by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s report begins with a discussion of how a hawkish Federal Reserve could impact financial markets and the global economy. Next, we review the latest international news, including developments in the Russian invasion of Ukraine. Afterward, we give a brief overview of economic and policy news and conclude with our pandemic coverage.

At the IMF spring meeting, Federal Reserve Chair Jerome Powell suggested the central bank may raise rates by 50 bps in its next meeting and hinted at the possibility of front-end loading policy if inflation remains elevated. His announcement had a negative impact on markets, with some investors pricing the possibility of a 75 bps rate hike in the June and July meetings.  The NASDAQ fell 2.1% from the prior day, while the S&P 500 fell 1.5%. The sell-off in equities was due to concerns that the Fed could make a policy mistake that could lead to an economic contraction.

In his remarks, Powell mentioned that the labor market was too hot and could not be sustained. The reference to employment suggests that the central bank may prioritize inflation over the economy. This point is reinforced by comments made by St. Louis Fed President and voting member James Bullard earlier this month. In an interview with the Financial Times, Bullard urged the Fed to curtail growth as a way to reduce inflation. Although Powell and other Fed officials have dismissed the possibility that increasing rates will lead to a contraction, the market is not convinced. The last time the Fed successfully engineered a “soft landing” was nearly three decades ago. Additionally, forecasts seem to indicate the economy is already showing signs of deceleration. The latest Atlanta GDPNow forecast suggests the economy expanded at an annualized rate of 1.3% in Q1 of 2022. If true, this would be a considerable slowdown in growth from the previous quarter’s rise of 6.9%

A hawkish Fed also has implications for central banks worldwide, but particularly for emerging markets due to concerns that higher U.S. rates will lead to more capital outflow and less foreign direct investment. As a result, central banks in emerging markets have already started to incorporate the Fed shift into their own policy planning.  The People Bank of China tried to mitigate the impact the Fed’s policy shift would have on its economy by lowering the official yuan midpoint. In Mexico, central bank Governor Victoria Rodriguez Ceja hinted the bank may accommodate its monetary policy to adjust for the Fed’s pivot toward tighter monetary policy.

When the Fed raises rates, it is particularly dangerous for emerging market countries that rely on the inflow of dollars to generate growth and repay debt. Currently, Sri Lanka appears to be most sensitive to rate moves as it was on the verge of a collapse even before the Fed started tightening monetary policy. It isn’t clear whether a default from Sri Lanka will be enough to start a ripple effect on the global economy; however, that doesn’t mean it can’t happen. The 1997 financial crisis started in Thailand and spread across East Asia. Rising food and fuel price will likely increase the chance of an economic collapse in Sri Lanka. As a result, we think rising rates are creating unfavorable investing conditions for emerging market equities.

International news

• In an unexpected remark, U.S. Treasury Secretary Janet Yellen warned European countries of the potential damage to the global economy if it bans Russian energy imports. Her concerns appear to be related to the impact that a lack of Russian oil production will have on prices. Although the U.S. has tried to address the shortfall of Russian energy by releasing some of the country’s oil reserves, it appears the Biden administration has failed to find a long-term solution. As a result, there are growing concerns that if Europe pursues its goal of banning Russian energy imports, it could lead to oil supply shocks similar to those that took place in the 1970s.
• The United Kingdom is preparing legislation that will allow it to scrap key parts of the Northern Ireland protocol. This protocol allows for trade from the EU to flow freely to Northern Ireland but places checks on goods from the U.K. It was implemented in the Brexit deal to prevent the need for a hard border between Northern Ireland and Ireland. The protocol has caused a lot of infighting in Northern Ireland as Unionists, a group loyal to the Crown, fear it could lead to eventual reunification with Ireland. The law would give ministers powers that will allow them to switch off key parts of the protocol in the U.K. The move could lead to greater friction between London and Brussels.
• Japan and New Zealand boosted their military ties amid growing tensions with Russia and China. The move comes two days after China signed a security agreement with the Solomon Islands that will potentially allow China to build military bases in the region as well as send in its troops. As China’s presence grows in the region, we expect rivaling countries to build closer ties and rely more on the U.S. for security.
• China has urged domestic investors to purchase more equities as it looks to prop up its financial markets. Chinese equities tumbled on Thursday after the country offered less than expected policy support. Its reluctance to provide stimulus in light of the COVID-19 lockdowns and slow economic growth is likely related to the country’s wanting to prevent the yuan from depreciating.

Economic News and Policy

• The U.S. reinforced its threat regarding its plans to hold China accountable if it supports Russia’s effort to invade Ukraine. In a speech in Brussels, Deputy Secretary of State Wendy Sherman stated China would face sanctions if it is discovered it is aiding the Russian war effort. The move signals the contentious relationship the U.S. and China now have due to the war in Ukraine and provides additional signs of a future decoupling of the two economies.
• Former U.S. President Barack Obama blamed the rise of disinformation on tech companies failing to address the problem. His speech provides more evidence of a growing bipartisan push to rein in Big Tech.
• New research links the labor shortage to an increase in substance abuse. A study released by the National Bureau of Economic Research argues that the pandemic led to increased drug use that prevented workers from returning to the labor force.

