by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with news of a new Western alliance to help develop strategic mineral resources outside of China’s control. We next review several other international and US developments with the potential to affect the financial markets today, including a surprise win for the German ruling party in state elections yesterday and potential new US restrictions against automatic driving and vehicle communications technology from China and Russia.

Global Strategic Minerals Market: On the sidelines of the United Nations’ General Assembly in New York this week, the European Commission and 14 allied countries ranging from the US to Australia will announce a new Minerals Security Partnership (MSP) to finance strategic mineral projects around the world. To reduce China’s near monopoly on the supply of many key minerals, MSP participants will direct their development finance and export credit agencies to work with private industry in support of projects such as a new nickel mine in Tanzania.

• Now that the US and rest of its bloc have come to perceive the military and economic threat from China over the last decade or so, they have increasingly imposed trade, capital, and technology restrictions against Beijing. As we have noted in the past, the China bloc and the China-Leaning bloc will likely respond by weaponizing their chokehold on key minerals in the coming years.
• The US and allied governments recognize that threat and are working to reduce it. A key question for investors is whether those allied efforts will help shield Western companies from potential supply disruptions and/or create new opportunities in the basic materials or industrial sector.

United States-Japan-Australia-India: At the “Quad” alliance summit over the weekend, the US, Japan, Australia, and India approved a plan for joint coast guard patrols in the Indo-Pacific region starting in early 2025. Under the plan, coast guard vessels from the Quad countries would be jointly manned by US, Japanese, Australian, and Indian personnel as they patrolled against illegal fishing in the region.

• Although the patrols would be ostensibly against illegal fishing, the focus almost certainly would be on Chinese vessels, which have been particularly aggressive and numerous in the Indo-Pacific fishing grounds.
• The joint crews are clearly meant to send a message to Beijing that if it continues its aggressive efforts to assert sovereignty over the region, it will have to deal with all four Quad members, rather than just one.
• The move, therefore, is likely to raise tensions with Beijing and lead to further decoupling between the US and Chinese blocs, with big risks for global investors.

United States-China-Russia: As early as today, the US Commerce Department is expected to unveil new rules banning the use and testing of Chinese and Russian technology for automated driving or vehicle communications. The new restrictions aim to keep the Chinese and Russians from being able to track, spy on, or sabotage US drivers remotely — a concern heightened by Israel’s attack last week on Hezbollah militants using compromised pagers and walkie-talkies.

• The US and allied governments have long worried about China-bloc countries infiltrating internet-connected equipment, from port cranes to electrical-grid computers, to spy on the West or be able to disable those systems in time of conflict. After the Israeli attack, it is now better understood that connected products, from cars and phones to refrigerators, can also be used for highly targeted kinetic attacks if their supply chains are compromised.
• In effect, Israel may have opened Pandora’s Box, which is now internet-connected. Having seen a successful kinetic attack using connected equipment whose supply chain was compromised, state and non-state actors around the world today are almost certainly exploring how they could do the same.
• In response, the US and other Western governments will impose even more restrictions on using connected goods or components from abroad. We suspect this will lead to further global fracturing as countries bring even more production back home or at least back to the friendly countries in their own geopolitical and economic bloc, despite the cost. As we have noted before, the result will be shortened, less efficient supply chains, higher and more volatile price inflation, and higher and more volatile interest rates.

Israel-Hezbollah: Following Israel’s attacks on Hezbollah last week, the militants dramatically increased their tempo of missile and drone strikes against Israel over the weekend. They also struck Israeli targets much farther to the south than they previously had and claimed the volley was only the beginning of a new phase. Israeli Prime Minister Netanyahu warned of even stronger attacks by Israel. In sum, there seems to be an increasing risk of a broader, more intense conflict in the region that could draw in the US and other regional powers and be highly destabilizing.

European Union-China: As the EU considers serious antidumping tariffs against the growing flood of Chinese electric vehicles, an EU industry group representing steelmakers has appealed for protection against a growing wave of metal imports from China. If the appeal results in a new antidumping investigation by the EU or eventual tariffs, it would signal further EU-China trade tensions and increased risk of a trade war that could hurt companies on each side.

Eurozone-Italy-German: Italian lender UniCredit said it has lifted its position in Germany’s Commerzbank to 21%, up from the 9% that unsettled the German government when it was announced two weeks ago. UniCredit has also applied to the European Central Bank to increase its holding in Commerzbank to 29.9%. The moves signal that UniCredit may be prepping a hostile takeover, which, if successful, could spur a new round of bank consolidation in the eurozone.

