financial Times, Irish central bank governor Gabriel Makhlouf pushed back against investors expecting the ECB to start hiking interest rates as early as June.  According to Makhlouf, the ECB could stop its net bond purchases in June or a few months later and would only raise rates after that.  His statement is consistent with efforts by ECB Chief Lagarde to walk back her recent hints of an early rate hike, which had unsettled European markets and gave a boost to the Euro.

Spain:  In a regional election over the weekend, the far-right Vox party secured 18% of the vote in Castile-León, likely putting it into position to join a regional government for the first time.  It also suggests that any center-right national government of the future might need to rely on the populists to govern.

U.S. Tax Policy:  As Democrats in Congress try to resurrect a version of President Biden’s “Build Back Better” program of social policy and climate stabilization measures, they’re finding that a key stumbling block is that Senator Joe Manchin of West Virginia is pushing for increased corporate and individual income tax rates, while Senator Kyrsten Sinema of Arizona opposes them.  With the Senate deadlocked 50-50 between Democrats and Republicans, both senators would need to agree for the measure to pass.

U.S. Monetary Policy:  In an interview with the Wall Street Journal, Kansas City FRB President Esther George said the Fed should consider selling bonds from its $9 trillion asset portfolio to address high inflation and guard against harmful effects that can result from short-term rates rising above long-term rates.

• George’s suggestion that the Fed shouldn’t just stop growing its balance sheet, but should actively reduce it, is yet more evidence that monetary policymakers are panicking about inflation and the need to tighten policy.
• We have little doubt the Fed will start to tighten policy next month.  However, we still suspect that the policymakers won’t be able to hike interest rates as far as the market currently suggests before hitting economic or financial potholes that will force it to curtail the tightening.
• For now, the prospect of tightening monetary policy will continue to foster financial market volatility.  If the Fed does curtail its tightening earlier than investors expect, however, it would likely cause a sharp rebound in bond prices.

COVID-19:  Official data show confirmed cases have risen to 412,134,811 worldwide, with 5,817,819 deaths.  In the U.S., confirmed cases rose to 77,740,175, with 919,697 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 213,869,678, equal to 64.4% of the total population. 

• In the U.S., data continue 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 92,896 over the weekend, down some 35% from just two weeks ago.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning! We begin today’s report with a few different views about inflation, followed by an update on the Canadian trucker protest. Afterward, we give our thoughts on the Russia-Ukraine situation. International news is next, and we end with our pandemic coverage.

Inflation: The BLS reported that inflation rose 7.5% from the prior year, its fastest pace in over 40 years. Unlike previous reports, inflation was particularly broad-based, with rent, energy, and food prices all making noticeable gains. The rise in inflation has placed more pressure on the Federal Reserve to raise interest rates. The market has now started anticipating up to seven rate hikes this year, with a possible 50 bps rate hike in March. However, Fed officials have offered mixed views on the need for additional rate hikes. Richmond Fed President Thomas Barkin stated he does not see a screaming need to raise rates 50 bps in March, and San Francisco Fed President Mary Daly said an aggressive rate hike wasn’t her preference. Meanwhile, St. Louis Fed President and FOMC voting member James Bullard asserted he would like to see rate hikes reach 100 bps by July 1. 

The reluctance of the Fed to put too much emphasis on the recent inflation report may be reasonable. In January, adverse weather conditions contributed to a sharp rise in electricity prices. Additionally, much of the base effects related to last year’s reopening that pulled inflation upward will conceivably start to drag on inflation this year. Services such as airline fares, car rentals, and lodging away from home will probably show signs of deflation due to a drop in demand. Additionally, the rise in energy and autos may contribute less to inflation than it did in the previous year because of prices already being elevated. This does not mean inflation will return to pre-pandemic levels; that should not happen any time soon. However, it does suggest inflation is entering its peak stage. The market is expecting the Fed to raise rates up to five times this year, within a range of 1.25%-1.50%.

Trucker Protest: The trucker protest has entered its fourth day, and it appears that officials may intervene. On Thursday, the Mayor of Windsor, Ontario, which borders Detroit, stated police were prepared to remove the anti-mandate protesters by force if necessary. The Ontario government has sought an injunction to end the protest and plans to seize trucks and reopen the bridge. At least six auto plants have halted production as a result of this protest. The U.S. also expects its truckers to protest in solidarity with the Canadian drivers over Superbowl weekend. These protesters are expected to proceed to D.C. early next month.

Russia-Ukraine conflict:  The U.S. has escalated its rhetoric in its attempt to dissuade Russia from invading Ukraine. In an interview with MSNBC, U.S. Deputy Secretary of State Wendy Sherman stated, “body bags will come back to Moscow” if troops enter Ukraine territory. The comment comes amid rising tensions between Russia and Ukraine and has led the country to ramp up military drills. Although talks between NATO and Russia are ongoing, there doesn’t appear to be much progress.  In previous reports, we mentioned the Russia-Ukraine stalemate will seemingly end without a major conflict, but Wendy Sherman’s comment has made us less optimistic.

