by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment begins with an update on the Russia-Ukraine war.  We next review a range of international and U.S. developments with the potential to affect the financial markets today, including confirmation that the European Central Bank will hike its benchmark interest rate in July.  We end with the latest news on the coronavirus pandemic.

Russia-Ukraine:  The Ukrainian military continues to push Russian troops away from the northeastern city of Kharkiv, reportedly to an area less than ten miles from the Russia-Ukraine border.  In response, the Russian military is reportedly redeploying troops to that area from their operations around the northeastern city of Izyum, which will likely further stall their advance southeasterly from that city.  Meanwhile, Russian and Russian separatist forces continue trying to encircle Ukrainian troops in the eastern Donbas region even as they keep trying to mop up the last Ukrainian resistance in the destroyed city of Mariupol.  Separately, the Belarusian military has stepped up its military exercises along its border with the Baltic states and Poland, probably a signal of its ongoing political support for Russia’s invasion of Ukraine.

• Citing Russian interference with its operations, privately held Gas TSO of Ukraine said it would halt natural gas flows through one of its pipelines in the Donbas region, potentially affecting one-third of Russian gas exports going to Western Europe through Ukraine.
  • The news has further boosted European gas prices by over 5% so far today.
  • On the other hand, Hungary has now demanded to be fully exempt from the EU’s proposed ban on Russian oil imports.  Hungary’s demand throws up another roadblock to the oil ban, at least temporarily easing the scramble for non-Russian oil supplies.
• Adding to the brutality Russia has already imposed on Ukraine, reports indicate Russian troops are seizing Ukraine’s stockpiles of wheat, sunflower oil, and other agricultural commodities and shipping them to Russia.
  • The Russians could use the stolen Ukrainian commodities for their own purposes, attempt to sell them on the open market, or treat them as bargaining chips.
  • In any case, the seizures highlight how the war is disrupting global food supplies and raising the risk of further inflation, hunger, and political unrest in many countries worldwide.
  • Although expectations had been high that French wheat exports could help make up for the loss of supply from Russia and Ukraine, the growing drought raises worries that France will see reduced production and exports this year.
• The House of Representatives last night approved $40 billion in new aid to Ukraine by a vote of 368 to 57.  Despite resistance from some Republicans who want a deeper analysis of the bill, it is expected to pass the Senate soon.  Among its main provisions, the bill would provide:
  • More than $18.7 billion will go to military and security aid, both to Ukraine itself and to backfill U.S. defense supplies that have been distributed.
  • Nearly $8.8 billion is for economic and budgetary assistance for Kyiv.
  • Approximately $5 billion will be used around the world to address food shortages caused by the war, bolstering U.S. international friendships.
  • About $900 million will go to U.S. agencies to provide refugee support services, such as housing, English language classes, and trauma and support services for arrivals and refugees from Ukraine.
  • Around $67 million will be for the U.S. Justice Department to help cover the costs of seizing, retaining, and selling forfeited property such as the yachts of Russian oligarchs.
• British Prime Minister Johnson has signed an agreement to help defend Sweden and Finland in the interim between their application to join NATO and their formal entry into the alliance.  The move aims to smooth the two countries’ entry into NATO and reassure them in the risky period before they would enjoy the mutual defense obligations.

Sri Lanka:  As an example of the unrest that could be unleashed by rising prices for food and other essentials, violent protests continue against Sri Lankan President Gotabaya Rajapaksa, despite his brother’s resignation as prime minister yesterday.  The army is now enforcing a nationwide curfew and threatening to shoot looters, but the government appears to be on the brink of collapse.

European Union:  Wrapping up an EU self-assessment process that included town hall meetings with citizens, French President Macron has proposed a system of tiered EU membership levels.  Full EU members would be the core of the group, while a second-tier would consist of countries that are official candidates for membership.  A broader “European political community” would also include democratic European countries adhering to EU values, such as the rule of law and freedom of the press.

• The broader “political community” group would potentially include countries like the U.K., Ukraine, Moldova, and Georgia.  Members of the group could cooperate with the core EU and EU candidates in areas such as security, energy, and infrastructure. They would not necessarily be guaranteed eventual full membership in the EU.
• Feeding suspicions that the proposal is merely a way to push off current EU aspirants, Macron offered no specifics on what obligations the broader group would have to meet along with its rights.  He also glossed over the immense difficulties that would be involved in changing EU treaties to accommodate the new EU organization.
• Along with Macron’s push for Europe to build its own “strategic autonomy” in defense, it’s tempting to write off his “European political community” as an unrealistic gambit that couldn’t be implemented for years at best.  Yet, Macron’s visions validly reflect a sense that Europe is now much stronger than when it lay in ruins at the end of World War II.  Macron’s proposals validly reflect the idea that Europe can and should take more initiative in providing for its own defense, and it needs to streamline its decision-making even as it expands to include more members.
  • If something like Macron’s visions were put into practice, Europe could become a stronger and more valuable partner for the U.S. as it works to sustain liberal democracy and free market capitalism in the face of rising authoritarianism.
  • The downside is that such visions could also tempt the EU to form its own geopolitical and economic bloc separate from the evolving U.S.-led bloc, as we described in our latest Bi-Weekly Geopolitical Report.

United Kingdom-European Union-Ireland:  British Prime Minister Johnson yesterday signaled he is ready to tear up the U.K.-EU deal laying out post-Brexit trading arrangements for Northern Ireland, calling the agreement “not sustainable in its current form” despite an appeal from his Irish counterpart not to take unilateral action.

• As we’ve noted, last week’s regional elections in Northern Ireland have sparked a crisis.  Irish nationalist party Sinn Féin won the most seats in Northern Ireland’s legislature, so it has a right to name the region’s first minister.  The Good Friday Agreement of 1998 would require Sinn Féin to share power with the Democratic Unionist Party (DUP), the biggest party seeking to keep Northern Ireland in the U.K., but the DUP is refusing to form a government unless the post-Brexit trade protocol is scrapped.  Johnson is signaling he will throw his weight behind the DUP.
• The tug of war raises the prospect of months of political limbo in which Northern Ireland would have no functioning chief executive.  If no new chief executive is in place in 24 weeks, Northern Ireland would have to hold new elections.
• More importantly, London is already drafting legislation that would allow the U.K. to abandon the protocol, as the DUP is demanding.  That move would likely spark an economically disruptive trade war with the EU.

European Union Monetary Policy:  In a speech today, ECB President Lagarde said her central bank is likely to hike interest rates and stop expanding its balance sheet as early as July.  The remarks are a clear sign Lagarde supports the growing number of ECB officials that have called for a 25-basis-point rise to the ECB’s deposit rate at its July 21 policy meeting.  The deposit rate is now -0.5% and has been in negative territory since 2014 when it was lowered to help fight the region’s debt crisis.

• Despite Lagarde’s statement, the ECB is not expected to tighten policy nearly as aggressively as the Federal Reserve.  Like most other major central banks, the ECB simply isn’t as behind the curve in fighting inflation as the Fed.
• With the ECB and other major central banks continuing to tighten policy slower than the Fed, the euro and other major currencies are likely to remain relatively weak against the surging dollar.  The chief investment officer at Europe’s largest asset manager recently said the euro should be trading at parity with the dollar within six months, i.e., its value would fall from $1.05 now to just $1.00.

