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 Russian forces continue to make only limited territorial gains but have intensified their efforts to Russify the areas they already occupy.  We next review a range of international and U.S. developments with the potential to affect the financial markets today.  Finally, we wrap up with the latest news on the coronavirus pandemic, including signs of even tighter lockdowns in Beijing that will continue to weigh on economic activity in China and globally.

Russia-Ukraine:  Russian forces continue to make only limited gains in the eastern Ukrainian region of Donbas and along Ukraine’s southern coast, even as they keep attacking strategic cities such as Kharkiv and Odesa with missiles, artillery, and aerial bombs.  Reports also indicate the Russians are increasingly taking steps to incorporate occupied territories into Russia proper.  For example, Russian sources said stores in occupied Melitopol and Volnovakha are beginning to transition to using the Russian ruble, and British Defense Intelligence reported the ruble would be used in Kherson starting on May 1 as part of a four-month currency transition scheme enacted by the occupation administration.  The measures, which are not necessary or normal in military occupation administrations, suggest that Russian President Putin likely intends to retain control over these areas and that his ambitions are not confined to Donbas.  Meanwhile, Ukraine launched a missile attack against a Russian command post in the northeastern city of Izyum over the weekend, killing at least one more Russian general and several other senior officers and reportedly wounding Russia’s Chief of the General Staff Valery Gerasimov.  The Ukrainian military also claimed its drones have sunk two small Russian patrol craft in the Black Sea.

• As we have written before, the ultimate risk in the war is if a frustrated President Putin decides to launch either a tactical, battlefield nuclear strike against Ukraine or a strategic nuclear strike against the U.S. and its NATO allies.  Perhaps the next-most dangerous risk is if Russia’s currently deployed forces still can’t make headway in Ukraine and Putin declares a general mobilization of Russian society for the effort.  Some sources have speculated that Putin may call for such a general mobilization at the May 9 celebration of the Soviet Union’s victory over Nazi Germany in World War II.
  • Whether formally or informally, a general mobilization would basically equate to a declaration of war.  Contrary to Putin’s current characterization of the conflict as a “special military operation,” such a situation would force Putin to seek maximalist war aims and constrain his flexibility in pursuing the war.
  • As in the run-up to World War I, a general mobilization by Russia would require at least Poland and the Baltic states to mobilize as well.  And, given that they are all NATO members, the overall alliance also might have to mobilize.
  • With potentially millions of soldiers mobilized and at the ready on both sides of the Atlantic, the risk of miscalculation or accident would increase dramatically.  Beyond that, the economic costs on both sides of the Atlantic would spike.  For example, the current severe labor shortage in the U.S. and some allied countries would worsen immensely if tens of thousands of reservists and national guardsmen were called up from their jobs.  The high economic cost alone could tempt some policymakers to bet on a quick military victory.
    • One important lesson may be the situation at the beginning of the Korean War in 1950.  At the time, the National Security Resources Board, headed by a former secretary of the Air Force, advocated for large-scale economic mobilization.
    • However, President Truman ruled out the idea and instead envisioned only a limited mobilization accompanied by aggressive wage and price controls.  The result was the passage by Congress of the Defense Production Act (DPA), which gives the president authority to order private businesses to take specific steps to support the war effort.
    • The DPA gives the U.S. a certain amount of flexibility in responding to the economic pressures of supporting Ukraine in the war or mobilizing the U.S. itself.  Other countries may not have the same amount of flexibility.  In a general NATO or Russian mobilization, high economic costs have the potential to prompt rash military decisions that would present enormous risks for investors.
• Separately, the German government said it would now support a ban on Russian oil imports into the EU that would be phased in over several months.  Previously, the government said Germany would need a phase-in period lasting to the end of the year.
  • Germany’s new stance increases the likelihood that the EU will impose a ban on Russian oil to punish President Putin for his invasion of Ukraine.  However, the ban is still not certain, as it would need to be approved by all EU countries.  Some of those countries highly depend on Russian energy supplies and will be reluctant to cut them off.  In an effort to ease approval of the sanctions when it is released tomorrow, the EU will reportedly offer some exemptions to Hungary and Slovakia, which are particularly reliant on Russian oil.
  • Just as important, we note that the ban under discussion would only apply to Russian oil.  It would not address Russian natural gas, on which some EU countries are even more dependent.
• EU Economics Commissioner Dombrovskis said EU officials are looking for ways to aid the Ukrainian government further.  According to Dombrovskis, the EU hopes to both accelerate the payment of €600 million under the bloc’s existing emergency support plan and bring forward a new round of lending.

Iran Nuclear Deal:  Despite the distractions of the Russia-Ukraine war, the EU told Iran that it was prepared to make a renewed push to reinstate the 2015 deal, lifting economic sanctions on Tehran in return for restrictions on its nuclear program.  Even though the text of a deal reinstating the program has been virtually finalized, negotiations on it have essentially been frozen since early spring.  EU officials say they are still waiting for Iran to respond to the offer.

European Union:  European Commission regulators say Apple (AAPL, 157.65) has broken EU competition law by abusing its dominant position in mobile payments to limit rivals’ access to contactless technology.  According to the preliminary charge, Apple is preventing competitors from accessing “tap and go” chips or near-field communication (NFC) to benefit its own Apple Pay system.

• Under EU law, Apple could face fines worth up to 10% of global turnover if the charges are upheld.
• The charge highlights our oft-stated concern that big, rich U.S. technology companies face increased regulatory risk both at home and abroad.