International news: 

• U.K. and EU officials are scheduled to meet on Friday to discuss Northern Ireland Protocol. Following a political backlash in Northern Ireland, the new round of discussions will try to improve the trading arrangement. The protocol was put in place to prevent a resurrection of a hard border between Ireland and Northern Ireland. Since the deal was made, there has been growing opposition from Northern Ireland officials. Last week, the country’s first minister, Paul Givan, resigned in protest to the rules established by the post-Brexit protocol. Negotiations have not gone well in the past, as the U.K. and EU have been unable to agree on the way goods can be transferred between Northern Ireland and mainland U.K. without border checks.
• OPEC and its allies continue to face production problems. The IEA has reported that group members have struggled to meet production pledges.  The agency reports that OECD industry oil inventories have plunged to their lowest level in seven years. Although Saudi Arabia and the United Arab Emirates, which have the sparest production capacity, could help ease oil markets, there is no sign they will. Thus, the lack of inventory could pave the way for $100 a barrel for oil.
• As the rest of the world raises rates to contain inflation, ECB President Christine Lagarde has held steadfast in her belief that higher rates are not needed at this time. She told a German publication that raising rates “would not resolve any of the current problems” and warned that it could hurt the economy and jobs. She also maintained she would only act if needed, and any moves would be gradual.

COVID-19:  The number of reported cases is 406,419,929, with 5,792,240 fatalities.  In the U.S., there are 77,437,156 confirmed cases with 915,618 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The CDC reports that 674,675,725 doses of the vaccine have been distributed with 545,477,120 doses injected.  The number receiving at least one dose is 251,655,172, while the number of second doses is 213,430,434, and the number who have received the third dose, granting the highest level of immunity, is 90,852,670. The FT has a page on global vaccine distribution.

• Hong Kong officials have requested assistance from mainland China. The region is struggling to contain an outbreak in cases and needs an additional temporary isolation facility.
• More states are starting to end mask mandates as infection rates decline. The moves come amid growing evidence that the pandemic is headed into its final stage.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning! Today’s report begins with an update on the Russia-Ukraine conflict. Up next, in the U.S. economics and policy section, we discuss the Canadian trucker protest and a few other stories. We then review central bank news, and we end with our pandemic coverage.

Russia-Ukraine: The situation in Ukraine remains fluid. On Thursday, Russia and Belarus began one of their largest joint military drills since the Cold War.  In Ukraine, troops have started drills using armed drones and antitank weapons provided by NATO and the U.S. Although Russia adamantly denies it is preparing to invade Ukraine unprovoked, the two sides appear to be getting ready for conflict. Additionally, leaders from the West are preparing for a response in case of a Russian invasion, even as they explore a path to de-escalation. British Prime Minister Boris Johnson has urged solidarity with NATO allies, as he plans to travel to Warsaw and NATO headquarters in Brussels. The U.K. sent 350 troops to Poland on Monday as a sign it is ready to defend Poland in the event of Russian aggression. Meanwhile, British Foreign Secretary Liz Truss traveled to Moscow to share the U.K.’s concerns about Russia’s actions along the Ukraine border to her Russian counter. In a speech, she warned that an invasion would lead to a severe response from the U.K. In response, Russia’s Foreign Minister Sergei Lavrov stated his country would not be cowed by threats made by the West.

Russia’s continued interaction with Western leaders and diplomats is possibly a sign that it does not intend to invade Ukraine imminently. We suspect Russia is trying to see what concessions it can get from the U.S. and NATO before deciding to invade Ukraine or withdraw its troops from the border. Russia would like a commitment from NATO that it will not admit Ukraine into the alliance, but we suspect Russia may be satisfied if Ukraine granted the regions Donetsk and Luhansk more autonomy. This will allow Russia to maintain its influence in those regions and Ukraine to retain its territorial integrity. We assume both Ukraine and Russia will push for a resolution before local elections in two major cities in Donetsk take place on March 27.  As the situation continues, some countries are already preparing for possible energy supply disruption. South Korea announced on Wednesday that it is prepared to release its strategic oil reserves in the event of a conflict. At this time, we suspect cooler heads will prevail, which should be bearish for commodity prices.

Economics and policy:

 Iran nuclear talks appear to be entering their final stages, according to the U.S. State Department. The two sides began discussions this week, and negotiations have reportedly been successful. The major obstacle in securing a deal is convincing Iran to revert to the curbs established in the 2015 agreement. If an agreement is reached, Iran would be able to sell its crude oil in the global market, and this should put downward pressure on oil prices.

• The trucker protests at the Ambassador Bridge over vaccine mandates have started to impact the economies of both the U.S. and Canada. The blockade has forced a Ford (F, $18.35) engine factory in Chicago to go idle. The bridge carries 25% of all trade between Canada and the U.S., this will likely make it harder for firms to receive needed materials. Officials from both the U.S. and Canada have warned the protests would exacerbate the ongoing supply chain bottlenecks.
• The world’s largest assembler of iPhones, Hon Hai, stated the supply shortages are showing signs of easing. This is promising news for the global economy, as it signals factories will eventually start operating at full capacity.

