by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with some interesting new revelations on the weekend’s short-lived rebellion in Russia.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including signs of growing pushback against the European Central Bank’s aggressive interest rate hikes and news of a potential new clampdown on the sale of artificial intelligence-related computer chips to China, which is weighing significantly on technology stocks so far today.

Russia Rebellion: Reports yesterday confirmed that Yevgeniy Prigozhin, the erstwhile ally of President Putin who led his Wagner Group mercenaries in a short-lived mutiny against the Ministry of Defense over the weekend, has landed in Belarus as agreed upon in a deal brokered by Belarusian President Lukashenko to defuse the crisis.  However, the extent to which the Wagner mercenaries will be disarmed or subsumed into the traditional armed forces remains unclear.

• Separately, President Putin claims the deal that convinced Prigozhin to cease his march on Moscow involved paying off him and his fighters with billions of dollars from the Russian government.
• As we have assessed previously, the incident has surely weakened Putin by undermining his popular image as a strong leader who doesn’t brook dissent and doesn’t back down from a fight. Putin’s admission that he paid Prigozhin and the Wagner fighters billions of dollars would likely further undermine Putin’s image.
  • Separately, new reports say Prigozhin initially planned to seize Defense Minister Shoigu and Chief of the General Staff Gerasimov when they visited southern Russia over the weekend. Prigozhin apparently expected that lower-level officers and troops would then swing to his support.  Indeed, he apparently sounded out some top generals about their potential support.  It looks like one of those officials alerted Russian domestic intelligence, forcing Prigozhin to move up his timetable and improvise his mad dash toward Moscow.
  • As if to confirm that scenario, U.S. intelligence has reportedly discovered that one or more senior Russian generals knew about Prigozhin’s plans ahead of time and may even have helped him.
  • If true, the reports suggest the Defense Ministry and the military leadership may be deeply fractured and riddled with dissent. That, too, would weaken Putin politically, although reports today say Putin is carrying out a widescale purge of disloyal officers throughout the military.
• At the same time, it’s entirely possible that Putin is whitewashing the real deal that got Prigozhin to back down. One theory that we find compelling is that the payoff to Prigozhin and his fighters actually came from powerful Russian oligarchs who had much to lose if the country descended into civil war or if Putin were deposed.
• In any case, if Prigozhin remains safely ensconced in Belarus, he will likely remain a political threat to Putin and his government for the foreseeable future.

Eurozone: Italian Prime Minister Meloni, in an impassioned speech to parliament earlier today, lashed out at the European Central Bank for its aggressive interest rate hikes.  According to Meloni, the ECB’s “simplistic” approach to fighting consumer price inflation would hurt Eurozone member countries more than it would help them.  Meloni said today’s high inflation was tied to the last year’s energy price shock, implicitly arguing that the ECB should look past the problem.  In any case, her statement points to growing pushback against the ECB’s plan to keep raising rates in the near term.

France: The suburbs surrounding Paris were wracked by rioting overnight following an incident in which police officers shot and killed a teenager during a traffic stop.  The violence was touched off after citizen video of the killing showed that police killed the driver, who was apparently unarmed, as he attempted to drive away.  Thousands of police have been deployed to control the rioting, which exacerbates the disruptions caused by this summer’s frequent protests against President Macron’s unpopular new retirement system reform.

United Kingdom: Senior physicians working for the National Health Service in England have voted to strike for higher pay next month.  We haven’t written much about the summer of labor action in the U.K. recently, but the latest vote shows that the country (and government) continues to face increased demands from employees in both the public and private sectors.  To the extent that the strikers win higher pay, it will likely bolster the U.K.’s current high price inflation and prompt still more interest rate hikes by the Bank of England.

Japan-China: In another apparent case of Chinese technology theft, a Chinese researcher at Japan’s National Institute of Advanced Industrial Science and Technology (AIST) has been arrested on suspicion of illegally sending research data obtained at the institute to a Chinese company.  The spate of these cases is likely to further worsen relations between China and the major developed countries, which we have frequently argued will likely present risks to investors.

