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 a key focus is now on the risks to a major nuclear energy plant in eastern Ukraine.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a few additional words on Federal Reserve Chair Powell’s speech at the Jackson Hole symposium on Friday.

Russia-Ukraine:  Depleted and combat-weary forces from both Russia and Ukraine continue to make only the most minimal territorial advances along their front lines, although both sides continue to use long-range missile and artillery strikes to weaken the other side.  Notably, shelling continues in the area around the Zaporizhzhia nuclear power plant, with both sides accusing the other of putting the plant in danger.  Meanwhile, media reports say a newly formed 3^rd Army Corps composed of recent volunteers from around Russia is now ready to deploy to Ukraine with highly advanced weaponry, although analysts are doubtful that the quickly trained troops will be competent enough to turn the tide of the war.

• Today, the UN’s International Atomic Energy Agency is due to send a team to the Zaporizhzhia nuclear plant to assess its condition.  Led by IAEA Chief Rafael Grossi, the team will also check safety and security systems and evaluate staff conditions.
• On the energy front, the CEO of Shell (SHEL, $54.88) warned that Europe’s energy crisis will last several years at least, even if it gets through this winter.  According to the executive, “It may well be that we have a number of winters where we have to somehow find solutions through efficiency savings, through rationing, and a very, very quick buildout of alternatives.”
  • With Europe facing extremely high energy prices, rationing, and increased interest rates, investors continue to push down the euro.  Investors also continue to bet on further depreciation in the common currency, with net short positions against the euro now at their highest level since the start of the coronavirus pandemic in early 2020.
  • The euro is staging a very modest rebound so far this morning, but it remains below par with the dollar at just $0.9996.

China-Solomon Islands-United States:  Earlier this month, The U.S. Coast Guard said the Solomon Islands failed to respond to an official request for one of its cutters to make a routine port call for replenishment, forcing the vessel to make its port call in Papua New Guinea.

• The refusal to grant permission to dock could be related to a secretive new security agreement struck between China and the Solomon Islands earlier this year.
• The incident suggests China may be requiring the Solomon’s government to distance itself from the U.S.  In return, China could support Solomon’s President Sogavare in his effort to delay his country’s next elections and stay in power.
• In any case, the matter illustrates how the South Pacific islands are becoming a key theater in the U.S.-China rivalry.  It also highlights how countries around the world are being pressured to ally themselves with either the U.S. or China.

United Kingdom:  In the race to succeed Boris Johnson as Conservative Party leader and prime minister, front-runner Liz Truss, the current foreign minister, is coming under increased pressure to outline her plan to support British families facing enormous energy bills this winter.  Truss has tried to hold the line against providing new cash “handouts,” preferring to provide tax cuts instead, but the opposition Labor Party is hammering her for the way that plan could provide outsized benefits to upper-income Brits.

Serbia-Kosovo:  Over the weekend, Serbia and Kosovo reached a deal to resolve administrative hurdles both sides had slapped on their neighbor’s citizens or threatened to do so.  Serbia agreed to abolish entry/exit documents for Kosovo ID holders and Kosovo agreed not to introduce them for Serbian ID holders.  The deal diffuses a flashpoint that could have spiraled into violence just as Europe is already dealing with the war in Ukraine.

Pakistan:  The Pakistani government says it has now secured the $37 billion in loans and investments needed to secure an additional $4 billion loan from the IMF to cover its budget shortfall for the current fiscal year.  IMF officials today will vote on approving the deal.  Securing the new funding means Islamabad now has pushed off the threat of a near-term default, although it still faces financial risks in the medium term because of issues like its fractious political dynamics and recent flooding.

Brazil:  Last night, current right-wing populist President Bolsonaro and leftist former President Lula da Silva squared off in their first debate ahead of this fall’s presidential elections, along with four minor candidates.  Bolsonaro has recently been trailing da Silva badly in the polls, but press reports suggest he landed a few blows by painting the former president as corrupt.  Meanwhile, da Silva stressed how good Brazil’s economy had been under his administration.

