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 Russia appears to be ramping up its ground attacks and missile barrages again after a partial operational pause.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including the latest on the U.K.’s Conservative Party leadership election and signs of thawing China-Australia relations.

Russia-Ukraine:  Russian forces appear to be ramping up their ground attacks in Ukraine’s eastern province of Donetsk again, following a partial operational pause in recent weeks.  However, we suspect that troop and equipment shortages will prevent them from launching major new offensives.  Indeed, Moscow did not claim any new seizures of territory yesterday.  Meanwhile, Russian forces have not only stepped up their missile attacks across Ukraine, but several reports say they have moved additional troops and equipment into the Kherson region to defend it from a planned counteroffensive that Kyiv has signaled.  Importantly, those troop and equipment moves could weaken Russia’s attacks around Donetsk, perhaps as Kyiv intended when it publicized its counteroffensive against Kherson.  Finally, we note that Russian Defense Minister Shoigu has ordered Russian troops to prioritize attacks on long-range artillery systems provided to Ukraine by its Western supporters.  The order underlines the importance those systems have had in bolstering Ukraine’s military capabilities.

 

• On Sunday evening, Ukrainian President Zelensky fired both the country’s general prosecutor and the head of its security service, a friend from childhood, amid allegations that their offices were riddled with officials who were collaborating with Russia.
• International Energy Agency Chief Fatih Birol today warned that there is a real chance Russia will completely shut off its supply of natural gas to Western European countries in retaliation for their support of Ukraine.  According to Birol, Western European nations must take urgent and coordinated action to avert a potentially disastrous supply crunch this winter, in what he termed “a historic test of European solidarity.”  Birol’s suggested steps include the following:
  • Temporarily step-up coal-and oil-powered electricity generation;
  • Launch public-information campaigns to reduce household gas demand;
  • Compensate industries for forgoing gas supplies;
  • Increase cooperation among national electricity operators; and
  • Plan for EU-wide sharing of what available gas supplies remain.
• EU Foreign Affairs Commissioner Borrell expressed hope that Russia, Ukraine, and other interested countries could strike a deal this week to restart grain shipments out of Ukraine and help ease the worsening global food crisis.
  • The prospect of an agreement to end the blockade comes as the EU prepares legislation to ease its sanctions regime against Moscow to allow trade in Russian food products as it attempts to address anger in Africa and elsewhere that rely on Russia food supplies.
  • Draft legislation to be considered by EU ambassadors today would provide exemptions to existing bans on transactions with certain Russian state-owned entities when it comes to food products, a tacit acknowledgment that sanctions against Moscow may have inadvertently led to a curb on Russian food exports.
  • As global food markets adjust to the war-related supply disruptions to date, and as traders factor in the risk of global recession, grain prices continue to retreat.  For example, corn and wheat futures are now down some 25% and 40%, respectively, from their early-spring highs.
• A recent analysis by the Economist Intelligence Unit estimates that commodity supply disruptions and other fallout from the war will reduce global economic output by approximately $1 trillion this year, with the biggest losses in Germany, France, and Italy.

European Union:  Most of Western Europe this week is suffering through a record-breaking heatwave and wildfire outbreak, which is already starting to threaten economic activity.  What’s less publicized is that the Continent is also suffering through a major drought.  One consequence of the dry weather is that hydroelectric power generation is falling, worsening Europe’s wartime energy shortages.

United Kingdom:  In the race to succeed Prime Minister Johnson as Conservative Party leader and prime minister, the latest poll of parliament members has whittled the field down to just five.  Former Chancellor Rishi Sunak remains the frontrunner, followed by Foreign Minister Liz Truss, Trade Minister Penny Mordaunt, Foreign Affairs Committee Chairman Tom Tugendhat, and Former Equities Minister Kemi Badenoch.

• Despite Sunak’s strength, he remains under threat from candidates to his right.
• After garnering a surge of support last week, Mordaunt’s star seems to be fading, and a poll of grassroots’ party members has revealed a strong preference for Badenoch.
• After a nasty televised debate last night, Sunak and Truss pulled out of a debate scheduled for Tuesday on concern that the divisiveness is damaging the party’s image.  That debate has now been cancelled.
• Another ballot is scheduled for today when the candidate with the lowest total of votes will be eliminated.

China:  As the highly transmissible BA.5 Omicron mutation of the coronavirus continues to spread, a Japanese investment bank estimates that 41 cities in China are now under full or partial lockdowns or district-based controls, covering 264 million people in regions that account for about 18.7% of the country’s economic activity.  More ominous is that major production centers including Shanghai and Tianjin have ordered mass testing in response to new cases, raising the prospect of renewed lockdowns in those cities.  The news highlights the continuing negative economic impact of President Xi’s strict Zero-COVID policies.

China-Australia:  After Chinese officials last week indicated they may resume importing coal from “down under,” Australian Treasurer Jim Chalmers said such a move would help restore ties between the two countries.  He also encouraged China to remove its restrictions on other imports from Australia, such as wine and barley.

• Beijing began blocking Australian imports in late 2020 to retaliate for former Australian Prime Minister Morrison’s call to investigate China’s role in the coronavirus pandemic.
• The potential loosening in Chinese policy stems in part from the fact that Morrison is no longer prime minister, and that the new government in Canberra has made a concerted effort to re-engage with China.  Just as important, Beijing’s interest in resuming Australian coal imports reflects a general tightening in the global energy market, as war-related disruptions to Russian supplies force many European countries to scramble for alternative energy sources.
• Thawing bilateral ties could potentially be a boon for Australia, although China’s economic slowdown would likely reduce the benefit for Australian companies.

Pakistan:  Former Prime Minister Imran Khan’s party won a critical by-election in Pakistan’s most populous province, putting him on track to force early parliamentary polls just months after he was ousted from office.  Khan’s victory is being ascribed to voter anger over high inflation and the painful belt-tightening measures current Prime Minister Sharif has imposed to restart lending under a $7-billion IMF program.  Without that program, Pakistan would be at even greater risk of defaulting on its foreign debt, as Sri Lanka recently has.

Sri Lanka:  Although President Gotabaya Rajapaksa resigned and fled into exile last week, protestors are now demanding that Acting President Ranil Wickremesinghe resign as well.  Wickremesinghe is seen as a close ally of the Rajapaksa clan that has dominated Sri Lanka’s government for decades.  The continuing political and economic turmoil bodes poorly for other emerging markets, some of which are facing challenges similar to those in Sri Lanka, including high debt service costs, rising interest rates, and a strong dollar.