U.S. Monetary Policy:  The Senate yesterday confirmed President Biden’s nomination of economist Lisa Cook as a governor of the Fed by a party-line vote of 51-50, with Vice President Harris casting the deciding vote.  The Senate is also expected to approve two other Biden picks this week, including economist Philip Jefferson as a governor and Jerome Powell as chair of the board of governors for a second term.

• The votes are unlikely to immediately affect the Fed’s plan to fight inflation by aggressively tightening monetary policy.
• Underlining that idea, Fed Governor Waller yesterday said the central bank is committed to bringing inflation down by reducing demand for goods and services.

U.S. Digital Currency Regulation:  After stablecoin TerraUSD “broke the buck” this week, as we described in our Comment yesterday, Treasury Secretary Yellen testified in Congress that the incident calls for legislation that would authorize regulating the product.  We continue to believe that digital assets will face growing regulation over time.

COVID-19:  Official data show confirmed cases have risen to  518,814,718 worldwide, with 6,256,004 deaths.  The countries currently reporting the highest rates of new infections include Germany, France, South Korea, and the U.S.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  In the U.S., confirmed cases rose to 82,060,805, with 998,069 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 220,223,617, equal to 66.3% of the total population.

• The seven-day average of people hospitalized with confirmed or suspected COVID-19 in the U.S. came in at 19,270 yesterday.  The tally of people hospitalized for COVID-19 is now up 19% from two weeks earlier, although it remains relatively low.
• China’s censors blocked rare public criticism of its strict “zero-COVID” strategy by the World Health Organization from social media today, as officials in Shanghai insisted there would be no change to policies that have locked tens of millions of people in their homes for weeks.
• With the world worrying that China’s strict policies will derail global economic activity, New Zealand has announced an easing of its own strict policies.  The government said it would reopen its borders two months ahead of schedule, on July 31, and ease immigration rules to lure skilled workers.  The move will end more than two years of severe entry restrictions.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment opens with an update on the Russia-Ukraine war.  Russian forces remain bogged down in the face of strong Ukrainian resistance and their own poor planning, weak execution, low morale, and resource shortages.  We next review a range of international and U.S. developments with the potential to affect the financial markets today, including a trading issue in a key digital currency that probably contributed to yesterday’s sharp market declines.  We close with the latest news on the coronavirus pandemic.

Russia-Ukraine:  Russian forces continue to make very little progress in their efforts to seize more territory in eastern and southern Ukraine, although they are consolidating their control over areas they already hold.  A senior U.S. defense official said Russian forces facing tough Ukrainian resistance are exhibiting extraordinarily poor discipline and morale.  Many Russian troops are reportedly refusing to obey orders, frequently abuse alcohol, and shoot at their own vehicles to avoid going to the frontline.  Russia also continues to face serious force generation problems.  In his Victory Day speech yesterday, President Putin failed to announce the kind of general mobilization that could eventually provide a substantial boost to Russian manpower.  Reports suggest young Russians are receiving draft notices under a “covert mobilization,” but those notices could merely represent the ongoing spring draft, which in ordinary times would run from April 1 to July 15.  We have also seen one document pointing to the call-up of reserves, but under the Russian personnel system, the pool of soldiers available in the reserves is very limited.  In sum, the Russian military is not only suffering from poor planning and amateurish operations but also from growing shortfalls in military equipment, supplies, and personnel.

• The EU effort to ban Russian oil imports continues to face resistance from several Eastern European members that are particularly dependent on Russian energy.  European Commission President von der Leyen yesterday traveled to Hungary in an effort to sell the ban to Prime Minister Orbán, who has been the principal obstacle to a deal but reportedly had no success.
  • The EU is reportedly offering to let Hungary, Slovakia, and the Czech Republic phase in the import ban over the next two years or more.
  • Even if the Eastern European countries get to keep importing Russian oil, for the time being, any import ban implemented by the major EU economies will keep the demand for non-Russian oil high.  It will tend to buoy prices despite the recent downdraft as investors fret about weakening economic growth in China.
• Separately, reports this morning say Brussels has shelved its plans to ban the EU shipping industry from carrying Russian crude oil.  That plan had faced hard pushback from Greece and Malta, which together account for more than half of EU-flagged tonnage.
• Despite the delay in new EU sanctions on Russia, the Ukrainian government is becoming increasingly confident and ambitious in its war aims.  According to Foreign Minister Kuleba, the government has upgraded its war aims and is now looking to push Russian forces out of the country entirely, as long as western allies rapidly deliver promised heavy weaponry.
  • Kuleba particularly noted the importance of pushing the Russians out of the Kherson region of southeastern Ukraine and regaining control over the country’s coast.
  • According to Kuleba, that would allow Ukraine to neutralize Russia’s Black Sea Fleet and restart exports through the country’s southeastern ports.

European Union-Ukraine:  In a development that would be as important for the EU as it would be for Ukraine, EU officials are planning an issue of €15 billion in joint debt to fund financial aid to Ukraine over the coming three months.  Although the debt issue wouldn’t be nearly as large as the groundbreaking mutual debt issued to fund the EU’s massive pandemic relief program, it could point to a certain normalization of joint debt backed equally by all members of the EU.

United Kingdom:  In the House of Lords today, Prince Charles, as heir to the throne, for the first time stood in for his mother to deliver the Queen’s Speech, laying out the government’s legislative priorities for the coming year.  It was the first time since 1963 that Queen Elizabeth had not delivered the speech herself.

South Korea-North Korea:  In his inauguration speech yesterday, conservative South Korean President Yoon Suk-yeol offered economic aid to North Korea if it suspends its nuclear weapons program and starts to denuclearize.  The offer marked a pivot away from his campaign promise to emphasize military deterrence to reduce the threat from Pyongyang.

Iran:  As the Russia-Ukraine war and other factors drive up global food prices, President Raisi said Iran would cut back and reform the country’s bread subsidy system.  Starting in about two months, the government will offer citizens digital coupons, allowing them access to a limited amount of bread at subsidized prices, while the rest will be available at market rates.

• The scheme will later include other goods such as chicken, cheese, and vegetable oil.
• Cutting back on food subsidies is a risky move because it could spark mass protests.
• As we have noted in the past, rising food costs have often sparked periods of political instability in emerging markets.

Philippines:  As expected, Ferdinand Marcos, Jr., the son of the former dictator, yesterday cruised to a landslide victory in the country’s presidential election.  His opponents fear he could use his power to wage political battles against his family’s adversaries, shield allies from scrutiny, and enrich his associates like his father did before an uprising ousted him 36 years ago.

Sri Lanka:  Prime Minister Mahinda Rajapaksa resigned after months of mass protests against his government’s handling of an economic crisis marked by high inflation and acute shortages of fuel and medicines.  It is not yet clear whether the prime minister’s resignation has been accepted by his younger brother, President Gotabaya Rajapaksa.