Germany: In Brandenburg’s state elections yesterday, the ruling center-left Social Democratic Party (SPD) is on track to eke out a win, with a projected 31% of the ballots, just ahead of the right-wing populist Alternative for Germany (AfD) with 30%. The far-left BSW party appears to have jumped to 13% of the vote. If the SPD’s win is ultimately confirmed, it would provide a reprieve for Chancellor Scholz and at least postpone new elections in the country.

Sri Lanka: In yesterday’s general election, Marxist candidate Anura Kumara Dissanayake won the presidency with about 42% of the vote, versus 33% for his closest rival. Dissanayake’s win marks a major turnaround from his dismal showing in the 2019 election, partly reflecting the electorate’s anger at traditional politicians who sparked an economic crisis in recent years. Going forward, however, the new president may have trouble pushing a fully leftist agenda, as he is required to name his cabinet from members of parliament, where his party has very few seats.

US Fiscal Policy: Republican and Democratic leaders in Congress yesterday agreed to a stopgap spending bill to fund the federal government from the end of the current fiscal year next Monday to December 20. If passed into law as planned later this week, the deal would avert the risk of a partial government shutdown right before the November election and give lawmakers more time to hash out spending plans for the remainder of Fiscal Year 2025.

US Nuclear Energy Industry: In a report Friday, Constellation Energy and Microsoft reached a deal in which Constellation will invest $1.6 billion to bring its Three Mile Island nuclear plant back on-line in return for Microsoft committing to a 20-year electricity purchase commitment to serve its artificial-intelligence efforts. The deal illustrates both the growing attractiveness of nuclear energy as a clean source of electricity and the rising electricity demands for AI.

• Those forces have already driven up electric utility stocks, and they could well continue doing so in the near term.
• After news of the deal, Constellation’s share price jumped 22.3% to close at $254.98.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Today’s market is still grappling with the implications of the recent rate decision. In sports news, Tina Charles etched her name in WNBA history, setting new records for career rebounds and double-doubles. Today’s Comment examines the market’s guarded optimism amidst the recent milestone of the S&P 500, the EU’s tightening regulations on US tech, and the implications of Japan’s monetary policy. As always, the report will include a comprehensive overview of domestic and international economic data releases.

S&P 500 Hits Highs: Equities continue to march forward as investors believe that a soft landing is possible.

• The S&P 500 reached an all-time high by surpassing 5700 on Thursday, marking its 39^th record of the year. The market’s buoyant sentiment was fueled by optimism that the Federal Reserve might have pivoted in time to avert a recession. Thursday’s decline in weekly jobless claims signaled continued reluctance among firms to lay off workers and showed a strong labor market. Meanwhile, the Atlanta GDPNow forecast model’s positive outlook also adds to the market’s optimism. Consequently, nearly every sector experienced gains, with technology stocks leading the way.
• However, beneath the surface, recessionary concerns linger. Despite recent mortgage rate decreases, existing home sales plummeted to a post-pandemic low in August. Moreover, FedEx, seen as an economic bellwether, missed profit targets and issued a warning of potential business slowdown in the coming quarters. The company attributed this to waning consumer demand for expedited shipping, further signaling rising price sensitivity within households. This sentiment was echoed in retail sales data released by the Commerce Department, indicating a growing number of online deal-seekers.

• The Fed’s recent shift in focus toward maximum employment over price stability will be tested next week by the PCE price index report. Recent data suggests that core inflation has made significant progress toward the Fed’s target, easing concerns about inflation risks. If core inflation rises modestly in August as expected, investors may become more confident in the Fed’s ability to achieve a soft landing. Fed speeches over the next week should also help guide market expectations as officials look to make their case that the central bank is not worried about recession.

The EU’s Digital Hurdle: The bloc has initiated a crackdown on foreign tech firms to bolster its regional presence in the industry.

• The EU has intensified its scrutiny of US tech giants under the Digital Markets Act. On Thursday, regulators cautioned Apple that it must allow competing tech firms access to its iPhone and iPad operating systems or face substantial fines. This warning reflects the EU’s broader effort to dismantle the dominance of foreign tech companies within the European technology market. Earlier this week, Google successfully appealed a $1.7 billion fine levied against its advertising business but agreed to divest this section of its company in order to resolve the ongoing antitrust probe.
• The EU’s escalating regulatory oversight of US companies signals a strategic pivot towards bolstering domestic industrial capabilities. As geopolitical tensions rise, the region is positioning itself for a more self-reliant future. A recent EU Commission study emphasized the imperative of developing a robust domestic technological infrastructure to mitigate risks associated with over-reliance on potential trade rivals, including China and the US. This shift is reflected in the region’s increased investment in military technology, which will rise from 142 million EUR ($158 million) to 1 billion EUR  ($1.1 billion) a year over the next few years.