Central bank news: 

• Susan M. Collins was chosen to replace Eric S. Rosengren at the Federal Reserve Bank of Boston. She will be the first woman of color to take over one of the central bank’s 12 districts. Currently, Collins is provost and executive vice president for academic affairs at the University of Michigan. The new president will have a voting role on the FOMC committee this year. She has stated that she is committed to maintaining the Fed’s inflation and employment mandates.
• The Bank of Japan has offered to buy unlimited quantities of government debt next week to head off investors who are testing the central bank’s commitment to yield curve control. In Japan, a sudden pick-up in inflation has led traders to speculate that the BOJ could begin to tighten monetary policy. The move by the BOJ suggests it is committed to ensuring its 10-year yield does not rise above the 0.25% level.
• The Reserve Bank of Australia ended its quantitative easing program on Thursday. The central bank’s balance sheet tripled under the program to about A$650 billion. Following the end of quantitative easing, the bank has not indicated what it would do with its purchases. Governor Philip Lowe stated the RBA would decide in May whether it would reinvest the proceeds of maturing bonds. There is no expectation the RBA will run off its balance anytime soon. Its first notable bond maturity isn’t until April 2023.

COVID-19:  The number of reported cases is 403,909,435, with 5,779,881 fatalities.  In the U.S., there are 77,267,876 confirmed cases, with 912,257 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The CDC reports that 673,608,245 doses of the vaccine have been distributed with 544,772,697 doses injected.  The number receiving at least one dose is 251,467,303, while the number of second doses is 213,246,140, and the number who have received the third dose, granting the highest level of immunity, is 90,533,404. The FT has a page on global vaccine distribution.

• The U.S. government is expected to authorize COVID-19 shots for kids under the age of five. The Centers for Disease Control and Prevention is on track to authorize the Pfizer (PFE, $51.47) vaccines for children 2-4 years of age. After the vaccine is approved, the government plans to deliver the doses by February 21.
• The country is heading out of the “full-blown” pandemic, according to Chief Medical Officer Anthony Fauci. In an interview with the Financial Times, Fauci stated that the country could end all pandemic-related restrictions in the coming months, including mask mandates.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

We open today’s Comment with an update on the Russia-Ukraine crisis, focusing on the interpersonal balance of power between Russian President Putin and the other major world leaders he is dealing with.  Next, we cover a range of U.S. and international developments that could affect the financial markets today.  We wrap up with the latest news related to the coronavirus pandemic.

Russia-Ukraine:  A day after French President Macron met with President Putin, which is increasingly described as a humiliating failure in the face of Putin’s uncompromising demands, the French leader held talks with Ukrainian President Zelensky in Kyiv.  In a joint press conference with Zelensky after that meeting, Macron again insisted that he sees “concrete, practical solutions” to the crisis, even if negotiating them with Putin might take months.  In contrast, Zelensky struck a more cautious note, saying Ukraine is looking for concrete steps from Putin to prove he is serious about de-escalating tensions and pulling back Russian troops from the border.

• Macron has been trying to portray himself as a source of influence over Putin, and even though he has suggested he secured commitments from Putin to avoid any further escalation and enter talks over his security demands, the French leader is probably overstating his success.  Indeed, Kremlin spokesman Dmitry Peskov took him down a notch (or two) with a statement yesterday in which he basically said it’s not possible for Russia to put any value on a deal struck with France or Macron.  According to Peskov, “It’s impossible because France is a member of the EU, and of NATO, where it is not the leader. A different country in that bloc is the leader. So how can we speak about any ‘agreements’?”
• We’ve written before about the way interpersonal power and leadership skills can be a decisive factor in geopolitics (for example, see our WGR from August 2021).  This week’s various diplomatic initiatives offer proof of that.  For example, Putin’s threatening military buildup on Ukraine’s border is based on the principle of “reciprocity,” as he’s offering to take away the threat and ease tensions in return for the security guarantees he has demanded.  More interesting, in his public comments and meetings with foreign leaders like Macron, the Russian leader is relying on the principle of “authority,” specifically in the sense that he is uncompromisingly “framing” or controlling the issue.  Putin’s insistence that NATO is the aggressor in this crisis and that Russia’s security is at risk may come off as fantasy to the Western ear, but strong, effective leaders who are committed to a clear goal can often move mountains by pushing their view of the world in just this manner (a fun discussion of the concept can be found in this analysis of the television series Game of Thrones).  The bottom line is that when two leaders are trying to use this framing tactic against each other, the one who wins is often the one who is most convinced of his power and importance.  When Macron publicly agreed, before he even left for Moscow, that Russia has legitimate security concerns, the French leader had already shown that his frame of the crisis was weaker than Putin’s, setting him up for failure.
• Going forward, the key relationship here will be between President Putin and President Biden.  Although Biden has muddled his message somewhat, the administration so far has been remarkably firm in its framing of the crisis and its insistence on principles such as the territorial integrity of Ukraine and the right of any sovereign nation to apply for membership in NATO.  Selling weapons to Ukraine and deploying U.S. troops to Eastern Europe has also sent a strong signal of firmness.  Diffusing the crisis, forcing Putin to back down, and removing this geopolitical threat from the financial markets may well turn on Biden and the administration maintaining their uncompromising rejection of Putin’s demands and tactics.

