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, including a discussion of the trend toward ever-greater U.S. and European sanctions, weapons shipments, and alliance building against Russia, which are likely to lead to greater risks over time.  We next review a range of international and U.S. developments with the potential to affect the financial markets today and conclude with the latest news on the coronavirus pandemic.

Russia-Ukraine:  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 apparently already taking place, and it looks like Ukrainian forces in the besieged southeastern port city of Mariupol may not be able to hold out much longer, and the Russians’ main attack may still be a week or two away.  In the meantime, the Russians continue to attack both military and civilian targets with artillery, missiles, and aerial bombardment.  Separately, Ukrainian officials said they thwarted a planned Russian cyberattack against the country’s electric grid last Friday.  That success not only illustrates the continued risk of cyberwarfare in the conflict but probably shows the effectiveness of U.S. and Western cyberdefense aid provided to the Ukrainians.  Finally, in his first extended remarks on the war in several weeks, Russian President Putin said ceasefire negotiations with the Ukrainians are at a dead end.  Consistent with the reports from various Western leaders who have met with Putin in recent months, Putin also signaled no intention to moderate Russia’s attacks or goals.  He insisted his forces would achieve complete victory in the war.

• To cut Italy’s reliance on Russian energy, Prime Minister Draghi and Algerian President Tebboune have struck a deal under which Algeria will boost its natural gas exports to Italy by 40% in 2023 and 2024.  Algeria would then displace Russia as Italy’s top source of gas, although significant investment will be needed to boost Algerian output to accommodate the increase.
• Finally, we think Putin’s unyielding position on the war and insistence on pressing forward will force the U.S. and its NATO allies to continue ratcheting up their economic sanctions, weapons transfers, and other involvement in the conflict.  It’s increasingly clear that Putin is now fully committed to the goal of recreating a vast, powerful new Russian Empire and will only back down if he is confronted with undeniable defeat or driven from power.  The U.S. and its allies will likely increase pressure on him gradually, in a process that will require taking ever-greater risks—probably up to the same level of risks taken during the Cuban Missile Crisis in 1962.
  • First, we suspect the West will focus on ratcheting up its economic sanctions, ultimately to the point of banning at least some imports of Russian oil and gas.  The momentum is moving in that direction even though a major study released today suggests that a full EU embargo on Russian energy would trigger a major recession in Germany, sending output down 2.2% next year and wiping out more than 400,000 jobs.
  • Second, we believe the continuing bloodshed, Russian atrocities, and Russian aggressiveness will spur ever-greater risks in terms of the weaponry provided to Ukraine.  We note that a new military aid package that President Biden is expected to unveil today will reportedly include Soviet-era Mi-17 helicopters and sea drones.  Ultimately, the tanks, artillery, and fighter jets that have been so controversial up to now will probably be provided to the Ukrainians as well.
  • Third, we think President Putin’s intransigence in prosecuting the war in Ukraine could be taken as a signal of what the rest of Europe can expect as long as he’s in power, and that will probably drive more front-line countries to join NATO.  For instance, Finnish Prime Minister Marin today said her country would decide whether to apply for NATO membership within weeks, despite Russian threats to retaliate against any such move.
  • To understand the fourth and last level of allied commitment, it’s only necessary to ask what happens if economic sanctions, weapons shipments, and a bigger NATO all fail to stop the Russians, especially in the event that Russian war crimes intensify to include chemical attacks or the use of tactical nuclear weapons.  As it becomes clearer that the Russian military is under-resourced, logistically incompetent, poorly led, and morally bankrupt, more observers will argue that while Russia can inflict severe damage on unarmed civilians, it is militarily little more than a paper tiger, and the U.S. and its allies should intervene to put a stop to the carnage.  Such an intervention could well extend to the allies deploying their own airpower or even their own troops on the ground.  The risk is that Putin might then be convinced that he is backed into a corner, at which point he might be tempted to use the most powerful weapons in his arsenal.  In other words, despite the ebb and flow of conventional warfare that will likely play out in the coming weeks and months, the war will continue to present enormous risks to the global polity, economy, and financial markets for as long as President Putin is in power.

U.S. Monetary Policy:  The last 24 hours have included a range of developments related to the Federal Reserve.  The first development to report is simply that former Treasury Department official Michael Barr has emerged as the Biden administration’s top choice to be the Fed vice chairman for regulation, following the withdrawal of former nominee Sarah Bloom Raskin in the face of Congressional opposition.  However, the other developments relate more specifically to Fed monetary policy:

• Federal Governor Brainard, an inflation dove who recently rattled the bond market with her hawkish statements on upcoming rate hikes, offered a benign view of policy going forward.  While reiterating that consumer prices are still rising too fast and that bringing down inflation is still the Fed’s most important task, Brainard said the ongoing moderation in federal fiscal stimulus and the Fed’s tightening of monetary policy would help reduce demand and bring down inflation over the course of the year.  Most optimistically of all, Brainard said the momentum in the economy would keep those factors from causing an outright recession.

• • Coupled with the big slowdown in the March “core” consumer price index (CPI) reported yesterday, Brainard’s argument for a soft landing in the economy gave a boost to both stocks and bonds.
  • Even though overall CPI inflation accelerated to 8.5%, the highest rate since 1981, bond buying strengthened enough to drive the yield on the 10-year Treasury note down to 2.748%.  The yield on the 2-year Treasury note fell to 2.426%.
• In contrast with Brainard’s view, St. Louis FRB President Bullard said in an interview with the Financial Times that the Fed needs to be more aggressive in its fight against inflation.  Arguing that it’s a “fantasy” to think the central bank can bring inflation down sufficiently without raising interest rates to a level where they constrain the economy, Bullard called for rates to rise to a point where they actively curtail growth.
  • Bullard’s hawkishness is well known to the market, which may explain why his comments don’t seem to have had much impact on bond yields yet.
  • However, fear of meaningfully tight monetary policy and the risk of the Fed going too far have contributed to concerns that the Fed could help spark a sharp economic slowdown or even recession in the coming months or quarters.

New Zealand:  In its battle against high inflation, the Reserve Bank of New Zealand today hiked its benchmark short-term interest rate by 50 basis points to 1.5% and signaled more rate hikes are likely to follow.  The rate increase today was the institution’s biggest in 22 years.

Japan:  As the Bank of Japan continues to stand by its policy of yield curve control, including a commitment to buy unlimited amounts of Japanese government bonds to cap 10-year yields at 0%, traders continue to sell down the yen.  Earlier today, the currency broke through ¥126 per dollar to trade at its weakest level in 20 years.  The yen is now approximately 9% lower than at the end of 2021.

South Korea:  A member of President-elect Yoon Suk-yeol’s transition committee said the new administration would reverse the country’s nuclear phaseout plan, which had been criticized for intensifying the east Asian country’s dependence on fossil fuels.  The statement underscores how nuclear energy has gotten a second look amid rising prices and supply disruptions for fossil fuels.  We believe the trend is bullish for uranium and other aspects of the nuclear industry.