France:  The traditional May Day labor marches yesterday were reportedly on the raucous side, as protesters warned newly re-elected President Macron that they want higher incomes, lower inflation, and an end to his proposals to raise the country’s retirement age.

• Macron faces his first major challenge in June as he tries to win another parliamentary majority in legislative elections that would enable him to pass his reforms.
• Parties on the left and right are exploring potential alliances to deprive him of that power.

U.S. Monetary Policy:  Federal Reserve officials this week will hold their latest two-day monetary policy meeting, in which they are expected to announce an aggressive 50-basis-point hike in the benchmark fed funds interest rate and 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.
• However, as we’ve mentioned before, we remain skeptical that the Fed can continue with its entire program of tightening without causing financial market disruptions or contributing to a sharper-than-planned slowdown in the economy.
• Considering factors like sky-high inflation, fiscal tightening, continued supply chain disruptions, and the blow to confidence from the Russia-Ukraine war, we believe there is an elevated risk of a sharp economic slowdown, recession, or financial market volatility in the next 12 to 18 months.

Global Green Energy:  One little-noticed alternative source of “green” energy is naturally occurring hydrogen, which small, start-up energy firms are already exploring for, or even producing in places like Australia and Africa.  While the gas isn’t renewable, boosters say burning it carries few of the environmental concerns of burning natural gas or other fossil fuels.

COVID-19:  Official data show confirmed cases have risen to  513,890,808 worldwide, with 6,236,772 deaths.  The countries currently reporting the highest rates of new infections include South Korea, Germany, 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 81,365,218, with 993,733 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 219,729,731, 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 17,248 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.
• In China, newly reported infections in Beijing only rose to 41 yesterday, but that was more than enough to prompt officials to ratchet up social restrictions under President Xi’s ultra-strict “zero-COVID” policy.  City officials closed gyms and cinemas and raised testing requirements in an effort to avoid replicating the situation in Shanghai, where tens of millions have been restricted to their apartments, sparking protests.

Economic and Financial Market Impacts

• In a report over the weekend, China’s official April purchasing managers’ index (PMI) for manufacturing fell to a seasonally adjusted 47.4, versus 49.5 in March.  As with all major PMIs, the China gauge is designed so that readings under 50 point to declining activity.  The reading for April was the lowest since February 2020, largely reflecting Xi’s “zero COVID” policy and its strict economic lockdowns.  Reports say some Chinese officials are now criticizing the policy, in private, for its negative impact on the domestic and global economy.
  • The official nonmanufacturing PMI plunged to 41.9 in April from 48.4 in March.
  • Nineteen out of 21 surveyed industries, including transportation, accommodation, and catering, recorded contractions in activity, the statistics bureau said.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s report begins with a brief update on the Russia-Ukraine war. Next, we review international news, focusing on the yen’s depreciation against the dollar. Afterward, we discuss U.S. economic and policy news. We end with our COVID-19 coverage.

Russian and Ukrainian troops have made no notable gains. Meanwhile, NATO forces are set to participate in military exercises in a move designed to deter further Russian aggression in Europe. We suspect Russian attacks will ramp up next week as Russian President Vladimir Putin seeks to find a military victory before he speaks on May 9. The aptly named Victory Day commemorated Nazi Germany’s surrender in 1945; given Moscow’s insistence that Ukraine has been “Nazified,” we suspect he will use this day to promote Russia’s success in Ukraine.

• Russia plans to introduce the ruble in Kherson on May 1, but the locals, who oppose Russian troops occupying their city, did not take the news well.
• Meanwhile, two U.K. aid workers were kidnapped by Russian forces, and a former U.S. marine died fighting in Ukraine. These reports suggest the war is slowly starting to impact countries outside of Russia and Ukraine.

International news

BOJ strikes back: The yen fell to its lowest level against the dollar in 20 years, with the exchange rate hitting ¥130 on Thursday. Over the last few weeks, the dollar has rallied against other major currencies due to the war in Ukraine, COVID-19 lockdowns in China, and hawkish fed policy. However, the dollar’s appreciation against the yen is unique in that it appears to be a deliberate policy move by the Bank of Japan. While the rest of the world has been looking to tighten monetary policy to combat inflation, the BOJ pledged to defend its yield target with unlimited bond-buying. The move by the BOJ suggests that the central bank is deliberately trying to keep its currency relatively weak compared to the rest of the world, likely in an attempt to promote export growth. Unlike most developed countries, Japan’s inflation rate is well below two percent, although it has been rising. Because of the lack of price pressure, the BOJ may view the global shift toward tighter monetary policy as an opportunity to boost economic growth domestically as the economy recovers from its recent COVID-19 outbreak. We suspect risk assets in Japan may become more attractive in the future.

Germany-China: The war in Ukraine is forcing Germany to rethink its entire foreign policy. On Thursday, Germany announced it would drop its opposition to Russia’s oil embargo. The move comes after Russia cut off gas supplies to Poland and Hungary due to each country’s refusal to pay for fuel using rubles. Additionally, Germany is beginning to view its relationship with China as untenable, given Beijing’s support for Russia. Even though China has consistently maintained that it seeks to remain neutral in the Ukraine-Russia conflict, it recently announced that it would remove tariffs on Russian coal. The move by China will make it easier for Russia to sell its energy as it looks to fund its invasion. Our view is that the world is moving toward multipolarity, where power is shared among several states instead of one dominant hegemon. We suspect the world is slowly moving toward blocs led by the U.S. and China.