U.S. Monetary Policy:  In his keynote address at the Kansas City FRB’s annual conference in Jackson Hole, Wyoming, on Friday, Fed Chair Powell poured buckets of cold water on the idea that U.S. monetary officials would pivot to easier policy anytime soon.  Powell not only signaled that the Fed will keep raising rates until they are high enough to restrain economic growth but will hold them there until inflation pressures come down significantly, even at the risk of pushing the economy into recession.  Isabel Schnabel, the German member of the European Central Bank’s executive board, drove home the point in her speech on Saturday.  According to Schnabel, the cost of inflation is so high that central banks must act decisively to stop it, without fear of causing a recession.

• The speech sparked a sizable pullback in risk assets on Friday, and we suspect it could continue to weigh on stock prices in the near term.
• Indeed, stock futures are down approximately 1% at this writing, and the 10-year Treasury note has risen to a two-month high of 3.116%.

U.S. Energy Policy:  The California legislature this week is set to vote on whether to extend the life of the state’s sole remaining nuclear generating station beyond its planned closure in 2025.  Governor Newsome has recently reversed course and called for extending the life of the plant amid rising electricity demand and reduced availability of electricity from other sources, such as hydroelectric.  A vote in favor of keeping the plant open would add to the recent momentum toward nuclear power not only in the U.S. but globally.

U.S. Space Program:  Earlier today, NASA was forced to temporarily scrub the planned launch of its Artemis I rocket for a trip to the moon, based on unresolved problems with the rocket’s engines.  Getting the program back on track would help ensure the continuance of the program, along with hefty revenue streams to its major aerospace contractors, even though it has been criticized for its cost.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment examines why Thursday’s economic data could encourage the Fed to raise rates more aggressively. Next, we explain how elections in Russia could impact its war with Ukraine. We conclude the report by discussing the U.S.-China rivalry and how it could impact Asia.

More Hikes? The positive Gross Domestic Income (GDI) report for Q2 could overshadow the negative Gross Domestic Product (GDP) numbers and pave the way for more Fed tightening.

• An alternative measure of economic output has bolstered the Federal Reserve’s claim that GDP might not reflect the underlying fundamentals of the economy. In the second quarter, GDI, adjusted for inflation, rose at an annualized rate of 1.4% from the previous period. The number contradicts the GDP reading of a 0.6% drop in economic activity in the same period and suggests that the economy may not have contracted at all this year. In an ideal world, the two numbers should be identical, as total spending should equal total income. However, statistical differences between the two variables have widened to levels never before seen in the series history.

• A strong labor market might be responsible for the divergence between the real GDP and real GDI. While GDP is the sum of the total market value of all the final goods and services produced, GDI is the aggregate income earned and cost incurred during production. In theory, the latter should reflect the underlying labor market strength. Although the initial claims have risen over the last few months, many workers that reentered the workforce were able to find jobs quickly. As a result, the tight labor market may have shielded the economy from the negative impacts of monetary tightening.
• The positive GDI number could push the Fed to raise interest rates aggressively over its next few meetings. St. Louis Fed President James Bullard has insisted that the central bank should lift its policy rate to 4.0%. Kansas City President Esther George has advocated that the bank should go even further. Assuming that the FOMC follows Bullard’s lead, it would suggest that they could raise rates by 50 bps in each of its next three sessions. Hence, financial conditions could tighten significantly throughout the rest of the year and possibly worsen in 2023.

The market will be on pins and needles when Fed Chair Jerome Powell gives the keynote address at the Jackson Hole Symposium. Over the last two days, investors have purchased more than    $1 billion in short-term bond ETFs and have pulled over $2 billion from ETFs attached to the S&P 500. So far, it is speculated that Powell will make hawkish comments during his speech; however, a dovish tone could lead to a strong rally.

Russia-Ukraine: The Kremlin is ramping up pressure in Ukraine to solidify gains before election season for Russia begins in September.