• A more assertive EU is expected to maintain its alliance with the US, driven by strong ties and shared interests. However, amid rising geopolitical tensions, EU governments are likely to prioritize industrial policies that bolster domestic firms. This strategic shift could lead to increased investment and higher debt levels for EU countries, but the long-term benefits may include greater corporate competitiveness. Meanwhile, US firms may need to adapt their business models to focus more on domestic markets, as access to foreign markets could become more challenging.

Bank of Japan Holds: The BOJ opted to maintain a patient stance on monetary tightening, awaiting the potential inflationary effects of the yen’s (JPY) recent appreciation.

• On Friday, the central bank announced it would keep interest rates unchanged, signaling that further hikes are unlikely in the near term. During a press conference, BOJ Governor Kazuo Ueda stated that the bank would consider raising rates if inflation and economic conditions remain on their current path. He expressed optimism that the recent appreciation of the yen has provided more flexibility for policy decisions. Ueda also cited uncertainty around a potential US soft landing as a key factor in the rate decision.
• While inflation has been steadily rising, there are indications that underlying price pressures remain relatively contained. Although the central bank’s headline inflation rate reached 2.8% in August, a substantial increase from the year’s beginning, core inflation, excluding volatile food and energy components, remains below the target of 2%. This reinforces the central bank’s stance that it can delay interest rate hikes, given that the recent currency appreciation is expected to place downward pressure on import prices. Japan’s heavy reliance on imports for energy and food makes this particularly beneficial.

• The Federal Reserve’s perceived delayed response to labor market pressures may have influenced the BOJ’s decision to maintain a patient stance. Last month’s market selloff was triggered by the BOJ’s unexpected rate hike and the Sahm Rule activation. The event highlighted the financial markets’ vulnerability to abrupt currency fluctuations, particularly in the context of yen carry trade unwinding. The BOJ’s cautious approach may ultimately enhance financial stability, particularly if inflationary risks remain contained in both countries.

In Other News: The Biden administration admitted that it no longer believes it will be able to negotiate a peace agreement between Israel and Hamas, which may lead to the possibility of escalating tensions in the Middle East. A bipartisan group of lawmakers bypassed House Majority Leader Mike Johnson to force a vote on a bill to expand Social Security access, in a strong sign that his party is losing faith in him. Brazil fined X for defying a platform ban, demonstrating the escalating rift between the two sides.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Markets are still digesting the Federal Reserve’s latest interest rate decision. In sports news, Shohei Ohtani continues his historic season, aiming to become the first player to hit 50 home runs and steal 50 bases in a single year. Today’s Comment will delve into the Fed’s decision to cut rates, explore why the market is not sold on the economy, and provide an update on Germany. Our report will conclude with a roundup of international and domestic news.

Pivot Complete: The Fed launched its easing cycle with a jumbo rate cut but cautioned the market not to expect it to become a trend.

• The Federal Open Market Committee (FOMC) concluded its two-day meeting by reducing its fed funds target rate by 50 basis points to 4.75%-5.00%. While policymakers expressed optimism about inflation’s trajectory toward the 2% target, they also voiced concerns about the cooling labor market. In the subsequent press conference, Fed Chair Jerome Powell indicated that future rate cuts are likely to be smaller going forward, with a 25 bps rate cut expected over the next two meetings.
• Following the Fed’s policy pivots, doubts emerged about the central bank’s commitment to controlling inflation. The dot plot revealed lingering concerns among committee members, with nearly half opposing more than one additional cut for the rest of year. Meanwhile, Michelle Bowman was the first governor since 2005 to dissent, having favored a smaller cut. These factors likely contributed to the slight steepening of the yield curve, with the 10-year Treasury yield rising more quickly than the two-year Treasury yield.

• Investors are shifting their attention from solely focusing on the Federal Reserve’s interest rate policy to broader economic factors like growth, inflation, and the national debt. Furthermore, the timing of the Fed’s exit from quantitative tightening could significantly influence bond yields due to its effect on the bond market supply. Despite these factors, we expect limited downward pressure on bond yields in the near term. In fact, upward pressure may emerge if economic indicators suggest rising inflation or stronger job growth.

Why the Gloom? The market offered mixed signals about the path forward for equities following the Fed’s pivot.

• Despite the initial positive reaction to the Fed’s rate decision, the S&P 500 and Nasdaq Composite indexes both closed slightly lower than the previous day, while the S&P 600 small cap price index experienced only minor gains. While some of this weakness can be attributed to profit-taking by investors who had bet on a specific outcome of the two-day meeting, the overall sentiment suggests underlying skepticism about economic growth. While the central bank expressed optimism about the US economy, the big rate cut does suggest that it is ready to take more aggressive steps if needed.
• There is major concern that the labor market might be cooling more rapidly than the central bank realizes. Since the Sahm Rule was triggered in July, there has been mounting evidence suggesting that firms are reducing their hiring. Recent payroll data reveals a significant slowdown in private-sector job creation, with the average for the past three months falling below 100,000 jobs — nearly half the rate that was observed in 2023. Additionally, the number of jobs available has also slipped, with the job vacancy rate falling to its lowest level since 2020.

