by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with an update on the Russia-Ukraine war, including an important indication that Russia still intends to take over or control the whole of Ukraine.  We then review a wide range of other international and U.S. developments with the potential to affect the financial markets today.

Russia-Ukraine:  Now that Russian forces have seized the province of Luhansk and could seize the province of Donetsk as well, it is notable that Russian Security Council Secretary Patrushev yesterday said his country’s military operation in Ukraine will continue until Russia achieves its goals of protecting ethnic Russian civilians from “genocide,” “denazifying” and demilitarizing Ukraine, and obliging Ukraine to be permanently neutral between Russia and NATO—almost exactly the goals President Putin announced in his February 24 speech justifying the war.  The statement seems to confirm that Putin’s public shift to the more limited war aims of defending Luhansk and Donetsk was merely a ruse.  Now that Putin feels emboldened by his military success in those regions (and perhaps because he’s facing pressure from Russian nationalists), he appears to be revealing that he still intends to control all of Ukraine in due time.

• If Putin hasn’t really abandoned his maximalist war aims in Ukraine, a long, protracted war of attrition is more likely.  Putin may order or allow his military to rest and regroup from time to time, especially if he thinks the Western allies are tiring in their support for Ukraine, or if he thinks that the upcoming elections in the U.S. or elsewhere will produce new leaders more likely to acquiesce in Russia’s invasion.  However, Putin could then order renewed offensives at a future time.
• If Putin retains his maximalist war aims, another important implication is that it would make no sense for the Ukrainians to concede any territory to the Russians in hope that they would be appeased.
• New reporting by the Wall Street Journal indicates Russian forces have transformed Ukraine’s massive Zaporizhzhia Nuclear Power Plant into a forward military base, likely hoping that safety concerns will prevent the Ukrainians from attacking it.  The report indicates that the Russians are deploying heavier, longer-range weapons to the plant almost daily, and that the base has therefore become the linchpin of Russia’s control over the surrounding region.

Global Oil Market:  Despite the ongoing supply disruptions from the war in Ukraine, the recent slump in some commodity prices accelerated sharply yesterday.  Crude oil prices fell especially hard, with Brent Crude closing 9.5% lower at $102.77.  Prices have rebounded to some extent this morning, but the sell-off reflects intensifying concerns about rising interest rates, signs of slowing demand, and a growing risk of recession in the coming months.  Other factors pushing down oil prices include the strong dollar and indications of increased production.

• The fall in crude oil prices and weakening demand already appear to be pushing down gasoline prices as well.
• According to AAA, average U.S. gasoline prices have now fallen modestly to $4.80 per gallon, compared with more than $5.00 per gallon last month.

Global Digital Currency Markets:  In more fallout from the recent plunge in cryptocurrency values, crypto broker Voyager Digital (VOYG.TO, 0.3350) filed for bankruptcy protection.  The move comes just days after the firm suspended withdrawals and trading on its platform and secured a $400 million emergency credit line from crypto broker FTX.

• Voyager Digital’s problems stem mostly from a loan that one of its subsidiaries made to crypto hedge fund Three Arrows Capital, which defaulted after taking heavy losses on its investment in multiple cryptocurrencies.
• FTX has recently played a key role in propping up other crypto firms in trouble, so it will be interesting to see if it takes a significant loss from the Voyager Digital debacle, or whether the debacle forces it to step back from helping other firms.

European Union Digital Markets Regulation:  The European Parliament yesterday gave final approval to two key laws that analysts believe could become models for global digital markets regulation.  The laws aim to rein in anti-competitive behavior and control services on digital platforms, with fines in extreme cases ranging up to 20% of an offending company’s annual revenue.  As we have warned in the past, such legislation reflects the growing regulatory risk facing technology companies in countries around the world.