• Russian President Vladimir Putin signed an order to boost the Russian troop total by 137,000 to 1.15 million. It was the first time that Putin had expanded the military headcount in over five years. The new decree has added to speculation that Russia believes that the war will be protracted. However, there is also the possibility that the order could be a bluff. Russia has not been able to take over Ukraine as swiftly as it initially implied it would. In short, Putin likely has a credibility problem. The war has lasted six months despite assurances from Putin that the conflict would only be a few weeks. Additionally, the government was forced to delay annexation referendums in Donbas due to its inability to secure the region properly. Thus, the Kremlin’s decision to increase the number of troops could be a way to signal to its population that the Russian military is still determined to win.
• The Moscow exchange plans to allow evening trading next month. Stock trading was halted for a month after the conflict began as the government attempted to hide the financial damage of the war. The government then began to allow limited securities trading in the morning sessions. The Russian Central Bank has maintained that regulators will block investors from “unfriendly” countries from trading on the exchange. The move to open the market for a full day reflects the government’s attempt to show a return to normalization after the invasion of Ukraine.
• Ukrainian President Volodymyr Zelensky has stated that the world narrowly avoided a radiation disaster. On Thursday, Ukraine’s largest power plant was forced to disconnect after fires damaged a transmission line. The incident has heightened concerns that the war could lead to a major nuclear disaster as Russian forces continue to use the power plant as a shield against attacks from Ukrainian troops. In addition, there was a mass power outage in areas nearby. A nuclear accident in Ukraine could lead to a global crisis and possibly slow the global push to use nuclear energy in other countries.

Elections are essential, even for authoritarian governments. Regional elections will take place on September 11, and this will be the first time Russian constituents are able to showcase their level of satisfaction with the government. A low turnout would suggest that the war has dented sentiment in the country. It could also force Putin to take more extreme measures to end the war as he prepares to run for reelection in early 2024.

Asia Risks: Friction between the U.S. and China remains the top risk in Asia.

• Regulators in the U.S. and China achieved a breakthrough in negotiations to keep Chinese firms listed on American exchanges. Chinese regulators have requested major accounting firms to bring relevant audit documents of Chinese firms to the U.S Public Company Accounting Oversight Board. The order will prevent Chinese companies from being delisted from American exchanges. Although this is a positive development, it does not change the trajectory of the U.S.-China relationship.
• Tensions between the U.S. and China continue to escalate as U.S. lawmakers continue to travel to Taiwan. Senator Marsha Blackburn (R-TN) is the third politician to travel to the self-governing island this month. House Speaker Nancy Pelosi (D-CA) and Senator Ed Markey (D-MA) also made the trip. China responded to the Pelosi trip by holding military exercises near Taiwan. Thus, Blackburn’s trip could also have a similar response. The big takeaway is that American lawmakers believe it is politically beneficial to poke China in its eye over Taiwan. Although China’s reaction has been mild, relative to its threat to the U.S. “not to play with fire,” their response to such provocation could escalate after President Xi is sworn in for a third term. Therefore, we still believe the risk of conflict between the U.S. and China remains elevated.
  • Additionally, China has urged the U.S. not to engage India in planned military drills along the two countries’ shared border, referred to as the Line of Actual Control (LAC). China believes that such exercises would violate the Beijing-New Delhi accords.
• China’s assertiveness has finally pushed Japan to ramp up its defense budget drastically. The Japanese government will double its defense spending over the next five years to address national security threats. In June, the government released a report showing the country’s concern about the Russia-Ukraine war, China’s intimidation of Taiwan, and their vulnerable supply chain technology. Behind only the U.S. and China, Japan will have the third largest military budget in the world.

The rivalry between the U.S. and China could lead to a broader war in the Indo-Pacific. Many countries in the region fear China’s rise as a military power and look to expand their capabilities in the event of a conflict. Although we do not expect tensions to rise significantly over the next few months, we do believe that the Chinese will become more assertive after the National Party Congress in the fall. The increase in defense spending likely favors our analysis that defense industries are positioned to benefit from increased global tensions.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment begins with an explanation as to why traders believe that central banks will become more hawkish over the next few months. Next, we review the ramifications of President Biden’s student loan forgiveness program. Lastly, we will give our thoughts as to whether the U.S. should intervene in Ukraine to protect the country’s nuclear power plant and what it could mean for financial markets.

 A Hawkish World: Market participants have placed bets that major central banks will raise rates aggressively in their next meetings.

• A day before Federal Reserve Chair Jerome Powell is set to speak at Jackson Hole, investors have dampened expectations that the central bank will alter its policy path. There has been speculation that the Fed will stop tightening late this year or early next year due to the poor economic data and a reduction in inflation. However, recent comments from Fed officials have tapered down those expectations. For example, Kansas City Fed President and voting member Esther George advocated that the Fed should discuss the pace of future rate hikes but continue to raise rates until inflation is firmly under control.
  • Investors have already baked in the possibility of a pause in 2023. Thus, Powell’s remarks stating the contrary could lead to a violent reaction from markets. In the chart below, the green line represents the implied three-month LIBOR rate from the two-year deferred Eurodollar futures, and the red line shows the fed funds target rate. The Fed usually begins to cut rates once the two lines cross. Although the model does not signal an imminent rate cut, the finish line is clearly in sight.