U.S. Fiscal Policy:  Yesterday, the House passed a bill to keep the federal government funded through mid-March, advancing a temporary fix that will give negotiators time to reach an overall agreement on fiscal 2022 spending after weeks of negotiations failed to yield a deal.  The Senate now plans to take up the measure and pass it quickly before the current temporary deal ends on February 18.

• If the stopgap spending bill does not pass by then, it will force the government into a partial shutdown.
• As we noted in our Comment yesterday, such an event would be negative for the financial markets because it would once again force investors to consider the risk of a U.S. debt default.

U.S. Monetary Policy:  As we’ve been arguing, the increasing panic about inflation among Federal Reserve policymakers and many investors may not lead to as many interest-rate hikes as people think.

• One consideration is that the current extended period of low interest rates probably bred excess risk-taking or other fragilities in corners of the financial market.  Even the mere rhetoric about higher rates could expose those problems and spark so much volatility that policymakers end their tightening programs early.
• On top of that, high debt levels and other economic headwinds may mean that even modestly higher rates will slow activity too much.  Indeed, some emerging markets that tightened policy early now face that very dilemma.  If economic growth proves more sensitive to rate hikes than the major central banks now believe, the policymakers may have to stop hiking their benchmark rates well before the market expects.
• If the Fed, the ECB, and other major central banks show any hint in the coming months of ending their tightening phase early, it would likely give a major boost to both bond prices and the value of risk assets.

United States-China:  In another sign of economic decoupling amid increased U.S.-China geopolitical tensions, U.S. regulators are reportedly planning to get more cautious about approving dozens of cancer drugs and other new medicines developed in China.  Specifically, the regulators have expressed concerns about the quality of studies largely conducted in China and whether the results can apply to patients in the U.S.

Japan-Taiwan:  In yet another sign of how China’s geopolitical aggression is pushing the U.S. and its allies into closer cooperation, Taiwan said it would relax a ban on Japanese food imports put in place after the 2011 Fukushima nuclear disaster.  The move is probably designed not only to help Taiwan secure more defense cooperation with Japan but to support its application to join the CPTPP trans-Pacific trade agreement.  In either case, greater Japan-Taiwan cooperation could boost each country’s trade and economic growth, which should be positive for investors.

Digital Currencies:  The Justice Department yesterday said it seized over $3.6 billion worth of digital currency stolen during a hack of a cryptocurrency exchange in 2016 and arrested two suspects for allegedly trying to launder the proceeds.  Although advocates cite transaction privacy and security as key advantages to digital currencies, the Justice Department action illustrates both the government’s improving capabilities in cyber investigations and the fact that digital currencies can’t be deemed 100% secure.

COVID-19:  Official data show confirmed cases have risen to  401,426,692 worldwide, with 5,766,919 deaths.  In the U.S., confirmed cases rose to 77,053,769, with 909,018 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 213,061,117, equal to 64.2% 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 approximately 111,000 yesterday, down 30% from its peak in January.  The seven-day average of deaths related to COVID-19 held roughly steady at 2,531.
• With Omicron receding and people pushing back harder against pandemic restrictions, politicians in the U.S. and other countries continue to signal they will soon ease their remaining rules.  In an interview yesterday, White House Chief Medical Advisor Fauci said the U.S. is moving out of the “full-blown” pandemic phase of the crisis, leaving him hopeful that there would be an end to all pandemic-related restrictions in the coming months, including mandatory mask-wearing.
• Despite Omicron’s apparent retreat in the U.S. and many other countries, Japan continues to face increased case counts.  The government is therefore considering extending its COVID-19 quasi-emergency designation for Tokyo and 12 other prefectures for about three weeks beyond Sunday’s expiration.

 Economic and Financial Market Impacts

• The massive Canadian trucker protest against vaccine mandates, which we described here yesterday, now threatens to spill over into the U.S.  Last night, protestors and their supporters shut down the Ambassador Bridge linking Detroit with Windsor, Ontario.  The bridge was reopened early this morning, but the incident suggests the truckers could try again to disrupt U.S.-Canadian trade in order to call attention to their demands.  These protests could also inspire copycat demonstrations in which truckers use their big rigs to occupy major U.S. thoroughfares to protest pandemic rules.
• Preliminary data from the CDC suggest the pandemic has led to a smaller baby bust than earlier feared.  According to the data, the U.S. saw only about 7,000 fewer births through the first nine months of 2021 compared with the same period the year prior.