• Despite recent economic concerns, there are positive signs. Jobless claims remain relatively low, indicating that firms are reluctant to lay off workers. Additionally, the Atlanta Fed’s GDPNow forecast has been revised upward from a week ago, suggesting a strengthening economic outlook. This strong growth suggests that businesses are well-positioned to maintain their current workforce. As a result, the central bank is likely still on track for the ever-elusive soft landing, but we will continue to monitor economic indicators closely.

Europe Growth Problems: The EU’s largest economy is faltering, raising concerns about the region’s overall economic health as it strives to maintain tight monetary policies and curb inflation.

• The German economy may already be in recession, according to the Bundesbank, which warned that growth could “stagnate or decline slightly” in the third quarter. This grim outlook comes after the economy has narrowly avoided the label despite having economic contractions two of the last three quarters. Additionally, firms are struggling as this month Volkswagen decided to halt production at some plants and BMW lowered its 2024 sales and earnings targets. Although the Bundesbank remains hopeful that the downturn won’t be severe, it conceded that industrial activity remains a problem.
• Economic weakness in Germany could complicate the European Central Bank’s (ECB) efforts to maintain tight monetary policy to bring inflation down to target. Although the region has taken successful steps to reduce price pressures, concerns are growing that this progress is stalling, particularly in the services sector. Overall inflation has fallen from a 2022 peak of over 10.0% to 2.1% in August 2024. However, much of this decline is driven by a slowdown in goods inflation, with services inflation remaining stubbornly high at around 4%.

• The ECB must decide whether to prioritize containing inflation across the region or instead avoiding a severe economic downturn in Germany. Given Germany’s economic weight and influence within the EU, a significant downturn could force the central bank to take more aggressive steps to ease monetary policy. The effectiveness of these measures in combating inflation will depend on whether wage pressures, a major contributor to services inflation, show signs of easing. If worker pay were to accelerate, it would likely put upward pressure on inflation and this could weigh on the euro.

In Other News: Republican House Majority Leader Mike Johnson failed to push through a stopgap funding bill on Wednesday, raising the risk of a government shutdown. The Teamsters union announced it will not endorse any candidate in the upcoming election, signaling labor’s potential shift toward the populist wing of the Republican Party. Meanwhile, Taiwan expressed concerns that China’s increasing military activities are making it harder to detect signs of a possible invasion. The Bank of England decided to keep its rates unchanged at 5.0% for this month but signaled a willingness to ease policy gradually.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is eagerly anticipating the Federal Reserve’s upcoming rate decision. In sports news, Bayern Munich set a new Champions League record for most goals by a single team with a nine-goal victory over Dinamo Zagreb. Today’s Comment will explore our thoughts on the Fed’s anticipated rate cut later today, the potential implications of the ongoing dockworker labor dispute, and the Brazilian central bank’s widely expected U-turn. Finally, we’ll round out our report with a review of the latest economic data.

Inflation to Unemployment: While the market is focused on the size of today’s rate cut, it should also pay close attention to the summary of economic projections, which will outline the future path of interest rates.

• Market expectations for a significant interest rate cut have surged, with the probability of a 50 bps reduction rising from 34% to over 60% since last Tuesday. This shift has been largely driven by former New York Fed President William Dudley’s editorial, in which he expressed optimism that the Fed will take bold action at its next meeting to address labor market challenges. Prior to the July meeting, he pushed the central bank to cut rates, and although the FOMC opted against it, the minutes of the meeting revealed that some members would have supported such a move.
• The decision to implement rate cuts now, rather than at a later time, reflects less of the central bank’s stance on inflation and more of its growing concern about the cooling labor market. These two economic indicators have been moving in opposite directions. While core inflation has decreased from 3.9% to 3.2% since the start of the year, the unemployment rate has risen from 3.7% to 4.2%. Consequently, for the first time since 2021, the unemployment rate now exceeds the inflation rate, reinforcing the view that its mandate of price stability and maximum unemployment is balanced.

• The Federal Reserve is expected to take a nuanced approach at its upcoming meeting, as plans to implement its first rate cut with the release of its eagerly anticipated economic projections. A 50 bps rate cut today would likely prompt the Fed to express a cautious outlook for future rate reductions. Conversely, a 25 bps cut could encourage officials to signal a willingness to take more aggressive action if needed in the future. However, market sentiment could deteriorate if investors perceive that the Fed is not committed to cutting rates to safeguard the economy.

