by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EST] | PDF

In today’s Comment, we open with Federal Reserve Chair Powell’s testimony to Congress yesterday, which contributed to the day’s big pullback in risk assets (which is on track to be at least partly reversed today).  We next review a range of international developments, most of which focus on national security threats.  Finally, we take a look at the latest developments regarding the coronavirus pandemic and the new Omicron mutation.

U.S. Monetary Policy:  In testimony before the Senate Banking Committee yesterday, Fed Chair Powell signaled he has come around to the idea that today’s high inflation rates may not be temporary.  It may be appropriate to start withdrawing monetary stimulus more quickly than policymakers had planned.  Specifically, Powell suggested the Fed’s bond-buying could be wrapped up months earlier than anticipated, allowing the benchmark fed funds interest rate to be raised in the first half of 2022.

• Coming on top of the latest red flags regarding the new Omicron variant of the coronavirus, Powell’s unexpectedly hawkish comments helped drive risk assets sharply lower yesterday.  His comments also undercut what otherwise would likely have been strong bond-buying from investors spooked by Omicron.
• Powell will continue his testimony before the House Financial Services Committee today, so investors will be watching closely to see if he reiterates his statements, tries to soften them, or even doubles down on them.  Going forward, the policymakers at the Fed will have a tough time threading the policy needle between hiking rates to tamp down demand and cool inflation pressures while still keeping policy loose enough to preserve economic growth in the face of Omicron.  In any case, the apparent shift toward tighter monetary policy could well keep markets volatile in the coming days and weeks.

U.S. Financial Conditions:  In a sign that consumer spending could keep driving the economy, a survey by the New York FRB found that almost 27% of U.S. consumers had applied for a credit card in the 12 months ended in October. That is the highest level since 2019 and well above the record low of 16% recorded a year ago.

United States-China:  For the first time since the Ronald Reagan Presidential Foundation and Institute began surveying Americans about national security four years ago, a majority of Americans—52%—named China as the nation posing the greatest threat to the U.S., while Russia came in at a distant 14%.  In other findings:

• Some 37% of those polled listed East Asia as the region where the U.S. should dedicate most of its military forces.  The Middle East came in second, with 17%.
• The survey found that 45% of Americans have a “great deal” of trust in the military, a drop from 70% three years ago. An additional 10% of respondents said they had “not much” trust in the military, compared with 2% three years ago.

China-Taiwan-Japan:  At a conference on Taiwan, former Japanese Prime Minister Abe said a Chinese attack on the island would constitute an “emergency” for Japan and the U.S.-Japan security alliance.

• Abe’s comment echoes statements by other key Japanese politicians in recent months that suggest Chinese aggression against Taiwan would be enough to meet the threshold for military action in Japan’s pacifist constitution.
• In fact, Abe went even further, advocating for a trilateral security dialogue between Japan, Taiwan, and the U.S.  Previously, Japanese leaders have shied away from such a proposal out of concern over antagonizing China.
• Abe remains a key player in Japan’s ruling Liberal Democratic Party, so his statements provide more evidence that Japanese leaders are toughening their stance against China’s geopolitical aggression in the Indo-Pacific region.  Indeed, Japan is rapidly becoming perhaps the linchpin ally for the U.S. in its effort to counter Chinese ambitions.

Russia-NATO:  As NATO foreign ministers meet to discuss a strategy to address Russia’s threatening stance toward Ukraine, Russian President Putin warned he would respond if NATO continued building up its infrastructure in the region, holding joint exercises, and providing advanced weapons to Ukraine.  Perhaps to drive home the point, Belarus has announced it will conduct joint military exercises with Russia on its southern border with Ukraine.