• The prime minister’s resignation points to continued political and economic disruptions in the country.
• While Sri Lanka isn’t a major economy or investment destination, it has been a high-profile recipient of Chinese investment under President Xi’s “Belt and Road” initiative.  The continued political and economic problems in Sri Lanka could therefore weaken China’s effort to build alliances and counter U.S. influence through trade and investment.

U.S. Financial Market:  Amid the widespread carnage in the financial markets yesterday, we took note that the TerraUSD stablecoin, a type of cryptocurrency whose value is supposedly pegged to $1.00, traded as low as $0.94.  The drop in value triggered a wave of selling, which likely contributed to yesterday’s substantial drop in the broad cryptocurrency market.

• As of last weekend, Terra was the third-largest stablecoin.  Unlike traditional stablecoins, Terra is strictly algorithmic, i.e., it isn’t necessarily backed by any assets at all.
  • Instead, algorithmic stablecoins rely on financial engineering to maintain their link to the dollar.  Such designs have been criticized as risky because they rely on traders to push the value back to $1.00 rather than having assets that continuously support the price.
  • Once Terra “broke the buck” yesterday, at least some traders panicked and rolled into more traditional asset-backed stablecoins.  At the same time, algorithmic rules prompted others to sell stablecoins such as ether and bitcoin in an effort to drive up the price of Terra again.
• We have long posited that the Wild West development of the cryptocurrency markets could pose risks for the traditional financial markets, especially as the Federal Reserve pushes up interest rates.  At this point, it’s not clear what sparked the loss of confidence in Terra, but we note a couple of important points:
  • The downdraft in stablecoin prices looked very much like “contagion” in the traditional financial markets.
  • To the extent that any of these assets have been pledged as collateral, the volatility in their values potentially could spark further selling and broader contagion.  We remain on the lookout for any such broader financial risks.
• More broadly, the Fed warned in its semiannual Financial Stability Report yesterday that the sharp upside surprises in inflation or interest rates “could lead to higher volatility, stresses to market liquidity and a large correction in prices of risky assets, potentially causing losses at a range of financial intermediaries.”

U.S. Labor Market:  With the tight labor market driving up wage rates, teens are now working in greater numbers than any other time since the Great Financial Crisis of 2008-2009.  Federal data show that about one-third of young people aged 16 to 19 are currently working, potentially helping keep some lower-paying firms in business.

U.S. Inflation:  In its April survey of inflation expectations, the New York FRB said respondents saw prices rising at an annual rate of 3.9% three years from now, versus 3.7% in its March survey.  However, those figures remain below the three-year forward expectation of 4.2% registered in the survey last autumn.

• When the April consumer price index (CPI) is released on Wednesday, we expect base effects will finally start to reduce the calculated inflation rate on a year-over-year basis.
• As of this writing, the April CPI is expected to be up 8.1% year-over-year, versus 8.5% for the March CPI.

COVID-19:  Official data show confirmed cases have risen to  518,073,573 worldwide, with 6,253,752 deaths.  The countries currently reporting the highest rates of new infections include Germany, France, South Korea, and the U.S.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  In the U.S., confirmed cases rose to 81,973,693, with 998,041 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 220,163,884, equal to 66.3% of the total population.

Virology

• The seven-day average of people hospitalized with confirmed or suspected COVID-19 in the U.S. came in at 19,009 yesterday.  The tally of people hospitalized for COVID-19 is now up 20% from two weeks earlier, although it remains relatively low.
• Just days after President Xi reiterated his “zero-COVID” policy, authorities in Shanghai are reportedly tightening the city’s lockdown.  New cases have been declining in the city, and officials haven’t formally announced tighter restrictions.  In recent days, however, residents have reported more forced quarantines at centralized facilities and halted deliveries of nonessential items, including medicines.
  • Other local and provincial governments are likely to follow Shanghai’s lead regarding redoubling their pandemic restrictions.  As a result, nascent popular protests against the policies could widen and intensify.
  • Just as important, any further tightening of China’s pandemic restrictions threatens to slow the economy further, creating additional headwinds for the global economy and financial markets.

Economic and Financial Market Impacts

• Reflecting how badly China’s lockdowns are hurting its economy, the China Passenger Car Association yesterday said April auto sales were down 36% year-over-year.  Production was down even more sharply, by 41% year-over-year.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with an update on the Russia-Ukraine war, where Russia’s advances remain stalled, and President Putin gave a Victory Day speech that was unexpectedly restrained.  We next review a range of international and U.S. developments with the potential to affect the financial markets.  Finally, we wrap up with the latest news on the coronavirus pandemic, where new data underscores the extent to which China’s “zero-COVID” policies are weighing on economic activity.  The data also emphasizes the threat to world economic growth, which, along with rising bond yields, has contributed to the downdraft in global stock markets so far today.

Russia-Ukraine:  The military situation in Ukraine remained relatively static over the weekend, with Russian forces failing to make any significant advances.  Russian forces appear to be massing in Belgorod, Russia, to reinforce Russian efforts in the northern Ukrainian city of Kharkiv and prevent the ongoing Ukrainian counteroffensive from pushing closer to the Ukraine-Russia border.  Russian forces near the northeastern Ukrainian city of Izyum focused on regrouping, replenishing, and reconnoitering Ukrainian positions in order to continue advances to the southwest and southeast of the city.  Meanwhile, Russian forces continued their ground attacks to drive to the borders of Donetsk and Luhansk Oblasts but did not make any territorial gains.  Finally, in Mariupol, Russian troops continued to assault the Azovstal Steel Plant and advanced efforts to integrate the city economically into the wider Russian economy.  In a rare instance of Ukrainian dissent, after the last civilians were evacuated from the Azovstal plant over the weekend, the commander of Ukraine’s Azov regiment defending the facility accused Kyiv of providing insufficient support.

• In his highly anticipated Victory Day speech on Red Square today, Russian President Putin focused on justifying his attack on Ukraine.  He said he called for a preemptive strike against the country after judging that growing Western support for Ukraine would have eventually put it in a position to attack Russia.  Contrary to expectations, Putin refrained from declaring any kind of victory in the war, and more importantly, he did not announce any broader mobilization of the Russian military or society.  However, he hinted Russia will seek to annex at least some of the territory Russian forces have seized, stating the country’s troops are “fighting on their own land.”
  • On a first read of the speech, we find it another curious instance of relative restraint and caution on Putin’s part, not unlike his unwillingness to launch major attacks against Western arms flows into Ukraine and his military’s failure to take down much of Ukraine’s telecommunications infrastructure so far.  The speech didn’t even repeat Putin’s recent nuclear saber-rattling against the West.
  • As of this writing, we take the speech as a reminder that Putin faces a number of political, military, economic, and financial constraints as he prosecutes the war in Ukraine, just as any leader would face constraints in prosecuting a major war.  One key question is what those constraints are.  For example, we have noted rumors of political opposition and potential coups throughout the war.  Lending some credence to those rumors, the massive flyover of military aircraft planned for the Victory Day festivities was scrapped at the last moment, perhaps because of security concerns.  With Russia’s military continuing to exhibit incompetence on the battlefield and Putin continuing to pull his punches, Western governments are likely to be emboldened by their support for Ukraine.  That will likely prolong the war, along with its economic and financial impacts, although it is also increasingly tipping the balance of power in Ukraine’s direction.
• Separately, the Biden administration announced new sanctions targeting Russian state-controlled media and banking executives, a ban on Americans providing accounting and management consulting services, and new export controls targeting the country’s industrial sector.
• The G7 countries yesterday also pledged during a virtual meeting with Ukrainian President Zelensky to ban or phase out Russian oil, aiming to erode Russia’s economic standing even further as it pursues its invasion of Ukraine.
• Finally, in an interview with the Financial Times, EU High Representative for Foreign Policy Borrell said the EU should not only freeze Russian foreign reserves under its control but also seize them for use in rebuilding Ukraine after the war.  The West’s freezing of Russia’s reserves has already accelerated the fracturing of the world into different geopolitical and economic blocs, and the extra step of outright asset seizures would further increase tensions between those blocs.