United States-Saudi Arabia:  On Saturday, President Biden completed his visit to Saudi Arabia with no concrete deliverables in terms of Saudi commitments to increase oil production and bring down prices.  On its face, the outcome is a significant disappointment for Biden, especially given that he has been strongly criticized for the trip by progressives looking for stronger U.S. action on human rights and policies to combat global warming.

• Despite Biden’s failure to win big, definitive concessions from the Saudis, it’s important to remember that the trip further advanced what could be called the “Biden Doctrine,” i.e., a concerted effort to rebuild U.S. influence and ties with key allies.
• For more than a decade, U.S. leaders have been trying to disengage from the messy politics and security issues in the Middle East to focus on the rising geopolitical threat from China.  Now that global politics and energy disruptions are drawing Biden back into the region, albeit kicking and screaming, U.S. re-engagement could ultimately help improve global security and economic stability, at least for as long as it lasts.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

In today’s Comment, we will provide updates on U.K. elections, Draghi’s resignation, and possible price caps, all of which are potential threats to the Western bloc’s unification against Russia. Next, we discuss international news with a focus on China’s latest GDP. We end with an overview of U.S. news. Below are the top stories moving financial markets.

 Top Stories: Equity markets clawed back most of the early losses on Thursday after central bankers cast doubts about a potential 100 bps rate hike during the next Fed meeting. Meanwhile, disappointing earnings reports from J.P. Morgan (JPM, $108.00) and Morgan Stanley (MS, $74.69) led to concerns that the economy may be harming financial equities.

• Central Bank: Fed Governor Christopher Waller reaffirmed his support of raising the Fed’s benchmark rate by 75 bps in the Fed’s upcoming meeting, but could back a more considerable rate hike depending on the incoming economic data. St. Louis Fed President James Bullard mirrored Waller’s sentiment by suggesting that he also favors a 75 bps hike. The reluctance of Fed officials to respond aggressively to Wednesday’s hot CPI report suggests that the Fed may be concerned about the economy. Although it is unlikely that the central bank will pause rates anytime soon, Fed officials may be hesitant to signal further rate increases as economic conditions deteriorate.

Maintaining the Western Alliance:  New elections, rising prices, and varying levels of commitment are preventing the West from presenting a unified front against Russia. As the Western bloc struggles to stay on the same page, Putin’s leadership position is pivotal in demonstrating Russia’s willpower to maintain its war in Ukraine.

• UK. elections: An unexpected candidate has taken the lead in the race to replace U.K. Prime Minister Boris Johnson. Betting sites favor Penny Mordaunt to take over as the new leader of the Tory party, although five candidates remain in the running. Predictit.org gives Mordaunt a 56% chance of winning, while Sky Bet also shows her as an early favorite. Assuming she wins, it is unlikely that she will have a different foreign policy than the outgoing prime minister, and therefore U.K. commitment to Ukraine is unlikely to change. Nevertheless, Mordaunt’s victory should be favorable to assets within the U.K. as she is anticipated to provide some political calm to the country.
• Draghi’s resignation: Italian Prime Minister Mario Draghi offered to resign on Thursday; however, his request was promptly denied by Italy’s President Sergio Mattarella who insisted that Draghi wait a week before deciding on whether to step down. The political chaos comes at a vulnerable time for the country as a new Italian government may be less friendly toward the EU. News of Draghi’s resignation caused the spread between Italian and German bonds to widen by 16 bps. A government collapse will probably not impact Italy’s commitment to the war in Ukraine, but it could pave the way for the break-up of the Eurozone. Polls show that the populist party Brothers of Italy is favored to win the majority of seats in an election. The party leader, Giorgia Meloni, is a noted eurosceptic but a vocal supporter of Ukraine.
• Price caps: The West is making progress on price caps for Russian oil. The U.S. and EU have stated that they may be willing to withdraw their sanctions on shipping insurance and financing services in exchange for support of a price ceiling. The move would reduce the price the EU is paying for reduced-volume purchases of Russian crude oil to similar levels that China and India are currently paying. Although price caps are an attractive alternative to sanctions, it isn’t the perfect solution. In theory, countries can refuse to pay the market price for Russian crude; however, Moscow can then respond by not selling to them. As a result, countries must be willing to risk losing access to Russian oil for the plan to work. Europe appears to be the guinea pig in this experiment as its dependency on Russian crude means it will be the primary enforcer of the cap. Given the sensitivity that EU countries such as Germany and France had around securing their energy resources, they may not go along with it, especially in the winter.

International: Improvements in the Middle East and the potential for policy accommodation in China are both positive developments for international equities; however, rising energy prices remain a risk, particularly for countries with limited energy reserves.

• Israel-Saudi Arabia: Normalization between Israel and Saudi Arabia edged closer to reality after the Israeli government green-lit a deal to cede control of two strategic islands in the Red Sea. In exchange for relinquishing control, Israeli airlines will be allowed to use Saudi airspace for flights to China and India. In addition, normalizing relations within the Middle East creates a favorable investment environment for the region.
• Japan energy: To prevent a potential power crunch, Japan would like to bring up to nine nuclear reactors online to diversify the country’s energy sources. As an island nation, Japan does not have the same capability as larger countries (such as the U.S.) to mine fossil fuels and is forced to import to meet its energy needs. As a result, the global rise in commodity prices has pushed the country’s inflation to its highest level in nearly a decade. The new reactors will likely provide some relief for the country, but it won’t be a long-term solution. Japanese officials estimate that the reactors could provide up to 10% of the country’s electricity needs. Approaching wintertime, we suspect Japanese firms will struggle to maintain profitability as they cope with rising energy costs. Therefore, until the BOJ steps in and tightens monetary policy to improve the yen’s strength, we view Japanese equities as having elevated risk.
• China’s growth: GDP in China rose 0.4% from the prior year, much lower than expectations of an increase of 1.2%. The drastic slowdown in Chinese growth is likely related to the country’s property meltdown and Zero-COVID policy. The disappointing GDP number could pave the way for Beijing to provide additional fiscal and monetary support, which should be favorable for Chinese equities.

Recent developments in China and the Middle East should result in improved sentiment about international equities in the short term. However, a hawkish Fed, a stronger dollar, and rising energy prices pose a risk for emerging economies. That said, we believe that Chinese equities are particularly attractive as we suspect Beijing will attempt to boost the economy heading into the 20^th National Congress of the Chinese Communist Party later this year.

 Domestic: A cooling housing market, increased scrutiny, and lower government spending will likely weigh on market sentiment as investors remain risk averse.