• As Putin tries to pressure Ukraine into submission as a part of Russia’s sphere of influence again, he has become perturbed by NATO countries’ support for Kiev, including new, advanced weapons systems that the Ukrainians have recently deployed against pro-Russian separatists in the country’s east.
• Putin’s buildup of forces around Ukraine could be meant to merely intimidate Kiev and warn off the NATO countries, but it is nevertheless building up tensions.  On top of that, U.S.-Russia relations remain tense, with Russia today announcing it will expel more U.S. diplomats in the latest in a series of tit-for-tat expulsions.
• In any case, such standoffs always carry the risk of escalation or miscalculation.  Rising tensions with Russia, therefore, are likely to be an added worry for investors as they continue trying to assess the new Omicron mutation of the coronavirus, rising inflation, and the prospect for tighter monetary policy around the world.
• There are also domestic political ramifications in the U.S., where Republicans in the Senate are blocking confirmation of dozens of President Biden’s foreign-policy nominees and disrupting approval of the annual defense authorization bill to protest the president’s decision not to sanction Russia’s Nord Stream 2 natural gas pipeline to Germany.

Turkey:  The Turkish central bank today announced it would return to intervening in the currency markets to prop up the plunging lira, despite its limited foreign reserves.  The announcement boosted the currency around 5% to approximately 13.2 per dollar, but that still left it down more than 40% for the year to date.

Afghanistan:  A new UN report forecasts that Afghanistan’s gross domestic product will contract by one-fifth over the next year, representing one of the worst downturns in history.

• The report attributes the expected decline to a number of factors, including not just the withdrawal of U.S. troops and aid last summer but also the impact of frozen assets, Taliban economic policies (such as restrictions on women working), drought, and the coronavirus pandemic.
• Whatever the cause, the economic crisis threatens to spark political and social instability within Afghanistan, potentially setting the stage for a new regional refugee crisis and increased terrorist activity.

COVID-19:  Official data show confirmed cases have risen to 263,003,778 worldwide, with 5,219,663 deaths.  In the U.S., confirmed cases rose to 48,560,280, with 780,241 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 have received at least their first shot totals 233,207,582.  The data show that 70.2% of the U.S. population has now received at least one dose of a vaccine, and 59.4% of the population is fully vaccinated.

Virology

• As scientists race to better understand the new Omicron mutation of the virus, they are paying close attention to cases in southern Africa, where the variant was first discovered on November 9.  New infections in South Africa totaled 4,373 yesterday, compared with less than 250 in the first few days of November.  Experts estimate Omicron is responsible for about 90% of the new infections in the country.
  • Salim Abdool Karim, director of the Centre for the AIDS Programme of Research in South Africa and one of the country’s leading epidemiologists, said on Monday he expected cases to reach 10,000 a day by the end of the week.
  • Another troubling trend is that many people who had earlier been infected with the Delta variant of the virus are now coming down with the Omicron variant.
• Meanwhile, the Biden administration is reportedly considering stricter COVID-19 testing requirements for travelers entering the U.S., including U.S. citizens, to slow the spread of the emerging Omicron variant.
  • The rules under consideration would require all travelers, regardless of their vaccination status, to present a negative test within 24 hours of boarding a plane to the U.S., rather than the 72 hours currently allowed for vaccinated travelers, the people said.
  • Travelers could also be required to take a second test three to five days after arriving in the U.S.
• In vaccine politics, a federal judge in Louisiana imposed a temporary injunction against the Biden administration’s mandate that all healthcare workers at facilities participating in Medicare and Medicaid be vaccinated.
• An outside panel of scientific advisers narrowly recommended the FDA authorize an experimental oral antiviral from Merck (MRK, $74.91) and partner Ridgeback Biotherapeutics LP.  The treatment is about 30% effective at reducing the risk of hospitalization for those infected with the virus.  If the FDA accepts the recommendation and authorizes the drug, it would be for high-risk patients only.

 Economic and Financial Market Impacts

• In its latest semiannual Economic Outlook, the OECD warned that the Omicron mutation could intensify the global supply chain disruptions that have been pushing up inflation and slowing economic growth.  Although the organization made little change to its growth forecasts, it said it now expects inflation mostly in the rich, developed countries of the OECD to average 4.4% in 2022, up from 3.9% previously.

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