Labor Strikes Back: Just weeks before the election, the dockworkers’ unions are ready to strike in an effort to secure a better labor contract.

• The White House has announced that it will not invoke federal legislation to prevent a potential strike by dockworkers on the East and Gulf Coasts if a labor agreement is not reached by the October 1 deadline. While the US president has the authority to intervene in labor disputes deemed a threat to national security, the administration has chosen not to exercise that power in this instance. Given that over half of US-bound cargo passes through these ports, a strike could significantly disrupt supply chains nationwide and could become a political issue.
• The decision not to intervene in the labor dispute indicates that the administration is keen to avoid actions that could be perceived as anti-union. Since the pandemic, support for labor unions has increased as a tight labor market has compelled employers to offer higher wages to attract and retain workers. This has bolstered the bargaining power of unions as they push for greater concessions. The dockworkers’ labor dispute appears to have reached an impasse over wage increases, with union leaders demanding a 77% pay raise, and a ban on automated cranes, gates, and container movements.

• A strike could disrupt supply chains and raise prices, but a more critical long-term concern is the potential slowdown in technological adoption. After the pandemic, workers initially gained a larger share of company earnings, but their shares sharply declined as the economy reopened. While increased immigration played a role, the rise of AI technology also contributed. The recent dispute suggests that technology could become an increasingly political issue in the coming years, especially if firms use it to offset rising labor costs.

Brazil Turns Hawkish: After being one of the first major economies to implement rate cuts, the central bank of Brazil appears to be on track to undo some of those measures later today.

• Brazil’s central bank is expected to raise its benchmark policy rate by 25 basis points to 10.75% on Wednesday. The decision comes as the central bank looks to establish its independence after previous criticism from President Luiz Lula da Silva. Since taking office, Lula has increased public spending, particularly on social programs, raising concerns that the resulting debt could fuel inflation. His chosen successor to take over the central bank, Gabriel Galípolo, has also adopted a hawkish stance, pledging to take whatever steps are necessary to curb inflation.
• The decision to tighten monetary policy reflects the Brazilian economy’s signs of overheating. In the second quarter, the economy expanded at an annualized rate of 5.9% — the fastest pace since late 2020. This robust growth coincides with a persistently tight labor market, where the unemployment rate remains near 20-year lows. The combination of strong growth and low unemployment has likely contributed to a rise in overall inflation, which is currently above the central bank’s target rate of 3%, and risks exceeding the tolerance range of 4.5%.

• The central bank’s anticipated rate hike should serve as a warning about the dangers of excessive interest rate cuts, particularly if the country fails to rein in its spending. While we do not foresee other central banks adopting a more hawkish stance in the near term, a resurgence of inflation could force central bankers to pause and reverse earlier rate cuts to contain price pressures. Should the central bank of Brazil raise interest rates as expected, the country’s currency is likely to appreciate relative to its peers.

In Other News: Republican presidential candidate Donald Trump has pledged to restore SALT if elected to a second term, aiming to appeal to high-income suburban voters. Meanwhile, Nippon Steel’s merger plans gained momentum as the Biden administration extended its bid for US Steel, despite delays due to national security concerns and bipartisan opposition. In another development, Google successfully appealed its 1.5 billion EUR ($1.67 billion) competition fine, signaling that big tech may be able to fend off further regulatory crackdowns.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with news that China has purportedly found a big, new deposit of rare earth minerals, possibly further cementing its lock on this key resource as the world electrifies. We next review several other international and US developments with the potential to affect the financial markets today, including a proposed European Commission cabinet that could lead the European Union toward adopting French-style economic policy and a few words on the fallout from the second assassination attempt against former US President Trump.

China: A Chinese mining firm told an international conference last week that it has discovered a 5-million-ton deposit of rare earth minerals in the southwestern Sichuan province. If confirmed, the find would increase China’s recognized reserves of rare earths by approximately 5%.

• Rare earths are a critical class of minerals for the electrified economy of the future, and China and its geopolitical bloc already account for the bulk of the world’s reserves, production, and refining.
• The new reserves would further boost China’s control over the key minerals, increasing the risk that Beijing could weaponize the minerals. Indeed, Beijing has already started to clamp down on exports of the minerals to the US and its allies.

United States-Japan-China: Washington and Tokyo are reportedly close to a deal that would cut exports of advanced semiconductor manufacturing equipment from Japan to China. Washington has also pressured The Hague to cut China’s access to Dutch exports of such equipment. The US demands aim to limit China’s economic and military development, but reports say Japan is especially worried that China could retaliate for such a deal by cutting off exports of key minerals, as discussed above.