China-Taiwan:  In detailed comments on China’s response to Russia’s invasion of Ukraine, CIA Director Burns said President Xi has been “unsettled” by the conflict.  Burns said that Xi, who prizes predictability, has been shocked to learn of the “reputational damage that can come to China by the association with the brutishness of Russia’s aggression [and] the economic uncertainty that’s been produced by the war.”

• Burns implied that Xi’s reaction actually has produced some daylight between him and President Putin, despite their assertions that their partnership has “no limits.”
• Burns added China was also dismayed by “the fact that what Putin has done is driving Europeans and Americans closer together” and was looking “carefully at what lessons they should draw” for Taiwan.  Yet, he still believes that Xi eventually intends to unify Taiwan with the mainland.

China-Hong Kong:  John Lee Ka-chiu, the sole candidate in Hong Kong’s leadership election, has been confirmed as the city’s next chief executive with 99.4% of the vote from the city’s electoral body.  In his acceptance speech, Lee vowed that the rule of law and stability would be among his key priorities in running Hong Kong.  Lee is considered a hardliner in imposing Beijing’s policies on Hong Kong.

• Before his promotion to chief secretary, Lee was security minister and oversaw the government’s handling of 2019’s social unrest.  His later involvement in implementing the Beijing-imposed national security law landed him on a U.S. sanctions list along with several other current and former officials.
• Lee’s vast majority in the voting committee illustrates how mainland China now completely controls the city’s political development.  Over time, that will continue to call into question Hong Kong’s position as the center of Asia-Pacific financial markets.

Chinese Technology Industry:  As major Chinese technology firms continue to face a tough regulatory crackdown by the government and U.S. investment restrictions, they are trying to boost their stock prices through buybacks and dividend hikes.  All the same, we still see heightened regulatory risks as a major issue for investing in Chinese tech companies.

United Kingdom:  In Northern Ireland, the latest voting tallies show the Irish Republican Party Sinn Féin is on track to become the biggest party in the province’s legislature.  The rival Democratic Unionists (DUP), who have led every power-sharing government in Belfast since 2007, suffered significant losses that will resign it to a painful second-place finish.

• Under the Good Friday peace deal, power must be shared with the largest unionist party. However, the DUP has vowed to block Sinn Féin from leading a power-sharing government unless the U.K. government first suspends EU-required checks on British goods arriving at Northern Irish ports, an act that could trigger trade retaliation from the EU.
• If no power-sharing deal is reached within 24 weeks, Northern Ireland will have to vote again.

Philippines:  Filipinos today began voting in a presidential election that pits the offspring of two leading political dynasties against a progressive candidate promising a break with the country’s increasingly authoritarian governance.  Ferdinand “Bongbong” Marcos, Jr., the son of a former dictator, and his running mate Sara Duterte, President Rodrigo Duterte’s daughter, hold a commanding lead in opinion polls over the nearest rival Leni Robredo, the sitting vice-president.

U.S. Electricity Supply:  From California to Texas to Indiana, electric-grid operators warn that power-generating capacity is struggling to keep up with demands, a gap that could lead to rolling blackouts during heat waves or other peak periods as soon as this year.

U.S. Port Operations:  West Coast dockworkers and cargo-handling firms will begin contract negotiations this week that carry high stakes for an American economy wracked by supply chain disruptions.  The labor talks cover about 22,400 workers at 29 ports, including the sizable Southern California facilities that make up the country’s busiest gateway for imported goods.  If the talks fail and a strike ensues, the added supply disruptions would likely further boost inflation, slow economic growth, and weigh on corporate profits and stock prices.

COVID-19:  Official data show confirmed cases have risen to 517,364,841 worldwide, with 6,251,376 deaths.  The countries currently reporting the highest rates of new infections include Germany, South Korea, France, and Italy.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  In the U.S., confirmed cases rose to 81,863,771, with 997,528 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 220,138,061, equal to 66.3% of the total population.

Virology

• In the U.S., the Omicron BA.2 variant continues to spread, especially in New England and Puerto Rico, but it is still generating relatively few serious illnesses or hospitalizations.  The seven-day average of people hospitalized with confirmed or suspected COVID-19 came in at 18,918 yesterday, up 21% from two weeks earlier.
• Shanghai, the epicenter of China’s current outbreak, reported a fall in new cases for the 15th consecutive day.  The city detected 3,975 new infections late yesterday, 5.7% fewer than a day earlier, although Beijing continued to report enough new cases to suggest that China’s latest draconian measures against the virus would continue.

Economic and Financial Market Impacts

• In a sign of just how badly China’s latest pandemic lockdowns are weighing on economic activity, official data today showed that April exports were up just 3.9% year-over-year, slowing from a rise of 15.0% year-over-year in March.  It marks the weakest annual growth in two years.  Coupled with President Xi’s recommitment to “zero-COVID” late last week, the data underscore the extent to which China’s policy approach is a threat to the domestic economy and the global economy and financial markets.
• The People’s Bank of China requested lenders provide easy credit to “whitelisted” manufacturers deemed to have undertaken sufficient measures to keep COVID-19 infections under control.  The additional lending to companies such as Semiconductor Manufacturing International (0981 HK, HKD, 16.10) and Tesla (TSLA, USD, 865.65) is designed to help them recover from Shanghai’s strict lockdowns in recent weeks.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s report begins with a discussion on yesterday’s FOMC meeting and an update on the situation in Ukraine. Next, we review a few international news stories. We conclude with economic and policy news and our COVID-19 coverage.

Market Update: A day after the Federal Reserve signaled that it was less hawkish than most investors anticipated, the market reversed the gain from the previous trading day. The Dow Jones and NASDAQ had their worst one-day performance since 2020. Primarily driven by a sell-off in tech, the slide in equities was due to investor concerns that inflation would remain elevated for the foreseeable future. These fears drove up yields as bondholders began selling off treasuries. Although the jobs report provided some relief briefly this morning, those gains reversed as investors remain skeptical the Fed will be able to bring down inflation. Former Federal Reserve Vice Chair Richard Clarida stated the central bank may need to raise rates into restrictive territory to contain inflation. As doubts over reducing inflation persist, we still believe commodities could benefit.