• The Digital Markets Act, which is aimed at anti-competitive behavior, will impose new obligations on how a small number of digital giants operate, with rules dealing with online messaging, digital advertising, and the app ecosystem.  For example, the law would bar dominant tech companies from using their platforms to promote their own goods and services over those from other companies.
  • On a related note, the EU and Amazon (AMZN, 113.50) have reportedly struck a deal that will lift an anti-competitiveness action against the company in return for Amazon changing some of its practices.
  • For example, Amazon would allow third-party sellers on its marketplace to access more information that can help them sell more products online.
• The Digital Services Act, which is aimed at regulating digital content, will require large social-media platforms to take steps to deal with illegal content and other material regulators view as harmful, and give users an avenue to register their complaints about content moderation

United Kingdom:  Prime Minister Johnson suffered a potentially career-ending blow yesterday when both his chancellor, Rishi Sunak, and his health secretary, Sajid Javid, resigned in protest over Johnson’s long string of ethical scandals.  More government members resigned early today.  Johnson has vowed not to resign, and internal Conservative Party issues suggest he could cling to power for months.  However, even if he remains in power for the time being, he may no longer have the political capital to push forward any policy proposals.

• The U.K. is likely to enter a period of greater political uncertainty, which would likely be a further drag on its economy and financial markets.
• Reflecting the economic and financial risks, the pound fell further.  As of this writing, it is valued at $1.1909, down 0.4% from yesterday and 11.8% from the end of 2021.

Norway:  The government stepped in to end a strike that threatened to more than halve the country’s natural gas exports, saying the walkout was causing widespread risks to Europe’s energy security.  Nonetheless, the Norwegian strike and similar ones around the globe show that raging consumer price inflation is spurring higher wage demands from workers and threatening to create wage-price spirals.

• The strikes also reflect falling labor force participation in some major countries, which has reduced the supply of labor and given employees more bargaining power.
• We continue to think that inflation rates will moderate over the rest of the year, but as we noted in our Comment yesterday, falling labor force participation, reduced labor supply, and workers’ increased bargaining power make up a key reason why inflation rates aren’t likely to return all the way to their low pre-pandemic levels.

Japan-South Korea:  To repair Japanese-South Korean relations as the two countries try to resist China’s rising power, the South Korean government has reportedly launched an initiative to resolve longstanding compensation claims against Japan for its forced labor practices during World War II.  Although South Korean courts have allowed the country’s citizens to sue Japanese firms for compensation, the initiative will try to channel those claims into an alternative process that doesn’t threaten seizures of Japanese corporate assets.

China:  We continue to see nearly constant reminders that President Xi’s Zero-COVID policies could disrupt the Chinese economy at any time, potentially undermining global growth and pushing down commodity prices.

• Authorities in Shanghai ordered a new round of mass testing for more than half of the city’s districts after 24 new cases were found.
• Officials in Beijing today announced that people wanting to enter public facilities such as museums, libraries, and gyms will need to show proof of vaccination starting July 11, instituting a vaccine pass for the capital for the first time.
• Authorities in Xi’an reported the country’s first community outbreak of cases related to the Omicron subvariant BA.5, prompting officials in the city of around 13 million people to shutter entertainment businesses, schools, and dine-in services for a week.

Congo-Rwanda:  The president of the Democratic Republic of Congo has warned that war could break out with Rwanda unless his neighbor stops backing rebel groups fighting in his country.  The statement by President Félix Tshisekedi follows a strong offensive in eastern Congo by the M23 armed group, which he said was backed by Rwanda.

U.S. Environmental Regulation:  A federal judge in California yesterday threw out Trump-era changes to the Endangered Species Act, including one that allowed economic factors to be considered when government officials are deciding whether to list a species as threatened or endangered.  The ruling also voids regulations that made it more difficult to give protections to species threatened by anticipated future events, such as the impacts of climate change.

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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 Russian forces seem to be on their way toward fully seizing Ukraine’s eastern Donbas region.  We next review other international and U.S. developments with the potential to affect the financial markets today with a focus on the disrupted supply of labor and industrial inputs that is keeping inflation so high.  Our discussion explains why those supply disruptions are likely to linger and prevent inflation from falling all the way back to pre-pandemic levels.