Japan: The yen (JPY) yesterday appreciated to 139.56 per dollar ($0.0717), marking a 13.5% rise in just the last two months and leaving it at its highest level in more than a year. The appreciation largely expects rising expectations for an aggressive 0.50% interest-rate cut by the Federal Reserve on Wednesday.

European Union: European Commission President von der Leyen today revealed her nominees for the commissioners who will fill out her cabinet. In the EU system, each member country gets to appoint a commissioner, and the commission president gets to decide what portfolio each will get, subject to approval by the European Parliament. In her nominating statement, von der Leyen vowed her commission would focus on economic competitiveness and defense, while de-emphasizing the climate policies that were prevalent in her first term.

• France’s nominee, Stéphane Séjourné, who is a close ally of President Macron, will lead EU industrial strategy, with a charge to focus on investment and innovation. Under the last-minute deal between Macron and von der Leyen that we noted yesterday, Macron will now have increased influence over EU economic policy, while von der Leyen will be rid of former French Commissioner Thierry Breton, a bitter political rival.
• Spain’s Teresa Ribera, the commission’s most senior Socialist, will be in charge of EU competition policy, with a charge to modernize it and develop a new state-aid policy.
• Slovakia’s Maroš Šefčovič will head up the EU’s foreign trade policy.
• Lithuania’s Andrius Kubilius will have a newly created post for EU defense policy.

United Kingdom-European Union: New modeling by an Aston University economist shows that British trade with the EU has plummeted after Brexit and the UK-EU Trade and Cooperation Agreement that came into force in 2021. According to the study, UK exports to the EU are now 17% lower than they would have been without Brexit, while imports from the EU are 23% lower. Prime Minister Starmer has ruled out rejoining the single market or forming a customs union with the EU, but the report will likely put new pressure on him to improve UK-EU trade.

United Kingdom: As British businesses increasingly worry that the government will impose new taxes to close its big fiscal deficit, Prime Minister Starmer yesterday insisted next month’s budget will include no provisions that would hurt economic growth. However, since Starmer has now ruled out increases in income tax, value added tax, corporation tax, and employee national insurance, it appears that he may be setting the stage for increased taxes on capital gains or assets held by the wealthy.

US Politics: As we continue to monitor the aftermath of the second assassination attempt against former President Trump on Sunday, we are struck by two issues.

• First, there was very little market reaction to the incident either Sunday or Monday. Volatility measures remained relatively low. In a sense, that is disturbing, since it suggests the markets and perhaps the broader society is becoming desensitized to political violence. Of course, a successful assassination attempt could well have a bigger impact.
• Second, the reports we’ve seen so far suggest the would-be assassin traversed a wide range of political positions and grievances over time, similar to the first attempted assassin. Whether or not that is ultimately confirmed, there will be plenty of fodder for accusations on either side of the political divide, which could exacerbate political tensions as the November election approaches. In other words, the relative calm in the markets yesterday could still give way to market volatility in the coming weeks.

US Monetary Policy: The Fed begins its latest policy meeting today, with its decision due tomorrow at 2:00 PM ET. The policymakers are widely expected to cut the benchmark fed funds interest rate at least 0.25% from its current range of 5.25% to 5.50%. Of course, some investors are still looking for a cut of 0.50%, but we think it’s more likely that lingering concerns about price inflation will keep the policymakers from being that aggressive.

US Labor Market: Amazon yesterday told its full-time office workers that they must be on site five days a week beginning in January. The move is one of the most aggressive back-to-office directives among US companies. If successful, the directive could prompt a more general return to the office, which would benefit both office building owners and related service businesses surrounding major office buildings.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with some interesting new research on how much the Chinese are spending on their military — an issue that has raised concerns about China’s intensions, which helped spawn global fracturing. We next review several other international and US developments with the potential to affect the financial markets today, including signs that the Bank of Canada may be ready to embark on aggressive interest-rate cuts and new reporting on how utility-sized batteries helped the US electrical grid handle near-record demand this summer.

China: A recent study by the American Enterprise Institute (AEI) estimates that China’s true military spending is about three times bigger than it admits publicly and rivals that of the US. Adjusting Beijing’s published defense budget to account for hidden military outlays, defense industry subsidies, and price distortions, the study finds that China’s all-in defense spending in 2022 was $710.6 billion, almost matching the US Department of Defense’s budget of $742.2 billion and rivaling the US’s all-in spending of $860.7 billion.