United States-Mexico:  Texas Governor Abbott is facing growing calls to abandon a two-week-old vehicle inspection program that has led to blockades and long queues at border crossings from Mexico into Texas.

• To protest the new security checks, Mexican truck drivers have blockaded the border crossings since Monday.
• Crossing times for commercial freight have slowed to 10, 20, or even 30 hours in some cases, threatening billions of dollars in trade and the lifeblood of many Texas businesses at a time when supply chains are already under strain.

United Kingdom:  The London Police Department has fined Prime Minister Johnson and Treasury Secretary Sunak for a series of Downing Street parties that broke the government’s own pandemic rules.  The fines, among 50 imposed on a range of officials, will revive a scandal that threatened to unseat Johnson early this year.  Given the prime minister’s leading role in responding to the Russia-Ukraine war, he is now much more likely to survive the scandal.

Global Oil Market:  In its April update, the International Energy Agency said it now expects that global oil demand in 2022 will rise to just 99.4 million barrels per day (mbpd) versus its March forecast of 99.7 mbpd.  The agency ascribed its lower forecast primarily to the big, new coronavirus wave sweeping across China and the government’s aggressive economic lockdown to combat it.  However, it also suggested that high energy prices are starting to curtail demand in the U.S. and other developed countries.

• Despite the modest drop in the IEA’s demand forecast, we continue to believe that factors like rising demand, high financial liquidity, geopolitical fracturing, and other supply disruptions will keep buoying oil prices for the foreseeable future.
• More broadly, we think those factors will continue to boost prices for a broad range of commodities going forward.

Global Industrial Metals Market:  As record-high energy prices curtail industrial production in Europe and the war in Ukraine crimps output from Russia, inventories of some of the world’s most important industrial metals have dropped to critically low levels.  Stockpiles of aluminum, copper, nickel, and zinc—four of the major contracts on the London Metal Exchange — have plunged by as much as 70% over the past year as traders and big consumers have tapped warehouses for material.  The trend supports our view that conditions remain bullish for commodity prices.

COVID-19:  Official data show confirmed cases have risen to  500,939,776 worldwide, with 6,185,579 deaths.  In the U.S., confirmed cases rose to 80,478,089, with 986,408 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 218,521,227, equal to 65.8% of the total population.

• In the U.S., the seven-day average of people hospitalized with confirmed or suspected COVID-19 came in at 14,870 yesterday, down 15% from two weeks earlier.
• Amidst the big new Omicron BA.2 wave in China, people looking with dismay at the draconian lockdowns and food shortages in Shanghai are stockpiling food and emptying store shelves of staples like toilet paper and instant noodles.  At the same time, ever more factories around Shanghai are closing down as government restrictions on transportation make it impossible to get supplies delivered.  The behavior highlights just how socially and economically disruptive the government’s “zero-COVID” policy is.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment opens with an update on the Russia-Ukraine war, where we see signs that the Battle for Donbas is starting.  We next review a range of international and U.S. developments with the potential to affect the financial markets today.  We close with the latest news on the coronavirus pandemic.

Russia-Ukraine:  As Russian forces refocus their efforts on seizing control of eastern and southern Ukraine, large-scale battles are starting or intensifying around the Donbas region and the besieged port city of Mariupol.  Ominously, the Ukrainian military said it is investigating a possible Russian chemical weapons attack in Mariupol.  At the same time, a French military policy unit entered Ukraine to help investigate possible Russian war crimes, marking the first deployment of troops from a NATO country into Ukraine since the war started.

• Separately, a meeting of European Union foreign ministers yesterday discussed further energy sanctions against Russia, but they failed to come to a conclusion.  Officials privately admit that hitting Russian oil is just a matter of time, but the sense of urgency that accompanied last week’s discussions has faded.
• However, there does seem to be more progress on a new round of EU arms deliveries to Ukraine.  German Foreign Minister Baerbock has urged Western countries to supply Ukraine with “heavy weapons” while issuing a thinly veiled criticism of her own Chancellor, Olaf Scholz, who has delayed deliveries of tanks to Kyiv.  Separately, a major German defense firm said it could deliver up to 50 Leopard I battle tanks to Ukraine within six weeks, while Slovakia said it is still working on a plan to deliver Soviet-designed MiG-29 fighter jets.
• Ukrainian Finance Minister Marchenko pleaded for financial aid from Western governments, the IMF, and the World Bank so it could keep prosecuting the war.  According to Marchenko, the Ukrainian government’s spending exceeded revenues by about $2.7 billion in March. He expects the gap to expand $5 billion to $7 billion a month in April and May.
  • Yesterday, the Kyiv School of Economics estimated that Ukraine’s total economic losses from the war total as much as $600 billion.
  • Marchenko demanded that Russia pay reparations for “the destruction of private and public property” during the war and stated Kyiv had assembled an international legal team to lodge claims against Moscow.

U.S. Energy Policy:  To help bring down energy prices that have been boosted in part by the Russia-Ukraine war, the Biden administration said it would temporarily allow the sale of gasoline with high ethanol content.  The decision will allow gasoline with 15% ethanol to be sold between June 1 and September 15.  Normally, only a 10% ethanol blend can be sold during that time period in the summer to reduce smog caused by the 15% blend’s higher volatility.

• According to officials, allowing fuels with a higher ethanol content will lessen reliance on oil, give drivers more options, and save drivers as much as 10 cents per gallon.
• However, oil-industry officials have questioned whether such moves would lower prices. Higher ethanol blending can sometimes raise prices on refiners. Corn prices, like oil, have also seen sharp increases this year because of Russia’s invasion of Ukraine.
• Overall, the announcement reflects how the administration is desperately grasping at straws—any straws—to bring down inflation and salvage its political prospects ahead of the November mid-term elections.  Considering the political constraints facing the administration and the limited tools at its disposal, it does not look like it will be able to cut inflation meaningfully in the near term.

U.S. Monetary Policy:  Chicago FRB President Evans provided further evidence that the Federal Reserve will hike interest rates aggressively at its early May policy meeting.  Although Evans isn’t a voting member of the policy committee this year, he argued at a speaking event in Detroit that a 50-basis-point hike at the May 3–4 meeting “is obviously worthy of consideration, perhaps it’s highly likely.”

• The statement is in line with comments by many other policymakers reflecting their panic over inflation and their intent to demonstrate inflation-fighting cred by jacking up interest rates and cutting the Fed’s balance sheet aggressively.
• As investors mull over the implications of the Fed’s aggressive tightening plans, the yield curve has steepened considerably again after inverting last week.  At day’s end yesterday, the yield on the 10-year Treasury note had reached a three-year high of 2.827%, while the yield on the 2-year Treasury note rose to just 2.549%.
• We continue to believe the policymakers will uncover financial or economic fragilities relatively soon and will not be able to tighten policy as far or as fast as most investors expect.  Still, even if the officials have to curtail their tightening early, the damage from high inflation and rising interest rates may already be done.  At this point, we already see an elevated risk of a sharp economic slowdown or recession starting in 2023.