View PDF

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, with a focus on two key diplomatic meetings yesterday.  We next turn to a range of U.S. developments, including another U.S. hurdle to investments in China.  Following that, we review other international news items that have the potential to move the financial markets today, and we close with the latest news on the coronavirus pandemic.

Russia-Ukraine:  As several divisions of Russian troops remain poised for attack along Ukraine’s borders, and as six additional Russian warships are being transferred to the Black Sea from the Mediterranean, the key developments in the crisis over the last day have centered on two diplomatic meetings, one of which had the characteristic of a carrot and the other a stick.

• Macron’s Carrot for Putin:  After hinting that NATO should be prepared to offer concessions to Russian security concerns, French President Macron met with Russian President Putin for more than five hours of talks inside the Kremlin.
  • At a joint press conference afterward, Putin remained combative and critical of NATO, blaming the West and Ukraine for the crisis, but said Russia would do “everything possible to reach compromises acceptable to everyone” on European security.
  • Macron was more positive, saying Putin had given him assurances that he was open to exploring ways to defuse the crisis.  He said Putin promised not to undertake any new military initiatives and agreed to launch a broad dialogue on Russian troop deployments, including an agreement to withdraw thousands of Russian troops from Belarus after completing their current exercises in the country.  Macron flies to Kyiv to confer with Ukrainian President Zelensky today.
• Biden’s Stick for Scholz:  Meanwhile, President Biden held a meeting at the White House with German Chancellor Scholz.
  • After a press conference alongside the German leader, Biden stated definitively that if Russian forces invade Ukraine again, the Nord Stream 2 natural gas pipeline from Russia to Germany will be shut down.  In Biden’s words, “If Russia invades, . . . then there will be no longer a Nord Stream 2. We will put an end to it . . . I promise you, we will be able to do it.”
  • Notably, however, Scholz continued to refrain from stating the same commitment.  He merely offered assurances that the U.S. and Germany are aligned fully in their approach to Ukraine’s security.
• Overall, these diplomatic moves illustrate the difficulty the NATO allies have in striking the right balance between conciliatory measures and firm threats to rein in Putin.  Macron’s willingness to respond to some Russian concerns has long worried others in the alliance, who fear he is only encouraging Putin’s belligerence.  Germany has also been reluctant to act as firmly as the U.S., the U.K., and NATO’s new Eastern European members.  Behind closed doors, German officials have assured the U.S. that they would shut down Nord Stream 2 in the event of a Russian attack on Ukraine.  However, Scholz’s refusal to say so publicly takes some of the bite out of the U.S. sanctions threats meant to dissuade Russian President Putin from attacking.  Overall, the situation remains fluid, and although we still suspect the crisis will eventually get resolved with Putin backing down, anything could happen.  The world’s financial markets will therefore remain on edge.

United States-China:  Chinese healthcare stocks are selling off sharply today after the U.S. placed 33 health companies on its list of Chinese firms that are restricted from importing certain advanced technologies from the U.S.  Hong Kong’s Hang Seng Healthcare Index ended the day down almost 5%, although some companies in the index fell much more than that.  The development is a reminder that U.S.-China geopolitical and economic tensions continue to present a risk for investors in Chinese companies.

United States-Japan:  The Biden administration has agreed to lift the import tariffs imposed on Japanese steel by the Trump administration in 2018, following a similar deal with the EU last fall.  Under the agreement, Japan can avoid duties on up to 1.25 million metric tons of steel shipped to the U.S. each year, a level similar to its exports in 2018 and 2019.

• The deal will remove an irritant in the countries’ bilateral relationship as the U.S. seeks to strengthen its alliance system to counter China’s growing geopolitical assertiveness.
• The agreement is clearly designed to discourage increases in imports by maintaining tariffs on shipments beyond the agreed-upon level.  All the same, the deal should help lower the cost of imported steel for U.S. users, marginally reducing the U.S. inflation pressures that have been pushing up interest rates and rattling risk markets.

U.S. Fiscal Policy:  House leaders scheduled a Tuesday vote to extend a temporary government funding measure through March 11, buying time for negotiators to work out a comprehensive fiscal 2022 package after a prolonged deadlock over how much to allocate for military and nondefense spending.  Without the passage of the temporary funding, the government would be at risk of a partial shutdown, and investors would once again have to consider the risk of a U.S. debt default.

EU Monetary Policy:  After refusing last week to rule out an interest-rate hike this year and saying there was “unanimous concern” about inflation among the Eurozone’s monetary policymakers, ECB President Lagarde yesterday played down the chances of a “measurable tightening” of monetary policy and insisted there was no rush to tackle inflation.  While she did admit Eurozone inflation was no longer likely to fall below the ECB’s target of 2% by the end of the year, her effort to walk back last week’s hawkishness probably reflects her discomfort with the financial market volatility sparked by such rhetoric in Europe, the U.K., and the U.S.