• Housing: The supply of homes for sale rose for the first time in two years. The increase in homes on the market suggests that rising pricing and financial costs have started to weigh on demand. Although prices are unlikely to fall on a nominal basis, the decline in demand indicates that housing prices will rise at a slower pace. Because most households derive the majority of their wealth from an increase in the equity value of their homes, a sluggish housing market may lead consumers to spend less. As a result, the economy and financial markets could suffer because of waning consumer and investor sentiment.
• Antitrust: Tech companies face growing regulatory risk as government agencies seek to increase competition within the sector. The DOJ is set to reject concessions from Alphabet (GOOG, $2,207.35), paving the way for a potential antitrust lawsuit over the company’s online ad market dominance. The move to limit tech dominance has bipartisan support. The right feels that tech companies have used their market power to ensure their voice, while the left believes that tech companies have used their platform to profit from disinformation. As a result, we expect the tech sector to be a less attractive place to invest as rising rates and regulatory crackdowns will make it harder for firms to expand.
• Manchin out: Senator Joe Manchin (D-WV) has jettisoned any hope that he would support an economic package that contains new spending on climate change or new taxes. He will now only back legislation that lowers drug prescription costs or extends enhanced ACA subsidies.

Concerns about a possible recession in the U.S. will likely persist as the lack of government spending and slowdown in residential investment weigh on growth. While this will probably hurt pro-cyclical stocks, we suspect defensive stocks in sectors such as Health Care, Utilities, and Consumer Staples may be attractive. Tech stocks, though, will likely face greater scrutiny as governments worldwide look to break up these companies.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment begins with a discussion about the latest CPI report and its impact on the Federal Reserve’s decision to raise rates. We then briefly review Biden’s trip to Israel. Next, we give an update on the latest development from Russia’s war in Ukraine. We end the report with an overview of other news stories that we believe will affect financial markets.

Central Bank News: Financial markets sputtered on Wednesday after a disappointing CPI report led to fresh concerns that the Federal Reserve could take more aggressive actions to tame inflation. The CPI report showed that the price index soared 9.1% from June the prior year, marking a four-decade high for inflation. The S&P 500 closed lower, and the two-to-10-year inversion deepened as investors priced in an increased likelihood of a 100 bps hike for the July Fed meeting. Atlanta Fed President Raphael Bostic, a notable dove, reinforced investor concerns after declaring that everything is in play as the FOMC looks to tame inflation. San Francisco Fed President Mary Daly also mentioned that a 100 bps hike is a possibility given the recent CPI report. Despite the hawkish tilt from non-voting FOMC members Bostic and Daly, there are some indications that the Fed may maintain its plans to raise rates by 75 bps. Cleveland Fed President Loretta Mester, a voting member, stated that the data suggested that at least a 75 bps hike was needed, but did not elaborate on whether she favored a more significant hike.

• The faster the Federal Reserve raises rates, the greater the likelihood it will push the economy into a recession. Over the last 40 years, the Fed has not been able to increase its benchmark rate above the previous cycle’s peak without causing an economic downturn. Now that the fed fund’s target rate is currently 1.675%, a 100 bps rate hike would place that target just above the previous peak.

• Four of the 12 Federal Reserve districts reported that economic growth either slowed or declined in the latest Beige Book. The report, which looks at the economic situation of each of the Fed districts, showed that business contacts reported signs of slower demand and substantial price increases. Although the report indicated that economic activity expanded at a modest pace, an improvement from six weeks ago, contacts in five districts noted concerns of an increased possibility of a recession.
• Shelter prices rose at their fastest pace since 1986, and it is still possible that prices will continue to speed up for at least another six to 12 months. Our data shows that shelter prices lag the FHFA House Price Index by about 18 months, with the peak hitting in June of last year. The increase in the prices for homes and shelter is likely the result of low residential inventory. Homebuilders over the last year have struggled to complete construction projects due to the shortage of labor and materials. Although prices for critical resources like lumber and steel have declined in recent weeks, it will probably be some time before the homebuilders can finish these projects.

 Biden’s Middle East Trip: President Biden and Israeli Prime Minister Yair Lapid signed an agreement that the two countries are committed to stopping Iran from developing a nuclear weapon. Despite the appearance of a united front, the two sides appear to have differing views on how to deter Iran’s nuclear program. Biden would like to return to the 2015 nuclear deal, while Israel would like to take more direct action. Besides agreeing to stop Iran from developing nuclear weapons, the two sides have also discussed improvements in military integration.

• We suspect that President Biden’s visit was partially aimed at preventing Israel from taking unilateral action against Iran. The potential for conflict between Israel and Iran remains elevated. We are watching this situation closely.

 Ukraine-Russia Update: In another change in the war’s tide, Russian forces have suffered several defeats on the ground in Ukraine as they try to take over smaller cities in the country’s eastern region. Meanwhile, the Kremlin has pushed the country closer to full-scale mobilization by ordering federal districts to recruit and financially reward volunteers willing to take part in the war. The latest development in Ukraine suggests that the investing environment in Europe will probably be fraught with risk as countries continue to struggle to adapt to the higher energy and food prices resulting from the conflict.

• A deal allowing Ukrainian wheat to leave ports in the Black Sea is close to being reached. The agreement is being worked out between Russia, Ukraine, Turkey, and the United Nations. Although there is optimism that all parties can sign a deal next week, there are some concerns that Russia may back out. If Ukrainian wheat can make it into global markets, it could bring down food prices and reduce the threat of global famine.
• Natural gas disruptions risk triggering a global recession, according to the International Monetary Fund. The multilateral organization warned that Russia’s war in Ukraine has weakened its global growth outlook.

Italy: A potential collapse of the Italian government is weighing on the euro. The Five Star Movement stated that it would pull its support from the current government over concerns that the coalition is not doing enough to help families deal with rising energy and food prices. Although the breakdown of cross-party alliances is not unusual for Italy, the resulting election could have implications for Ukraine. The Five Star Movement does not support offering Ukraine military weapons to fight against Russia due to concerns that it may prolong the war. Thus, if the Five Star Movement gains influence after the next election, Ukraine may have difficulty finding support for its war efforts.

• A pro-NATO right-wing party is expected to gain the most seats in the Italian parliament if the country heads to elections. Assuming polls are correct, the Brothers of Italy party should take the most seats in the parliamentary run-off. Although a populist right-wing party, the Brothers of Italy has recently moderated some of its policy stances to appeal to a broader base. Party leader Giorgia Meloni has been a vocal critic of Russia’s invasion of Ukraine and supports sending weapons to Kyiv. The party’s populist tilt, however, could make it difficult for the group to find partners to form a coalition. The group is known to challenge EU norms, such as marriage equality, and has a reputation for being a party for eurosceptics. As a result, the new elections will probably not improve financial conditions significantly in Italy as political uncertainty will likely remain.