• In Europe, elevated inflation has led money market funds to place bets that the European Central Bank will raise rates by 100 bps by its October meeting. That would put the central bank’s key rate at 1.00%, the highest level in over a decade. The bank has faced pressure to become more hawkish after inflation in the Euro area outpaced the U.S. in July for the first time since the pandemic. Additionally, the increase in energy prices due to the Russia-Ukraine war still threatens to worsen European inflation in the winter. If the ECB raises its policy rate, the rise in borrowing costs will likely hurt riskier southern European economies disproportionately. In other words, investors will demand an additional risk premium to lend to those countries due to their high debt burdens and relatively weak economies.
• • Investors have piled onto bets that Italian bonds will fall. The total value of Italian bonds that traders have wagered against has hit its highest level since the financial crisis. The prospect of higher European interest rates and a return of right-wing populists to power has added to investor concerns that the country may struggle to repay its debts.
• Chinese regulators have pressured banks not to sell the yuan in order to prevent further devaluation of the currency. The slowdown of the Chinese economy coupled with hawkish U.S. monetary policy have pushed the yuan down against the dollar. Currency depreciation, especially for commodity importers, can add to inflationary pressures because most goods are priced in dollars. As a result, if the currency continues to drop against the dollar, the People’s Bank of China could be forced to remove monetary accommodation, which would lead to slower GDP growth for China and could hurt the global economy.

The strong dollar poses a significant threat to international equities, particularly as oil and gas prices remain elevated. Because Fed tightening has contributed to the dollar surge throughout the year, a reversal could provide a tailwind for struggling economies. That said, Fed officials have made it clear over the last few weeks that it would like inflation to drop before it decides to reverse course. As a result, we maintain our position that the current investing environment does not favor international equities.

Student Loan Debt Relief: President Biden announced student loan forgiveness of up to $10,000 for students making under $125,000 a year.

• The debt forgiveness program will likely have minimal impact on financial markets. Only 13.5% of the population has student loan debt, therefore, it does not impact many people. So far, economists have not been able to show any significant economic effects. Bloomberg estimates show that the executive order could add up to 0.2% to annual inflation. However, there is a possibility that consumer confidence could receive a temporary lift. Thus, from an economic standpoint, the order is fairly insignificant.
• There is speculation that the student loan forgiveness program could provide some relief for the housing market. Although the recent home-price surge has disproportionately hurt young adults, most of the proposed debt relief will not go to low-income households. As a result, the financial positions of the most vulnerable potential homebuyers will not change significantly because of this executive order.

(Source: Strategas)

• The program could impact President Biden’s reelection ambitions if he decides to run again in 2024 but will likely not change the outcome of mid-term elections in the fall. Millennial and Gen Z voters make up a vital block for Democrats; however, recent polling has shown that these groups’ enthusiasm has dipped significantly since the 2020 election. Although President Biden has seen a recent surge in popularity, the Democrats are still heavily favored to lose the House and are only slightly favored to maintain the Senate.

The recent decision by the President to forgive student loans will have political ramifications. Essentially, Biden has decided to show favoritism to a critical voting bloc. Although this is not unusual for a president, especially when elections are near, it does raise the likelihood of a potential voter backlash during mid-term elections in November. Generally speaking, a deadlocked Congress is favorable to equities because it means that laws will be unlikely to change significantly. Hence, a Republican takeover of either or both houses in Congress should be viewed favorably by markets.

Russia-Ukraine Update: Russia has raised the stakes of its invasion of Ukraine with its seizure of the Zaporizhzhia nuclear plant.