Russia-Ukraine Update: Ukraine is showing some resilience after repelling Russian troops trying to retake positions it lost in Kharkiv city and Izyum. Officials from Ukraine maintain it views the complete removal of the Russian forces out of the country as a victory. The comment suggests that Ukraine feels more confident it can withstand the onslaught from Russia and is prepared for a long war. However, it appears Russian forces are getting closer to taking over the remaining steel plant in Mariupol.

• Former National Security Council official Fiona Hill stated Putin might take one-sided action to force the West to succumb to Russian demands. Her unease comes amid concerns the Russian president could use tactical nuclear weapons in Ukraine to secure a win before giving his speech on Russia’s victory day on May 9.
• The U.S. has offered Sweden and Finland reassurance that it would support them against Russia if they apply to join NATO. The two countries sought to join the military alliance after Russia invaded Ukraine. There is growing speculation that Russia will view the Nordic countries’ membership as a threat and could take military action. As a result, the possibility that Russia could expand its war outside of Ukraine remains elevated.
• In response to pleas from Hungary to slow the pace of the phase-out of Russian oil, the EU is considering giving the country more money to adapt to the embargo. The ban on oil purchases is still pending, but members may have a deal in place by the weekend. The EU is expected to focus on banning Russian gas after the oil ban is finalized.

International News

• During a pre-election defense policy debate in Australia, Defense Minister Peter Dutton accused China of trying to influence the federal election on May 21. He stated there is evidence of Beijing supporting the opposition center-left Labor Party. The accusation highlights the growing hostilities between the two sides.
• Leaders in China have been warned not to criticize President Xi Jinping’s zero-Covid strategy. Lockdowns and other pandemic-related restrictions have been a source of discontent within China because the country appears to be where it started during the pandemic. As China heads into its 20th National Congress later this year, the Communist Party will look to show that its handling of the COVID-19 was superior to the West.
• The European Central Bank is poised to raise rates in July after dovish members have indicated that they are willing to end negative interest rates. The hike will come after the bank completes its bond purchasing program. The hawkish shift comes after euro area inflation rose 7.5% from the prior year.
• Beijing has ordered central government agencies to replace foreign-made PCs with Chinese-made computers. The push for domestically made computers suggests China is looking to promote its industries but could also signal that the country is preparing for isolation. The decision will likely harm U.S. computer companies such as HP (HPQ, $37.91).

 Economic and Policy News

• The Biden administration has outlined a plan for the government to refill the emergency crude stockpile later this year. The administration wants to encourage oil companies to invest more in production. The government’s need to refill its stock of oil sold off is intended to boost investor confidence that oil demand will remain high. Hence, the sell-off of the strategic reserve is not a long-term solution to keep prices down.
  • Despite the administration’s plan, oil producers still struggle to expand production. Drilling for shale oil has become more expensive due to rising input costs. As a result, firms find it challenging to keep cost pressures down. The rising cost may make investors wary of investing more in expanding production, as the industry has prioritized profitably.
• The Federal Reserve and the Biden administration are preparing to change decades-old rules regarding lending to low-income The change will look to encourage banking in under-represented communities. These proposed changes could harm financial equities; it could mean that banks could face additional scrutiny.

COVID-19:  The number of reported cases is 516,137,649 with 6,247,392 fatalities. In the U.S., there are 81,692,541 confirmed cases with 996,946 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 730,391,415 doses of the vaccine have been distributed, with 577,843,905 doses injected. The number receiving at least one dose is 257,960,561, the number of second doses is 219,974,190, and the number of the third dose, granting the highest level of immunity, is 101,011,852. The FT has a page on global vaccine distribution.

• The FDA announced it is limiting the emergency authorization of the Johnson & Johnson (JUN, $176.76) COVID-19 vaccine to people 18 and older for whom other vaccines aren’t appropriate or accessible and to those who opt for J&J because they wouldn’t otherwise get vaccinated. The move is due to the risk that the vaccine can cause blood clotting in rare cases.
• European companies are becoming more reluctant to invest in China following its strict lockdown policy. The EUCC for European businesses in China has become sour on the country due to the onerous restrictions.
• A new subvariant of the coronavirus spreading throughout the U.S. It is the subvariant of the 2 but can spread much faster.
• Positive news: Shanghai claims that there were no new COVID-19 cases spread in seven of its 16 districts, although people remain in lockdown. Meanwhile, Japan is expected to allow foreign tourists as it eases restrictions. The reduction in COVID-19 cases in Asia is a good sign for the global economy, although not necessarily beneficial for supply chains. Ports are worried about an increase in congestion after lockdown restrictions are lifted in China.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s report begins with a discussion on yesterday’s FOMC meeting and other central bank news. Next, we give a roundup of the latest news regarding the Russian invasion followed by international developments, with a focus on U.K. local elections. Lastly, we end with the latest COVID news.

The Fed: The Federal Reserve raised its target rate for the federal funds by 50 bps on Wednesday, the most significant increase in 20 years. Investors had anticipated a possible 75 bps rate hike. The market responded favorably to the decision as it suggests the Fed has become less hawkish. Following the announcement, equities rose, Treasury yields fell, and the dollar weakened. In addition to raising rates, the central bank also decided to start its balance sheet reduction on June 1 but at a slower pace than expected. The March meeting minutes indicated that the Federal Reserve planned to reduce its balance sheet at a maximum rate of $60 billion in Treasuries and $35 billion in mortgage-backed securities. However, the recent announcement shows that the Fed will wait three months before reducing it that fast. In the meantime, the Fed will reduce its balance sheet by $30 billion in Treasuries and $17.5 billion in mortgage-backed securities.

The Fed’s reluctance to raise rates by 75 bps and reduce the balance sheet at the maximum rate suggests that members still suspect that inflation will prove to be transitory. Their confidence is likely related to the latest CPI report. Although core CPI rose 6.6% from the year in March, well above the Fed’s 2.0% target, the monthly change was 0.3%, barely above its long-term average. Next week’s CPI report will provide further insight into whether inflation is indeed transitory. Finally, the modest walk back from monetary tightening increases the possibility that the Fed may be able to avoid causing a recession.

Other Central Bank News:

• The Bank of England warned that the economy could slip into recession later this year as higher energy prices push inflation upward. However, the central bank appears to be committed to tightening its monetary policy. On Thursday, it voted to raise its policy rate by 25 bps to 1%, its highest level since February 2009.
• ECB board member Fabio Panetta told Italian newspaper La Stampa that the central bank should not raise rates in July. He added that the euro area economy is “de facto stagnating” and that the bank should hold off until it has seen GDP numbers for the second quarter. Panetta is considered a dove, and his opinion is not in line with some of his colleagues. His comments signal that policymakers are finding it more complicated to determine whether they should prioritize economic growth or inflation.
• The Reserve Bank of India raised rates by 40 bps to 4.40% and the reverse repo by the same amount as the central bank tries to rein in inflation in India.