• That sensitivity to market volatility is a significant reason the policymakers at major central banks may not tighten policy this year as much as investors think.  More broadly, there is also some concern about the impact of higher interest rates on less-developed countries.
• If the policymakers ultimately get cold feet, especially as “base effects” start to push down inflation around mid-year, any signal of an early end to rate hikes would likely give a major boost to bond prices and bring yields back down.

EU Industrial Policy:  The European Commission today introduced legislation to make available about $49 billion in public and private funding for the chip-making industry.  The proposal, known as the European Chips Act, could unleash tens of billions of dollars in funding for research and new production facilities, part of the bloc’s economywide effort to boost its commercial independence.

• If successful, the program could eventually help resolve supply constraints that have been driving up prices for computer chips and worsening inflation.
• If the program successfully reinvigorates Europe’s semiconductor industry, it could also eventually expand opportunities for technology investors.

Poland:  Finance Minister Koscinski has resigned amid a widening backlash against the government’s “Polish Deal” economic reforms last year.  The reforms, supported by the EU’s new pandemic relief fund, included higher spending on healthcare and other public services, along with tax cuts for lower- and middle-income people.

• However, implementation has been poor, resulting in some people paying higher taxes than before.
• Political shakeups in major countries always have the potential to affect investors.  If Koscinski’s resignation leads to significant economic policy changes in Poland, it could have big implications for the country’s investment climate going forward.  However, there is no indication right now who might replace Koscinski or how the country’s economic policy might evolve.

Sri Lanka:  Asia’s top high-yield bond issuer, Sri Lanka, is edging closer to default on its billions of dollars of debt.  The South Asian island was plunged into crisis after a cascade of rating downgrades following large tax cuts in 2019 and the loss of tourism during the pandemic.  That has left it unable to tap global markets as it faces some $7 billion in debt service payments due this year.

COVID-19:  Official data show confirmed cases have risen to  397,963,515 worldwide, with 5,753,381 deaths.  In the U.S., confirmed cases rose to 76,853,612, with 905,544 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 212,920,278, equal to 64.1% of the total population.

In the U.S., the seven-day average of people hospitalized with confirmed or suspected COVID-19 dropped to 115,173 yesterday, extending its drop over the last two and a half weeks.  The seven-day average of new cases stood at 265,700 on Monday, after falling under the 300,000 mark on Sunday for the first time this year.

• Even though the highly transmissible Omicron variant appears to be in retreat in at least some major countries, drug firms continue their efforts to develop one-shot vaccines that could be used in the future.
• Officials in several Democrat-led states yesterday said they would lift their mask mandates for schools or other indoor areas in the coming weeks as COVID-19 cases fall.
  • The governors of Connecticut and New Jersey said school districts would be able to determine their own masking policies starting February 28 and March 7, respectively.
  • California Governor Newsom said his state’s indoor mask mandate would expire on February 15.
• In Canada, hundreds of truckers and their big rigs continue to occupy parts of the capital city of Ottawa to protest Prime Minister Trudeau’s vaccine mandates.  The protest, now in its 12^th day, aims to put political pressure on Trudeau to reverse his policies.
  • However, vaccination support among Canadians remains high, with more than 85% of the population fully or partially vaccinated.  Indeed, Trudeau won reelection last fall in part on a promise to impose vaccine mandates.
  • Moreover, the disruptions to everyday life in Ottawa have pressured police to begin taking a hard line against the protestors, including arresting some.
• In contrast to the loosening restrictions and mandates in the U.S. and other countries, Hong Kong is tightening its mandates in conjunction with China’s zero-COVID policy.  Under the new rules, unvaccinated residents will be barred from Hong Kong’s supermarkets and malls.  The restrictions expand a vaccine mandate scheduled to begin on February 24 that already covered venues like restaurants and gyms.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Today’s comment begins with an update on the Russia-Ukraine situation. We then cover a range of U.S. and international developments that have the potential to affect the financial markets today. We wrap up with the latest news on the coronavirus pandemic.

Russia-Ukraine:  National Security Advisor Sullivan and other officials have revealed that the latest U.S. intelligence assessments show Russia has now boosted its forces on the Ukrainian border to the point where it could launch an attack at any moment.  The assessments show Russia currently has 83 battalion tactical groups arrayed close to Ukraine’s borders, a substantial increase from the 53 groups it had in December and 60 last month.  Separately, Russian media said some parliament members may try to bring up a bill recognizing the independence of Ukraine’s Donbas region, dominated by ethnic Russians, and has been waging a separatist war against Kyiv since 2014.  U.S. officials worry such a move could offer the Kremlin political cover for an attack.  All this comes as Ukraine faces a severe energy crunch that has forced it to operate all 15 of its nuclear electricity plants simultaneously for the first time since the end of the Soviet Union.  Meanwhile, French President Macron today is visiting Russian President Putin in Moscow in an effort to de-escalate the situation, while President Biden is hosting German Chancellor Scholz at the White House to persuade him to take a tougher line against Russia.