• Russian forces have occupied the Zaporizhzhia nuclear plant for six months. The power plant is the largest in Europe and contains six of Ukraine’s 15 functional reactors. The country has relied on nuclear power for its energy needs to reduce its dependence on Russia. Thus, Russia’s occupation of the area poses a severe risk to Ukraine’s power supply. If the Kremlin decides to take the plant offline, citizens would be forced into a virtual blackout. Although this scenario has yet to bear fruit, there is speculation that Russia could attempt this in the winter.
• President Biden has received calls for the U.S. to aid Ukraine in its effort to remove Russian troops from the power plant. Ukrainian and former U.S. government officials have urged the White House to send military personnel to secure the site and protect the International Atomic Energy Agency inspectors.

A nuclear disaster at the power plant could disrupt the global supply chains, hinder food production, and make energy problems much worse. Although it is unlikely that the U.S. would send military to help secure the area, President Biden will likely be forced to step in if the situation deteriorates into a global crisis. A potential nuclear disaster could have a seismic impact on financial equities. We will continue to monitor this situation closely.

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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.  Today is Ukraine’s national Independence Day and marks six months since the start of the war.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including the European drought, tension in Brazil, and the latest student loan forgiveness program.

Russia-Ukraine:  Russian and Ukrainian forces continue to make only limited attacks and territorial gains against each other, but momentum continues to shift gradually toward the Ukrainians.  One piece of evidence in that regard is that Russia has reportedly been forced to transfer more national guard forces to the Russia-supporting province of Luhansk in eastern Ukraine to maintain order as more citizens there begin to oppose the war.  Separately, reports indicate that Russian President Putin has lost so much trust in Defense Minister Shoigu that he has taken direct control over many of the Russian units fighting in Ukraine.

• In an address today to mark Ukraine’s Independence Day, President Zelensky said the country had been reborn because of Russia’s invasion, and he defiantly vowed that Russian forces would be pushed out of all Ukrainian territory. As if to emphasize the point, Ukrainian forces destroyed another Russian ammunition dump in occupied territory in the country’s east.

European Drought:  A new report by an EU research center says about 47% of the EU is under drought warning conditions and 17% in drought “alert,” meaning vegetation and crops are being affected.  The report also warns that the drought is having a severe impact on hydroelectric production and is threatening the cooling systems of other energy facilities.  The report projects that the drought will persist until November, prolonging the risk of food production disruptions, high energy prices, and the associated economic headwinds.

United Kingdom:  As Foreign Minister Liz Truss and Former Chancellor Rishi Sunak continue to battle it out to succeed Boris Johnson as Conservative Party leader and prime minister, the prolonged mudslinging is starting to erode popular support for the party.  The latest polling shows support for the opposition Labor Party is currently 12 percentage points higher than the support for the Conservatives. However, although there is still some chance that the Conservatives could recover once their leadership race ends in a couple of weeks.

Japan:  Prime Minister Kishida reportedly plans to announce that Japan will not only restart several nuclear power plants shuttered after the 2011 meltdown at Fukushima but will also start studying the construction of new, modern plants.  The move would mark a major policy shift in Japan, which had virtually shut down its nuclear sector after the Fukushima disaster.  The move could also be a harbinger of a broader re-embrace of nuclear power globally.

China-Vietnam:  Sources say Apple (AAPL, $167.23) is in talks to produce its Apple Watches and MacBooks in Vietnam as it expands its effort to diversify production away from China.  Even though Apple is still reluctant to stray too far from China, its effort to move more production to Vietnam illustrates how Western countries are increasingly wary of putting all their eggs in the Chinese basket as U.S.-China tensions worsen.

Brazil:  In a major escalation of political tensions, Brazil’s electoral court ordered searches of the homes of several prominent businessmen over their alleged support for an undemocratic seizure of power if President Bolsonaro loses his re-election bid this autumn, as anticipated.

United States-Iran:  In the negotiations to restart the 2015 deal limiting Iran’s nuclear program, U.S. diplomats said “gaps” remain in Iran’s response to the EU’s “final draft” of a new deal, despite some progress being made.  Given that Iran evidently continues to make progress on its nuclear development, which would reduce the benefit of a new deal, it is looking increasingly unlikely that a substantive new agreement will be reached.

U.S. Monetary Policy:  At an event yesterday, Minneapolis FRB President Kashkari said that when consumer price inflation is as high as it is now, the Fed should err on the side of tighter monetary policy and not worry too much about putting the economy into recession.  Even though Kashkari isn’t a voting member of the Fed’s policymaking committee this year, his statement may reflect the sentiment of other policymakers.  His statement, therefore, adds to concerns that investors may be placing too much hope on a near-term Fed pivot toward lower interest rates.