Russia-Ukraine Update:

• After refusing Russian demands to pay for natural gas using the ruble, Poland received fuel from its allies. The Russian energy company Gazprom has threatened to reduce gas transit from countries that have helped supply Poland. It is not clear how Gazprom will respond; however, it could mean that other countries will face a reduction of gas from Russia.
• Ukraine is preparing for the possibility that Belarus will help Russia in its invasion. Armed forces in Belarus have been holding military drills along the border of Ukraine. The potential involvement of Belarus raises the likelihood that the war could spread further into Europe. However, it is unclear whether the Belarusian government can convince its public to support the effort. One poll from a British think tank suggests that most Belarusians are opposed to their country’s involvement in the war.
• The Kremlin has rejected rumors that Russian President Vladimir Putin will declare war against Ukraine in his speech on Monday. May 9 marks the anniversary of Germany’s surrender in World War II. There is speculation that Putin will use the day to make a big announcement, such as declaring war on Ukraine or declaring victory. Since the invasion began on February 24, Putin has described the conflict as a “special operation.” A declaration of war could mean that Russia is prepared to escalate the amount of force in its quest to take Ukraine.
• The war in Ukraine is having an impact on the German economy. In March, factory orders fell by 4.7% from the prior month as factories faced soaring costs and input shortages due to the war. The slowdown in orders suggests that Germany may be headed toward an economic contraction.
• The EU’s proposed ban on Russian oil has been met with pushback from smaller member countries. Hungary would like to change the timing of the phase out, while Greece, Malta, and Cyprus voiced concerns about restrictions regarding shipping oil to third-world countries. The pushback suggests that the EU ban will be complicated as countries try to adapt to life without Russia.
• Israel has expressed willingness to support Ukraine in its war efforts against Russia.

International News:

• Brazil’s presidential front-runner Luiz Inacio Lula da Silva has criticized the West for not doing enough to prevent Russia from invading Ukraine. In an interview with Time magazine, he argued that the reluctance of Western leaders to negotiate with Putin is what caused the war and warned that sanctions on Russia would hurt the global economy. Lula da Silva’s remarks are another example of how developing countries have primarily sided with Russia in its invasion of Ukraine.
• North Korea launched a ballistic missile toward its eastern waters. The launch comes six days before a new South Korean president is set to assume office. North Korean leader Kim Jong-un has pledged to accelerate his nuclear program and has threatened to use it against rivals. The increased hostilities will likely create unfavorable market conditions for risk assets in North Korean rivals Japan and South Korea.
• In the U.K., voters are headed to the polls for local elections. The results will gauge the popularity of PM Boris Johnson. Scandals have plagued the Johnson administration for several months, but the war in Ukraine has helped reshape his image. As a result, the Tories are expected to lose as many as 548 seats in England and Wales.
  • In related news, Northern Ireland is expected to elect a majority of its seats to Sinn Féin, a nationalist Irish party. If true, this would be the first time the country’s First Minister seat will be held by someone that is not loyal to the throne. This outcome could affect the Brexit agreement as the NI protocol remains a contentious issue for the U.K. and the EU. The protocol removed the need for a hard border between Northern Ireland and Ireland by allowing British goods to transfer through checkpoints into Northern Ireland. Unionists, a group loyal to the throne, have pleaded with the U.K. to eliminate the protocol as they believe it could pave the way for the region’s exit from the commonwealth. Assuming Sinn Féin wins, it will likely create unfavorable conditions for risk assets in the U.K. In addition, it raises the likelihood of a return to the Troubles, an ethno-nationalist conflict in Northern Ireland that lasted from 1960 to 1998.
• OPEC+ is expected to maintain its policy of raising production by 430,000 barrels per day for June. The decision comes as oil prices remain above $100 per barrel. The Senate is considering anti-trust legislation to allow members of the oil cartel to be sued. However, it is unclear whether such a law would impact countries’ willingness to produce more oil.
• India is considering placing limits on wheat shipments due to concerns of a shortage resulting from the war between Russia and Ukraine. However, the move could worsen inflation in global food prices.

COVID-19: The number of reported cases is 515,416,787 with 6,244,507 fatalities. In the U.S., there are 81,620,610 confirmed cases with 996,694 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 729,623,415 doses of the vaccine have been distributed, with 577,306,842 doses injected. The number receiving at least one dose is 257,881,623, the number of second doses is 219,902,417, and the number of those who have had the third dose, granting the highest level of immunity, is 100,901,425. The FT has a page on global vaccine distribution.

• COVID-19 cases are surging again in South Africa. The country was the starting point for the Omicron variants. As a result, scientists have been paying close attention to rising cases within the area.
• In April, lockdowns in China have led the country to a severe slowdown in services activity. The latest CAIXIN China Services PMI fell to its lowest level since the pandemic began in February 2020.
• In positive news, the newer variants of COVID-19 have faded away faster than previous variants. If true, this could mean that the virus is becoming less lethal.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with an update on the Russia-Ukraine war, where a significant Ukrainian counteroffensive may be thwarting Russia’s effort to encircle some of Kyiv’s best troops in eastern Ukraine.  There are also more reports that suggest President Putin is preparing to make a formal declaration of war against Ukraine and launch a general Russian mobilization.  We next review a range of international and U.S. developments with the potential to affect the financial markets, especially regarding the Federal Reserve’s latest monetary policy decision coming up today.  We wrap up with the latest news on the coronavirus pandemic.

Russia-Ukraine:  Russian forces continue to make only slow, plodding advances in eastern and southern Ukraine, coupled with artillery and airstrikes against a broader set of military and civilian targets.  The Russian troops continue trying to move southeast from Izyum and westward from Donetsk in order to encircle the Ukrainian forces that have been battling Russian separatists in the Donbas region since 2014.  However, a range of reporting says the Ukrainians have launched a significant counteroffensive that pushed the Russians about 25 miles east of the major city of Kharkiv.  According to the Institute for the Study of War, the counteroffensive may allow for a broader operation to drive the Russians from most of their positions around Kharkiv. This could pose a dilemma for the Russians.  They will have to decide whether to reinforce their positions near Kharkiv to prevent the broader Ukrainian operation, potentially pulling forces away from their effort to encircle the Ukrainian troops in the Donbas, or risk losing most or all of their positions in artillery range of the city.

• Ukrainian officials reported with increasing confidence that the Kremlin will announce a general mobilization on May 9.
  • Ukrainian Main Military Intelligence Directorate Chief Budanov said the Kremlin has already begun to prepare mobilization procedures and personnel ahead of the expected announcement and has even carried out a kind of covert mobilization.
  • Ukraine’s National Security and Defense Council said high-ranking Russian officials are trying to legitimize a prolonged war effort as World War III against the West rather than the “special military operation” against Ukraine that President Putin has cited up until now.
• As expected, European Commission President von der Leyen announced the EU would phase in a ban on all imports of Russian oil, whether it be the crude or refined product, seaborne or delivered by pipeline.  Crude imports would be cut off within six months, while refined product imports would be prohibited by the end of the year.  Since Hungary and Slovakia are particularly reliant on Russian oil supplies, they would be given until the end of 2023 to comply with the ban.  The EU is also proposing cutting off more Russian banks from the SWIFT system of international money transfers as part of its latest package of sanctions against Russia.
  • Despite the concessions to Hungary and Slovakia, it is still an open question whether they will agree to the oil ban.  EU rules require the ban to be approved by all member countries, so either Hungary or Slovakia could scuttle the plan if they feel their needs aren’t being met.
  • Even though the Russian oil ban was widely expected, and Hungary or Slovakia could still hinder it, today’s formal release of the proposal has accelerated a global scramble for replacement supplies.  As of this writing, Brent crude prices have risen approximately 2.5% to $107.58.
  • As we’ve noted, the Western sanctions against Russia are becoming increasingly costly, not only by cutting off much of the EU’s trade, capital flows, and energy resources but by further boosting global energy prices and accelerating the cleavage of the world’s countries into blocs.  The crisis remains a major risk for the world economy and financial markets in the near term and long term.