Japan:  An additional complication for Fed policymakers will come from Japan.  The rapid depreciation of the yen over the last week is raising hedging costs for Japanese investors and making it harder for them to buy U.S. bonds.  Decreased demand from Japan could make it harder for the Fed to implement its planned sell-off of assets held on its balance sheet without disrupting the bond market.

France:  Working to solidify his status as the frontrunner in the April 24 presidential run-off election, President Macron climbed down from an earlier campaign pledge to raise the French retirement age from 62 to 65 by 2030.  Courting left-leaning voters who might otherwise be tempted to support right-wing populist Marine Le Pen, the president said he would consult unions and other political parties over the pace and timetable of reform.  He also hinted that he might be willing to submit the reform to a popular referendum.

• In the latest opinion polls, Macron is currently supported by 52.8% of the electorate, while 47.2% support Le Pen.  Macron’s support has improved slightly since his better-than-expected performance in the first round of voting last Sunday.
• Nevertheless, the election remains fraught with danger for Macron, France, and Europe in general.  Le Pen has softened her hard-edged populism going into this year’s election.  Her policy goals, if elected, would probably still include steps like clamping down on Muslim rights within France, restricting immigration, pulling France out of the NATO military command structure, and undermining European Union powers over its member states.

Sri Lanka:  Amid a financial crisis touched off by the coronavirus pandemic, surging commodity prices, and political tensions, the government announced that it would suspend all bond payments, including debt service on some $35 billion of foreign sovereign bonds.  The government will also request help from the IMF.

• The crisis is one example of the financial and political instability that can be touched off by high global commodity prices, as we’ve written about many times.
• The debt default also could have geopolitical ramifications.  Sri Lanka’s biggest foreign creditor is China, and Western analysts have long worried that aggressive Chinese lending would give it leverage over the country.

COVID-19:  Official data show confirmed cases have risen to  499,748,065 worldwide, with 6,181,560 deaths.  In the U.S., confirmed cases rose to 80,449,398, with 985,826 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 218,430,663, equal to 65.8% of the total population.

• In the U.S., the seven-day average of people hospitalized with confirmed or suspected COVID-19 came in at 14,940 yesterday, down 17% from two weeks earlier.  Nevertheless, new cases of the Omicron BA.2 variant continue to surge in the Northeast.
• Because of increasing Omicron BA.2 cases, officials in Philadelphia said they would reinstate a citywide indoor mask mandate.  Residents and visitors will be required to wear masks in public spaces indoors, including schools, starting next week.
• The Omicron BA.2 waves continue to worsen in parts of Asia and Europe, with China being hit particularly hard by the government’s draconian “zero-COVID” policy.  The U.S. State Department has now ordered all nonessential employees out of its consulate in Shanghai, responding to the government’s stringent lockdown there.  Even though the municipal government modestly eased its strict lockdown rules yesterday, Shanghai remains largely shut down for the time being.
• Two new, peer-reviewed studies found that the risk of inflammatory heart conditions after receiving a COVID-19 vaccine was similar to the risks after receiving other popular vaccines and lower than the risk after contracting COVID-19 itself.  Since the relative risk of a COVID-19 vaccine is middling, researchers hope the findings will encourage more people to get vaccinated or boosted.

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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 both sides are preparing for a new phase in which Russia will focus on seizing only eastern and southern Ukraine.  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 the war remains in a relative lull, with Russian forces having pulled out of western Ukraine, including the region around the capital city of Kyiv, to regroup and reequip for an effort to seize control of the eastern Ukrainian region of Donbas and the country’s southern coastline.  In the meantime, Russian forces continue to attack a range of military and civilian targets with artillery, missiles, and aerial bombs.  Satellite imagery and other intelligence suggest Russian ground forces are already deploying into battle positions in eastern Ukraine, although some analysts think they will need several more weeks of preparation before launching major new assaults.

• In any case, the next phase of the war is likely to look much different from the first.  Rather than the Ukrainians holding off the Russians with insurgency-style, hit-and-run attacks with small units, the next phase concentrating on Donbas will likely look much more like World War II, marked by prolonged, pitched battles between large formations of tanks, armored personnel carriers, artillery, and other equipment.  Those characteristics will probably favor the Russians and their preponderance in equipment and personnel.  Nevertheless, they are still likely to be hindered by poor morale and losses in the war to date.  Reports indicate the Russians are calling up some 60,000 reservists to augment their forces for the coming battles.
• The Russians have also abandoned their disastrous decision to run the war from Moscow.  Instead, President Putin has reportedly named Army Gen. Aleksandr Dvornikov to command the Russian attack on the ground in Ukraine.  Dvornikov is famous for having led Russia’s successful intervention in Syria almost a decade ago, but it is important to remember that the highly motivated, professionalized, well-equipped Ukrainians are likely to be a much tougher adversary than Dvornikov faced in Syria.
• On the economic front, S&P late Friday downgraded Russia’s sovereign foreign debt to “selective default,” saying it didn’t expect that the rubles Moscow deposited in payment on debt due last week could ultimately be converted into dollars as required by the loan documents.  Failure to pay under the terms of the documents would mark Moscow’s first default in more than 100 years.
• In other economic fallout from the war, Western Europe continues to struggle with the challenge of weaning itself off Russian energy.  In Germany, the chief executive officer of major utility E.On (EONGY, $11.29) ruled out extending the life of its sole German nuclear power plant, which is due to go offline at the end of this year.  According to the CEO, “There is no future for nuclear in Germany, period.  It is too emotional. There will be no change in legislation and opinion.”

France:  In the first round of presidential elections yesterday, centrist President Macron and the far-right firebrand Marine Le Pen came out on top, setting them up for a head-to-head matchup in the second and final round on April 24.  With some 97% of the votes counted, the tallies currently show Macron winning 27.6% and Le Pen 23.4% of the first-round votes, ahead of the far-left candidate Jean-Luc Mélenchon with 22.0%.  Le Pen benefited from a late surge that reflected widespread disaffection over inflation, security, and immigration.

• Two polls right after the vote indicated that Macron would narrowly beat Le Pen in the run-off.  One poll found Macron would win the run-off by 52% to 48%, within the margin of error.  The other poll showed he would win 54%-46%.  Along with Macron’s slightly better-than-expected showing on Sunday, this has given a boost to both the euro and French stocks so far today.
• Le Pen has been skeptical of the EU, and she said she would withdraw from NATO’s military command structure.  In addition, she has expressed admiration for Russian President Putin.  As with nationalist populists in many countries, Le Pen performed best among the less educated, traditionalist, and rural electorate.
  • A Le Pen win signals the continued power of right-wing populists in Europe.
  • If she wins, it will also signal a potential fracturing of the EU and the acquiescence of a major European power in Russia’s invasion of Ukraine.

Pakistan:  After Prime Minister Khan was ousted in a no-confidence vote over the weekend, parliament today is set to confirm opposition leader Shehbaz Sharif as the country’s new leader.