• Meanwhile, the Kansas City FRB kicks off its conference in Jackson Hole, Wyoming, today, with Fed Chair Powell set to deliver his keynote address on Friday morning. Investors remain concerned that Powell will also push back on recent market expectations (hopes?) that the policymakers will soon pause their aggressive interest-rate hikes or even pivot to cuts.
• One important impact of the Fed’s rate hikes is that they’ve helped boost borrowing costs worldwide, including in less developed countries. Those countries are now burning through their foreign currency reserves as they deal with higher interest rates and higher prices for food and energy imports, potentially setting up more emerging market debt defaults.

U.S. Fiscal Policy:  President Biden today reportedly plans to announce a student loan forgiveness program that would cancel up to $10,000 of student debt for people making less than $125,000 per year or married couples making up to $250,000 per year.  The action is expected to eliminate student debt for about 15 million people, although the program is also likely to generate legal and political pushback, in part because of its impact on the federal budget deficit.

U.S. Energy Markets:  When we wrote our Comment early yesterday morning, we mentioned that natural gas prices at the time were surging on concern about another cutoff of Russian gas supplies to Europe.  Later yesterday, however, Freeport LNG announced that it would delay the restart of its LNG export facility in Texas, which has been shut down for repairs after a fire several months ago.  With U.S. gas exports now expected to be impeded for longer than previously thought, gas has fallen back below $10.00 per BTU and is currently trading at approximately $9.37.

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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 military operations remain relatively quiet.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including more evidence of financial volatility and economic weakness in Europe.

Russia-Ukraine:  Russian forces continue to make only the most limited of territorial gains in Ukraine’s eastern Donbas region, and some observers suggest those gains have only been possible because the Ukrainians are thinning out their lines in the region in order to move more troops to the Kherson area.  The Ukrainians continue to suggest they will launch a counteroffensive to retake the city of Kherson and surrounding areas from their Russian occupiers, and in recent weeks they have taken some steps toward preparing for that counteroffensive.  Lately, however, we have seen very little sign of the counteroffensive ramping up in earnest, suggesting the Ukrainians may have changed their plans.

• Since tomorrow is Ukraine’s national Independence Day, the U.S. warned that Russia could use the occasion to increase its artillery and missile strikes against civilian areas.  Wednesday also marks the sixth month since the start of the war.
• Russia now says the assassin who killed nationalist commentator Daria Dugina in a car bombing over the weekend has fled to Estonia.  That accusation could be used as an excuse to threaten the Baltics, and there is probably some chance that the bombing was a false flag attack expressly for that purpose.  However, we suspect it could also reflect Russia’s own rough-and-tumble internal politics.
• As the U.S. and other Western allies continue to provide more advanced weapons to the Ukrainians, the momentum in the war appears to be shifting slightly in their favor.  We continue to see reporting that suggests that Western governments are secretly sending more advanced weaponry than they have publicly acknowledged.

Global Energy Markets:  Saudi Arabia Energy Minister Prince Abdulaziz bin Salman has warned that OPEC and its Russia-led allies may cut their crude oil production because of the recent volatility in futures markets.  In response, global oil prices have jumped almost 1.4% so far this morning, with Brent now trading at $97.82 per barrel.

• We would note that key members of the OPEC+ alliance haven’t been able to meet their production targets.  Most importantly, some analysts have questioned how much spare capacity Saudi Arabia really has.  An announced production cut might, therefore, have relatively little impact on actual supply.  The energy minister’s statement could well have been geared merely to reverse the recent softening in oil prices as investors grew more concerned about weakening economic growth across the globe.
• Meanwhile, Russia’s latest announced “maintenance” shutdown of the Nord Stream 1 natural gas pipeline to Europe and high demand for air conditioning in Europe’s heatwave continue to buoy gas prices.  U.S. natural gas futures have reached $10.00 per BTU, up some 20% over the last month and equal to their highest level in 14 years.
• Reflecting the difficulties and long lead-time likely required to secure Europe’s energy security, Belgium Prime Minister Alexander De Croo has warned that the Continent’s next “five to ten winters will be difficult.”