COVID-19: The number of reported cases is 507,561,599 with 6,211,101 fatalities.  In the U.S., there are 80,848,684 confirmed cases with 990,663 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 720,813,845 doses of the vaccine have been distributed, with 571,201,893 doses injected.  The number receiving at least one dose is 257,058,180, while the number of second doses is 219,160,055 and the number of the third dose, granting the highest level of immunity, is 99,804,811 The FT has a page on global vaccine distribution.

• The return of mask mandates to combat the rise in COVID-19 cases has been met with skepticism throughout the country. Philadelphia was forced to scrap its mask mandates two weeks after bringing them back. As states grapple with developing a strategy to contain the latest surge in cases, it is becoming clear that Americans are trying to put the pandemic behind them. So far, hospitalizations have not risen to the level hospitals cannot handle; thus, it is still possible this new variant will not pose a severe threat to the economy. That being said, it is too early to make a final judgment.
• On the bright side, cases in Asia appear to be decelerating at a stable pace. Hong Kong announced it would allow foreign travelers to enter starting May 1. Meanwhile, Singapore plans to remove all of its COVID-19 restrictions by April 26. Any moves by Asian countries to lift restrictions may help relieve some supply chain pressures.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s report opens with a discussion of the growing division within Russia over its invasion of Ukraine and what it could mean for emerging markets. Next, we briefly discuss other international news stories and close with our pandemic coverage.

Russian President Vladimir Putin declared victory in Mariupol. Russian troops have trapped the remaining Ukrainian soldiers in an industrial complex. Putin has stopped troops from entering the area to protect Russian soldiers from further harm, preferring to starve the holdouts. Ukraine has not officially surrendered the city, although it does seem to be a formality at this point. A win in Mariupol could help boost country morale after Russian soldiers failed to achieve their original objective to seize Kyiv. This could potentially buy Putin more time as he seeks to rebut growing criticism regarding his handling of the Ukraine conflict.

Putin’s decision to invade Ukraine appears to be driving divisions within Russia. A report from Bloomberg suggests Russian elites are becoming more alarmed by the growing toll the war is taking on the economy. The report states that elites not only believe Russian President Vladimir Putin’s plan is failing, but they suspect he could resort to using targeted nuclear weapons if the mission doesn’t soon prove to be successful. Putin’s increased isolation has also been a cause for concern. It appears he has surrounded himself by hardliners who either accept his view that he had no choice but to invade or are reluctant to challenge him. However, that does not mean Putin doesn’t have any support. Russian troops riding through Ukraine have been photographed waving the Russian flag. Although these instances are isolated, it suggests lower-level officials hope the war in Ukraine will lead Russia to reassert itself as a regional power.

The division within Russia should not be surprising. During times of war, the capitalist class’s interest does not always line up perfectly with the government. In the book The Predictioneer’s Game by Bruce Bueno de Mesquita, the author argues that the reluctance of the elites in Greece to offer their best horses for the war efforts was a key reason the Spartans were defeated by the much smaller and less sophisticated Thebes. A modern-day version of this happening in Russia can be seen in the withdrawal of foreign currency from Russian banks following the Ukraine invasion. Thus, the perceived lack of loyalty could explain why Putin may be suspicious of wealthy individuals who criticize his decision to go to war.  Another reason for the division could be related to differing experiences. While capital holders have been forced to back the war effort at a great financial cost, workers have been able to stay on their employers’ payrolls, even when the company has pulled out of the country. The divide between upper and lower classes is likely a signal that the low morale among Russians caused by the war may be higher than we have anticipated in recent weeks. If true, we suspect Putin will probably do more to promote his military capabilities to silence his critics and build public support.

That being said, it is becoming increasingly difficult for Putin to hide the fact that his country is becoming a pariah nation. More countries are deciding to distance themselves from Russia as they seek to remain in the U.S.’s good graces. Israel, a country with strong ties to Moscow, is now providing military equipment to Ukrainian soldiers. Additionally, Putin complained to the WTO that his country has been unable to secure key materials because of sanctions. A boycott of Russian petroleum has forced Russia to reduce its output from 11.06 mbpd in March to 10.11 mbpd as of April 19.  As the country slowly accepts its pariah status, we notice increased saber-rattling. In a show of strength, Russia launched an ICBM on Wednesday. The launch signals that as the country moves away from global integration, it will look to use its military as a propaganda tool.

In our assessment, the Russian invasion could give insights into how other authoritarian governments could respond if they are forced to distance themselves from the West. Putin’s insistence that capital holders absorb all costs of the war in the name of patriotism is a strong narrative, especially in a country with great inequality. Furthermore, we also expect more displays of his country’s military capabilities. If other countries move in this direction, it suggests market conditions are becoming increasingly less favorable to equities in emerging markets, particularly in Europe.