• As Europe moves away from Russia, it builds closer ties with the U.S. The U.S. has agreed to provide the EU with liquified natural gas through 2030.
• Beijing referred to its relationship with Russia as the new model for the world. The reference alludes to countries wanting the world to move away from building alliances against individual countries.

 U.S. economic and policy news

GDP report: The latest GDP report showed the economy shrank at an annualized rate of 1.4% in the first quarter. The contraction was caused by an acceleration in imports, a decline in inventory building, and a reduction in government spending. Yet, despite the drop in growth, we remain optimistic about the economy. The decrease in government spending and inventory building is likely temporary. Government spending was driven mainly by a decline in defense spending, likely increasing as the U.S. spends more to help Ukraine defend itself against Russia.

Meanwhile, the drop in inventory spending is related to supply chain issues that should improve. Additionally, we suspect that consumption should accelerate in the next quarter; people tend to spend more on leisure and hospitality in the warmer months. The trade deficit will likely remain a liability for the economy. The increase in imports value was related to a rise in trade prices, particularly fuel. Although we are confident that this report will not impact the Fed’s decision to raise rates next week, the weak GDP information could prevent the Fed from attempting a more hawkish policy, such as a 75 bp rate hike later this year.

• President Biden is expected to ask Congress to authorize another $30 billion in aid for Ukraine as the White House seeks to boost security and humanitarian assistance. The U.S. is looking to bolder Ukraine security, we expect defense companies will benefit. The chart below shows several defense companies, such as Lockheed Martin (LMT, $441.71), Northrop Grumman (NOC, $445.71), Raytheon (RTX, $98.00), and General Dynamics (GD, $241.20), have already experienced a boost following the Russian invasion.[1]

Build Back Better: President Biden’s agenda faced another setback after Senator Joe Manchin (WV-D) announced that he was not willing to support a spending package that would expand EV credits from $7,500 to $12,500.

COVID-19: The number of reported cases is 512,225,941, with 6,230,957 fatalities. In the U.S., there are 81,249,259 confirmed cases with 993,156 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 725,595,715 doses of the vaccine have been distributed, with 574,738,978 doses injected. The number receiving at least one dose is 257,496,852, while the number of second doses is 219,550,028, and the number of the third dose, granting the highest level of immunity, is 100,411,112. The FT has a page on global vaccine distribution.

• In a sign that the pandemic is entering its final stages, Denmark has officially announced that it will end its COVID-19 vaccination program.
• Measles cases are starting to surge worldwide as the pandemic disrupted childhood vaccinations.

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[1] Boeing (BA, $154.22) is also included in the chart.

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s report begins with an update on the War in Ukraine, while Europe is coping with Russia cutting off gas supplies. Next, we discuss international news, followed by our economics and policy coverage, and we close with the latest COVID-19 news.

Russian forces, learning from their earlier mistakes, have changed tactics as it tries to take over Ukraine. Earlier in the conflict, Russian troops tried to blitz Kyiv, attempting to overwhelm the Ukraine forces and bring down the capital. After that plan failed, Moscow became more systematic in its fight to take over the country. Although Russia is still relying heavily on air bombardments, it is trying to encircle Ukraine’s forces on the ground as it seeks to take over areas around the city of Izium in eastern Ukraine. So far, the new approach has had limited success, but it is still unclear whether the Russian forces are capable of achieving their objective.

Additionally, Russia may be opening another front in its war. Russian proxies in the Moldovan territory of Transnistria are falsely claiming Ukrainian forces are planning to attack the region. The accusation has prompted concerns that the Kremlin could be preparing to launch a missile strike on Moldova. By attacking Transnistria, the Kremlin may seek to escalate the war to include other areas in Europe. Ukraine has adopted a similar strategy as it broadens attacks on Russian cities along its border.

After Russia decided to cut off gas flows to Bulgaria and Poland, the European Union described the move as blackmail and maintained it would not comply with the Russian demand for natural gas payments to be made in rubles. Responding to rising gas prices, the Italian government has moved to fund a $6.3 billion aid package to protect consumers and companies from the increases. Greece announced it would deliver natural gas to Bulgaria to compensate for the gap. Poland has already been preparing for this scenario. Despite the early signs of unity, there is some evidence that the European coalition is fracturing. Brussel’s ambiguous advice on ways to pay for Russian energy while avoiding sanctions has led to complaints from member countries. Meanwhile, European firms have started exploring ways to comply with Russian demands. However, the energy problem cuts both ways, as the end of winter means the demand for Russian natural gas is falling. There is speculation that a compromise between the sides is possible; however, countries in Europe, particularly Germany, will look to diversify their supply away from Russia.

Other Russia-Ukraine News

• The U.S. and Russia agreed to a prisoner swap on Wednesday in a rare gesture of compromise. The move shows the two sides are in communication with each other. This development is a positive sign given the escalating tensions over Ukraine.
• The West is still trying to ramp up pressure on Moscow. The EU is expected to impose sanctions on Russian Sberbank (SBER, RUB 132.00), and the U.S. House of Representatives passed a nonbinding resolution that will allow the government to sell seized Russian assets to fund the Ukraine war.
• Russian government data appears to be hiding the war’s impact on the economy. Information reported by the government and private data providers shows conflicting stories. The Kremlin may be looking to hide the war’s impact on the economy, or private firms find it harder to access accurate data. Either way, conflicting data suggest that investing in Russia will be difficult.
• U.K. foreign minister Liz Truss hinted the West could impose sanctions on China if evidence shows Beijing is providing support to Russia.
• Russia has deployed trained dolphins at its Sevastopol naval base in Crimea.