• The move will end weeks of political uncertainty that fueled a devaluation of the rupee, pushed down the stock market, and forced the central bank to raise interest rates.
• However, Sharif’s appointment as the new prime minister doesn’t necessarily imply good governance and bright economic prospects going forward.
  • Sharif, the former chief minister of the country’s largest province, is the brother of a former prime minister who was jailed on corruption charges.
  •  Sharif will inherit a $6 billion IMF loan program, which has involved unpopular measures such as raising utility prices.

Mexico:  President Andrés Manuel López Obrador was projected to win more than 90% of his referendum questioning whether he should serve out the second half of his six-year term.  However, the turnout was below 20%, well short of the 40% needed for the result to be binding.  Many critics and opponents of the president considered the poll a farce or mere grandstanding.

U.S. Labor Market:  Evidence continues to suggest that more retirees may be returning to the labor market, which could potentially help relieve labor shortages and hold down wage rates.  Perhaps driven by the steep rise in consumer price inflation, more than 480,000 aged 55 and over started working or looking for work in the past six months, compared with just 180,000 who entered the labor force in the six months before the pandemic struck.

U.S. Financial Market:  The Federal Reserve continues to tighten monetary policy; state and local governments have responded by calling off bond issuances and spending down their federal stimulus cash.  As a result, bond issuance by state and local governments dropped 8% in the first quarter from a year earlier. At the same time, data show that spooked investors yanked money from municipal-bond funds, which suffered their biggest quarterly outflows since 2013.

Global Electrical Vehicle Industry:  The CEO of major Australian lithium producer Lake Resources (LLKKF, $1.38) warned that if Western governments and companies can’t find a way to break China’s dominance in raw material supply chains, battery manufacturers will continue to confront a severe lithium shortage, and the West’s electrical vehicle industry will be hampered.

COVID-19:  Official data show confirmed cases have risen to  498,154,313 worldwide, with 6,176,420 deaths.  In the U.S., confirmed cases rose to 80,399,474, with 985,482 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 218,377,792, equal to 65.8% of the total population.

Virology

• In the U.S., the seven-day average of people hospitalized with a confirmed or suspected COVID-19 came in at 15,058 yesterday, down 18% from two weeks earlier.
• Meanwhile, the big new wave of infections continues in China, South Korea, Vietnam, and some other Asian and European countries.  In Shanghai, new infections hit another record for the 10^th straight day.  Fearful of the rapid spread in that city, the tech hub of Shenzhen has launched dramatic new testing and isolation protocols that will likely have major economic impacts.

Economic and Financial Market Impacts

• As China keeps responding to its vast new wave of infections by clamping down even harder on its economy, supply disruptions and shutdowns at key factories are raising concerns about an outright tailspin for the economy, driving Chinese stocks sharply lower today.
• More broadly, China’s draconian shutdowns are also prompting worries about a fall in global oil demand, which is weighing on global oil prices.  So far today, Brent crude has fallen about 3.5% to $99.44 per barrel.

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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 the economic fallout from the Russian invasion. We then cover a few central bank updates. Economic and policy news follows, and we close with our COVID-19 coverage.

Less than two months into its invasion of Ukraine, Russia is already feeling the pain of the sanctions. Russia expects to be headed toward one of its worst economic crises in recent history. According to a Bloomberg survey, Russia is on track to contract for two consecutive years for the first time since the breakup of the Soviet Union. In an unscheduled decision, the Central Bank of Russia cut its key rate by 300 bps to 17%. The quick slash of rates suggests that the government has started to change its focus from stabilizing the financial system to stimulating the real economy. Although policy rates remain far above their level prior to the invasion, it does signal that the central bank still has some tools at its disposal to soften the blow of the economic sanctions. That being said, as food prices rise globally, we suspect Russia will likely have to be very cautious with its policy accommodation as it is forced to decide how much inflation and unemployment it is willing to tolerate.

As Russia looks for ways to cushion the impact of the economic sanctions from the invasion, the West tries to ramp up the pressure.  On Thursday, Congress officially passed a bill that would ban Russian commodities. Additionally, Congress approved removing Russia’s and Belarus’ most favored nation status, a move that could potentially expose the countries’ exports to tariffs. The U.S. has started to enforce its export controls against companies sending tech made in the U.S. or containing parts made in the U.S. The move comes as the government tries to ensure that Russia lacks the equipment needed to maintain its aggression in Ukraine.

Germany is also trying to cope with mounting pressures from the war. On Thursday, Germany’s ruling coalition agreed to a stimulus package to support domestic companies impacted by economic sanctions. In the commodity sector, German regulators have asked banks and trading partners to continue to do business with Russian gas firm Gazprom.  In a letter, the Federal Network Agency, the German regulatory office for electricity, gas, telecommunications, post, and railway markets, warned that shunning the company could force it into bankruptcy, leading to further disruption in the gas market. Therefore, it appears energy concerns have taken a back seat to the Ukraine conflict. Germans are pushing their government to do more to help Ukraine defend itself from the Russian invasion. A survey by ARD-DeutschlandTrend showed that 45% of respondents believe that the government’s response to the invasion is insufficient, with only 37% holding the opposite view. The increase in public support suggests the government has amassed a lot of political capital as it tries to deal with its changing relationship with Russia.

Since the start of the war, we have been paying close attention to Germany because of its strong dependency on Russian energy. In our view, wars are fought by the public just as much as by the military. As long as the public supports the government in its effort, a war will be able to continue. However, if the people express an unwillingness to pay the economic cost needed to maintain the war, the ruling government risks being ousted., German support of the invasion is likely a sign they will continue to support Ukraine in its war effort, but sentiment may change in the winter when Germany feels the bite of rising energy costs. In response to energy concerns, the country appears to be building its inventory, but it isn’t clear whether Germany will have enough storage to prevent an energy crisis during the colder months. Russia also has a public perception problem. Although it can stop media outlets from showing unfriendly news about the war, it cannot stop people from mourning the death of family members fighting in Ukraine. Thus, there are still risks on both sides regarding maintaining their position. With respect to markets, this could mean conditions remain unfavorable to equities.

Central Bank News

St. Louis Fed President James Bullard stated he would like the Fed to raise rates sharply in order to counter inflation. He also pushed for the policy rate to be near 3-3.25% by the end of the year. History suggests that the Fed could cause havoc in the financial system if it follows this recommendation. Over the last three decades, the Federal Reserve has not been able to raise rates above the preceding business cycle’s peak without triggering a market issue. The previous business cycle was not an exception. Although it is true that the pandemic forced the Fed to push rates back down to zero, there were also problems within the repo market prior to that happening. As we mentioned yesterday, we suspect the Fed is still taking a wait-and-see approach to inflation. Thus, there remains a chance that the Fed could slow the pace of rate hikes as new economic data is released. We are paying close attention to the CPI and GDP reports because we suspect that a deceleration in economic growth or inflation could lead to a rethink on the current pace of policy hikes.