Eurozone Financial Markets:  While the major central banks’ monetary tightening has affected financial markets all over the world, there is increasing evidence that the ECB’s reduced bond buying has stoked volatility in the Eurozone’s bond market.  For example, German government bond yields have recently been more volatile than at any other time in the last decade, and spreads between German and Italian yields are reaching concerning levels again.  Fears of a looming recession and Europe’s usual summer trading lull have also sapped liquidity.

Eurozone Economy:  As shown in the Foreign Releases section in the pdf, S&P Global’s flash composite purchasing managers’ index for August fell to 49.2, as compared with 49.9 in July.  As with most major PMIs, the index is designed so that readings below 50 signal contracting economic activity.  Now that the index has been below that mark for two straight months, it’s becoming clearer that the European economy is indeed slowing and could be on the verge of the recession many analysts are already expecting.

• The news has helped push the euro down even farther so far this morning.
• The currency is currently trading at $0.9920, its lowest level in some 20 years.

Hong Kong:  The municipal government reported 6,617 new cases of COVID-19 yesterday, marking the sixth straight day in which the tally topped 6,000.  Officials have also said the city now has multiple transmission chains, raising the prospects of a sharp clampdown under President Xi’s Zero-COVID policy.

U.S. Labor Market:  Teachers at the Columbus School District, the largest in Ohio, have voted to strike over a wide range of issues including classroom sizes, teacher pay, caps on the number of class periods in the day, and heating and air conditioning availability in school buildings.  As we’ve noted before, falling labor force participation and fast economic growth have tightened labor markets in many countries, giving workers the leverage to demand better pay and working conditions.  If the wave of strikes drives up labor costs enough, it would help keep inflation high and erode corporate profit margins.

U.S. Apartment Market:  New details show that some 420,000 apartment units are due to be completed in the U.S. this year, marking the highest rate of completions in 50 years.  Initially, many of those new units will likely be snapped up by people shut out of the single-family home market by soaring prices and high interest rates.  Eventually, however, the new units could help bring down rents and inflation rates.

U.S. Military:  As we’ve mentioned previously, U.S. military forces have been facing huge challenges in recruiting new members, with the Army likely to end up with far fewer troops than planned in the next year or two.  Now, it turns out that applications to West Point and the other highly selective, prestigious service academies are down 10% to 30% from last year.  The shortfalls reflect problems ranging from the strong labor market, declining interest in the military after the long U.S. wars in Iraq and Afghanistan, and restrictions on in-person recruiting during much of the pandemic.

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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 very few new territorial gains are being made by either side, but the weekend assassination of a Russian nationalist influencer has sparked concern that Russia may now be forced to intensify its efforts.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a few words on this week’s Federal Reserve conference in Jackson Hole, Wyoming, where officials could well push back against the market’s recent optimism about a halt to interest-rate hikes.

Russia-Ukraine:  It now appears that Russia has exhausted its limited offensive capabilities of the last few months, and it is now making very few territorial gains in Ukraine’s eastern Donbas region.  Meanwhile, it continues to dig in against an expected Ukrainian counteroffensive against the areas Russia controls around the southern city of Kherson.  Russia continues to use aircraft, missiles, and long-range artillery to attack targets around Ukraine, but that constitutes most of the damage it’s inflicting for the moment.  At the same time, the Ukrainians continue to leverage precision, long-range artillery and other systems from the West to destroy Russian logistics nodes and troop concentrations.

• In an interview with the Financial Times, Russia’s permanent representative to the UN in Geneva said he sees no possibility of a diplomatic solution to end the war and expects a long conflict, mostly because of what he suggested was unwarranted support for Ukraine from the West.
• A car bombing near Moscow on Saturday killed Daria Dugina, a hawkish political commentator and daughter of philosopher Alexander Dugin, who has loudly called for a re-establishment of the Russian Empire and has urged the Kremlin to escalate its attack on Ukraine.  Officials in Kyiv denied that they had anything to do with the attack, but the killing of Dugina still could push President Putin to increase his efforts against Ukraine.
• In a move that could further galvanize or help rejuvenate support for Ukraine in the West,  the leader of a Russian-backed breakaway statelet in eastern Ukraine announced details of plans to put captured Ukrainian soldiers on trial in Mariupol.  Ukrainian President Zelensky warned any such trial would mean an end to all negotiations between Kyiv and Moscow.
• New data from China’s General Administration for Customs showed that Russia remained the country’s biggest supplier of crude oil for the third straight month in July.  The figures illustrate how the war has pushed China and Russia closer into each other’s arms, accelerating the fracturing of the world into relatively separate geopolitical and economic blocs.