United States-China: As the U.S. clamps down on selling advanced technology with potential military applications to China, sources say Chinese users have developed a large black market in smuggled U.S. computer chips.  The Chinese are reportedly focused on acquiring the graphics processing units (GPUs) needed to train artificial intelligence systems, such as the A100 and H100 from Nvidia (NVDA, 418.76).  The report says the black market has thousands of individual intermediaries sourcing the chips, often at a considerable premium to list prices.

• This news suggests the U.S. technology clampdown will merely slow China’s AI development but probably won’t completely stop it.
• In response, reports say the Biden administration is considering further restrictions on the sale of AI-related chips to China. Any such action would be included in the final rules codifying and expanding the administration’s October export control measures.  Since the new rules would apply even to the less-advanced chips that Nvidia and other makers are currently allowed to sell to China, the news is weighing heavily on semiconductor firms so far this morning.

U.S. Cybersecurity: Cybersecurity experts are becoming increasingly concerned about a recent, little-noticed hack of software firm Progress Software Corp. (PRGS, $54.00).  After Russian hackers broke into the company’s systems and stole sensitive data from hundreds of its corporate customers, investigators expected the criminals to launch extortion scams against them.  However, now it appears the criminals are focused on sensitive personal data that could be used, in conjunction with deepfake software, to launch more lucrative extortion scams against masses of individuals.

U.S. Uranium Market: As we wrote in our Bi-Weekly Geopolitical Report from May 15, 2023, we think global uranium prices will be buoyed in the coming years by heightened U.S.-China tensions and a potential new nuclear arms race between the two countries.  As if to confirm that viewpoint, a number of nuclear-related asset prices have recently been climbing.  The latest data shows spot prices for uranium (triuranium octoxide) are up roughly 18% year-to-date, while the share price for Canadian uranium miner Cameco Corp. (CCJ, $29.58) is up 29%.

U.S. Private Credit Market: Moody’s (MCO, $338.83) has issued a report warning that the young private credit industry faces its first serious challenge as tens of billions of dollars of loans underwritten at the top of the market in 2021 are strained by sharply higher interest costs and a slowing economy.  Nevertheless, the credit rater didn’t downgrade its ratings or outlook for any of the major, publicly traded firms in the sector.

U.S. Supreme Court: As we noted in our Comment yesterday, investors are still bracing for the release of several key decisions over the coming days before the court ends its current term on Friday.  The expected decision with perhaps the most implications for businesses will relate to the legality of affirmative action in college admissions.  Whatever the justices rule, the decision is likely to affect affirmative-action policies in corporate settings as well.

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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 Russian political stability following the weekend rebellion by Wagner Group mercenaries.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including fresh signs of further interest rate hikes in the Eurozone, the likelihood of currency market intervention in Japan, and some unexpected good news for office valuations in New York City.

Russia: In the aftermath of the short-lived weekend mutiny by Yevgeniy Prigozhin and his Wagner Group mercenaries, President Putin and Prigozhin himself spent yesterday trying to spin the events to their favor.  In a televised statement, Putin pilloried Wagner for threatening bloodshed and extolled the Russian people for rallying around their government, despite clear evidence that many Russians were indifferent to Putin’s fate and supported Prigozhin.  Meanwhile, Prigozhin insisted he had never tried to topple the government itself, despite the fact that his troops marched to within 125 miles of Moscow and killed over a dozen Russian aviators.

• Having survived the rebellion, at least for now, Putin has tried to go on the offensive against Prigozhin, initially announcing through his government that the Wagner leader still might be arrested and offering the Wagner troops just three options: sign up as regular soldiers in the official armed forces, go home, or follow Prigozhin into exile in Belarus. The Putin government today also said that Wagner’s heavy weapons would be transferred to the national guard.
• In any case, Putin’s statement suggests Wagner is finished as an independent, organized force. A key question will be whether Prigozhin accepts that fate as it would render him completely powerless.  As we mentioned in our Comment yesterday, the crisis in Russia’s leadership is almost certainly not yet over.