• Russia may be forced to default on its debt after an industry body overseeing credit default swaps ruled the Kremlin failed to meet its debt obligation when it decided to repay its loans using rubles instead of dollars.
• The Russian defense ministry has taken steps to make it difficult to discern the number of wartime casualties. The department has proposed having families of soldiers who have died during the war apply for compensation directly with the military. This additional step is designed to make soldiers’ deaths a secret in order to maintain support for the war.
• At the G-20 meeting, Western officials walked out when the Russian foreign minister spoke. The walkout is another example of the West isolating Russia following the Kremlin’s decision to invade Ukraine. It is further evidence that economic ties between the West and Russia will likely not be restored any time soon.

International news

• The European Central Bank is expected to raise rates in the second half of the year. The central bank aims to start rate hikes following the end of its bond purchasing program in June.
• United States Defense Secretary Lloyd Austin is set to have a phone call with his Chinese counterpart on Thursday. The two are expected to discuss China’s support for Russia as well as other issues.
• Last night, French President Emmanuel Macron and challenger Marine Le Pen debated each other on national television. Polls suggest viewers were more persuaded by Macron. At this time, we suspect Macron is going to win Sunday’s run-off election. However, if Le Pen pulls off an upset, her victory will likely not be taken well by equities. She has advocated for France’s withdrawal from NATO and has built her reputation on being Eurosceptic.

COVID-19: The number of reported cases is 506,793,550 with 6,207,183 fatalities.  In the U.S., there are 80,801,505 confirmed cases with 990,206 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 719,789,345 doses of the vaccine have been distributed, with 570,485,199 doses injected. The number receiving at least one dose is 256,935,026, while the number of second doses is 219,047,079, and the number of the third dose, granting the highest level of immunity, is 99,663,805 The FT has a page on global vaccine distribution.

• The CDC requested that the Department of Justice appeal a federal judge’s decision to remove mask mandates on public transportations. The request comes amidst growing concerns of another wave of cases hitting the country.
• Hong Kong is looking to ease COVID-19 restrictions as the number of cases continues to fall. Disneyland and other tourist attractions were allowed to reopen. However, Shanghai is still experiencing rising COVID-19 cases. On Wednesday, the death toll rose to 25.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today begins with an update on the Russia-Ukraine war.  Russian forces continue to ratchet up their attacks on eastern and southern Ukraine, and the U.S. is preparing a new shipment of artillery and other heavier arms.  We next review a range of international and U.S. developments with the potential to affect the financial markets today.  We end with the latest news on COVID-19.  For the first time in quite a while, there are many new developments on the pandemic, especially in China.

Russia-Ukraine:  Russian forces continue to ratchet up their attacks on the Donbas region of eastern Ukraine and the country’s southern coast, with a particular focus on mopping up the remaining Ukrainian defenders of Mariupol.  However, military analysts continue to debate whether the Russians are really ready to launch their new offensive or whether they are moving prematurely before fully regrouping and re-equipping from their failed attacks on western and northern Ukraine.  Meanwhile, after a call with European allies, President Biden said the U.S. would send additional artillery, anti-armor, and anti-aircraft weapons to Ukraine.  That aid package is likely to be formally announced in the coming days.

• Sweden’s biggest-selling newspaper has endorsed the country joining the NATO alliance, and an opinion poll showed a record number of Swedes support the idea as well.  The news adds to the evidence that Russian President Putin’s invasion of Ukraine has backfired on him by reinvigorating the West and strengthening its alliances.
  • The Swedish newspaper endorsement is especially important because it came from a publication affiliated with the ruling Social Democratic Party, whose leaders have been resistant to the country joining NATO.
  • Separately, Finland’s parliament today will begin debating its security arrangements; all signs point to the country filing an application to join NATO in the coming weeks, ahead of a June summit of the alliance.
  • Given that joining NATO is a long-term commitment, any move by Sweden and Finland to enter the alliance would help confirm that the European security situation has changed permanently.  That would imply that the many ramifications of the Russian invasion—from accelerating deglobalization to spurring increased defense budgets—will likely be long-lasting.
• In the realm of energy sanctions on Russia, leaders in Germany continue to resist restarting the country’s nuclear power plants to help wean it off Russian oil and gas.  In addition, Algeria is finding it difficult to boost shipments to Europe because of years of underinvestment in its energy sector.

France:  President Macron and far-right challenger Marine Le Pen tonight will hold their final debate before Sunday’s presidential run-off election.  Recent polling shows Macron has slightly opened up his lead over Le Pen and might win the election by a margin of 55% to 45%, but we think Le Pen could still pull off an upset.  Because of her vow to reduce France’s deference to the EU and pull the country out of NATO’s military command, a Le Pen win would likely be very negative for European equities.

China-Solomon Islands:  The Chinese government said Foreign Minister Wang and his Solomon Islands counterpart have already signed a controversial security agreement, appearing to grant China the right to dock warships in the Solomon Islands, just 1,200 miles off the northeast coast of Australia.  A draft of the deal circulating on the internet indicated it would also allow China to use its military forces to protect Chinese citizens and investments there.