Russia-Ukraine:  Russian forces over the weekend took control of the key city of Lysychansk and the overall province of Luhansk in eastern Ukraine’s Donbas region, while maintaining defensive positions in the areas they hold in southern Ukraine.  Following the seizure of Luhansk province, Russian President Putin appeared to order an operational pause so that the involved units can rest and refit, although the Russian military will likely be wary of taking the pressure off Ukrainian forces.  Meanwhile, influential Russian military bloggers criticized the seizure of Luhansk as too little gain for the manpower and equipment lost in the battle, probably to increase pressure on the Kremlin to call for a fuller military mobilization.  At the same time, the Ukrainian military is increasingly employing Western-provided precision artillery and missiles to destroy Russian military supply resources.

• The Ukrainian government released a $750-billion recovery plan to rebuild and get the economy moving again once the war has ended.  Releasing the plan, Prime Minister Shmyhal said Russia’s invasion had caused more than $100 billion of damage to infrastructure and demanded that the “key source” of funds for reconstruction should be the confiscated assets of the Russian government and its oligarchs.
• In Germany, the government has drafted a law that allows it to take stakes in companies crippled by the soaring cost of imported gas as tensions with Russia threaten to plunge the country’s power sector into crisis.  If passed by parliament, the law would clear a path for the government to bail out Uniper (UNO1.DE, 10.96), the largest importer of Russian gas into Germany.

Global Semiconductor Market:  The recent rout in cryptocurrencies and a slowdown in personal computer sales have combined to put a damper on semiconductor demand, easing the shortages that have caused problems for industries ranging from autos to home appliances.  As evidence of the change, Intel (INTC, 36.34) recently initiated a hiring freeze in its PC-chip division.  If semiconductor supply and demand now come into balance, it could help ease inflation pressures and eventually prompt the Federal Reserve to cool its interest-rate hikes.

Global Labor Market:  We continue to note increasing labor unrest across the globe.  In a new example, union workers at Norwegian oil and natural gas producer Equinor (EQNR, 33.83) went on strike last night in a bid for higher wages to compensate for raging consumer price inflation, forcing the firm to shut down three oil and gas fields.  The union is threatening even stronger measures in the coming days, which the Norwegian Oil and Gas Association warns could cut Norway’s gas exports by 13%.  Since Norway is now Europe’s second-biggest supplier of gas and has become a go-to source to replace supplies from Russia, the move has helped push European gas prices up some 8% so far today.

• The strike at Equinor follows a major British railway strike, a Scandinavian airline pilots’ strike, a picket by U.S. airline pilots over the holiday weekend, a potential strike by West Coast longshoremen, and a move to increase unionization at iconic technology and consumer services firms.
• This labor unrest probably reflects not only the challenges faced by workers during the pandemic, but also the way they’ve gained bargaining power as the pandemic pushed legions of workers out of the labor market (especially Baby Boomers).  The fall in labor supply has increased workers’ relative power versus employers, although probably not enough to dramatically bring down wealth and income inequality.
• Since the many workers who finally went into retirement probably won’t come back, labor supply will likely continue to be restrained in the future.  As with the supply of key goods, this will likely keep inflation from dropping back to pre-pandemic levels.
  • Our labor market analysis has long emphasized that as workers approach and first enter retirement, they tend to reduce their spending and boost saving, helping push down inflation.  However, our recent research has focused more on what happens once they are fully into retirement.
    • At that point, even though they have dramatically cut their spending, they still consume plenty of food, energy, and other goods and services.  The difference is that they are no longer contributing to the production of such goods and services.
    • With the demand from legions of retirees (and other dependents) relatively high compared with their production, the result will likely be increased upward pressure on overall prices.
  • We see a similar dynamic taking hold in global supply chains.  While factors like increased investment, the end of pandemic lockdowns, and demand destruction will probably help bring down global prices for a range of goods in the coming months and quarters, we still think deglobalization and increased geopolitical tensions will keep supplies tighter than they were at the height of globalization over the last decade.  That will also tend to keep inflation from falling all the way back to the levels seen in the decade before the pandemic.