Russia-Bulgaria: Bulgarian Economy Minister Bogdan Bogdanov suggested Russia may have been behind the explosion and fire that struck another weapons factory over the weekend.  As Bulgaria has helped Ukraine arm its military in recent years, a number of the country’s defense industry facilities have suffered mysterious mishaps that are widely seen as Russian sabotage.

Eurozone: At the European Central Bank’s annual conference in Portugal today, ECB President Lagarde said tight labor markets, rising wages, and sticky price inflation will require “persistent” new interest rate hikes in the coming months.  The statement provides additional evidence that the ECB’s benchmark rate will continue to move higher from its current level of 3.5%.  If the Federal Reserve continues to slow its rate hikes, or if it stops them altogether, the additional rate hikes in the Eurozone could help push the value of the euro beyond its current resistance level of approximately $1.10 per dollar.

• Despite the hawkish stance taken by Lagarde and many other key central bank leaders, IMF Deputy Managing Director Gopinath warned at the conference that they may need to pull their punches and allow inflation to remain above the 2% target for some time if rate hikes threaten to cause a financial crisis.
• According to Gopinath, the central bankers risk being faced with a stark choice between solving a future financial crash among heavily indebted countries and raising borrowing costs enough to tame stubborn inflation.

Japan: With the yen continuing to lose value, top currency official Masato Kanda yesterday said he would not rule out any options regarding intervention in the currency market, and Finance Minister Shunichi Suzuki today said the authorities would “respond appropriately” if the drop becomes excessive.

• So far today, the yen is trading at approximately 143.57 against the dollar, down almost 11% from its most recent high early this year.
• The yen is still a bit stronger than the 150.15 per dollar level that it hit last October before the government stepped in to buy up yen and sell foreign reserves to prop up the currency. Nevertheless, it is looking increasingly likely that the Japanese government could soon intervene in the currency markets again to prop up the yen.

Indonesia: President Widodo has indicated in a speech that he won’t back down on a new law that bans the export of bauxite ore despite concerns that China could file a complaint about it at the World Trade Organization.  The law forces miners to refine their bauxite into aluminum before it can be exported, thereby creating domestic manufacturing jobs.  It is similar to an older rule banning the export of raw nickel ore.  The rules exemplify the growing global trend toward industrial policy that intervenes in the free market to bolster domestic industrial development.

United States-China: U.S. Treasury Secretary Yellen plans to visit Beijing in early July to meet with her new Chinese counterpart, according to press reports.  The meeting would mark another step in the Biden administration’s efforts to ease tensions with China, or at least to been seen as doing so.  However, if the meeting happens, it could come just before the administration announces new measures aimed at further curtailing U.S. investments in China.  Prospects for improved relations from the meeting therefore seem low.

U.S. Dollar: The latest annual survey of central banks by the Official Monetary and Financial Institutions Forum (OMFIF) found that reserve institutions managing almost $5 trillion of assets combined expect the U.S. dollar to decline only gradually as a proportion of global reserves over the coming decade.  The surveyed banks estimate the greenback will still account for 54% of total global reserves in 10 years’ time compared with 58% currently.

U.S. Stock Market: Just in the month through yesterday, investors have now bought more call options on the VIX volatility index than in any other month on record.  The data suggests that investors are becoming more concerned that stock prices could turn volatile after a relatively smooth, technology-driven run up for the year to date.  Since we continue to believe the economy is likely to slip into recession in the second half of the year, we would not be surprised if the U.S. stock indexes stage a significant retreat in the coming months.

U.S. Commercial Real Estate Market: Rising interest rates and work-from-home trends continue to batter office owners and commercial real estate lenders, but real estate investment trust SL Green (SLG, $28.20) has managed to sell its stake in a prime New York City office tower at a price that values the building at $2 billion.  The price was only a modest decline from the building’s previous value, giving a healthy boost to much of the REIT sector in trading yesterday, including a 19.8% jump in SL Green shares.

U.S. Supreme Court: With the court wrapping up this year’s term on Friday, investors are bracing for the release of several key decisions over the coming days.  The expected decision with perhaps the most implications for businesses will relate to the legality of affirmative action in college admissions.  Whatever the justices rule, the decision is likely to affect affirmative-action policies in corporate settings as well.

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