• The secret signing of the deal comes despite Australian expressions of concern and the impending arrival of a U.S. diplomatic delegation to discuss it.
• China’s push for the deal reflects its aggressive approach to extending its military power throughout the Asia-Pacific region.  A Chinese presence in the Solomon Islands would potentially pose a grave threat to Australian security and U.S. interests in the region (see map on the next page).
• For investors, the takeaway is that frictions continue to grow between China and the U.S.-led bloc of liberal democracies in the Asia-Pacific.  Those frictions will keep geopolitical risks high and threaten to further weigh on U.S.-China capital flows, which, in turn, would likely mean continued regulatory risk for Chinese equities.

U.S. Debt Markets:  Bond investors have modestly boosted their buying so far this morning, driving the yield on the 10-year Treasury note down slightly to 2.888%.  However, recent trends point to potential problems down the road for the legions of low-rated companies that borrowed at floating rates last year.  Higher costs for those loans could also end last year’s big buy-out boom, undercutting valuations for target companies.

U.S. Housing Market:  As we reported in yesterday’s Comment, we’re only now seeing the first signs that rising interest rates may start to weigh on the housing market.  As home prices keep surging beyond many people’s ability to pay, “YIMBY” activists are agitating for easier zoning rules and less stringent regulations on building new supply, especially in dense, costly cities on the coasts.  YIMBY stands for “yes in my back yard.”

Global Economy:  In its latest World Economic Outlook, the IMF cut its forecast for worldwide economic growth in 2022 to just 3.6%, down from an interim January forecast of 4.4% and far weaker than the 6.1% growth in 2021.

COVID-19:  Official data show confirmed cases have risen to 506,120,436 worldwide, with 6,204,345 deaths.  Currently, the countries reporting the highest rates of new infections include South Korea, Germany, France, and Vietnam.  In the U.S., confirmed cases have risen to 80,732,936, with 989,366 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 218,996,86, equal to 66.0% 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 14,790 yesterday, down 4% from two weeks earlier.

• A day after a federal judge struck down the administration’s mask mandate on public transportation, President Biden said people should decide for themselves whether to mask up on planes, trains, and other public vehicles.  Nevertheless, the Justice Department later said it would appeal the ruling if the CDC concludes in the coming weeks that a mask mandate remains necessary to protect public health.
• In China, the Omicron BA.2 outbreak and associated lockdown in Shanghai has received the most attention, but a little-noted development is that infections and lockdowns have now spread to dozens of other sizable cities as well.  In some places, only a single case has been enough to prompt disruptive economic clampdowns and mass testing.
• Scientists say China’s outbreak reflects two major problems: weak penetration of booster shots, especially among the elderly, and the low efficacy of the country’s homegrown vaccines compared with foreign shots.  Scientists are, therefore, urging the government to look for alternatives to its two homegrown vaccines.
• Authorities in Shanghai have now announced a modest loosening of the city’s lockdown, allowing some residents to leave their homes and walk about their neighborhoods, but indications suggest the overall Chinese lockdowns will remain draconian.  One sign of this is the government censoring an early April editorial in which top pandemic expert Zhong Nanshan argued China can’t pursue “dynamic zero-COVID” in the long term and should reopen to bring social and economic life back to normal. The government’s censorship of the article provides even more evidence that it will maintain or even double down on its strict pandemic lockdowns, despite rising economic costs.
• On the vaccine front, Moderna (MRNA, $152.72) said new research shows a “bivalent” vaccine, which combines its original compound with one targeted specifically at the Beta mutation, can offer a high degree of protection not only against the original and Beta versions of the coronavirus, but also against the Delta, Omicron, and other mutations. The research suggests a stronger, longer-lasting vaccine may be available this autumn.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today, we open our Comment with an update on the Russia-Ukraine war; reports suggest Russian forces have launched the long-anticipated Battle for Donbas.  We next review a range of international and U.S. developments with the potential to affect the financial markets.  We close with the latest news on the coronavirus pandemic.

Russia-Ukraine:  In an address last night, Ukrainian President Zelensky announced that the Battle of the Donbas has begun, with Russian forces launching a major offensive along the line of control running through eastern Ukraine from Kharkiv to Donetsk, Luhansk, and the southeastern port city of Mariupol.  While that couldn’t be confirmed, U.S. military sources said the Russians have increased the number of their battalion tactical groups (BTGs) in the region to approximately 75 and were taking preliminary steps for a major attack.  Russian forces also continue trying to stamp out the last remaining Ukrainian defenders in Mariupol by dropping “bunker buster” bombs on them.  The U.S. and its NATO allies are therefore accelerating their efforts to ship heavier weapons to the Ukrainians and train their soldier on how to use them.  In the coming days, the U.S. expects to move forward with training Ukrainian troops outside of Ukraine on using howitzers and new radar systems, including counter-battery radars to pinpoint the course of Russian artillery fire. The U.S. is sending more than a dozen 155-mm howitzers as part of a fresh infusion of weapons.