Economic and Policy News

• Treasury Secretary Janet Yellen stated it would take years to develop a central bank currency if the U.S. decides to create one. Following President Biden’s signing of an executive order on cryptocurrency, the administration has been studying the possibility of issuing a national digital currency. One of the goals of issuing a central bank currency is to provide low-income households with more access to the banking system.
• The UN General Assembly voted to suspend Russia from the Human Rights Council. In a previous vote condemning Russia for the humanitarian crisis, the number supporting its removal was greater. The outcome suggests that more countries are feeling uncomfortable choosing sides between the West and Russia over the conflict in Ukraine. Prior to the vote, Russia stated it would view support for its removal as unfriendly, implying that Moscow could retaliate by limiting energy exports.

COVID-19: The number of reported cases is 495,763,966, with 6,169,643 fatalities. In the U.S., there are 80,289,237 confirmed cases with 984,571 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 708,450,345 doses of the vaccine have been distributed, with 563,999,093 doses injected. The number receiving at least one dose is 255,975,678, while the number of second doses is 218,135,613, and the number of the third dose, granting the highest level of immunity, is 98,424,742. The FT has a page on global vaccine distribution.

• China continues to be the current epicenter of COVID-19, with over 21,000 cases in Shanghai on Thursday. Beijing is facing growing pressure from the public, who are experiencing lockdown fatigue due to the country’s zero-COVID-19 policy.

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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 the latest developments from the Russian invasion. We then discuss central bank news with a focus on the Fed meeting minutes. Next, we review economic and policy news, followed by a brief roundup of international news. We conclude with our COVID-19 coverage.

Russia has focused its war efforts on taking over the eastern region of Ukraine. So far, they have started air attacks on the eastern parts of the country as Russian forces attempt to encircle Ukrainian troops. A Ukrainian official has warned residents remaining in the area that time is running out for them to evacuate. The change in strategy suggests that Russia is desperate for a military win. In 2014, Russian President Vladimir Putin boasted Russia could take Kyiv in two weeks.  It has been 42 days since his forces invaded Ukraine, and they have yet to take a major city. With this new offensive, we suspect Russia could be targeting areas where there is a lot of pro-Kremlin sentiment, such as Donetsk and Luhansk. Military victories in these cities would be hard to overturn, given the area’s sizable Russian population. However, if Russia fails to take control of these areas, it would be a major blow not only to its military’s reputation but also to troop morale. Therefore, Moscow may view winning the east as its only option. If forces are successful, we expect a revamped military effort to take over Kyiv.

Other Ukraine related news

• Russia continues to find it difficult to avoid the pain of sanctions. In China, state oil refiners are reluctant to purchase oil from Russia over concerns about violating sanctions. Refiners have continued to honor their contracts, but they have been hesitant to sign new ones even with the steep discounts. The cautiousness comes as foreign firms have been wary of giving off the appearance of helping Moscow avoid sanctions. Recently, Shell (SHEL, $55.30) announced that it would be exiting Russia. Although the U.S. has not explicitly told foreign firms to choose between it or Russia, this does appear to be the underlying fear of firms willing to work with Moscow. On Thursday, the U.S. warned India of “significant and long-term” consequences if it continues to align itself with Russia. India has maintained that it has not aligned with any country over the invasion.  Despite its stance, India is increasingly finding it difficult to justify remaining neutral in light of the evidence of atrocities in Ukraine.  At the UNSC meeting on the Russia-Ukraine war, India has called for an investigation into the killing in Bucha, its strongest condemnation of Russia since the conflict began.
• Russia still has some buyers for its goods. In Hungary, Prime Minister Viktor Orban stated that his country was willing to pay for Russian gas in rubles. Hungary is the first European Union member country to agree to Putin’s terms. Meanwhile, Russian officials announced it has sold out of Sokol crude for May, with ships expected to head to China, India, Japan, and Korea.
• Regardless of sanctions, the ruble was briefly able to return to its pre-war levels. Even though the recovery is impressive, it is likely not a sign of growing confidence in the currency. After the Kremlin reopened its markets, it forced restrictions on how the currency is traded. For example, exporters were limited in their ability to accept other currencies for payments, residents were discouraged from saving in other currencies, and foreigners were not allowed to sell their securities. Under normal market conditions, the currency would likely have seen at least a slight improvement, especially after the initial shock of the Russian invasion wore off, but it probably would not have been as strong as what we are currently seeing. That being said, a part of the appreciation in the currency could be related to countries holding on to rubles in case Putin follows through on his threat to stop supplying countries that pay in other currencies.

Central bank news

On Wednesday, the Federal Reserve released the minutes from its two-day meeting on March 15-16. The minutes showed that despite the FOMC voting to raise rates 25 bps, “many” members favored raising rates by 50 bps. Russia’s invasion of Ukraine helped sway the FOMC from pushing rates higher. As a result, there is growing speculation that the Fed will make up for lost time by raising rates 50 bps in the May and June meetings. The minutes also revealed that the Fed would like to start reducing its bond holdings in May with a cap of $95 billion a month. The notes from the meeting suggest the Fed could phase in the drawdown to ensure a smooth transition.

Financial markets responded negatively to the minutes. There was a sell-off of stocks and bonds as investors prepared for more market volatility. As a result, there are expectations that the Fed will push rates above two percent by the end of the year.  In our view, the Fed may still be open to changing course on its policy path if next month’s CPI report shows that inflation peaked in February. We believe the recent rise in energy prices due to the war in Ukraine will likely make any deceleration in inflation modest at best. However, if inflation rises even higher than it did in February, we expect the Fed to become decidedly more hawkish than they are today.

• The ECB is mulling raising rates soon as inflation in the Eurozone remains elevated and shows no signs of abating.

U.S. economic and policy news

• The U.S. appears to be exploring more ways to punish Russia and countries that align with it. Treasury Secretary Janet Yellen expressed interest in creating an escrow account that could track proceeds from Russian oil and gas sales. She also added that the U.S. Treasury Department is prepared to use its tools on China if it were to make a move on Taiwan.
• House Representative Nancy Pelosi (CA-D) is rumored to be traveling to Taiwan following her stay in Japan this weekend. The visit has not been confirmed by her office, but Chinese officials have already expressed outrage. Beijing warned that if Pelosi does visit Taiwan, it would be forced to take strong measures. The vague threat comes amid growing friction between the U.S. and China over the Russian invasion of Ukraine.

International news

• Following the retirement of Hong Kong leader Carrie Lam, Beijing is reportedly backing former police officer John Lee as her replacement. The choice suggests that Beijing still sees Hong Kong as a security risk.
• Russian oil refiners Taif and Lukoil (LUKOY, trading halted) stated they are running out of fuel storage capacity as they cope with the lack of demand for oil due to sanctions.
• The EU is set to ban Russian coal starting in August as it looks to cut ties and reduce its dependence on the country because of the invasion of Ukraine.

COVID-19: The number of reported cases is 495,181,447, with 6,166,970 fatalities. In the U.S., there are 80,249,038 confirmed cases with 983,817 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 707,281,045 doses of the vaccine have been distributed with 563,391,773 doses injected.  The number receiving at least one dose is 255,873,739, while the number of second doses is 218,043,500, and the number of the third dose, granting the highest level of immunity, is 98,312,742. The FT has a page on global vaccine distribution.