 International News

• China is looking to stimulate its economy to avoid another pandemic-related slowdown. Earlier this week, President Xi Jinping promised new infrastructure spending to promote growth. On Wednesday, China’s State Council pledged to allow internet platforms to grow and give out cash handouts to the poor. The move comes as the communist party looks to boost morale before the 20th National Congress of the Chinese Communist Party.
• In a speech, Kim Jong-un announced North Korea is willing to use Nuclear force not only to deter actions but against any country that moves against “Pyongyang’s interest.” The threat is another sign that North Korea has growing confidence in its nuclear capabilities.
• At $1.05, the euro is trading at its lowest level against the dollar in nearly 20 years. The Ukraine crisis and a lack of monetary tightening have prevented the currency from appreciating. Although the European Central Bank is signaling that it is prepared to raise rates sometime this year, fears of an economic slowdown could lead to a rethink. Overall, a weaker euro should make equities within the EU attractive for dollar-based investors.

U.S. Economics and Policy

• The Democrats are reluctant to push President Biden’s Build Back Better plan, given the closeness of the midterm elections and the president’s low approval ratings. Democrats are expected to lose control over the House and the Senate in November; thus, Democrats need to act sooner rather than later if it wants to get the law passed.

COVID-19: The number of reported cases is 511,562,837, with 6,228,088 fatalities. In the U.S., there are 81,188,133 confirmed cases with 992,721 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 724,696,315 doses of the vaccine have been distributed, with 574,232,736 doses injected. The number receiving at least one dose is 257,423,254, while the number of second doses is 219,483,386 and the number of the third dose, granting the highest level of immunity, is 100,316,900. The FT has a page on global vaccine distribution.

• Chief Medical Advisor Dr. Anthony Fauci announced the U.S. is out of the pandemic phase and is entering the transition phase. He noted that this does not mean that the pandemic is over, but rather, the virus does not pose as serious of a threat as it has over the last two years. This development suggests that the remaining COVID-related restrictions could end soon. Therefore, the lack of regulations should lead to more economic activity.
• Moderna (MRNA, USD, 142.43) is pushing to have its vaccine authorized for young children.
• COVID-19 cases are starting to pick up across the country.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment opens with our update on the Russia-Ukraine war, where Russian forces are now consistently making some small territorial gains in eastern and southern Ukraine.  There are also increasing signs that the war may be spreading into Moldova, which lies on Ukraine’s southwestern border, and even into Russia itself.  We next review a range of international and U.S. developments with the potential to affect the financial markets today.  Finally, we have the latest news on the coronavirus pandemic.

Russia-Ukraine:  Russian forces continue to probe and advance slowly into the Donbas region of eastern Ukraine, suggesting they have learned a few lessons from their disastrous rush to take Kyiv in western Ukraine early in the war.  Russian troops also continue to attack Ukrainian defenders in Mariupol, including the Azovstal Steel Plant, despite Russian President Putin’s claim there is no more fighting in the city.  Finally, the Russians are apparently ramping up their false-flag operations in the Transdniestria region of Moldova, along with efforts to destabilize the country (see map below).  As we have mentioned before, a growing body of evidence suggests Putin plans to take over not only Ukraine but also Moldova.  On the Ukrainian side of the war, new reports suggest the Ukrainian military has launched more small-scale air attacks against Russian military supply lines throughout the country’s border region.  Apparent attacks were reported today near the Russian cities of Kursk, Voronezh, and Belgorod.  So far, Ukraine has not officially claimed responsibility for the attacks.  A Ukrainian presidential advisor today ascribed them to “karma.”  Separately,

Source:  Financial Times

• Russian natural gas giant Gazprom (OGZPY, $1.10) said it would halt gas flows to Poland and Bulgaria starting Wednesday.  It marks the first time it has followed through with President Putin’s threat to cut off countries that don’t pay for their gas in rubles.
  • The decision will have little effect on Poland, which was already set to become independent of Russian gas by the end of this year. It’s a much bigger deal for Bulgaria, which gets over 75% of its gas from Russia and has few immediate options to replace it fully.
  • The Russian decision to cut off only Poland and Bulgaria while sparing major customer Germany (so far) is probably an attempt to undermine Europe’s unity against the war.  Germany’s responses to Russia’s invasion have been reluctant, at best, and now that Poland and Bulgaria see what a Russian energy shutoff really looks like, German leaders may be even more tempted to appease Putin.  On the other hand, cutting off Poland and Bulgaria shows Russia to be an unreliable supplier, or even an “energy imperialist,” and that could help swing more Germans against Russia.  In what may be just a show of bravado, German Economy Minister Habeck yesterday said his country could end its reliance on Russian oil “within days.”  Time will tell.
  • More broadly, the move introduces the possibility that Russia could eventually target more European economies, which deeply depend on Russian gas.  In response, European gas prices rose as much as 20% earlier today before pulling back to levels about 10% higher than yesterday.
    • As of this writing, the euro has fallen to a five-year low of $1.0588.  The currency’s value has now declined 6.9% so far in 2022, and it has depreciated 12.4% from its level one year ago.
    • Concerns about the war and Europe’s vulnerability to energy shortages hurt the euro.  It is also hurt by muted economic growth and the European Central Bank’s relative reluctance to hike interest rates compared with the U.S. and some other major central banks.
• According to oil traders, Russian oil giant Rosneft (OJSCY, $3.00) found no takers for almost 40 million barrels of crude oil it put out to bid last week.   The problems with the sale give an early indication that European sanctions targeting Rosneft, and due to kick in on May 15, are starting to disrupt Russia’s ability to move crude from oil fields to overseas buyers.
  • Since Russia has relatively limited oil storage capacity, the inability to sell could quickly require producers to shut in their wells.
  • Once wells are turned off, they can be hard to turn back on to their previous capacity.  If that leads to long-lasting production declines in Russia, it could contribute to persistently high oil prices and faster inflation out into the future.

