by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with reports of a big new housing support program in China. We next review several other international and US developments with the potential to affect the financial markets today, including another possible election-driven tax cut in the UK and expectations for new US tariffs against foreign solar cells and panels.

Chinese Housing Market: The government today announced a large program to prop up the housing market, which was upended in 2021 by Beijing’s clampdown on excess capacity and developers’ high debts. The program encourages local governments to buy up unfinished homes now weighing on the market and convert them into affordable housing for low- and middle-income buyers. It also scraps minimum interest rates on mortgages and reduces minimum down payments by buyers.

• Excess capacity, high developer debt, and faltering home prices have become a major headwind for Chinese economic growth, so investors will be hopeful that the new program will be successful. However, Beijing hasn’t been clear so far about how extensive the program will be and how local governments will fund the home purchases. As they say, the devil is in the details.
• Despite the lack of detail in the plan, it has apparently helped give Chinese stocks a lift today.

(Source: Dow Jones)

Chinese Economic Performance: April industrial production was up 6.7% year-over-year, beating expectations for a 5.5% rise and accelerating from the 4.7% increase in the year to March. The improving output stems in large part from government support for manufacturing and exports. In contrast, fixed-asset investment in January through April was up just 4.2%, falling short of expectations and slowing from the annual growth of 4.5% in January through March. The annual growth in retail sales also slowed in April.

Russia-Ukraine War: The Ukrainian government said Russian forces have advanced about 10 kilometers from the Russia-Ukraine border toward Kharkiv, leaving them just 25 km from the city. According to the Ukrainians, the Russian troops were stopped as they ran up against the first line of defense around Kharkiv. Nevertheless, the Russian advance in northeastern Ukraine illustrates how they are trying to capitalize on Kyiv’s weakness in personnel and equipment before refreshed aid from the US arrives.

Eurozone: With investors now expecting the Federal Reserve to hold US interest rates higher for longer, many US firms are boosting their euro-denominated bond issuance in Europe. Data from Bank of America shows US firms have borrowed some 30 billion EUR ($32.5 billion) via such “reverse Yankee” deals so far this year, which is on track to match or exceed the record 88 billion EUR ($95.5 billion) in reverse Yankee deals in 2019. This European issuance could help hold down US companies’ interest charges even as they roll over lower-cost debt from previous years.

United Kingdom: With the ruling Conservative Party still trailing by some 20% in opinion polls ahead of the autumn elections, Chancellor Jeremy Hunt today hinted that the government wants to again cut national health insurance contributions, this time to 6% of wages and salary income. If put into place, the Tories will have cut the insurance contribution in half, potentially creating further fiscal challenges for the UK down the road.

US Fiscal Policy: New research by the University of Washington indicates metabolism-related health issues linked to aging and obesity will continue to rise, even as infectious diseases and maternal/child health issues become less prevalent. Since metabolism-driven health issues can be chronic and expensive, we suspect that this will lead to continued spending pressure for programs such as Medicare, Medicaid, and Veterans’ health, making it even harder to cut the federal budget deficit.

US Trade Policy: Just days after announcing a range of big tariff increases aimed squarely at Chinese dumping, the Biden administration today is expected to announce a boost in tariffs on solar panels and cells that will be applied more globally. Because of China’s huge excess capacity for solar-energy manufacturing, global prices for panels and cells have fallen dramatically, boosting US imports from Asian producers such as South Korea, Malaysia, and Vietnam. The new tariffs are designed to protect US producers.

US Financial Market Regulation:  Yesterday, the Supreme Court affirmed by a vote of 7-2 that the Consumer Financial Protection Bureau (CFPB) is constitutional, overturning an appeals court ruling that the body’s funding structure was unallowable. The broad consensus on the agency’s constitutionality will likely cement its position in the nation’s financial regulatory scheme.