Cryptocurrencies-China:  The slump in cryptocurrencies has also led to well-publicized problems for crypto lenders, brokerages, and hedge funds, but now we are also seeing more reports of corporate investors facing problems.  The latest example is the Chinese selfie app owner Meitu (1357.HK, 0.93), which has said its first-half loss may more than double because of bad bets that it recently made on cryptocurrencies.

Eurozone:  The strikes, the war, and other economic challenges continue to weigh on the euro, driving the currency down as much as 1.4% so far this morning, to a 20-year low of $1.0279.  With the Eurozone expected to face continued headwinds even as the ECB continues to tighten monetary policy slowly, it increasingly looks like the currency will soon reach parity with the dollar (a value of $1.00).

Spain-Morocco:  In an incident little noticed amid the Russia-Ukraine war and major Western summits last week, some 2,000 migrants tried to storm Spain’s enclave of Melilla on Morocco’s northern coast in late June, resulting in 23 deaths.  Spanish Prime Minister Sánchez said the deaths were necessary to defend “the national sovereignty and the territorial integrity of Spain,” but he has been taking intense criticism at home and abroad for the tough response.

United States-China:  Reports over the weekend said President Biden this week plans to lift tariffs on some Chinese consumer goods, such as clothing and school supplies, to help bring down inflation.  He reportedly also plans to announce a new framework allowing importers to request tariff waivers.

• However, there are sharp disagreements over the move within the administration, so the move could still be delayed.
  • Officials including Treasury Secretary Yellen oppose the tariffs on grounds that they are a drag on economic growth and often push up prices unnecessarily.  Yellen and Chinese Vice Premier Liu He reportedly discussed the tariffs today in a video conference, which the Chinese state press described as “constructive.”
  • Officials including National Security Advisor Sullivan and Trade Representative Tai support the tariffs because they provide leverage in the U.S.’s geopolitical and economic disputes with China.  At most, these officials want any reduction in consumer good tariffs to be matched by higher tariffs on key industrial goods.
• In any case, even if the consumer goods tariffs are lifted, we expect the impact on inflation would be minimal.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Today’s Comment begins with discussing the latest Supreme Court ruling and its potential ramifications. Next, we examine crypto regulations and the latest update in the Ukraine war. We conclude with a review of various stories that we expect to impact markets.

EPA decision: In a 6-3 decision, the Supreme Court ruled that the Environmental Protection Agency does not have the authority to regulate carbon emissions for power plants. In the majority opinion, Chief Justice John G. Roberts Jr. stated that although capping carbon emissions solves the problem of climate change, it was unlikely that Congress intended the agency to have the power to develop a scheme on its own. Moreover, the court’s ruling will likely affect other regulations outside of the EPA’s jurisdiction. The court’s decision possibly calls into question other federal agencies’ ability to unilaterally issue vaccine mandates, prevent evictions, and ensure net neutrality.

This ruling is the latest decision by the judiciary signaling the Supreme Court’s rightward shift. We expect that the court will look to limit the authority of federal agencies to regulate firms. This decision can have potential ramifications for various industries, particularly tech and finance. The latest ruling likely paves the way for additional challenges to regulatory oversight, which could cause uncertainty on how firms should comply with current rules. We will monitor the situation closely.

Crypto regulation: Digital assets are facing regulatory scrutiny from governments. On Thursday, EU officials agreed to a set of rules that will govern how cryptocurrencies can be used as investment vehicles. For example, stablecoins will be required to hold significant reserves in case of a sudden rush for withdrawal. U.S. Treasury Secretary Janet Yellen has also advocated that Congress implement similar measures. We suspect that government oversight of cryptocurrencies on its platforms could be bearish in the short term but have the potential for upside in the future. As regulators grow their understanding of the digital asset market and how it works, they will likely be able to weed out some of the market’s riskier elements, creating a safer, more legitimate investing environment. Until then, we suspect governments will attempt to limit the use of crypto in the financial system.