China: Fears of a Chinese housing crisis are rising after a growing number of homebuyers refuse to pay mortgages for unfinished housing projects. As a result of the boycott, Chinese authorities met with major banks to discuss solutions to the upheaval.  The rising defaults from property developers undermines the likelihood that the projects will be completed, leading homebuyers to refuse to repay mortgage loans on unfinished construction.  The weakness in the property sector suggests that China’s traditional method of boosting growth through debt-driven real-estate investment may be losing its potency. Therefore, Beijing may have a more challenging time stimulating the economy as it moves away from its Zero-COVID strategy.

• In another setback for China, SEC Chair Gary Gensler dampened expectations about a deal with Beijing to keep Chinese companies listed on U.S. exchanges. Beijing and Washington are engaged in discussions that would allow a third-party to oversee the audit of Chinese companies listed in the U.S, as required by law. China is hesitant of foreign oversight of its companies, which is the source of the deadlock in talks. If an agreement is not reached, Chinese companies could be forced to delist from U.S. exchanges by 2023.

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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.  Both sides remain in an operational pause, of sorts, but they continue to stage limited, localized attacks on each other.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including an overview of President Biden’s trip to Israel and Saudi Arabia, which began today.

Russia-Ukraine:  Russian and Ukrainian forces remain in a partial operational pause as they focus on resting, refitting, and regrouping ahead of future attacks.  All the same, they continue to launch limited, small-scale probing and positioning attacks, especially with long-range artillery.  In particular, the Ukrainians continue to make good use of advanced artillery systems recently delivered by the West.  Reports today say they used one such system to destroy a key Russian air-defense system protecting the skies over occupied Luhansk province.

• The Russian-appointed administrator of a town in occupied eastern Ukraine has been killed in a car bombing, presumably at the hands of Ukrainian saboteurs.  Separately, occupation authorities said the Russian-installed district head of Melitopol, one of the first towns in southern Ukraine to fall to Russian forces, had escaped an attempt on his life by a saboteur shooting at his house.  The reports indicate Ukrainian partisans remain active and could cause significant casualties to Russian forces and their supporters in occupied areas.
• With President Biden and the Democratic Party still polling poorly, many observers are growing concerned that isolationist, “America-first” Republicans will shut off U.S. aid to Ukraine and open the door to a Russian victory after November’s mid-term elections.
  • Moderate, internationalist Republicans in Congress helped push that aid through in the early months of the war, before far-right opponents were able to organize resistance.  Now, far-right isolationists and admirers of Russia’s authoritarian government are better positioned to mount a concerted pushback.
  • We would note that much of the U.S. aid to Ukraine – especially the transfer of major weapon systems – ultimately flows back to U.S. defense firms and their workers.  Because of that consideration, and the risk of Russian aggression in a region where the U.S. has vital national interests, it is probably not a foregone conclusion that a Republican victory in November will end U.S. aid to Ukraine.

United Kingdom:  In the race to replace Boris Johnson as Conservative Party leader and prime minister, nominations closed yesterday with eight parliament members meeting the qualification standards.  Former Chancellor Rishi Sunak remains the front-runner, although he is facing a stiff challenge from candidates from the party’s far-right wing.

• Under party rules, an initial ballot of parliament members will be held today.  Any candidate who wins a majority of the votes will become Conservative Party leader and prime minister.  Any candidate who fails to secure at least 30 votes will be knocked out of the running.
• If needed, a second ballot is expected to take place Thursday, in which the last-place candidate and any candidate securing fewer than 30 votes will be knocked out.
• A third ballot, if one needs to take place, has been penciled for next Monday, July 18. Successive ballots are expected to take place daily on the same terms, until only two candidates remain by July 21.
• The final two candidates will then be put to a vote of grassroots Conservative Party members — thought to number around 200,000 people in total — lasting most of the summer, with head-to-head debates to be held at hustings around the country. The winner of that ballot will replace Johnson as prime minister on September 6.

China:  In Shanghai, 378 new cases of COVID-19 have been discovered across all 16 districts in the last nine days, prompting officials to reopen some centralized quarantine sites.  Many neighborhood committees have also advised residents to prepare 14 days of food and medicine.  The report serves as a reminder that China remains susceptible to tough pandemic lockdowns under President Xi’s zero-COVID policy.

United States – Israel – Saudi Arabia:  As we noted in our Comment yesterday, President Biden embarked on a four-day trip to Israel and Saudi Arabia today, where he will be seeking to repair security and economic relations.  Despite the long-term trend of U.S. leaders trying to extricate America from the Middle East, that’s proving hard to do.  Indeed, U.S. efforts to pull back from the region since at least the Obama administration have ruffled the feathers of regional leaders and created a dangerous opening for Iranian aggression; all of which Biden is now trying to reverse.

• In Israel, Biden’s first stop, the talks will likely focus on the military threat from Iran, cooperation in missile defense, and efforts to further improve relations between Israel and Saudi Arabia.
• In Saudi Arabia later in the week, the talks are expected to focus on U.S.-Saudi relations and securing a boost in OPEC oil production.  In return, reports suggest the Saudis will demand renewed U.S. commitments to the defense of the kingdom, probably in conjunction with warmer rhetoric on Biden’s part.

 Global Oil Market:  In its monthly report, the International Energy Agency cut its forecasts for global crude oil demand by approximately 250,000 barrels per day for both this year and next year, mostly because of slowing economic growth and demand destruction from today’s high prices.  The agency now sees demand rising more moderately to 99.2 million bpd in 2022 and 101.3 million bpd in 2023.  Meanwhile, the new forecasts call for global supply to increase to 100.1 million bpd this year, in part because Russian output hasn’t fallen as much as anticipated in response to Western sanctions over the war in Ukraine.

• Expectations for reduced demand and rising supply help explain the recent pullback in global oil prices.
• So far this morning, WTI is trading at approximately $96.85 per barrel, up 1.1% from yesterday but still down some 20.7% from its recent high in late June.

Global Population:  In updated forecasts, the United Nations Population Division said the world’s population will reach 8 billion in November 2022, but the annual growth rate will slip below 1% for the first time since 1950.  The global population is now projected to plateau at about 10.4 billion in the 2080s.  In other interesting tidbits, the new forecasts state:

• India will become the world’s most populous country in 2023, with more than 1.4 billion people, just ahead of China.
• The population of 61 countries is projected to decrease by 1% or more between 2022 and 2050, driven by a fall in fertility.  The biggest decliners include several countries at risk of Russian aggression including Ukraine, Latvia, and Lithuania.
• Falling fertility rates will produce a temporary “demographic dividend,” in which working-age adults will become a greater share of the population in many countries, boosting average output per capita.
• Eventually, however, the drop-off in births will boost the share of the population that is retired and elderly, creating labor shortages and putting upward pressure on public budgets.