• The intelligence assessments suggest that between 3,000 and 10,000 Russian troops and between 5,000 and 25,000 Ukrainian troops could be killed or wounded if Russia launches a full-scale invasion of the country. The assessments also warn that a full invasion could produce 25,000 to 50,000 civilian casualties, depending on the extent of fighting in urban areas.
• As we’ve seen before, the Ukrainian government tried to put on a brave face and played down the latest Russian maneuvering. Foreign Minister Kuleba issued a statement saying, “Don’t believe in apocalyptic scenarios… Ukraine possesses a powerful army, unprecedented international support, and the faith of Ukrainians in their state. The enemy is the one who has to fear us, not the other way around.”
• The latest intelligence assessments provide a hint at the potential humanitarian cost of a Russia-Ukraine conflict. With an attack likely leading to massive economic sanctions against Russia, a potential disruption to Russian energy exports, and the possibility of a wider conflict and more extensive economic damage, investors would also face falling values for risk assets.  We would, however, expect a conflict to boost prices for U.S. Treasury obligations, gold, crude oil, and natural gas.

United States-China:  The Biden administration is reportedly close to finalizing its strategy to boost trade in the Asia-Pacific region to counter China’s growing influence there.  The new Indo-Pacific Economic Framework would focus on rebuilding ties with friendly nations in areas such as digital commerce, supply chain development, and green technology.  It would not involve a full-fledged, tariff-cutting free-trade agreement like the Trans-Pacific Partnership, which the U.S. abandoned in 2017.

U.S. Healthcare Industry:  At least a dozen states, led by both Republicans and Democrats, have recently enacted or are considering enacting laws aimed at reining in aggressive financial tactics by healthcare providers and collection agencies.  For example, some of the laws include requirements for hospitals to provide financial assistance to people with low incomes or limit aggressive debt-collection practices.

• Medical bills are the biggest source of debt in collections, larger than all other types of debt combined, including credit cards and utilities, according to an analysis of a sampling of credit reports published in the Journal of the American Medical Association last July. Before the housing crisis in 2007-2008, medical bills were the most prevalent source of household financial stress and bankruptcy.
• If the clampdown on hospital billing and collections continues to grow, it could have ripple effects on pricing for a wide range of healthcare firms. Since healthcare is one of the largest sectors of the stock market, such price pressures could hurt returns for many investors.

United Kingdom:  Prime Minister Johnson has revamped his staff after several top officials resigned late last week amid the scandal over his pandemic rule-breaking social gatherings.

• London’s police continue to investigate whether the parties broke any laws. Johnson’s grip on power remains tenuous, with an increasing chance he will be forced out of power.
• Political instability is rarely good for an economy or its stock market. If Johnson is forced out of office, British equities would likely face downward pressure.

 France:  New polling shows right-wing candidates are in an extremely close race for the run-off spot in the April presidential election.  The latest surveys show President Macron still has the highest support, but upstart far-right firebrand Éric Zemmour has now almost pulled even with long-term right-wing leader Marine Le Pen, who is only about one percentage point behind traditional center-right conservative Valérie Pécresse.  The election bears watching because the potential election of a far-right populist in a country as important as France would likely rattle financial markets in Europe.

 Global Monetary Policy:  In a Financial Times opinion piece yesterday, former PIMCO chief investment officer Mohamed El-Erian warned that even though the Fed and the ECB are now in a “hawkish pivot,” the switch to tighter policy is still partial at best, too slow, and likely to lead to an over-compensation later this year.

• If El-Erian is correct, it would imply a long series of benchmark rate hikes and a quicker reduction in Fed and ECB balance sheets, which would likely keep boosting bond yields and undermining equities throughout the year.
• We still think it’s more likely that tighter policy will quickly spark disruption in some corners of the financial market or start to slow the economy, forcing policymakers to end their tightening cycle earlier than many investors expect. As shown in the chart below, investors are still expecting about 1% of total tightening in the Fed’s benchmark fed funds interest rate by the end of the year, equivalent to about four 0.25% hikes.

Source:  Cmegroup.com

Global Financial System:  With the world awash in capital seeking higher returns, and with banks wanting to offload risk to reduce capital buffers, Credit Suisse (CS, $9.64) has securitized an $80 million portfolio of loans backed by its ultra-high net worth clients’ yachts, private jets, and other assets.  And what is the interest rate on the portfolio?  It is over 11%.

COVID-19:  Official data show confirmed cases have risen to  395,540,912 worldwide, with 5,741,726 deaths.  In the U.S., confirmed cases rose to 76,506,842, with 902,639 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 212,806,521, equal to 64.1% of the total population.

• Major companies in a wide range of industries have reported their operations and growth were held back in the latest quarter because of workers on sick leave with the Omicron mutation.
• In South Korea, the government is abandoning its vaunted test-and-trace system in the face of a surge of Omicron cases that threatens to overwhelm the country’s health system.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning. Today’s report begins with U.S. economics and policy, including updates on Ukraine and President Biden’s pick for the FOMC.  Next, we discuss the significance of the Beijing Winter Olympics. International news follows, and we conclude with our pandemic coverage.