• A new study showed there is an increased risk of developing blood clots months after experiencing mild COVID infections.
• Leading infectious disease expert Anthony Fauci stated he expects the latest omicron variants to spread into the U.S., possibly leading to a serious surge in cases in the fall.

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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 little has changed militarily over the last day, but geopolitical and economic pressures on Russia continue to mount.  We next review a range of international and U.S. developments with the potential to affect the financial markets today.  We wrap up with our pandemic coverage.

Russia-Ukraine:  Militarily, reports continue to indicate that the Russian invasion forces in western Ukraine around the capital city of Kyiv are being pulled back, apparently for reequipping and regrouping before being redeployed to Kharkiv, the Donbas region of eastern Ukraine, and the country’s southeast coast.  Other fresh units based in Russia proper are also reportedly being prepared for action in eastern Ukraine.  In the meantime, the Russians continue to attack civilian areas throughout the country with artillery, missiles, and aerial bombs.  Simultaneously, Ukrainian officials continue to unearth evidence of apparent war crimes in areas previously occupied by the Russians.

• In his virtual speech to the UN Security Council yesterday, Ukrainian President Zelensky warned that evidence of even more horrendous atrocities was likely to be uncovered.  In frustration that the UN probably can’t take action because of Russia’s permanent seat on the Security Council, Zelensky called for it to be reformed or dissolved.
  • Indeed, the UN is probably a major loser because of the war.  Since Russia has a veto over Security Council decisions by virtue of its seat in the group, it has been able to thwart UN efforts to stop the war.  The crisis has shown the UN to be powerless in disciplining permanent Security Council members and their allies.
  • Although the UN continues to enjoy public support for many of its initiatives, from food aid to helping set trade standards, its ineffectiveness in stopping the war will likely fuel calls for it to be reformed or dissolved, just as Zelensky demands.  As the world fractures into at least a U.S.-led bloc and a rival Chinese/Russian-led bloc with diametrically opposed values and policy aims, having all three of those lead countries on the Security Council will probably be a recipe for permanent stalemate.
    • Dismantling the UN system may not seem like a direct threat to investors, but it would probably be quite important.
    • Without a common and accepted forum for addressing global political disputes, the evolving blocs would be more likely to operate under a “might makes right” ethos in which destructive wars would be harder to avoid.
• Meanwhile, the U.S. and its Western allies continue to impose new sanctions on Russia.  The U.S. today will reportedly announce a new package of sanctions that would include a ban on all new investments in Russia.  Looking ahead, several senior, centrist European officials are now even calling for a ban on Russian oil and gas imports (for a breakdown of Europe’s major imports from Russia, see graph below).  Press reports indicate the previously announced sanctions are already having an impact within Russia.
  • Just days after the U.S. Treasury Department blocked U.S. banks from handling dollar payments from Russia, halting $649 million of interest and principal payments on a Russian dollar bond, the Russian government said it would try to make the payment today in rubles.
  • According to the Russian government, payments will instead be deposited into ruble-denominated accounts in Russia; the proceeds can be converted into dollars following the “restoration of the Russian Federation’s access to foreign currency accounts.”
  • While the Russian action illustrates the government’s effort to avoid an international bond default, the tough stance by the U.S. Treasury Department underscores how divergent the two sides are operating in the midst of the war.
• In other economic fallout from the war, it turns out that crude oil isn’t the only type of oil being affected.  The war has also sparked a global shortage of sunflower oil, which has, in turn, pushed prices of other edible oils to record highs, hitting food makers and consumers already grappling with inflation.  Separately, the International Committee of the Red Cross yesterday warned a quarter of Africa’s population is facing a food-security crisis driven by severe drought, raging wars, and a rise in world food prices caused by Russia’s invasion of Ukraine,

Hungary:  Just days after Prime Minister Orban, a right-wing nationalist and Russia sympathizer, scored reelection by a landslide, the European Union has launched a process that could allow it to impose financial penalties on Hungary for corruption and rule-of-law abuses.  Use of the “conditionality mechanism” could jeopardize some of the €24 billion that Budapest is due to receive up to 2027.

Sri Lanka:  The country is facing a foreign exchange crisis as its government grapples with looming debt payments, widespread protests, and an economic emergency.  After President Rajapaksa yesterday was forced to end emergency rule imposed just days earlier, the Sri Lankan rupee is hovering near 300 per dollar.  It is down 32% year-to-date and lagging even Russia’s ruble.

• The crisis stems in part from rising commodity prices following the outbreak of the Ukraine war, as well as rising interest rates around the world.
• The crisis, therefore, illustrates how emerging markets around the world are facing growing economic, social, and financial risks.

U.S. Monetary Policy:  Federal Reserve Governor Brainerd, who has ordinarily been considered a dove on inflation, yesterday said “it is of paramount importance” for the central bank to start reducing today’s fast price increases, both by hiking interest rates and selling down its portfolio.

• Brainerd’s statement sparked a sharp sell-off in longer-maturity bonds, with the yield on the 10-year Treasury note jumping to 2.600% from 2.409% on Monday.
• With the jump in longer-term yields, the yield curve inversion that began last week was erased—just barely.  By day’s end, the yield on the 2-year Treasury note stood slightly below the 10-year yield at 2.580%.
• Fed policymakers are clearly in a panic over inflation and currently plan to tighten policy aggressively to fight it.  We should learn more about their plans later today when they release the minutes from their March meeting.  Nevertheless, we continue to doubt that the policymakers will be able to hike rates as fast or as far as they intend without exposing financial fragilities or unduly slowing the economy.

U.S. Agriculture:  Amid the search for hedges against galloping inflation, investors are reportedly ramping up their purchases of U.S. farmland and driving up prices.  Land values in the Midwest grain belt have gained 25-30% in just the past year, and auctions draw intense bidding for available ground.  Real estate investment trusts (REITs) focused on farmland, such as Farmland Partners (FPI, 13.83), have also been strongly appreciating.

COVID-19:  Official data show confirmed cases have risen to  493,765,532 worldwide, with 6,159,580 deaths.  In the U.S., confirmed cases rose to 80,209,061, with 982,585 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 217,955,850, equal to 65.6% of the total population.

Virology

• In the U.S., the seven-day average of people hospitalized with a confirmed or suspected COVID-19 came in at 15,383 yesterday, down 27% from two weeks earlier.
• Even though new cases and hospitalizations remain low in the U.S., the Omicron BA.2 variant that has been sweeping through parts of Europe and Asia is starting to boost cases in the northeast U.S.  The mixed signals are prompting officials to warn that BA.2 will likely lead to a more viral transmission.  There is hope among public-health experts that warming weather and built-up immunity in the population are muting the variant’s impact.
• In China, the authorities recorded more than 16,400 new local cases on Monday, the highest daily tally in mainland China in more than two years. Over 80% of the latest daily cases were in Shanghai.