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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, focusing on the two sides’ artillery attacks even as they remain generally in an operational pause.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including an important warning from a Federal Reserve official that the central bank may be tightening policy too rapidly.

Russia-Ukraine:  Russian and Ukrainian forces both remain in a relative operational pause, with both sides engaging in only limited, sporadic ground attacks.  However, both sides also continue to stage more substantial long-range artillery attacks on each other.  According to Kyiv, the Ukrainian military used advanced artillery systems recently delivered from the West to destroy at least one Russian command post and ammunition depot near the occupied southern city of Kherson, killing a dozen Russian officers.  Other reporting suggests the Ukrainians may have destroyed as many as 20 ammunition depots with the new weapons, producing increasingly severe shortages for the Russian forces.  Meanwhile, the U.S. announced last week that it will send four more HIMARS long-range artillery systems to Ukraine, bringing the total sent to 12.  Finally, in a welcome sign that Ukraine could eventually resume some food exports despite the war, officials said the recent liberation of the strategically located Snake Island off Ukraine’s southern coast has allowed eight foreign ships to access Ukrainian ports.

• S. National Security Advisor Sullivan said intelligence indicates Iran is preparing to provide Russia several hundred drones, including weapons-capable versions, to help on the Ukrainian battlefield. Under the deal, Iran will also train Russian troops to use the drones, beginning as early as this month.
• In a sign that at least France hasn’t yet lost its urgency to rebuild its armed forces in response to Russian aggression, Defense Minister Lecornu proposed a €44-billion military budget for 2023, up €3 billion from the 2022 budget. If enacted, the defense budget increase would be nearly twice as large as any in the last two years.
  • In part, the higher defense spending is needed to replenish munitions and equipment that have been sent to Ukraine.
  • The government is also looking to fund major modernization efforts, support ongoing efforts to combat terrorism, and boost its defense industrial base.

Eurozone:  Reflecting Europe’s wartime energy crisis, record-high inflation, and lagging monetary policy, the euro continues to lose value and almost fell to parity with the dollar earlier today.  At its lowest point, the euro could be bought for just $1.0002, its lowest level since 2002.

• Despite the inopportune timing, EU finance ministers this morning will give their final thumbs up to Croatia’s adoption of the euro from January 1. According to studies of how the euro transition in other countries worked out, we would look for a modest increase in Croatian inflation early next year as shopkeepers take advantage of the opportunity to round up their new euro prices.
• We also note that with its adoption of the euro, Croatia will gain a seat on the ECB’s policy board.

European Travel Industry:  London’s Heathrow Airport said it would cap the number of departing passengers from the facility at 100,000 a day until September and has asked airlines to stop selling new tickets from the airport for the summer season.  The move follows similar caps imposed at London’s Gatwick Airport and Amsterdam’s Schiphol Airport as rebounding travel demand collides with post-pandemic labor shortages.

United Kingdom:  Former Chancellor Rishi Sunak has emerged as the front-runner in the race to replace Boris Johnson as Conservative Party leader and prime minister.  Sunak currently has more publicly declared support from other members of parliament than any of the other remaining nine candidates, including several high-profile supporters. However, his challenge is to head off opposition from the right of the party, notably from other contenders with more aggressive tax-cutting platforms.

Argentina:  In her first official press conference yesterday, newly appointed Finance Minister Batakis said she is committed to the IMF-Argentina financing deal struck earlier this year.  She also promised that Argentina “is not going to spend more than we have.”  Meanwhile, IMF Managing Director Georgieva said she felt positive after her first meeting with Batakis last week.  Despite the good vibes, however, we think the Peronist government in Buenos Aires will have a hard time regaining investor confidence after its long string of debt defaults.

South Pacific:  After months of controversy over China’s move to build security ties among the island nations of the South Pacific, both Kiribati and the Marshall Islands have abruptly pulled out of a Pacific Islands Forum summit meeting.  The news has stoked concern that Chinese meddling was behind the rupture, as it tries to weaken the region’s most important diplomatic body and assert its own leadership instead.

Global Personal Computer Market:  Data firm Gartner (IT, $244.37) said global PC shipments in the second quarter were down 12.6% year-over-year, marking their steepest annual decline in nine years.  The decline reflects several challenges for PC makers, including geopolitical uncertainty sparked by the Russia-Ukraine war, spending shifts as consumers adjust to higher inflation, a reversal of pandemic-driven electronics demand, and ongoing supply chain issues.  The report could be a further headwind for technology stocks in the near term.

United States – Saudi Arabia:  As President Biden embarks on a trip to the Middle East tomorrow, his administration is reportedly considering reversing its policy of only selling defensive weapons to Saudi Arabia.  As Biden seeks to repair U.S.-Saudi relations and secure a boost in OPEC oil production, the reports suggest that the Saudis will demand renewed U.S. commitments to the defense of the kingdom in return, probably in conjunction with warmer rhetoric on Biden’s part.

U.S. Monetary Policy:  Kansas City FRB President Esther George, who has traditionally been one of the strongest inflation hawks on the Fed’s policymaking board, said in a speech that the Fed may be hiking interest rates and pulling back its balance sheet too rapidly for the economy and financial markets to absorb.

• The statement supports the view that the Fed’s rapid policy tightening will produce a recession in the coming months and force it to reverse course much earlier than planned.
• Coupled with other recent signs suggesting that the economy may be losing momentum, George’s statement about economic problems spurred by monetary policy is probably one reason for the further downdraft in risk assets so far today.

U.S. Labor Market:  According to new data from the National Labor Relations Board, the number of workplaces where employees have started trying to organize unions jumped to 1,411 in the first half of 2022, up 69% from the same period in 2021.

• In large part, the rise probably reflects the increased bargaining power that workers feel after so many people dropped out of the labor force during the coronavirus pandemic. In addition, greater unionization efforts may reflect improved sentiment toward unions among the broader public.
• All the same, we note that the unionization efforts in the first half of the year were no higher than in 2015. The long-term trend has been for decreased unionization in the U.S., which has contributed to economic inequality but probably supported corporate profit margins.  We suspect that new unionization efforts would need to expand much further to reverse those trends.