• Like the Soviet Union during the Cold War, China currently releases only minimal information on its defense spending. The few figures Beijing does release are widely seen as under-counting China’s military effort.
• The AEI estimate is consistent with Congressional statements suggesting that the CIA believes China’s all-in defense spending is around $700 billion per year.
• Leaders in Beijing almost certainly want to replace the US as the global hegemon eventually. For now, however, China remains more like a regional power, with a defense sphere covering roughly the eastern half of the northern hemisphere, or one-quarter of the earth’s surface. If the AEI estimate is correct, China’s military spending is now more than $14,000 per square mile of its defense sphere.
• The US, in contrast, is still the global hegemon, with a defense sphere covering the entire globe excluding Antarctica (which is nominally neutral). US military spending today amounts to only about $4,800 per square mile of its defense sphere.
• The enormous resources that China is pouring into its military within the East Asian region is one reason why countries around the world have become more fearful of Beijing’s intentions. The Chinese military expansion is therefore a key reason why the world is fracturing into relatively separate geopolitical and economic blocs, with big implications for the global economy and financial markets.

(Source: American Enterprise Institute)

China-Philippines: On Sunday, the Philippine coast guard ship Teresa Magbanua, which had been anchored at a disputed shoal in the South China Sea since April to assert Manila’s sovereignty, returned to a Philippine port for repairs and supplies. Manila said the ship will soon return to the disputed shoal, but China is likely to swarm the area in the meantime with its own vessels, potentially setting the stage for a dangerous new crisis.

Russia-Ukraine: Russian forces today continue their counteroffensive against the Ukrainians who have seized some 1,200 square kilometers of Russia’s Kursk region. However, they have apparently only taken back about 63 square kilometers. Since one key reason for the Ukrainian incursion was to gain a bargaining chip for future negotiations, the question now is how tenaciously the Ukrainians will fight to hold the area and what military resources they might lose in defending it.

France: President Macron has nominated his outgoing foreign minister, Stéphane Séjourné, to be France’s next EU commissioner. The move followed a deal in which European Commission chief Ursula von der Leyen told Macron she would give France a more powerful commissioner post if Macron would sack France’s previous commissioner, Thierry Breton, who is a political enemy of von der Leyen. Upon hearing of the deal, Breton resigned, opening the way for Séjourné. (A bit hardball? Yes. But this is why we love French politics.)

Canada: In an interview with the Financial Times, Bank of Canada Governor Tiff Macklem said his policymakers are increasingly concerned about the country’s weakening labor market and the prospect for further declines in oil prices. With consumer price inflation now almost back down to the central bank’s target of 2.0%, Macklem’s statement sets the stage for further and/or more aggressive interest-rate cuts over the coming months.

Argentina: In a speech yesterday, President Milei proposed a 2025 budget with a primary surplus (i.e., revenues minus outlays excluding interest payments) of 1.3% of gross domestic product. Milei’s austerity program produced a primary surplus of about 1.4% of GDP in the first seven months of 2024, but political and popular opposition is rising, and his 2025 goals depend on a dramatic increase in economic growth and a sharp decline in price inflation. It is not yet clear whether he can continue his reforms and rein in Argentina’s destabilizing debt.

United States-China: The Biden administration on Friday proposed a rule change that would dramatically tighten up the “de minimis” tariff exemption, which allows foreign producers to ship goods directly to US customers if the shipment’s value doesn’t exceed $800. The exemption was used by low-cost consumer goods producers in China, such as Shein, to send about one billion tariff-free shipments to the US last year, creating competitive challenges for US producers.

US Monetary Policy: The Fed begins its latest policy meeting tomorrow, with its decision due on Wednesday at 2:00 PM ET. The policymakers are widely expected to cut the benchmark fed funds interest rate at least 0.25% from its current range of 5.25% to 5.50%. Of course, some investors are still looking for a cut of 0.50%, but we think lingering concerns about price inflation will keep the policymakers from being that aggressive.

US Electrical Grid: Despite record-high temperatures and strong electricity demand for air conditioning this summer, a Wall Street Journal article today shows the US electrical grid managed to handle the load with relatively few problems. The article tags the success largely to recent investments in both renewable energy, such as solar and wind farms, and battery storage, especially in California and Texas. The surprisingly critical role played by batteries suggests investors will continue pouring funds into battery makers and battery materials.

US Technology Industry: In another article today, the Journal highlights a little-noticed announcement as Apple rolled out its new iPhone last week. According to the company, the Food and Drug Administration has approved use of its AirPods Pro 2 as a hearing aid. Once Apple releases the required software update this fall, an AirPod Pro 2 will be a medical device. It also could well become one of the most popular, low-cost, over-the-counter hearing aids on the market and open a whole new market for consumer tech firms.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Markets await more data to assess the economy’s health. In sports news, Dolphins quarterback Tua Tagovailoa suffered multiple concussions during the team’s loss to the Buffalo Bills. Today’s Comment delves into growing concerns about a government shutdown, explains why the Fed may not ease as aggressively as the market expects, and offers our perspective on the recent European Central Bank’s rate decision. As always, the report concludes with international and domestic data releases.