Economic and Financial Market Impacts

• Also in China, new data shows the government’s strict lockdowns have had a devastating effect on the country’s service sector.  As shown in the data tables below, the March Caixin services PMI dropped all the way to 42.0 from 50.2 in February.  Like all major PMIs, the Caixin services PMI is designed so that readings below 50 point to contracting activity.
• Separately, the lockdowns are also exacerbating serious shortages of fertilizer, labor, and seeds, just as many of the country’s biggest agricultural provinces prepare for their crucial spring planting season.  According to official data, as many as a third of farmers in northeastern Jilin, Liaoning, and Heilongjiang provinces have insufficient inputs after authorities sealed off villages to fight the pandemic.

U.S. Policy Responses

• As early as today, the Biden administration will announce plans to extend until the end of August a pause on federal student-loan payments.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

We open our Comment today with an update on the Russia-Ukraine war, where the newly discovered atrocities by Russian troops continue to reverberate.  Further sanctions against Russia are due to be announced as early as today, while reports say the Czech Republic has sent a small number of Soviet-era tanks to the Ukrainians.  We next review a range of international and U.S. developments with the potential to affect the financial markets today.  We close with the latest news on the coronavirus pandemic.

Russia-Ukraine:  The most recent reports confirm Russian forces continue to withdraw from around the capital city of Kyiv.  They are now redeploying for what will likely be an effort to take control of Kharkiv, the Donbas region of eastern Ukraine, and the entire southern coastline of the country.  In the areas where Russian forces have pulled out, Ukrainian authorities continue to uncover evidence that they committed war crimes against civilians, including rapes, torture, and mass executions.  As we discussed in our Comment yesterday, reports of the atrocities have sparked calls for additional sanctions against Russia.  In addition, several European countries yesterday registered their disgust by expelling large numbers of Russian diplomats.  Germany and France each expelled dozens.  Lithuania even expelled the Russian ambassador.  Ukrainian President Zelensky will make a video speech to the UN Security Council regarding the atrocities today, which could fuel further actions to punish the Russians.  Separately, the continuing war has prompted further military support for Ukraine, including the Czech Republic’s quiet provision of more than a dozen Soviet-era tanks to Kyiv in recent weeks.

• The European Commission today is set to propose broad new sanctions on Russia, including a ban on imports of Russian coal, a cap on the import of potash for fertilizer (also widely purchased from Russian ally Belarus), restricted access to the bloc for Russian land and sea shippers, and a block on some high-tech machinery exports.
• Once the new round of sanctions is announced, attention is expected to turn toward developing a ban on importing oil from Russia. Although many EU countries are still resistant to the idea of cutting Russian oil and gas imports, political momentum for such a move is becoming overwhelming.  A compromise currently being discussed would impose tariffs on Russian oil and/or gas in order to start ratcheting down demand.  The discussions suggest commodity markets will continue to be roiled by the Russia-Ukraine war for the foreseeable future.
• Meanwhile, the U.S. Treasury Department said it would make it more difficult for the Russian government to make debt payments in dollars through U.S. banks, bringing Moscow one step closer to a potential default on its obligations to international investors.
  • The department said it would no longer permit any dollar debt payments to be made from Russian government accounts at U.S. financial institutions. Russia, therefore, must choose between draining its remaining dollar reserves, using new revenue coming in, or defaulting.
  • The Russian government had been due to make an $84 million coupon payment and a $552 million repayment on a maturing bond yesterday, but it was unable to proceed because of the department’s action. Russia now has a 30-day grace period to get the cash to investors before it is in default.
  • Prices for Russian sovereign dollar bonds had rebounded somewhat from their post-invasion slump, but they started falling again today. A bond maturing in 2028 traded at a price of 34 cents on the dollar, down from 42 cents yesterday.
• As we’ve discussed many times before, the war and the resulting sanctions continue to accelerate the breakup of the global economy into two or more blocs: a U.S.-led block of liberal, free-market democracies; a Chinese-led bloc marked by heavy state intervention in the economy and authoritarian politics; and perhaps a group of smaller economies trying to maintain their freedom to maneuver.  Importantly, such fracturing may be hard to reverse once it happens.

Brazil:  State-owned oil giant Petrobras (PBR, $15.15) has been thrown into disarray after the government’s choice of a new chief executive pulled out of the job over conflict-of-interest rules, just a day after the withdrawal of an incoming chair also handpicked by Brasília.

United States-China:  As Chinese regulators continue to show new flexibility in meeting U.S. demands for access to audit records for Chinese companies listed in the U.S., some Chinese firms are reportedly using workarounds to prevent their delisting here.  That has raised hopes for a thaw in U.S.-China capital flows, but it’s important to note that U.S. regulators still need to sign off on the moves.

U.S. Labor Market:  In another sign that the tight labor market has shifted economic power toward workers, an eight-day strike by Sacramento teachers and school staff ended in a tentative deal to boost pay and improve health benefits.  To date, businesses and organizations have been able to absorb the higher cost of compensation and benefits.  Corporate profits remain robust.  Going forward, however, continued high employment costs could potentially cut into profits, spur further inflation, and weigh on stock prices.

• The deal, which the unions and school board will vote on later this week, includes annual 4% pay raises for teachers and staff, plus back pay retroactive to 2019-20 and bonuses.
• Substitute teachers will get 25% higher pay, and the staff contract includes several provisions to recruit more bus drivers, including a $5,000 signing bonus.

U.S. Cryptocurrency Regulation:  As SEC Chair Gensler continues to look for ways to regulate digital currency exchanges, he has asked his staff to explore forcing them to separate their custody and market-making functions.

• To support the effort, Gensler cited statistics showing that some $14 billion in crypto assets were stolen last year, and issues can arise when crypto exchanges trade as principals against their own customers on their platforms.
• Gensler’s continued push for SEC regulation of crypto exchanges is a reminder that the asset class faces significant regulatory risks, despite the growing popularity of digital currencies.

COVID-19:  Official data show confirmed cases have risen to  493,924,905 worldwide, with 6,171,092 deaths.  In the U.S., confirmed cases rose to 81,495,687, with 997,129 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 217,882,466, equal to 65.6% of the total population.

Virology

• In the U.S., the seven-day average of people hospitalized with a confirmed or suspected case of COVID-19 came in at 15,692 yesterday, down 27% from two weeks earlier.
• The Biden administration announced it would soon donate 100 million doses of the children’s vaccine from Pfizer (PFE, $50.94) to poorer countries, but a dispute with Congress means the funding to get the doses delivered to their final recipients is not yet in place.

U.S. Policy Responses

• A group of Senators unveiled a $10 billion proposal to further fund the U.S. response to the pandemic with money repurposed from earlier aid rounds. Although the funding is only about half the amount requested by the Biden administration for vaccines and therapeutics, it would allow the U.S. to purchase supplies ranging from tests to vaccines.  The bill is set to come to a vote in the Senate later this week.