Economics and policy:

• The Biden administration has accused Russia of trying to fabricate an incident along the Ukraine border to justify an invasion. White House officials alleged Russia planned to release a fake video showing a Ukrainian attack on Russian or Russian-speaking people. Russia has denied the accusation. Following a classified briefing, Senators from both parties are looking to pass a sanctions bill to deter Russia. Although the sides are close to an agreement, there are concerns that progress is not moving fast enough. In Europe, French President Emmanuel Macron plans to meet with the leaders of Russia and Ukraine next week. Macron will seek to act as a mediator for the two sides to avoid a conflict.
  • Russian President Vladimir Putin and Chinese President Xi Jinping met in Beijing on Thursday. Following the meeting, Putin announced a 30-year agreement with China to provide the country with natural gas through a new pipeline. The sale of natural gas will be settled in euros and not dollars.
• President Biden’s nominees to the FOMC testified before the Senate on Thursday. Although all the candidates are expected to be confirmed by the Senate, Sarah Bloom Raskin appears to be the most vulnerable to being rejected. Despite previously serving on the FOMC, her work with the fintech company Reserve Trust has been under scrutiny. The company received access to the Federal Reserve’s payment system after Raskin joined its board in 2017. It is the first state-chartered trust company to receive this access. When asked if she personally lobbied the Federal Reserve on the company’s behalf, she stated she did not violate any of the Federal Reserve’s ethical rules.
• 50% of U.S. small companies reported they raised wages in January in order to attract workers, according to the National Federation of Independent Business. Over a quarter of small business owners surveyed stated that they still plan to raise wages over the next few months.
• President Biden intends to extend tariffs on solar cells and panels imposed by the prior administration but loosen some restrictions. The new tariff restrictions will exclude bifacial solar panels, which are needed to expand solar capacity. The tariffs were scheduled to expire on Sunday but have been extended for another four years.
• As the winter storm passes from Texas, electricity demands are expected to soar as more households turn up the heat. Due to last year’s statewide power outage, residents are fearful that the Texas power grid will not be able to support the demand. So far, the grid has held up as strong winds have allowed wind farms to contribute to the state’s electricity supply.

 China:

• The 2022 Beijing Winter Olympics kick-off on Friday. Chinese President Xi Jinping will look to use the game to burnish his country’s reputation as a global power. Recently, China has come under increased scrutiny from abroad following its crackdown on Hong Kong protesters and has been accused of mistreating Uyghurs, a Muslim minority group. Additionally, there have been concerns that the government has ramped up its surveillance, leading some athletes to purchase burner phones. In protest of China’s human rights violations, several countries, including the U.S., have decided to boycott the games by not sending diplomats. Only a few countries have joined the boycott. That being said, the winter games will probably be an opportunity for Xi to show that China remains an attractive destination for foreign tourists and investors, despite its increased crackdown. Assuming that there is no controversy, similar to the Mexico City Olympics in 1968, we suspect the event will go off with little contention.

International news: 

• The Spanish Parliament passed a controversial labor reform bill on Thursday, forcing the country to reduce the proportion of the Spanish workforce on temporary contracts. The bill’s passage allowed Spain to unlock additional funding from the EU Recovery Fund.
• Chilean President Sebastián Piñera selected Rosanna Costa to take over the Bank of Chile. Costa will be Chile’s first female central bank chief. She was nominated based on her experience and support for inflation control.
• After the Bank of England raised rates in back-to-back meetings, central bank governor Andrew Bailey tried to quell fears of market uncertainty. In an interview with CNBC, he stated the rate hikes would likely continue at a gradual pace as the BOE tries to stem rising inflation. On Thursday, the central bank raised rates by 25 bps. Although the rate hike was in line with expectations, four out of the nine members of the Monetary Policy Committee voted for a 0.50% raise, suggesting the committee has become increasingly hawkish. In a separate interview with the BBC, Bailey urged workers not to demand big pay raises as it could make inflation harder to contain. The comments indicate the BOE may also view their labor market as being too tight.

COVID-19:  The number of reported cases is 388,686,859 with 5,715,128 fatalities.  In the U.S., there are 75,994,966 confirmed cases with 897,377 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The CDC reports that 669,540,355 doses of the vaccine have been distributed with 541,410,847 doses injected.  The number receiving at least one dose is 250,593,665, the number of second doses is 212,336,183, and the number of the third dose, the highest level of immunity, is 88,983,833. The FT has a page on global vaccine distribution.

• Lawmakers in Austria successfully passed legislation that could pave the way for making vaccinations mandatory for adults. If signed into law, Austria would be the first Western democracy to legally require vaccination and could provide a test case for other countries around the world.
• Several states will allow their health emergency declarations to expire on February 15. The move will allow states to reduce pandemic restrictions, such as mask mandates, and in some cases, lead states to limit the release of public health data.
• The omicron sub-variant has started to make up a growing portion of South Africa’s COVID-19 cases. The variant jumped from making up 4% of the cases in December to 23% in January.

View PDF