Global Commodity Markets:  In its annual Commodity Markets Outlook, the World Bank said commodity prices would remain elevated for years to come as supply disruptions like the war in Ukraine alter how commodities are traded, produced, and consumed around the world.

• The institutions forecast that energy prices will soar 50.5% this year from last, after nearly doubling in 2021. Energy prices are then expected to fall 12.4% in 2023.  Food prices are projected to rise 22.9% this year before declining 10.4% next year.
• The forecasts dovetail with our expectations that even if inflation moderates over the coming year or two, it will probably settle at rates well above those of the last decade.  The analysis suggests commodities may be well placed to provide good returns.

European Union:  Despite the ECB’s relative reluctance to tighten monetary policy as aggressively as the Fed, investors increasingly bet the dam will eventually break, and the central bank will accelerate its interest-rate hikes.   Many investors now think the ECB will take its deposit rate, which currently stands at -0.5%, into positive territory by the end of this year and to more than 1.0% next year.

Brazil:  In an effort to bring down the country’s sky-high credit card interest rates, which can exceed 400% APR, the central bank has launched a new regulation requiring banks to share clients’ credit and investment information, such as loan-repayment histories, with their competitors. The effort to boost competition also forces financial institutions to make their fees public, so consumers can compare costs before choosing a lender.  Lowering credit costs and spurring more consumer spending would likely be a positive for the Brazilian economy and risk assets.

China:  New reports suggest Chinese officials are at odds with each other over President Xi’s stringent “zero-COVID” policies and tough crackdown on the country’s real estate developers.  Regulators led by Vice Premier Liu He are concerned that the government is underestimating the economic impact of its policies.  Indeed, because of recent big losses, Chinese stocks are on track to mark their steepest monthly loss in six years during April.  However, other senior officials have opposed any efforts to ease the policies.

• As Xi approaches a major Communist Party conclave this autumn, where he will try to secure an unprecedented third term in office, he is likely to err on the side of policy easing to boost growth.
  • As we reported in our Comment yesterday, Xi recently ordered his economic team to ensure that Chinese economic growth this year surpasses that of the U.S.
  • Yesterday, Chinese state media said Xi called for accelerated investment in a wide range of critical infrastructure sectors; the report did not specify an amount or timeframe for the effort.
• Nevertheless, the disagreements within the Chinese government suggest that there could be continuing uncertainty and backtracking on policy.  If the disagreements stall any easing efforts, Chinese growth could slow further, putting downward pressure on global economic growth and risk assets.

China-Pakistan:  The Chinese government has demanded a thorough investigation into a van explosion in Karachi that left three of its nationals dead.  The separatist Baloch Liberation Army claimed responsibility for the attack, which killed the director of the University of Karachi’s Confucius Institute, as well as a lecturer and a volunteer.  Chinese nationals have also died in other terrorist attacks in Pakistan.  The new attack will raise tensions between these two countries.

United States-China:  The Biden administration is looking into claims that Yangtze Memory Technologies Co, a privately held Chinese semiconductor maker, has supplied chips to sanctioned Chinese telecom equipment giant Huawei in violation of U.S. export controls.  The investigation will likely further exacerbate U.S.-China economic tensions and potentially lead to further trade and capital controls between the two countries.

U.S. Monetary Policy:  As expected, the Senate yesterday confirmed Fed Governor Lael Brainard as the central bank’s new vice chairperson.  The vote was 52-43.  Since Brainard has already been serving as a Fed governor, her confirmation as vice chair shouldn’t alter the policy board’s plans to hike interest rates aggressively.

• In the coming days, the Senate should confirm nominees Lisa Cook and Philip Jefferson to the board of governors.
• It is also expected to confirm Jerome Powell to a new term as chair.

U.S. Financial Markets:  Amid growing investor appetite for commodities and products tied to the energy transition, Invesco (IVZ, $19.03) said it is launching an exchange-traded fund for metals used to build electric vehicles.  The Invesco Electric Vehicle Metals Commodity Strategy No K-1 ETF will hold futures contracts and other financial products tracking the prices of metals such as cobalt, copper, nickel, and aluminum that are in high demand for their uses in electric cars and other clean-energy projects.

COVID-19:  Official data show confirmed cases have risen to 511,086,383 worldwide, with 6,225,750 deaths.  The countries currently reporting the highest rates of new infections include South Korea, Germany, 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 81,101,161, with 991,959 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 219,423,356, equal to 66.1% of the total population.

 In the U.S., the Omicron BA.2 variant continues to spread, especially in upstate New York, 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 15,908 yesterday, up just 6% from two weeks earlier.  Because of the low level of hospitalizations and general fatigue with the pandemic, the recent outbreak is generating few new policy responses.