Russia-Ukraine war:  Lysychansk continues to face relentless shelling from Russian forces; it is the last city under Ukrainian control in the eastern Luhansk region. Fighting between Russian and Ukrainian troops has started around an oil refinery along the city’s edge. Reports show that the pro-Russian forces have made their way across the Siverskyi Donets river. If true, Ukraine forces will probably be forced to retreat and continue their fighting elsewhere in the country. Despite Ukraine’s recent setbacks, leaders believe it can launch a counteroffensive in August to retake the land it lost to Russia. Although it has received a plethora of military equipment from the West, it could take months before weapons are operational. In the meantime, Ukraine appears to be biding its time until it can retaliate.

• Indonesia has vowed to continue cooperating with Russia in light of international sanctions. Indonesian President Joko Widodo went to Moscow to discuss the situation in Ukraine with Vladimir Putin. During his visit, he emphasized that the G-7 countries need to ensure that sanctions do not affect food supplies such as wheat and fertilizer. We view these comments by Widodo as evidence that Russia’s commodities can keep countries in its orbit despite sanction pressures from the West.
• Ukrainian officials are looking to restructure some of the country’s debt, as war expenses have made it difficult to repay bondholders. Kyiv is scheduled to make a $1.4 billion payment by September 1. The country would like to remain in good standing with global investors to maintain access to the international financial system.
• A Russian missile strike hit an apartment building and a recreation center close to Odessa. We do not assume these strikes are intentional, but they do reflect Russia’s low-grade weaponry. Given the sanctions banning the export of technology, it is plausible that Russia is prioritizing using older Soviet-style weapons over its more sophisticated ones. We suspect that the older weapons likely lack the precision capability of modern weapons, which is why missiles are hitting unintended targets.
• Hungarian President Viktor Orbán conceded that his country would no longer stand in the way of non-energy-related sanctions. He also stated that he plans to boost his country’s defense capabilities as the war moves closer to its borders. The sudden change in Orbán’s tone may be related to a recent poll showing that the EU is more popular in Hungary than his party. According to Politico, 63% of the population supports the ruling party. At the same time, a poll conducted by Median showed that nine in 10 Hungarians would vote to remain in the EU even if Orbán pushed to leave it.

Erdoğan’s warning: Turkish President Recep Tayyip Erdoğan threatened to reject Finland and Sweden’s entry into NATO if these countries don’t comply with his demand to turn over terrorists. We suspect that Erdoğan’s comment is likely posturing so that he could ask for additional concessions in the future. As a result, we do not expect Turkey to pull its support for Finland and Sweden to join the military alliance.

• President Biden reassured Erdoğan that Congress will approve the sale of F-16 fighter jets to his country. The U.S. suspended plans to deliver jets to Turkey in 2019 after Ankara agreed to purchase an anti-defense missile system from Russia. Turkey could block Finland and Sweden’s bid to join NATO if Biden fails to convince Congress to approve the sale of jets.

Israel Parliament dissolves: Lawmakers in Israel voted to dissolve the government in a widely expected decision. This vote will cause the fifth election in less than four years. Polls show that Benjamin Netanyahu’s Likud party will likely win the most seats. However, it is still unclear whether his party can overcome right-wing opposition. Hence, it is still possible that Israel will head into another stalemate in parliament, creating more uncertainty in Israel.

New Zealand-Europe trade: The EU and New Zealand agreed to a trade deal on Thursday. The agreement will remove most trade tariffs between countries and include provisions that will allow either party to impose sanctions for violating the Paris Climate Agreement. The EU’s outreach to countries in the Pacific also seems to be another attempt to isolate China by bringing Pacific countries into its orbit. As the world begins to separate into blocs, we suspect trade deals like these will become more common.

EU inflation: The latest CPI reading for the Euro Area showed that prices rose 8.6% from the prior year in June, well above the previous month’s reading of 8.0%. The rise in prices was primarily driven by increasing food and energy prices. Core CPI rose only 3.7% from the previous year, which is in line with the previous month’s reading. The surge in prices across the Euro Area increases the likelihood that the ECB could raise rates by 50 bps in September.

• In other news, the ECB is expected to start purchasing bonds from Italy, Spain, Portugal, and Greece using the proceeds from maturing bonds from Germany, France, and the Netherlands on Friday. The move is designed to prevent bond yields among Eurozone countries from diverging.

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