• Some military analysts believe that if the Russians have really launched their full-scale assault on the Donbas, they may be making yet another major mistake.  That’s because the Russian forces have not taken the expected operational pause necessary to reconstitute damaged units withdrawn from northeastern Ukraine and integrate them into operations in eastern Ukraine.
  • Russian forces withdrawn from around Kyiv and sent back to fight in Donbas have, at best, been patched up and filled out with soldiers from other damaged units.  The Russian military has few, if any, cohesive units not previously deployed to Ukraine to funnel into new operations.
  • Frequent reports of low Russian morale and continuing logistics challenges indicate the effective combat power of Russian units in eastern Ukraine is likely a fraction of their on-paper strength in numbers of BTGs.
  • If Russian forces are indeed launching their offensive prematurely, it probably reflects pressure from President Putin or other top officials seeking to notch political points by announcing a major victory in the coming weeks.
• On the economic front, the European Union continues to debate a ban on Russian oil and gas imports to punish Russia for its invasion and reduce funding for the Russian war effort.  Italian Prime Minister Draghi suggested that a viable interim step would be for the EU to cap how much it pays for Russian energy.  However, it’s not clear whether Russia would continue to send energy into the EU if it wasn’t receiving full market prices.
• Also on the economic front, Bank of Russia Chief Nabiullina said the consequences of Western sanctions were only beginning to be felt in Russia, while Moscow’s mayor said 200,000 jobs were at risk in the capital alone.
  • Nabiullina also said the Russian government is preparing lawsuits against western governments over their freezing of almost half of Russia’s foreign reserves.  Any such lawsuits would likely be very slow-moving and ultimately unsuccessful.
  • On a related note, U.S. Deputy Treasury Secretary Adeyemo yesterday argued in a speech that the financial sanctions against Russia would not cleave the global economy into competing currency blocs because the Western financial system is too attractive for countries to ignore.

France:  Days ahead of the final round of the presidential election on Sunday, a French investigative news site has published extracts of an EU report alleging that far-right populist candidate Marine Le Pen misappropriated more than €100,000 of EU parliamentary funds.  The EU’s anti-fraud office confirmed it had finalized a report last September, while Paris prosecutors said they received the allegations in March and have begun examining them.

• Le Pen has been dogged by such allegations for years, but since yesterday’s leak came so close to Sunday’s neck-and-neck election, it smacks of a dirty trick by President Macron.  It remains to be seen what impact the leak will have on the final outcome of the election.  The latest opinion polls continue to suggest Macron will win by 54% to 46%.
• Given Le Pen’s past calls for France to leave the EU and her current calls to wrest powers from Brussels back to Paris, a Le Pen win would likely cast the future of the EU into doubt and be a major negative for European markets.
• Last week, Le Pen also reiterated her call for France to pull out of NATO’s military command and suggested the alliance make a “strategic rapprochement” with Russia.  That illustrates a Le Pen win would also have significant geopolitical implications that would undermine European stock values.

Israel:  The Israeli military today carried out airstrikes in Gaza in response to a rocket fired from the Palestinian territory, raising fears of a wider conflict amid heightened tensions after days of clashes at a sensitive holy site in Jerusalem.

Japan:  The yen continues to plunge, dropping against the dollar for a record 13^th consecutive day.  As of this writing, the currency is trading at 128.45 per dollar, down 11.4% from the end of 2021 and 19.2% from the end of 2020.

• As we wrote in our Bi-Weekly Asset Allocation Report yesterday, the drop is primarily in response to the Bank of Japan’s recommitment last month to its policy of yield curve control, even as the Federal Reserve and other major central banks are hiking interest rates and letting bond yields rise.
• A secondary issue is that Japan’s economic structure has now shifted to the point where it has a chronic trade deficit.

United States-China:  Despite the renewed Russian threat in Europe, the U.S. continues to reorient its military toward the Asia-Pacific region to counter the rising threat from China.  The U.S. Navy has now designated Guam as the home port for five Los Angeles-class fast-attack submarines, up from just two as recently as November.

U.S. Monetary Policy:  St. Louis FRB President Bullard, perhaps the most notorious uber-hawk on the Fed’s policy-setting committee, said he wouldn’t rule out a 75-basis-point hike in the benchmark fed funds rate in the coming months, although he suspected a series of 50-basis-point hikes would be sufficient to tame inflation.  According to Bullard, the fed funds rate should stand at about 3.50% at year’s end.

• Bullard’s year-end target of 3.50% would imply hiking rates by 50 basis points in each of the Fed’s six remaining policy meetings this year.
• The statement underscores that Fed policymakers remain in a panic over inflation.  They continue to plan to tighten monetary policy aggressively.  High inflation and the prospect of aggressive Fed tightening continue to reduce bond values, driving the yield on the 10-year Treasury note to 2.851% yesterday and 2.895% so far today.
• Real 10-year Treasury yields, as reflected in the market for Treasury Inflation-Protected Securities (TIPS), are even on the verge of turning positive for the first time in more than two years.  The yield on the 10-year TIPS currently stands at approximately -0.04% compared with readings below -1.00% for much of the last year.
• Coupled with factors like tightening fiscal policy and high inflation, rapid monetary tightening could well help spark a financial crisis or significant economic slowdown in the coming 12 to 18 months.  Obviously, such an event would be a negative for risk assets.