• A new CDC study suggests that 58% of U.S. residents had detectible, infection-induced antibodies to the coronavirus as of February 2022, up from just 34% last December.  The figure, coupled with the number of people vaccinated and boosted, it indicates a very high share of the population now has at least some immunity to COVID-19.  That should be promising news for investors, as it suggests any new waves of infection could impose minimal disruptions on the economy.
• In China, health authorities reported 17,724 new locally transmitted infections across the country, more than 95% of which were in Shanghai. Officials said Beijing had just 22 new cases, seven fewer than the previous day, but the government still plans to proceed with its massive testing and lockdown measures.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with an update on the Russia-Ukraine war, where Russia’s refocus on attacking eastern Ukraine still seems stalled, but Western officials, sensing Russian weakness, continue to call for stronger support for the Ukrainians.  We next review a range of international and U.S. developments with the potential to affect the financial markets and close with the latest news on the coronavirus pandemic.

Russia-Ukraine:  As Russian forces continue to probe Ukrainian defenses in the eastern region of Donbas and along Ukraine’s southern coast, they also conducted precision missile strikes against five Ukrainian railway stations in central and western Ukraine yesterday.  The strikes were likely an effort to disrupt Ukrainian reinforcements to eastern Ukraine, hinder Western aid shipments, and warn the U.S. off from providing more support for Ukraine after Secretary of State Blinken and Secretary of Defense Austin visited Kyiv over the weekend.  Meanwhile, local Ukrainian counterattacks retook some territory north of Kherson and west of Izyum.  Separately, there are increasing fears of an eventual Russian move on Moldova, where there have been several mysterious explosions this week, including one that destroyed a radio transmission tower used to broadcast Russian-language programming.  Some fear the explosions are intended to provide cover for a Russian invasion to protect Russian-speaking inhabitants of Moldova.

• Despite the Russian railway attacks yesterday, Russian precision strike capabilities will probably remain limited and are unlikely to affect the course of the war decisively.  According to open-source research organization Bellingcat, the Russian military has likely used 70% of its total stockpile of precision missiles to date.
• As we have warned previously, the increasingly obvious weaknesses in Russia’s conventional military capabilities continue to encourage more aggressive Western responses to the crisis.  For example, a high-level British defense official today endorsed the idea that Ukraine could use the weapons provided by Western governments to attack across the border into Russia.  The German government also finally agreed to provide heavy anti-aircraft weapons to Ukraine, and the Polish government confirmed that it has sent tanks.  Those moves come after Defense Secretary Austin said, over the weekend, that the U.S. would like to see Russia weakened by the war so it could no longer threaten such attacks in the future.  While Austin took flak for what some saw as “spilling the beans,” it may well be that the aggressive statement was planned in advance, in part to bolster Austin’s profile, but also in part to signal the U.S. resolve to keep supporting Ukraine as it erodes Russian military strength.
• Faced with the Russian military’s poor performance and the West’s continued support for Ukraine, Kremlin officials have, yet again, engaged in nuclear saber-rattling.  Russian Foreign Secretary Lavrov yesterday complained that the West was using Ukraine to fight a proxy war with Russia, creating a “serious” risk of a nuclear confrontation.  While a strategic or tactical nuclear strike is not the most likely result of the war, Lavrov’s statement is a reminder that it remains a risk, which alone is a reason for investors to monitor the situation closely.

Global Defense Spending:  The Stockholm International Peace Research Institute (SIPRI) yesterday issued its annual estimate of global military spending.  According to this year’s edition, global military expenditures increased for a seventh straight year in 2021, reaching an all-time record of $2.1 trillion.

• The report indicates total defense spending rose 6.1% in nominal terms last year, but only 0.7% after stripping out inflation.  For the average country, military spending in 2021 equaled about 2.3% of gross domestic product (GDP).
• The report showed the U.S. defense budget fell 1.7% last year, reducing the U.S. defense burden to 3.5% of GDP.  In contrast, Russian military spending surged 2.9%, lifting the country’s defense burden to 4.1% of GDP.
• As we noted in our Bi-Weekly Geopolitical Report of March 28, many countries began to hike their military budgets around the middle of the last decade after Russia seized control of the Crimean peninsula and fomented a separatist movement in eastern Ukraine.  Now that Russia has launched a much more threatening attack on the whole of Ukraine, we believe the world will keep boosting its military expenditure in the coming years.  As we note in our report, that could potentially create opportunities for investors in areas like the traditional defense industry, semiconductors, artificial intelligence, and other software, and even in firms producing dual-use goods for both the civilian sector and the military.

Source:  SIPRI

China:  President Xi has reportedly ordered his economic officials to ensure that Chinese GDP grows faster than U.S. GDP this year, despite the rise in China’s COVID-19 infections and the government’s own disruptive economic lockdowns to combat them.  In response to the directive, Chinese government agencies are discussing plans to accelerate extensive construction projects, especially in the manufacturing, technology, energy, and food sectors.  They are even considering a plan to issue coupons to individuals to spur consumer spending,

• To justify the order, Xi said it is critical to show that China’s one-party system is a superior alternative to Western liberal democracy and that the U.S. is declining both politically and economically.
• We note the order also comes ahead of this autumn’s high-level Communist Party meetings, where Xi plans to garner a third term in office.