North Korea:  The Japanese Defense Ministry said North Korea today launched an apparent ballistic missile that traveled 310 miles before landing in the Sea of Japan outside Japan’s exclusive economic zone.

United States-Saudi Arabia:  CIA Director Burns made an unannounced trip to Saudi Arabia last month to meet with Crown Prince Mohammed bin Salman, with officials reporting that the conversation had “a better tone than prior U.S. government engagements.”  The news suggests the Biden administration is making a concerted effort to repair ties with Saudi Arabia.  If successful, it could help lead to more cooperation with the West in thwarting Russia’s invasion of Ukraine and, potentially, increased exports of Saudi oil that would help bring down energy prices and inflation.

United States-China Sanctions:  The Biden administration is reportedly laying the groundwork to place sanctions on surveillance-technology giant Hikvision (002415 CH, CNY, 42.49) for its role in alleged human rights violations.  If implemented, the sanctions could affect a wide range of countries and customers that use the firm’s monitoring technology worldwide.  The sanctions would also add to the strained U.S.-China relations and further drive the two countries apart diplomatically and economically.

United States-China Tariffs:  Amid a legally required review of Trump-era tariffs against Chinese imports, officials in the Biden administration are reportedly split on whether to pare back the duties in order to cut consumer costs and reduce inflation.

• On one side, Treasury Secretary Yellen and Commerce Secretary Raimondo favor easing the tariffs on some of the roughly $360 billion of Chinese imports annually.
• On the other side, Trade Representative Tai and others are reluctant to relinquish U.S. leverage over China in a continuing effort to reshape Chinese economic behavior.

U.S. Monetary Policy: The Fed wraps up its latest monetary policy meeting today, with the officials expected to approve an aggressive 50-basis-point hike in the benchmark fed funds interest rate.  If the action is as expected, it will mark the first time the Fed has raised rates at back-to-back policy meetings since 2006, and it will be the first 50-basis-point hike since 2000.  The policymakers are also expected to detail a relatively quick run-off of bonds on the central bank’s balance sheet.

• We remain skeptical that the Fed can implement its entire planned program of tightening without causing financial market disruptions or contributing to a sharper-than-planned slowdown in the economy.
  • Investors have already started backing away from the riskiest corporate bonds in the U.S.  The value of junk bonds trading for 70 cents on the dollar or less, considered a sign of distress and a warning that a company may struggle to repay its debts, has climbed to $27 billion from about $14 billion at the end of 2021.
  • Amid sky-high inflation, fiscal tightening, continued supply chain disruptions, and a blow to confidence from the Russia-Ukraine war, we think the risk of a sharp economic slowdown, recession, or financial market volatility in the next 12 to 18 months remains elevated.
• All the same, central banks around the world remain in aggressive inflation-fighting trim.  The Reserve Bank of India announced an emergency hike in its benchmark repo rate to 4.40% from 4.00%.  Separately, today, an influential German member of the European Central Bank’s executive board said she could see the ECB hiking rates in July for the first time since 2011.

COVID-19:  Official data show confirmed cases have risen to  514,949,273 worldwide, with 6,241,184 deaths.  The countries currently reporting the highest rates of new infections include Germany, South Korea, France, and Italy.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  In the U.S., confirmed cases rose to 81,506,838, with 994,748 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 219,849,502, equal to 66.2% of the total population.

Virology

• In the U.S., the Omicron BA.2 variant continues to spread, but it is still causing relatively few serious illnesses or hospitalizations.  The seven-day average of people hospitalized with confirmed or suspected COVID-19 came in at 17,532 yesterday, up 18% from two weeks earlier.
• In Hong Kong, city officials unexpectedly announced an easing of pandemic social restrictions after new data suggested those rules led to a sharp economic contraction in the first quarter.  However, officials in mainland China continue to maintain or even tighten restrictions despite the cost to the Chinese and global economies. In Beijing, for example, officials have suspended many public transport routes and closed subway stations to curb the spread of COVID-19.  In Shanghai, millions have been under strict lockdown for more than a month.

Economic and Financial Market Impacts

• Some U.S. companies warn that COVID-19 lockdowns in Shanghai and elsewhere in China are denting sales, disrupting operations, and putting an added strain on supply chains that could be felt well into the summer.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

We begin today’s Comment with our update on the Russia-Ukraine war.  Military action yesterday apparently involved no new Russian advances, even as the U.S. warned that Russia is preparing to annex the swaths of eastern and southern Ukraine that it currently occupies.  We next review a range of international and U.S. developments with the potential to affect the financial markets today.  We wrap up with the latest news on the coronavirus pandemic.

Russia-Ukraine:  Russian forces reportedly refrained from staging any new ground attacks in either eastern or southern Ukraine yesterday, apparently in order to regroup and re-equip for future attacks.  Also, Russian operations may still be disrupted by Ukraine’s April 30 rocket artillery strike on a command post of the Russian Airborne and 2nd Combined Arms Army near Izyum.  However, the Russians continue to launch attacks on military and civilian targets throughout Ukraine using missiles, artillery, and aerial bombs.  Separately, a high-level U.S. official said Russia is planning sham elections to annex wide swaths of eastern and southern Ukraine, just as it did after seizing Crimea in 2014.

• According to a Russian Telegram channel citing a high-placed Kremlin official, President Putin will undergo surgery for abdominal cancer shortly after the big May 9 parade celebrating the Soviet Union’s victory over Nazi Germany in World War II.  As we noted in our Comment yesterday, some Western officials believe Putin will use the May 9 event to announce a major change in the war, perhaps including a call up of reservists and a general mobilization to intensify the war.
  • Under Russia’s constitution, presidential power during Putin’s incapacitation should temporarily be transferred to Prime Minister Mishustin, a former tax service chief.  Yet, the report says Putin will name Security Council leader and former top foreign intelligence official Nikolai Patrushev to run the war while he is under the knife.
  • We have seen no other reporting that would confirm the Telegram report.  We note the channel claimed 18 months ago that Putin was suffering from abdominal cancer, but that thesis doesn’t seem to be widely accepted.  In any case, it would seem inconsistent for Putin to launch a new initiative and then immediately be unable to oversee it.  There is a good chance that either the major May 9 announcement or the presidential surgery won’t happen.
• Meanwhile, European Union energy ministers are meeting today to discuss a sixth package of EU sanctions on Russia, including a phased-in ban on importing Russian oil.  Although Germany has swung to support the idea, Economy Minister Habeck warned that such a ban would cost the European economy dearly.
  • The sanctions would need to be approved unanimously, but Hungary and Slovakia are expected to resist because of their out-sized dependence on Russian oil.  The key question is whether the officials can identify exemptions or other types of special treatment that will allow the ban to be approved.
  • Even though the new ban wouldn’t apply to natural gas, Russia’s other major energy export to the EU, it could still be very disruptive to regional and global markets.  Any ban on Russian oil would worsen the current scramble for other supply sources, potentially pushing prices even higher.  Some refiners could be left with insufficient supplies of certain grades, while firms dependent on Russia’s refined or semi-refined products could be out of luck.  On Russia’s side, ongoing sanctions and infrastructure limitations could make it hard to find other markets, potentially forcing wells to be shut in.
  • Overall, the situation is a reminder that the Russia-Ukraine war will likely contribute to a long-term supply jolt that will help keep commodity prices high and inflation elevated for years into the future.