U.S. Housing Market:  Privately held online mortgage provider Better.com has launched its third round of layoffs since December and its first cuts since offering voluntary buyouts to some employees nearly two weeks ago.  With housing inventory low, prices soaring, and mortgage interest rates rising fast, the downsizing at Better.com is one of the first signs that a slowdown in the housing market may be at hand.

U.S. Labor Market:  The NLRB ruled that workers at an Amazon (AMZN, $3,055.70) delivery center in New Jersey have won the right to hold a vote on unionizing the facility.  If successful, the vote would mark the company’s second facility to be unionized after a successful process at a warehouse in New York earlier this month.

• The successful unionization drives at Amazon facilities illustrate how today’s labor shortages and low unemployment rates have shifted economic power to workers.
• If unionization continues to expand, it could eventually boost wages, increase workers’ purchasing power, and reduce income inequality.  However, the downside is that it could also weigh on corporate profit margins or touch off a wage-price spiral that worsens inflation, both of which would likely be negative for financial assets.

COVID-19:  Official data show confirmed cases have risen to  505,095,194 worldwide, with 6,200,389 deaths.  In the U.S., confirmed cases rose to 80,686,455, with 988,912 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 218,937,361, equal to 65.9% 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 a confirmed or suspected case of COVID-19 came in at 14,653 yesterday, down 6% from two weeks earlier.  Because of the low level of hospitalizations and general fatigue with the pandemic, the new outbreak is prompting few new policy responses.
• Yesterday, a federal judge in Florida ruled that the Biden administration’s mask mandate on public transportation exceeded the CDC’s legal authority and is, therefore, unlawful.  In response, the Biden administration said it would not try to enforce the mandate while it decides whether to appeal.  Several major airlines have already lifted the requirement on their flights, and others are soon expected to follow suit.
• In China, Health Minister Ma Xiaowei wrote in an editorial that the country must stick to its “dynamic zero-COVID” policy and reject any thoughts of “coexisting with the virus” to ensure the Communist Party has a successful 20^th National Congress in the autumn.  The statement provides further evidence that the government will maintain or even double down on its strict lockdowns in Shanghai and other cities, despite the rising economic costs.

Economic and Financial Market Impacts

• To offset some of the economic damage from China’s stringent new pandemic lockdowns, the People’s Bank of China announced 23 measures aimed at encouraging financial institutions to support local government infrastructure projects, the property development sector, and industries hurt by the lockdowns.  However, as with this week’s cut in banks’ reserve requirement ratio and earlier interest-rate cuts, the moves are considered cautious and minimalist as Chinese leaders try to support economic growth without exacerbating the country’s high debt levels.

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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 it appears the southeastern city of Mariupol is about to fall to the Russians.  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:  The military situation in Ukraine remained largely unchanged over the holiday weekend.  Russian forces continue to regroup, reequip, and reposition for a concentrated effort to seize control of the Donbas region of eastern Ukraine and the country’s southern coast.  The initial skirmishes in that effort are already taking place, and the Ukrainian forces in the besieged southeastern port city of Mariupol may not be able to hold out much longer, although the Russians’ main attack may still be a week or two away.  In the meantime, the Russians continue to attack primarily military targets throughout the country with artillery, missiles, and aerial bombardment.

• An eighth Russian general has reportedly been killed in combat in Ukraine.  State media in Russia reports that Major General Vladimir Frolov, deputy commander of the 8th Army, was buried Saturday.  Meanwhile, reports circulating on the internet state the commander of Russia’s Black Sea Fleet, Igor Osipov, has been arrested following the sinking of the fleet’s flagship Moskva late last week.
• As intriguing evidence of just how creative and flexible the Ukrainian forces are, reports indicate the Ukrainians first distracted the Moskva with at least one, and possibly a swarm, of Turkish-made Bayraktar TB2 drones.  With the Moskva and its crew distracted by the threat from the drones, the Ukrainians were able to slip two Neptune anti-ship cruise missiles through the cruiser’s defenses.

France:  With just one week to go before the final round of France’s presidential election on April 24, President Macron has tried to blunt far-right challenger Marine Le Pen’s populist attacks by calling for an EU-wide cap on corporate executives’ pay.  Macron is also making a play for France’s left-wing voters by emphasizing his support for renewable energy sources.  The latest polls suggest Macron will win the election with 54% of the vote, compared with 44% for Le Pen, but the president clearly isn’t leaving anything to chance.