Shutdown Coming? With time running out, House officials are racing to prevent a government shutdown in October.

• House Minority Leader Hakeem Jeffries firmly stated that Democrats will not support the Republican funding bill. Earlier this week, Republican leader Mike Johnson had to withdraw a vote on the stopgap measure due to strong opposition from both House Democrats and members of his own party. A major sticking point is the proposed requirement for proof of citizenship to vote. Despite this, there is hope that a short-term funding agreement will keep the government open until mid-December.
• In the post-financial crisis era, political infighting has forced lawmakers to repeatedly extend government funding with temporary measures known as continuing resolutions. Only once since 2009 has more than one appropriation bill been passed before the October 1 deadline. These stopgaps prevent government shutdowns but also prolong the appropriation process and contribute to the ballooning budget deficit. The government has already relied on four continuing resolutions this year, which have helped push the deficit to $1.9 trillion. This puts it on track to be the largest deficit outside the pandemic era.

• While budget disputes are common, there seems to be a heightened risk of a government shutdown during the election this year. The ongoing political infighting over the budget is likely to raise investor concerns about the US government’s ability to address its fiscal challenges. The two major rating agencies have already downgraded the US credit rating, citing concerns about partisan gridlock preventing an agreement to reduce the deficit. As a result, we anticipate that continued political bickering over the debt will likely impact long-term interest rates in the future.

Too Much, Too Soon: The market remains optimistic about a significant shift in monetary policy, even though the economy is still demonstrating signs of resilience.

• As of today, market sentiment suggests a nearly 60% likelihood of the Fed implementing a rate cut of 125 basis points or more before year’s end. This expectation is fueled by concerns about a potential economic slowdown, which have been exacerbated by a series of weak labor market indicators. The rise in the unemployment rate in July, which triggered the Sahm Rule, along with this month’s confirmation of slowing hiring trends, has heightened concerns. However, we remain optimistic that the market may be getting ahead of itself.
• Historically, the Fed “takes the stairs up” during rate-hike cycles and “takes the elevator down” during rate cuts, typically in response to recessions. However, there are currently no clear signs of an economic downturn. The recent uptick in the unemployment rate is largely due to new entrants into the labor force. Meanwhile, the Atlanta Fed’s GDPNow forecast indicates a modest economic slowdown in the third quarter, with growth projected at an annualized rate of 2.5%, down from 3.0% in the previous month.

• The recent market reaction aligns with a pattern observed in the past two years, where investors often overestimate the likelihood of aggressive rate cuts in response to perceived economic weakness. This tendency has consistently been met with resistance from the Fed. Despite recent unfavorable data, the economy is expected to remain in expansion, suggesting that this pattern may continue in the coming months. While we anticipate a rate cut in September, we believe the Fed will adopt a more measured approach, with less reliance on jumbo cuts than the market currently expects.

ECB Rate Decision: The European Central Bank (ECB) has lowered benchmark interest rates for the second time in three months and has signaled more to come.

• The ECB on Thursday lowered its deposit rate by 25 basis points to 3.50%, signaling a shift in focus from inflation control to economic support. ECB President Christine Lagarde emphasized during a press conference that interest rates are not predetermined but are on a downward trajectory. While the central bank has not ruled out a rate cut in October, there is speculation that it might do so at the December meeting, when the central bankers will have more data to paint a better picture of the economy.
• Closely monitoring regional wage trends will provide valuable insights into the trajectory of services inflation. Unlike the US, which has experienced a steady rise in unemployment, the EU has witnessed a historic decline. This tight labor market has contributed to persistent wage pressures that have defied the central bank’s tightening efforts and the economic slowdown. This has translated to higher earnings, which explains nearly 60% of its variation of services inflation. As a result, if these wage pressures persist, the ECB may be forced to halt its easing cycle prematurely.

• Historically, the ECB has tended to be less aggressive than the US in raising rates during easing cycles but more cautious in lowering them. Given the persistent tightness of the labor market and its impact on wages, we anticipate that the ECB will likely adopt a more moderate approach to rate cuts to prevent a resurgence of inflation. This could help narrow the interest rate gap between the ECB and the US, potentially providing a boost to the euro. However, the currency could face downward pressure if inflation unexpectedly returns.

In Other News: OpenAI released a new artificial intelligence model that will help process complicated mathematical and coding problems. The development is a reminder of how AI capabilities are evolving. Former members of the Trump administration are considering selling shares in Fannie Mae and Freddie Mac in a move that could disrupt the housing market. Meanwhile, Russian President Vladimir Putin has threatened retaliation against a NATO ally if Ukraine is allowed to use US weapons to attack military bases in Russia, raising concerns about escalating tensions.

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