United Kingdom:  If you thought U.S. consumer prices are rising fast, and even if you thought U.K. prices were rising even faster, you ain’t seen nothing yet!  Analysts at Citigroup (C, $52.61) predict Britain’s consumer price index in January will be up 18.6% year-over-year, mostly due to Europe’s soaring natural gas prices and the planned lifting of price caps on that gas.

• Such an inflation rate would likely push the U.K. economy deep into recession and force the Bank of England to keep raising interest rates aggressively.
• Rising energy prices are also putting pressure on Foreign Minister Truss and Former Chancellor Sunak to spell out policies to address the cost-of-living crisis as they continue to campaign to succeed Boris Johnson as Conservative Party leader and prime minister.
• In addition to rising energy costs, the U.K. is also facing a wave of strikes as workers leverage the tight labor market to demand higher pay and better working conditions.  Today, barristers in the country’s criminal court system voted to go on strike beginning September 5, joining transport and other workers who have staged walkouts.  If the strikes lead to higher wage costs, they will also contribute to rising price pressures.

China:  As is normal shortly after the People’s Bank of China cuts interest rates, as it did last week, commercial banks in China have implemented a series of modest prime-rate cuts on commercial and household loans.  The biggest cut was in the benchmark five-year mortgage rate, which was reduced from 4.45% to 4.30%.  However, the rate cuts are quite modest and are not expected to give any major boost to the economy.

• While China has reopened from the most recent COVID lockdowns, the economy is still facing serious headwinds from pandemic uncertainty, government crackdowns on property development and technology, and other factors.
• Southwestern China also continues to face a debilitating drought and heatwave, which has reduced hydroelectric production and prompted the government to impose energy conservation rules.

China-Taiwan-Japan:  Following a number of high-profile visits to Taiwan by U.S. lawmakers to show their support for the island democracy, a delegation of Japanese parliament members has begun a similar three-day trip to Taipei today.  The Japanese visit underscores how Tokyo has thrown its weight behind the U.S.’s effort to counter China’s growing geopolitical aggressiveness in the region.

Pakistan:  Former Prime Minister Khan has been charged with terrorism offenses after a weekend political rally in which he warned that his supporters “won’t spare” the officials from current Prime Minister Sharif’s government who were responsible for detaining Shahbaz Gill, one of his allies, earlier this month.  Khan’s supporters are seeing the charges as an attempt to silence Khan politically.  The rising tensions threaten to produce further political instability in Pakistan.

United States-South Korea:  Today, for the first time in four years, the U.S. and South Korea will begin more than a week of live military exercises together.  The joint drills will signal stronger cooperation between the two allies as the threats from China and North Korea increase, although they will also likely increase tensions with those two countries.

Canada:  Prime Minister Trudeau’s government is proposing that farmers cut their use of fertilizers in order to reduce their emissions 30% from 2020 levels by 2030, with those refusing to do so facing reduced eligibility for green investment incentives.  Although the government so far isn’t facing the intense backlash seen in the Netherlands when its government proposed new farming rules to reduce greenhouse gas emissions, farmers and farm-dependent provinces in Canada are pushing back strongly against the proposal.

U.S. Monetary Policy:  The Kansas City FRB opens its annual conference in Jackson Hole, Wyoming, starting on Wednesday, and investors are bracing for the possibility that Fed Chair Powell and other policymakers will push back against the recent market optimism over the possibility of a pivot toward interest-rate cuts.  Stock futures, bonds, cryptocurrencies, and a range of commodities are trading weaker this morning, while the dollar is up.  In addition, the euro has fallen back below parity, recently trading around $0.9900.

U.S. Education Policy:  In an interview yesterday, Education Secretary Cardona called on school districts to provide more competitive salaries to teachers, improve their working conditions, and give them a greater voice in school administrative decisions.  That follows on the Biden administration’s call for school districts to help alleviate the national teacher shortage by providing pay increases with part of the money they received last year from the administration’s pandemic relief program, although many Republicans want to alleviate the shortage by loosening teacher licensing standards.

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