• Given her past calls for France to leave the EU and her current calls to wrest powers from Brussels back to Paris, a Le Pen win would likely cast the future of the EU into doubt and be very negative for European markets.
• Last week, Le Pen also reiterated her call for France to pull out of NATO’s military command and suggested the alliance make a “strategic rapprochement” with Russia.  It illustrates that a Le Pen win would also have significant geopolitical implications that could undermine European stock values.

China:  While U.S. markets were closed on Friday, the People’s Bank of China announced it would cut its reserve requirement ratio for major banks to 8.10% from 8.35%.  To counter the Chinese economy’s slowdown in response to new pandemic lockdowns, high inflation, and the government’s regulatory crackdown on key industries, the central bank’s move is expected to spur an additional $80 billion in bank lending throughout the country.

• Notably, the central bank made no change to its benchmark interest rate.  The rate on its one-year medium lending facility remained unchanged at 2.85%.  The minimalist approach to monetary loosening shows how China’s high debt levels constrain the government’s ability to boost economic growth by making credit cheaper.
• The slow pace of monetary loosening will likely cap Chinese economic growth this year, which, in turn, will limit global economic growth and weigh on financial markets.  As shown in the data tables below, China’s first-quarter GDP was up 4.8% year-over-year, beating expectations and accelerating from the 4.0% rise in the year ended in the fourth quarter of 2021.  However, weak figures for March industrial production and retail sales added to the evidence that growth in full-year 2022 will fall short of the government’s goal of about 5.5%.

Israel:  Palestinian-Israeli violence continued to boil over the weekend, with clashes in the area around Jerusalem’s Al-Aqsa Mosque, Islam’s third-holiest site.  At the same time, Prime Minister Bennett is struggling to adjust to the defection of one of his party’s parliament members, which has deprived him of his one-seat majority.

U.S. Economy:  Amid mixed signals regarding just how pessimistic U.S. consumers are about the economy, earnings releases by major banks show credit-card spending is rising briskly.  Higher card spending and continued consumer optimism would suggest that the economy can keep growing in the near term.  Yet, we continue to think that factors like high inflation and rising interest rates are creating a significant risk for a recession in perhaps 12-18 months.

Global Bond Markets:  With inflation surging and central banks around the world hiking interest rates, new data shows the value of global bonds offering a negative yield has fallen to $2.7 trillion from $14.0 trillion as recently as mid-December.  In the U.S., the 10-year Treasury note is currently yielding 2.830%, its highest level since late 2018.

Latin American Agriculture:  As we’ve noted before, food supply disruptions arising from the Russia-Ukraine war have further boosted global food prices.  One region that seems well placed to take advantage of that is Latin America, where farmers are looking to help fill the gap for wheat, corn, soybeans, and other products that are no longer available from Russia and Ukraine.  Because of the expected economic boost from stronger prices for food products, minerals, and other commodities, we think Latin American equities are now more intriguing than they have been in a long time.

Mexico:  President Andrés Manuel López Obrador has failed to push through Congress a controversial reform of the country’s energy industry that would have favored state-owned electricity utility CFE over private generators.

• The proposal, which also included canceling power generation permits and prioritizing CFE power over private renewables on the grid, had raised further fears about private property rights in Mexico.
• Failure of the measure in Congress is therefore positive news for private businesses and investors.  However, the Mexican’s heavy-handed regulatory approach remains a major constraint on the country’s economy and financial markets.

COVID-19:  Official data show confirmed cases have risen to  504,598,742 worldwide, with 6,198,694 deaths.  In the U.S., confirmed cases rose to 80,632,301, with 988,618 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 218,907,165, equal to 65.9% 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 14,936 yesterday, down 6% 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, where the Omicron BA.2 wave has kept parts of Shanghai under lockdown for weeks, small protests have now broken out against the government’s stringent measures, including its decision to requisition citizens’ apartments for quarantine facilities.
• Shanghai’s health authorities said three COVID-19 patients have died, marking the first pandemic-related deaths to be reported in the city since the outbreak started last month.  Despite the announcement, however, many observers still accuse the government of underreporting the death toll from the outbreak and associated lockdowns.

Economic and Financial Market Impacts

• As noted above and shown in the data tables below, the new pandemic lockdowns in Shanghai have already begun to weigh on Chinese economic data.  China’s March industrial production was up just 5.0% year-over-year, slowing from a rise of 7.5% in the first two months of the year.  Retail sales were down 3.5% year-over-year.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! In today’s report, we give a fresh update on the Russian invasion of Ukraine and what it may mean for the global economy. Next is a brief overview of international news, followed by economic and policy news. We end with our COVID-19 coverage.

After peace talks reached a dead end, Russian forces have started to renew their efforts take over southern and eastern Ukraine. Russia has deployed more troops and launched a new airstrike on Mariupol. Currently, there still seems to be a stalemate, as both sides are still finding military success. On Wednesday, Ukraine announced it was able to hit a major Russian warship in the Black Sea. Meanwhile, Russian media stated that a thousand Ukraine marines surrendered in Mariupol. Nevertheless, it is becoming clear that Mariupol is getting closer to being under Russian control. Ukrainian President Volodymyr Zelensky has called on the West to send additional resources to aid the country in the war. The West has responded by expanding its intelligence to Ukrainian forces and sending $800 million worth of additional weapons. Furthermore, the Pentagon has asked defense companies to ramp up their arms production. Russia has responded to the increased support by declaring the weapons in transportation to Ukraine are legitimate targets.