European Union:  Austrian Foreign Minister Alexander Schallenberg has called for radical changes to the EU’s foundational treaties to expedite neighboring countries’ ability to join and avoid domination by Russia.  Besides signaling a shift from Austria’s traditionally tight relationship with Russia, Schallenberg’s suggestion illustrates the sea change in geopolitical thinking touched off by Russia’s invasion of Ukraine.  Not only has the invasion prompted a likely effort by Sweden and Finland to join NATO, but it could also spur a reinvigoration and expansion of the EU.

European Equity Markets:  Citigroup (C, $48.71) acknowledged that one of its traders had the “fat finger” that sent some European stocks into a sudden, short tumble yesterday.  According to Citi, the employee made an error while inputting a trade order for a basket of shares that included many Swedish stocks.

• Nordic stocks were particularly hard hit, with Sweden’s benchmark OMX 30 tumbling as much as 7.9% before recovering to close 1.9% lower.
• Overall, the regional Europe Stoxx 600 index slid as much as 3% yesterday before trimming its losses to trade down 1.5%.

Australia:  Joining the global fight against inflation, the Reserve Bank of Australia today hiked its benchmark short-term interest rate more aggressively than expected to 0.35% from 0.10% previously.  The increase was the central bank’s first in 11 years.

• It was also the RBA’s first rate hike during an election campaign since 2007.
• The hike, even from a historically low rate, has forced Prime Minister Morrison to defend his record of economic management — his main weapon in the election campaign — as the cost of living has risen sharply.

Israel:  Palestinian militant group Hamas has stepped up a mass-media campaign urging Palestinians in the West Bank and Israel to attack Jews in the wake of clashes between Israeli security forces and Muslims around the Al-Aqsa Mosque in Jerusalem’s Old City.  The renewed violence could threaten stability in the region and weigh on Israeli asset values.

Africa:  Little noticed against the backdrop of the Russia-Ukraine war and high consumer inflation around the world, weak rainfall in the Horn of Africa has produced the region’s worst drought in four decades and put some 20 million people at risk of hunger.  Besides adding to the demand for food from other regions, the drought could also spark market-disrupting political unrest in countries like Ethiopia, Somalia, and Kenya.

U.S. Monetary Policy:  Today, Federal Reserve officials start their latest two-day monetary policy meeting, where they are expected to approve an aggressive 50-basis-point hike in the benchmark fed funds interest rate.  At the meeting’s end tomorrow, they are also expected to detail a relatively quick run-off of bonds on the central bank’s balance sheet.

• We have no doubt the Fed will embark on an aggressive tightening of policy, just as the officials have indicated.  Ahead of the meeting, the yield on the 10-year Treasury note yesterday briefly rose above 3.0% for the first time since late 2018.  The rise in Treasury yields has also pushed up the income flow from foreign government bonds.  The yield on 10-year German government bonds, the benchmark in Europe, today surpassed 1% for the first time since 2015 before slipping back to 0.974%.
• All the same, we remain skeptical that the Fed can implement its entire planned program of tightening without causing financial market disruptions or contributing to a sharper-than-planned slowdown in the economy.
• Amid sky-high inflation, fiscal tightening, continued supply chain disruptions, and a blow to confidence from the Russia-Ukraine war, we think the risk of a sharp economic slowdown, recession, or financial market volatility in the next 12 to 18 months remains elevated.

U.S. Oil Industry:  Even though the Fed is trying to squelch inflation and the tight labor market makes it hard to find workers, high oil prices, touched off by factors such as rebounding demand and the Russia-Ukraine war, have finally prompted an uptick in U.S. oil drilling and more business for oil services companies in the U.S. oil patch.  Recent data show the number of drilling rigs active in the U.S. is now up 60% from one year ago.  Crude production is up more than 8% over the last year.

U.S. Labor Market – Unionization:  The National Labor Relations Board said workers at a facility owned by Amazon (AMZN, $2,490.00) in Staten Island, New York, have voted against unionizing, despite last month’s pro-union vote at another Amazon facility close by.  Even though today’s tight labor market has given employees more bargaining power and spurred an uptick in unionization, the result suggests any trend toward representation remains uneven.

• Widespread unionization could spur rapidly rising wage rates, higher inflation, and compressed profit margins.
• Added to those direct impacts on stock valuations, putting more of the nation’s income into the hands of workers would likely reduce the amount of capital channeled into the financial markets, given workers’ relatively higher propensity to consume.

U.S. Labor Market – Immigration:  A new policy will address an unprecedented backlog of 1.5 million work-permit applications.  The federal government said most immigrants with recently expired or soon-to-expire work permits would be able to continue working on those documents for up to a year and a half after they expire.  The move will help prevent firms from losing employees at a time when finding replacements would likely be difficult and expensive.

COVID-19:  Official data show confirmed cases have risen to  514,284,882 worldwide, with 6,238,487 deaths.  The countries currently reporting the highest rates of new infections include Germany, South Korea, France, and Italy.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  In the U.S., confirmed cases rose to 81,444,332, with 993,999 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 219,778,035, equal to 66.2% of the total population.

Virology

• In the U.S., the Omicron BA.2 variant continues to spread, but it is still causing relatively few serious illnesses or hospitalizations.  The seven-day average of people hospitalized with confirmed or suspected COVID-19 came in at 17,220 yesterday, up 16% from two weeks earlier.  Because of the low level of hospitalizations and general fatigue with the pandemic, the new outbreak is generating few new policy responses.
• Amid China’s strict measures to fight its latest infection wave, a Shanghai nursing home put an elderly resident infected with COVID-19 into a body bag and loaded her into a crematorium van, only to find just before the vehicle drove away that she was still alive.  The event, caught on camera, has exacerbated some citizens’ criticism of the government for its draconian measures against the pandemic.

Economic and Financial Market Impacts

• The pandemic’s resurgence in China has helped pull metals prices down from highs hit following Russia’s invasion of Ukraine.
  • Worries that new economic lockdowns will erode demand from the world’s largest commodity consumer have dragged aluminum and tin down more than 17% from their recent all-time highs.
  • Copper has lost 8.5% since its March record.
  • Zinc and lead are off 8.7% and 10% from this year’s highs, respectively

View PDF