Japan-South Korea:  Today, Japanese Prime Minister Kishida warmly welcomed a delegation of South Korean lawmakers and academics sent by President-Elect Yoon Suk-yeol, arguing that Japan and South Korea must improve relations in order to work better with the U.S. against rogue nations and other foreign challenges.  Importantly, better Japanese-South Korea relations would help the U.S. counter China’s geopolitical aggressiveness in the Asia-Pacific region.  Better relations could also help improve trade opportunities between Japan and South Korea, potentially boosting economic and financial market performance.

Japan:  Even though the yen has rebounded a bit so far this morning, it remains near its 20-year low of almost 130 per dollar, prompting increased speculation that the Bank of Japan might intervene in the market to prop up the currency for the first time since 1998.  (Of course, the flip side to the weak yen is the extraordinarily strong dollar, which has been boosted by strong U.S. economic growth and the Federal Reserve’s aggressive plans to boost interest rates.  The U.S. Dollar Index, which tracks the greenback against six other currencies, including the euro and sterling, is now at its highest level since March 2020 and is up roughly 12% in the past year.)

Canada:  In parliamentary testimony, Bank of Canada Governor Macklem said his policy board would consider another 50-basis-point hike in its benchmark interest rate at its next meeting on June 1.  That would follow the central bank’s 50-basis-point hike earlier this month, bringing the benchmark rate to 1.0%.  The statement underscores the extent to which some major central banks are panicked about inflation and intend to tighten monetary policy aggressively in the coming months, despite the risk of excessively slowing down economic growth and unsettling financial markets.

U.S. Monetary Policy:  The Senate today expects to vote to confirm Lael Brainard as the Federal Reserve’s new vice-chair.  The Senate has also taken steps to schedule a vote to confirm economist Lisa Cook as a member of the board.  It is still unclear when the Senators will vote to confirm Jerome Powell to a new term as chair or Philip Jefferson as another new board member.  In any case, we do not expect the newly confirmed policymakers to change the Fed’s rate-hiking intentions in the near term.

U.S. Consumer Spending:  Several sellers of big-ticket consumer goods, ranging from appliances to mattresses, have reported they have seen a drop-off in demand.  Corporate leaders ascribe the drop to several factors, including high inflation, rising interest rates, reduced savings balances, and rising pessimism from the Russia-Ukraine war.  As we have noted previously, all those factors point to an increased risk of recession and troubled financial markets in the coming 12 to 18 months.

COVID-19:  Official data show confirmed cases have risen to  510,286,262 worldwide, with 6,221,232 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 81,043,362, with 991,609 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 219,370,557, equal to 66.1% of the total population.

Virology

• In the U.S., the Omicron BA.2 variant continues to spread, 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 15,639 yesterday, up just 4% from two weeks earlier.  Because of the low level of hospitalizations and general fatigue with the pandemic, the recent outbreak is generating few new policy responses.
• In China, new Omicron infections remain relatively low compared to other countries.  However, the mutation continues to spread rapidly, prompting even-stricter testing regimes and lockdowns by government authorities, with the effort now shifting away from Shanghai and toward Beijing.

Economic and Financial Market Impacts

• As Chinese authorities keep clamping down on economic activity to contain the pandemic, companies throughout the country and Hong Kong continue to face disruptions and lost business.
• The Chinese lockdowns are also showing up in other countries’ economic data.  Reports today showed South Korea’s first-quarter GDP was up just 3.1% year-over-year, slowing from a year-over-year rise of 4.2% in 2021’s fourth quarter.  The slowdown reflected some impact from slowing exports to China, as well as weaker investment and consumption.

Foreign Policy Responses

• Chinese stocks and the renminbi continue to weaken.  To bolster the currency, yesterday, the People’s Bank of China cut its foreign-exchange reserve requirement ratio to 8% from 9% previously.  By allowing financial firms to hold less foreign currency to back their assets, the central bank hopes to undermine the demand for foreign exchange and put a floor under the renminbi.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment opens 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.  Perhaps the most important development on that score is that French President Macron has won re-election by a wider-than-expected margin.  Finally, we wrap up with our coronavirus coverage, where the news is much less positive.  The latest data shows COVID-19 continues to spread rapidly in China.  That raises a risk that the government’s strict pandemic lockdowns will slow global growth and exacerbate inflation going forward, which goes far toward explaining the weakness in global risk assets today.

Russia-Ukraine:  Over the weekend, Russian forces continued to focus on conducting dispersed, small-scale probes against Ukrainian positions in the Donbas region of eastern Ukraine rather than holding back, regrouping, and resupplying, as some analysts believe they need to do.  Reports indicate those probes have produced virtually no significant territorial gains for the Russians.  In addition to their probing in the Donbas, the Russians also continue to attack military and civilian targets throughout the country with artillery, missiles, and aerial bombardment.  For example, they are reportedly planning yet another effort to clear the Ukrainian defenders holed up in the Azovstal Steel Plant at the southeastern port city of Mariupol, and over the weekend, they staged a missile attack against a large residential building in Odesa.  Meanwhile, consistent with the evidence we noted weeks ago, the Russian state-owned media outlet Interfax quoted a Russian general saying the military’s war aims included taking control of not only the Donbas but all of Ukraine’s southern coast and perhaps even the country of Moldova.  The statement underscores the likelihood that President Putin’s aggression would not be satisfied by taking a chunk of Ukraine.  The risk that he could be seeking much more territory will continue to keep Western European nations on edge and should help ensure that the reinvigoration of NATO and the increase in Western defense budgets will continue.