Following its pledge to provide more military support to Ukraine, the West has accused Russia of committing war crimes. The Organization for Security and Co-operation in Europe (OSCE) stated that it has found credible evidence of violations of fundamental human rights. Although the organization fell short of describing the killings that took place in Ukraine as genocide, it did not dismiss President Biden’s characterization of the killings as such. The condemnation comes as the West attempts to portray Russia as an aggressor attacking a hapless victim. As the war rages on, we suspect the West will use claims of war crimes to force countries to choose sides. As we have mentioned in the past, we believe that the Russian invasion will accelerate the world away from globalization and toward regionalization. So far, emerging market countries have been receptive to Russia’s claim that the invasion was to stop NATO expansion, making it harder for the West to find allies in developing countries. The move away from global order could make equities in emerging markets less attractive.

This policy shift is further supported by Treasury Secretary Janet Yellen’s allusion to friend-shoring. Friend-shoring is when supply chains are built using countries that were friendly with the U.S. Earlier this year, Moscow announced a similar approach with its demand for unfriendly countries to pay for Russian commodities using rubles. The move away from globalization puts China in a vulnerable situation. Beijing has expressed sympathy for Russian claims of security concerns, but it has still maintained its relations with Western firms. We believe the breakdown of this order will likely be decided by China. As long as Beijing views strong trade ties with the West as beneficial, the global order will probably stay in place.

Economic Policy and News 

• Rising fuel costs are continuing to add to inflation woes. Amazon told its third-party sellers it would add a 5% delivery surcharge to offset the rise in energy prices.
• The International Energy Agency predicts that the global oil market will avoid a “sharp” deficit in oil due to the strategic release of oil by major countries and the slowing demand from China to offset lower Russian production. The agency expects Russian output to decline by 1.5 mbpd in April and double in May.

International News  

• Treasury Secretary Janet Yellen announced China could face consequences if it supports Russia in its invasion of Ukraine. The U.S. is trying to apply more pressure on China in an attempt to get Beijing to convince Russia to end its war in Ukraine. The threat of sanctions has prevented Chinese companies from exporting to Russia. However, some firms have started to sever ties with the West to prepare for rising tensions. A Chinese energy company, CNOOC (883 HK, HKD, 11.46) announced that it would exit its operations in Britain, Canada, and the United States. If other countries follow, it could add to further evidence that China is moving away from global trade.
• Finland and Sweden are moving closer to joining NATO in response to the Russian invasion of Ukraine. A poll in Finland showed the majority supports joining the military alliance, while Sweden’s ruling party announced that the country could apply by June. The move has led to speculation that Russian aggression could extend into other parts of Europe. Moscow has vaguely threatened a nuclear response if the two countries were to join NATO.
• French presidential candidate Marine Le Pen articulated her foreign policy views in a 90-minute news conference on Wednesday. She told the French media that her relationship with Putin has been exaggerated but reaffirmed that she would like to pull France out of NATO if elected president. Currently, Le Pen is considered a long shot to win the presidency, according to the prediction market website Predictit. However, if she wins, her appointment could complicate efforts to maintain NATO.
• Although Emmanuel Macron remains the overwhelming favorite to retain the presidency, his status of being wealthy has made voters uncomfortable. A great example of this is seen in the ongoing McKinseygate. Thus, the chance of an upset in the run-off election may be more prevalent than most post polls realize.
• The European Central Bank is moving closer to announcing that it will raise interest rates this year and withdraw stimulus at a faster pace. A push for higher rates comes amid rising inflation worries in the Eurozone after the flash estimate of CPI showed prices rising above 7% in March. The war in Ukraine will likely make inflation worse as there is growing evidence that the conflict will lead to an increase in food and energy prices. The shift away from accommodative policy raises the likelihood that the currency bloc could have an economic contraction.

• After the German government took over its affiliate groups in Germany, Russian energy company Gazprom(GAZP RX, RUB, 229.32) announced these units would not return to Russian control. This further suggests that Russia may be accepting a permanent change in its relationship with Europe.

COVID-19:The number of reported cases is 501,512,915, with 6,188,577 fatalities. In the U.S., there are 80,518,050 confirmed cases with 987,331 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 713,605,745 doses of the vaccine have been distributed, with 567,188,881 doses injected. The number receiving at least one dose is 256,489,187, while the number of second doses is 218,622,907, and the number of the third dose, granting the highest level of immunity, is 99,035,505. The FT has a page on global vaccine distribution.

• The Center for Disease and Control and Prevention (CDC) will extend the mandate on public transportation for 15 days as the department monitors a recent rise in COVID-19 cases.
• Pfizer stated that its vaccine booster has been shown to protect children ages 5-11 from Omicron.

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