U.S. Energy Market:  Yesterday, the Electric Reliability Council of Texas asked residents to conserve electricity as extreme heat blanketed much of the state and threatened the power grid’s capacity.  If electricity supplies get stretched too thin, the organization can order large customers or transmission companies to turn off their power.  In extreme circumstances, it can also begin rolling blackouts, which could meaningfully disrupt economic activity in the state.

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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, although there is relatively little to report since both sides remain in an operational pause.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today.  In particular, we note that a resurgence in COVID-19 infections in China and beyond has left many investors concerned about new lockdowns and further headwinds for the global economy and financial markets.

Russia-Ukraine:  Both Russian and Ukrainian forces remain in an operational pause to rest, resupply, and regroup for future fighting.  However, that doesn’t mean all fighting has stopped. In particular, both sides continue to engage in savage long-range artillery duels, with the Ukrainians saying they are already reaping big benefits from the recent delivery of advanced long-range systems from the West.  Meanwhile, the Russian government continues to take extraordinary steps to bolster its limited troop numbers, including forming ad-hoc volunteer units, and private military company combat organizations partly comprised of older men and criminals to support operations in Ukraine.

• On Saturday, the Canadian government granted an exemption to its sanctions against Russia, allowing delivery of a turbine vital to increasing the flow of natural gas through the Nord Stream 1 pipeline to Western Europe.  Nevertheless, the pipeline was shut down today for 10 days of regular maintenance, and some observers worry that Russia will keep the pipeline shut beyond the maintenance period to further pressure the Europeans to drop their sanctions.
• As the U.S. and its Western allies continue to provide advanced weapons, ammunition, and other supplies to Ukraine, there is growing concern that they are dangerously depleting their own stores and won’t be able to restock quickly.

United Kingdom:  Following fast on Prime Minister Johnson’s resignation last week, almost ten Conservative Party parliament members have said they will compete to succeed him as party leader and head of government.  The process will involve a series of party votes designed to whittle down the candidates to just two top contenders by July 20.  So far, the announced candidates’ promises have focused on reversing or softening a recent hike in health insurance premiums and scrapping a planned hike in corporate income taxes.

• Top candidates who have announced their intent to compete so far include:
  • Former Chancellor Rishi Sunak
  • Incumbent Chancellor Nadhim Zahawi
  • Former Health Secretary Sajid Javid
  • Former Health Secretary Jeremy Hunt
  • Former Defense Secretary Penny Mordaunt
  • Attorney General Suella Braverman
• As early as today, a few other top candidates are also expected to announce, including:
  • Foreign Secretary Liz Truss
  • Incumbent Defense Secretary Ben Wallace

France:  STMicroelectronics (STM, $31.24) and GlobalFoundries (GFS, $45.27) are teaming up to build a semiconductor manufacturing factory in France; a multibillion-euro project that will receive significant government support as part of Europe’s effort to boost its independence in critical technologies.

Japan:  In weekend elections for the upper house of parliament, Prime Minister Kishida’s coalition won most of the seats being contested.  Importantly, the coalition also may have won enough seats to push through constitutional revisions.

• In response, Kishida called for accelerated discussions on an amendment that would affirm the legality of Japan’s military forces and grant the government new authority to deal with national emergencies—ideas long advocated by Former Prime Minister Abe before he was assassinated last week.
• The amendment would require a two-thirds vote in both houses of the Diet, but following the concern about Chinese aggression and the Kishida coalition’s strong majority, the amendment may have a better chance of passing than when Abe failed to push it through.
• Shifting the constitution away from its current pacifist orientation would complement other initiatives Japan is making to boost its defense capability, including a planned hike in its defense budget, the development of new offensive missiles, and closer military cooperation with the U.S. and other allies.  These changes will likely make Japan a more important player in the evolving U.S.-led geopolitical bloc.

Chinese Technology Sector:  The State Administration for Market Regulation over the weekend fined some of the country’s largest internet companies for failing to make proper antitrust declarations on previous deals.  The regulator also warned it would gradually publish more penalty decisions on other cases.  The news is weighing heavily on Chinese technology stocks so far today, as it suggests the government is not yet finished with its effort to rein in the sector.

Chinese COVID-19 Cases:  Officials reported more than 3,300 new, locally transmitted COVID-19 cases over the weekend, and Shanghai reported its first case of the BA.5 Omicron subvariant.  The resurgence in infections has raised concern about yet another wave of strict lockdowns in and around the country.  In fact, Macau has already set a weeklong shutdown of casinos and other businesses to combat its surge in cases.

• Fears of new lockdowns in China and its region are weighing further on Asia-Pacific stocks so far this morning.
• If broad new lockdowns are implemented in and around China, global demand could take a further hit, hurting risk assets worldwide.

Sri Lanka:  President Rajapaksa and Prime Minister Wickremesinghe said they would resign this week after antigovernment protesters stormed and occupied the president’s residence and office on Saturday.  The resignations reflect popular anger over an economic crisis that has seen the country deplete its foreign reserves, default on its debt, and lose its ability to import needed food, fuel, and medicines.

• The two leaders’ intent to resign comes after an emergency meeting of the country’s political party leaders that demanded they step aside to make way for an interim, all-party government.  During the meeting, the party leaders also resolved to hold early elections.
• Sri Lanka’s problems stem largely from reduced tourism revenues, excessively large tax cuts, and the government’s delay in seeking aid from the IMF.  Nevertheless, its crisis is also being seen as a harbinger of the risks facing highly indebted emerging markets as global oil prices rise, major central banks hike interest rates, and the dollar strengthens.  Other key emerging markets at risk include Pakistan, Lebanon, and Zambia.

Iran-Venezuela:  The Venezuelan government has agreed to make one million hectares (about 2.5 million acres) of agricultural land available to Iran so it can grow soybeans, corn, and other crops there.  The deal aims to improve Iran’s food security and get around the country’s chronic shortage of fresh water.  It reportedly follows a similar agreement in which Russia provided 100,000 hectares of land for Iranian agriculture.

• After Western countries effectively seized Russian foreign reserves at the outbreak of the Ukraine war, the Iranian deals offer more evidence that countries concerned about the security of their reserves may channel more of their resources into commodities, land, and other physical resources.
• If such a shift of foreign reserves becomes widespread, we think it could help buoy prices for those resources.

Global Shipping Rates:  In additional evidence that slowing demand is starting to bring down prices, maritime and over-the-road shipping rates are starting to come down, although they remain higher than they were before the pandemic.  Weakening demand has also started to push down some commodity prices, including oil and copper.