• Adding to the evidence that Putin is far from stopping his war, people briefed on recent conversations with Putin say he truly believes the Russian media’s positive spin that the country is winning big.  Therefore, he is pushing for an all-out victory and has lost all interest in a negotiated settlement.
• Yesterday, U.S. Secretary of State Blinken and Defense Secretary Austin traveled to Kyiv to underscore U.S. support for Ukraine.  Blinken and Austin were the highest-level U.S. officials to meet with Ukrainian President Zelensky in Kyiv since the war began.
• To hide how badly Western economic sanctions are hurting the economy, the Russian government has stopped publishing a range of economic and financial data, including figures on oil production, international trade, government debt, and bank performance.

France:  In yesterday’s run-off presidential election, centrist President Emmanuel Macron defeated far-right populist Marine Le Pen by a bigger-than-expected margin of about 58% to 42%.  Macron’s re-election will likely be taken as a positive for European markets since it means Le Pen won’t be in a position to follow through on her nationalist, socially divisive policy proposals.  Some examples include her calls for France to take back power from the EU, pull out of NATO’s military command, align itself more closely with Russia, and erect new trade and immigration barriers.

• Despite Le Pen’s loss, France and Europe, in general, will probably continue to face social tensions, political fracturing, and challenges from right-wing populists.  We note that France’s voter turnout yesterday was only 72%, its lowest participation rate since 1969.  Le Pen’s performance was also the best by a right-wing populist in France since the end of World War II.  As in the U.S., popular discontent in Europe reflects a number of frustrations related to globalization, technological change, slowing economic growth, income and wealth inequality, and elitist politicians who often seem out of touch with the average citizen, especially among the middle classes.
• Even though Macron will struggle to manage these challenges at home during his second term, the European Union will be much more stable and calmer than it would have been with Le Pen in the Élysée Palace.  We expect Macron to continue to push for the EU to develop its own independent, indigenous diplomatic and military power.  That may be disconcerting for those who look back with nostalgia on Europe’s relative weakness and deference to the U.S. in the decades when it was recovering from World War II.  However, if Europe becomes stronger and more assertive while remaining generally in sync with U.S. policy goals, it will take some of the military, diplomatic, and economic burden off the U.S. as it tries to maintain its position as a leading global power.
• Macron’s predisposition, along with the pressure he still faces from the right-wing nationalists, will likely also lead him to assert France’s power within the EU.  That may seem a distant threat to many people who focus on the “German Problem” and how it has played out over the last century, and to those blinded by France’s inability to defend itself in World War II.  However, it’s important to remember that France has been a dominant European power for far more of the last two thousand years than Germany has.  For much of those two thousand years, Europe quaked at the prospect of French armies on the march.  It’s no coincidence that the American revolutionaries turned to France, the superpower of the day, to serve as midwives for their independence in the late 1700s.  With this history in mind, it will be interesting to see if Macron can strengthen and stabilize France and make it more assertive in European and global politics, especially as Germany has shown that it has apparently lost the will to power.

Slovenia:  In another blow to Europe’s right-wing populism, Prime Minister Janša’s party suffered a heavy defeat in yesterday’s parliamentary elections.  The Freedom Movement, a leftist Green party taken over and revamped by businessman Robert Golob only in January, received around 33% of the vote, compared with 28% for Janša’s Slovenian Democratic Party.

U.S. Technology Sector:  Press reports indicate Twitter (TWTR, $48.93) has caved billionaire Elon Musk and his effort to buy the company.  Reports say the two sides worked through the night to hash out a deal that would be valued at $54.20 a share, although there are no guarantees they will reach one.

U.S. Labor Market:  New data shows that job-switchers are often reaping double-digit pay increases.  According to a survey by ZipRecruiter, 64% of recent job-switchers said their current job provides more pay than their previous job. Among these workers, nearly half received a raise of 11% or more, and nearly 9% are now making at least 50% more.

• The big pay gains show how workers have gained bargaining power in the midst of today’s severe labor shortage.
• The data also suggest that large increases in wage income may continue, giving workers more purchasing power and helping keep inflation high.

Global Food Inflation:  Global palm oil prices have shot higher, and the Indonesian rupiah has dropped today after Jakarta levied a blanket ban on exports of the edible oil.  The action is in a bid to contain surging food prices resulting from the war in Ukraine.

COVID-19:  Official data show confirmed cases have risen to  509,566,779 worldwide, with 6,218,302 deaths.  The countries currently reporting the highest rates of new infections include South Korea, Germany, France, and Italy.  In the U.S., confirmed cases rose to 80,984,943, with 991,254 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 219,338,297, equal to 66.1% of the total population.

 In the U.S., the Omicron BA.2 variant continues to spread, 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 15,594 yesterday, up just 4% from two weeks earlier.  Because of the low level of hospitalizations and general fatigue with the pandemic, the recent outbreak is generating few new policy responses.

• Even though newly reported Chinese cases aren’t among the highest in the world, they are rising fast enough to raise concerns that the government’s strict “zero-COVID” policies will slow the global economy.
  • Shanghai’s deaths soared to 51, while symptomatic cases jumped 76.4 percent over 24 hours by 2,472, according to data released today.
  • Even more worrying, Beijing’s symptomatic cases more than doubled to 60, as authorities acknowledged that the coronavirus had spread in the Chinese capital without being detected for about a week.  Panic buying has gripped the Chinese capital as local cases rise and residents brace for a Shanghai-style lockdown.
  • Hong Kong reported 431 cases today.  The civil service chief admitted “gaps” existed in the anti-pandemic work undertaken by more than 140,000 government employees.

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