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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 the big news is the apparent discovery of widespread atrocities carried out by Russian troops in the areas they are currently withdrawing from.  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:  Multiple reports over the weekend appeared to confirm that Russian forces are withdrawing from around the capital city of Kyiv and other major urban centers to focus their attacks on the Donbas and other areas in eastern and southern Ukraine.  As the Russians pull back from the western and northern areas of the country, Ukrainian authorities are finding extensive evidence of war crimes, especially in the city of Bucha.  The bodies of civilians were found with their hands tied behind their backs and shot in the head, as well as dead women who had been raped and had their bodies burned.  Other reports have indicated massive looting by Russian soldiers as they pulled out of the area.  Meanwhile, British Prime Minister Johnson told ministers he wants to arm Ukraine with anti-ship missiles to prevent Russian bombardment and attacks on the southeastern port city of Odesa, which was the target of Russian missile strikes over the weekend.

• The well-verified reports of civilian massacres, summary executions, and rapes have given the major European countries a taste of what they’re in for if Russian aggression is left unchecked.  The reports have prompted a range of European countries to consider additional sanctions against Russia, possibly including a ban on Russian energy imports.  For example, French President Macron today said he would be in favor of an EU ban on Russian oil and coal imports.
  • Evidence of heinous acts approaching those of Nazi Germany during World War II will likely spur additional weapons transfers to Ukraine as well.
  • Ultimately, if the fighting intensifies and Russian brutalities expand, it would not be surprising to see increased calls for outright intervention in the conflict.
• Notably, even the widespread evidence of these brutal acts of violence hasn’t been enough to sway China from its support for Russia.  Indeed, as of this writing, the Chinese government has made no statement regarding the apparent war crimes in Ukraine.  On Chinese social media, posts containing images of the atrocities remained available today, with a few users expressing horror at the news, but the Chinese microblogging platform Weibo was filled with posts by prominent bloggers questioning the veracity of the photos of corpses and blaming the violence on Ukrainian “Nazi” fighters.
  • Chinese President Xi is trying to strike a balance between his “limitless” support for Russian President Putin and looking neutral enough to avoid being tied too closely to the Ukrainian invasion and atrocities.
  • Despite Xi’s balancing act, however, his refusal to condemn Russia, despite the ongoing violence, suffering, and war crimes, could well draw increasing opprobrium and help build pressure in the West to impose economic and financial costs on China as well.
  • In other words, by refusing to distance China from Russia, Xi is risking further isolation and a faster fracturing of the global economy into separate blocs, as we’ve been warning.  If so, it would suggest that investors in Chinese securities will face even more risk of a clampdown on capital flows and loss of value, despite recent signs of thawing in the U.S.-China dispute over audits for Chinese firms listed in the U.S.
• Regarding the economic impacts of the war, the sanctions on Russia and the shutoff of Russian mineral supplies continue to push key commodity prices up, even though energy prices have moderated a bit in response to Western countries’ decision to release oil from their reserves and China’s demand-sapping coronavirus clampdowns.  A new report by Farasis Energy says the cost of the nickel, lithium, and cobalt needed for a 60KWh battery, enough for a large SUV, rose from $1,395 a year ago to more than $7,400 in early March.

Hungary:  In elections yesterday, a coalition led by Prime Minister Viktor Orban’s party evidently won 135 of the 199 seats in parliament, giving the Russia-supporting Orban a fifth four-year term in power.  With Orban’s victory, Hungary is likely to put a brake on further EU sanctions against Russia and complicate NATO’s response to the Russia-Ukraine war.

Serbia:  In its elections yesterday, Serbia re-elected hardline populist President Aleksandar Vucic and gave his party the largest number of seats in parliament.  Vucic has come under strong international pressure over his refusal to impose economic sanctions on Russia for its attack on Ukraine.  Even with his re-election, he is not expected to change course dramatically on that stance, given many of his voters sympathize with Russia’s campaign against Kyiv and resent the West, which bombed Belgrade during the Yugoslav wars in 1999.

China-Hong Kong:  As we suggested last week, Hong Kong Chief Executive Carrie Lam said she won’t seek a second five-year term in office in the municipal elections this spring.  Sources say Lam’s deputy, hardline former security minister John Lee, will probably seek the position.  In any case, Lam’s absence from the race will allow Beijing to impose a tougher, security-focused official who would more likely hew the central government’s line on policy.

Pakistan:  Over the weekend, Prime Minister Khan survived an attempted no-confidence vote in parliament, after which the country’s president dissolved parliament to prepare for new elections to be held within 90 days.

Costa Rica:  In elections yesterday, former World Bank economist Rodrigo Chaves came out ahead with 53% of the vote.  Chaves has vowed to renegotiate last year’s $1.8 billion loan from the IMF aimed at supporting the country’s economic recovery from the pandemic, and he has indicated that he wants to strengthen trade ties in the Asia-Pacific region and attract more Chinese tourists.

• Chaves’s party will only have 10 seats in the country’s 57-seat congress, so he will have to rely on coalitions to pass legislation.
• Nevertheless, his plans to strengthen ties with the Asia-Pacific region, and China, in particular, could be a test of how much investor-friendly globalization survives now that the war in Ukraine has accelerated the forces of deglobalization around the world.

U.S. Economy:  In his widely followed annual stockholder letter, Jamie Dimon, CEO of JPMorgan (JPM, $135.31), offered an upbeat read on the U.S. economy, saying consumers and businesses are flush with cash, wages are rising, and the economy is growing rapidly after its pandemic slowdown. Nevertheless, he also warned that the war in Ukraine could collide with rising inflation to slow the pandemic recovery and, consistent with our concerns, potentially alter global alliances for decades to come.

• Separately, high-frequency spending data shows consumers are starting to cut costs on mainstays from toothpaste to baby formula as inflation finally hits consumer staples.
• Meanwhile, investors continue to bet that the Federal Reserve’s panic over inflation will prompt it to hike interest rates aggressively in the coming months, potentially pushing the economy into recession.  As a result, the yield curve solidly inverted late last week (see chart below), and it remains in inversion so far this morning.  At this writing, the yield on the 10-year Treasury note stands at 2.375%, while the yield on the 2-year Treasury note has risen to 2.416%.

Source:  SeekingAlpha.com

Global Government Debt:  As governments around the globe try to shield their citizens from galloping inflation by offering subsidies and other support, their efforts are boosting already high government debt just as borrowing costs are rising. For some countries, the increase may prove too much to afford, raising the specter of political unrest and the risk of debt crises in the future.

COVID-19:  Official data show confirmed cases have risen to  491,498,231 worldwide, with 6,153,320 deaths.  In the U.S., confirmed cases rose to 80,155,446, with 982,566 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who are considered fully vaccinated now totals 217,834,304, equal to 65.6% of the total population.

 In the U.S., the seven-day average of people hospitalized with a confirmed or suspected case of COVID-19 came in at 15,949 yesterday, down 28% from two weeks earlier.

• The new coronavirus wave continues to worsen in some parts of Europe and Asia, particularly in China.  Today, Shanghai began testing all 25 million of its residents for COVID-19, aided by thousands of medical workers who arrived over the weekend from across the country.  The entire city is now effectively under a lockdown that was meant to be in its final days.

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