United States – COVID-19:  Hospital admissions are rising across Europe and the U.S. as highly transmissible COVID-19 variants like BA. 5 Omicron drive infections.  However, the resulting illness is proving to be less likely to be severe or cause death than in previous waves.

United States – Baby Formula Market:  Abbott Labs (ABT, $109.26) has reopened its key baby formula plant in Sturgis, Michigan, following a nearly three-week closure stemming from severe thunderstorms that blew through the state. The company has restarted production of its EleCare formula for babies with digestive issues and will begin shipping it in the next few weeks.  The development may soon alleviate a supply shortage that proved politically damaging to President Biden and led to the U.S. easing rules to boost imports of foreign formula.

United States – Commodity Markets:  Exchange operator CME Group (CME, $208.90) said it will revamp its lumber contract and give it the new ticker of “LBR” beginning next month.  To boost trading in 2×4 derivatives and improve liquidity, the new contract will be fulfilled with a truckload of boards instead of a railcar full (which is about one-quarter the volume of wood) delivered to Chicago rather than a remote Canadian rail junction. The specifications will allow for eastern species of spruce, pine, and fir, instead of only varieties that grow in the West.  The current contract that expires in May 2023 will be the last listed under existing specifications.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment begins with a discussion about Shinzo Abe’s unfortunate assassination. We then examine central bank news from Europe and the U.S. and its impact on the euro-dollar exchange rate. Next, we provide an update on the latest development from the Ukraine war. Finally, we end the report with an overview of various stories that we believe will affect financial markets.

Attack in Japan: Former Japanese Prime Minister Shinzo Abe was shot and killed during a campaign visit to Nara. His assailant has been apprehended and is currently in police custody. The shooter claimed that the killing was not politically motivated. Shinzo Abe was one of Japan’s longest-serving prime ministers holding office from 2012 to 2020. He will be remembered for his push to rebuild Japan’s military and implement Abenomics, a strategy aimed at boosting the economy’s growth through accommodative monetary policy, fiscal stimulus, and structural economic reforms. So far, there is no sign of whether this event will delay the Japanese national elections scheduled to take place on Sunday.

 Central Bank News:  The Federal Reserve reaffirmed its commitment to raising rates. Meanwhile, the ECB struggled to articulate its policy path as it plans to raise rates this month. The hawkish tone of the Fed official and lack of policy certainty of the ECB helped drive the euro-dollar exchange rate closer to parity.

• ECB’s New Tool: The European Central Bank’s anti-fragmentation tool will not be ready by the July 21 meeting. According to the minutes released by the ECB, the bank is still working out the details of its plan to prevent financial fragmentation within the Eurozone. The specifics of the policy tool were scheduled to be released over the next two weeks, but there are still disagreements about how the central bank should implement the new tool, especially as it seeks to raise rates to contain inflation. Typically, when the ECB increases its policy rates, borrowing costs for southern European countries rise faster than northern European countries. Although a small spread is sustainable, a significant divergence in bond yields threaten to overwhelm southern governments’ debt-paying capacity. The lack of policy uncertainty suggests that the ECB may be reluctant to take aggressive action in curtailing inflation, therefore leading to weakness in the euro.
• Fed comments: Despite the recent spate of disappointing economic data, Fed officials are still pushing for a 75 bps hike in July. On Thursday, St. Louis Fed President James Bullard and Fed Governor Christopher Wallace insisted that the Federal Reserve needs to get inflation under control. Bullard argued that the Fed is in danger of losing its credibility if it does not continue raising rates. At the same time, Wallace claimed that high inflation could slow economic activity in the future. The hawkish tone from the Fed officials suggests that they remain certain that the economy can withstand additional rate hikes. Waller described market concerns of a downturn as being “overblown,” while Bullard maintained that the Federal Reserve can still achieve a soft landing.

The comments by Waller and Bullard suggest that they prioritize taming inflation over economic growth. Although both appear to downplay the notion that a recession is imminent, it is unlikely that these officials would ever admit to wanting to raise rates into a recession. Instead, officials may be trying to ensure that the Fed maintains some flexibility in its ability to raise rates in case growth remains stable and inflation is elevated. If we are correct, the Fed may wait to see solid evidence of economic deterioration before ending its tightening cycle.

Russia-Ukraine Update: The Kremlin announced that it is pausing some of its military activity to rest and prepare for new operations. Experts widely expected the pause as Russian forces sustained significant casualties in their fight to take over the Luhansk region. Although troops are expected to continue to maintain small-scale operations, Russia could be preparing for another run to take over Kyiv. In a show of defiance to Western sanctions, Russian President Vladimir Putin stated that the war in Ukraine has not even started, and challenged the West to meet it on the battlefield. Nevertheless, Putin’s provocative remarks suggest that his recent success could encourage him to take more decisive action in the war.

• World leaders gathered in Bali earlier today to discuss the war in Ukraine and its impact on the global economy. Although the Indonesian Foreign Minister urged countries to use the gathering to reduce tensions, the divide between the U.S. and Russia was palpable. While U.S. officials were looking to gain support for potential price caps on Russian oil, officials from Moscow were looking to gain reassurances from China. The competition between the U.S. and Russia over influence will probably have geopolitical ramifications. If a country sides with one, it must be prepared to isolate itself from the other. We believe that this trend reflects a broader move toward forming regional blocs, which will eventually affect how countries trade with one another.
• Russian Foreign Minister Sergey Lavrov stated that he was prepared to negotiate over wheat; however, he walked out of several meetings after criticism over Russia’s invasion. Lavrov’s exit suggests that Russia will probably continue its efforts to block Ukraine’s wheat exports.
• US. Senators Lindsey Graham (R-S.C.) and Richard Blumenthal (D-Conn.) met with Ukrainian President Volodymyr Zelensky on Friday. The two senators are looking to push legislation that would classify Russia as a state sponsor of terrorism, which should open the country to additional sanctions and trade restrictions.

Chinese News: Chinese car sales jumped in June, suggesting that the economy is seeing an improvement in consumption following the lifting of COVID restrictions. The China Passenger Car Association reported that vehicles sales rose 23% from the prior year. The increase in purchases suggests that consumers are feeling more confident about the economy.

• The Biden administration is considering reducing U.S. tariffs on Chinese goods. Although President Biden has not made a final decision, members of his administration, including Treasury Secretary Janet Yellen, have argued that tariff reduction could lessen price pressures. Meanwhile, advocates of tariffs have argued that keeping them in place will give the White House more negotiation leverage in trade talks with Beijing.

Housing market: Mortgage rates posted their steepest one-week decline since 2008. According to Freddie Mac, the average 30-year fixed-rate mortgage fell 40 bps from 5.70% to 5.30%. The sharp drop in rates reflects a broader decline in interest rates for longer-term bonds as investors are growing more concerned about a recession.

Boris Johnson Exit: The U.K. conservative party is exploring plans to expedite Prime Minister Boris Johnson’s transition from the premiership. Johnson wanted to stay on for three months while the party chose his successor. The party is currently in the process of selecting two candidates for party leader and is expected to hold a vote by early September. There is no indication that Johnson’s replacement will cause a significant shift in the country’s policy agenda.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment begins with a recap of the minutes from the FOMC meeting in June. Next, we discuss the latest events in Ukraine and other situations related to the war. Afterward, we review various stories from around the world, including developments in the European Energy Crisis, China’s new stimulus, and the possibility of inflation cooling in the U.S.

Fed Meeting Minutes: The Federal Reserve reaffirmed its commitment to fighting inflation in its June meeting. The minutes from the meeting revealed that FOMC members were concerned that the central bank was at risk of losing its credibility. As a result, the members decided that a 50 or 75 bps rate hike would be appropriate for their July meeting. The market had little reaction to the minutes, as recent economic data did not convince investors that the minutes represented the Fed’s current thoughts on the economy. Thus, equities closed slightly higher than open, and the two and 10-year Treasury remained inverted.

Russia-Ukraine: For the first time in 133 days, Russia has not reported any territorial gains in Ukraine. The lack of progress suggests that Moscow may be implementing a pause in its invasion. Although Russian forces are still conducting limited military offensives in Ukraine, it appears that the Kremlin is preparing for more expansive operations in the future. This assessment is supported by the Russian government adopting a new law that will give it direct control over its economy. The measure allows government officials to recall workers from vacation, reschedule their time off without consent, and force them to work weekends, holidays, and nights. This change in law will allow the government to allocate more of the country’s resources toward its war effort as it seeks to take over the entirety of Ukraine. This development provides evidence that this war will probably not end soon.

• The West is continuing to look for ways to curtail the Russian invasion by targeting its energy exports. After sanctions failed to deter countries from purchasing Russian oil, the U.S. and its allies are now looking to implement price caps. The caps on the price of Russian oil will range from $40-$60 a barrel, and are designed to limit Russian export revenues. So far, it isn’t clear when the caps will be imposed; however, there does seem to be some momentum for the measure. The U.S. officials are meeting with G-20 members in Bali to work out the details.
• As the Russian blockade continues to prevent Ukraine from exporting grain to the rest of the world, there is a growing push to transfer these crops via rail. On Thursday, Romania announced that it was able to reopen its railway earlier than expected to help facilitate the shipment of wheat. As a result, Ukraine can transfer its grain to countries whose ports are not blockaded. The improvement in the transportation of wheat will possibly reduce the likelihood of a global food crisis.
• Ukrainian President Volodymyr Zelensky revealed that the weapons it received from the West are helping to slow Russian advances in his country. His statement suggests that Ukraine could look to revamp efforts to retake lost territory after a noticeable lull in the conflict. This will likely mean that the stalemate between the two sides will continue as both have the weapons needed to keep the war going.

Shake-up in Europe: As the war looks to ramp up pressure on Russia, Europe is also dealing with political headaches.

• PM Boris Johnson: Boris Johnson was forced to resign from his post following a slew of resignations and growing calls from within his party to step down. More than 30 people have left his administration, and Johnson fired a key minister after urging his resignation. Although he plans to stay in power until a new party leader is chosen, there is growing pressure for him to step down immediately. Details of a timeline of his departure are expected to be released next week. The possibility of decreasing political uncertainty following Johnson’s resignation led to a brief rally in the pound. Currently, there are several candidates to replace Johnson, but no clear front-runner.
• European Energy Crisis: As commodity prices rise, Europe is taking extreme action to help ensure its energy security. On Thursday, the French government agreed to nationalize nuclear energy company EDF (ECIFY, $1.74). France’s decision to take it over is designed to assure the company’s survival as the country prepares to secure its energy resources moving into the winter. In a similar move, the German government bailed out energy provider Uniper (UNPRF, $10.75) on Tuesday. Recently, energy shocks due to the war in Ukraine have forced governments to make bold moves to protect the stability of energy prices. Although the EU has not altered its commitment to fight climate change, the rise in the amount of coal use and its reclassification of green energy to include natural gas and nuclear suggest it is becoming more flexible in meeting its ambitious climate standards. In the short run, this could bolster commodity prices as it appears Europe has no other alternatives to fossil fuels.
• Draghi in trouble? The Italian parliament is in danger of collapse as disagreement over the Ukraine war has led to fractures within the ruling government. Leader of the Five Star Movement Giuseppe Conte met Prime Minister Mario Draghi to deliver a list of demands to ensure the party’s support of the coalition. The list included measures to protect the Five Star welfare payment program and raise the minimum wage. Although the Five Star Movement confirmed its commitment to supporting the current government, it is not clear how long that will last. The inter-coalition rift started when the Five Star Movement voted against offering Ukraine military support and urged the government to use more of the country’s resources to improve people’s lives at home. Tension within Italy has led to heightened political uncertainty risks and could have ramifications for the euro area in the long run.

Inflation cooling: As the economy shows signs of slowing, there is evidence that prices may be cooling. The latest data from Zumper suggest that rental prices are starting to slow. Meanwhile, the chipmakers are reporting quicker delivery times of semiconductors suggesting that the shortage of chips may be waning. Lastly, energy prices, one of the largest contributors to inflation, have started to decline. Brent Crude has dipped below $100 a barrel for the first time since April and declining demand could see it fall further later this year. These developments indicate that inflation may have already peaked.

China: Although economists forecast that the Chinese government will report that its economy grew 1.5% in the second quarter, other data sources suggest that the economy shrank. The slowdown in the economy is forcing Beijing to take action to ensure that it meets its target of 5.5% growth by the end of the year. To meet its goal, China is exploring a rare mid-year sale of bonds to help fund a $220 billion stimulus package. The funds will be used to boost infrastructure and stimulate the economy.

• After loosening some of its COVID restrictions and offering stimulus, Beijing may also try to help its economy by improving ties with U.S. politicians and pushing vaccinations. According to the National Counterintelligence Security Service, China plans on recruiting state and local leaders to lobby Washington on its behalf. If true, the report suggests that Beijing may not be in a rush to decouple from the U.S. as it seeks to rebound from its recent economic setback.
• New lockdowns may be imposed in Shanghai after the city reported that the number of new infections doubled on Wednesday to 54. The outcome suggests that supply chains issues may persist in China.

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