US Housing Market: New analysis from the Wall Street Journal shows several major cities in Texas and Florida are posting higher inventories of homes for sale and falling home prices due to strong building activity in recent years. While most of the significant cities are dealing with reduced inventories and rising prices, the situation in cities such as Austin and Cape Coral is a reminder that home values could soon start to peak and even turn negative as inventories catch up to demand.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equity markets are calmer today after yesterday’s investor enthusiasm over the inflation report cooled. In sports news, the Boston Celtics have eliminated the Cleveland Cavaliers and now advance to the Eastern Conference Finals. Today’s Comment will examine the impact that recent economic data will have on Fed policy, explain why the first presidential debate will be historic no matter who wins, and explore rising political violence in Europe as parliamentary elections approach. As usual, the report concludes with a summary of international and domestic data releases.

There Is a Chance: Wednesday’s economic data releases kept the possibility for rate cuts alive by confirming signs that demand is starting to cool.

• Inflation showed signs of cooling, while retail sales lagged. Consumer inflation eased slightly, with the Consumer Price Index (CPI) rising 3.4% year-over-year, down from 3.5% in the previous month. Core CPI, which excludes volatile food and energy prices, also slowed, increasing 3.6% year-over-year, down from 3.8% in the previous month. The slowdown may be related to weak demand. In the same month, real retail sales, which are adjusted for inflation, fell 0.3% from the previous year. Combined, the reports suggest firms may be having trouble moving volume as consumers struggle to absorb price increases.
• Weak economic data has likely kept the possibility of interest rate cuts on the table this year, making further hikes a less attractive option. Reinforcing this cautious stance, Minneapolis Fed President Neel Kashkari emphasized the need for stronger evidence that inflation is moving towards the Fed’s 2% target before policymakers would consider a rate cut. So far this year, the non-seasonally adjusted CPI data, which is never revised, is currently showing that prices are trending at a slower pace than the previous two years, but still remain above the trend of the three years before the pandemic.

• The improvement in inflation is likely a welcome sign for Fed officials but not enough for them to consider lowering rates in June. Next week’s FOMC meeting minutes may provide further clues about how committee members viewed inflation in the first quarter. Based on recent speeches, we suspect that at least one official has signaled a preference for a rate hike this year, which is unlikely to change following one month of subpar economic data and a better-than-expected inflation report. However, if this trend continues to hold over the next couple of months, sentiment could favor a September cut.

Presidential Faceoff: Prospective presidential nominees Joe Biden and Donald Trump will have their first debate next month as they look to set the tone for the election cycle.

• This will be the earliest televised presidential debate in history since the tradition began in 1960. Notably, it was announced before some states had even held their primary elections. The decision to fast-track the debate comes at a time when both candidates want to solidify their names as the leaders of their respective parties in hopes of generating more fundraising. Despite the initial bump after the State of the Union address, President Biden’s approval ratings have significantly declined in recent polls. Meanwhile, former President Donald Trump has faced challenges in fundraising, largely due to ongoing legal expenses.
• An earlier debate should make it easier for the market to gauge which presidential candidate holds the advantage going into the election. The Republican candidate will likely capitalize on the perception that they are stronger on the economy and immigration issues, while the Democratic candidate will likely emphasize the strength of the labor market and the protection of women’s reproductive rights. Although polls currently show that former President Trump has an advantage over President Biden in most swing states, the prediction market, which was a more reliable predictor during the 2020 election, indicates a dead heat with Biden holding a 2-point electoral lead.

• This election is likely to be a toss-up, given that these candidates remain quite unpopular. This explains why both candidates are still facing a notable amount of protest votes during the primary contests. As a result, we suspect that the market is still underpricing the threat that a third-party candidate who has been excluded from the debate, Robert Kennedy, Jr., will have on the outcome of the election. His rising popularity, especially among fringe voters, has allowed him to pull votes from both sides. Currently, there is an elevated chance that the two major candidates will not reach the 270 votes needed to secure victory, which could lead to some market uncertainty.

European Violence:  Attacks on government officials have started to pick up across Europe as the bloc prepares for parliamentary elections.

• On Wednesday, Slovakian Prime Minister Robert Fico was shot after leaving a government meeting. The politician’s condition appears to be improving following the incident, although he is still considered to be in critical condition. The assassination attempt comes a week after two German lawmakers were attacked at two separate events. These violent acts have likely added another level of complexity to European elections that are set to take place June 6-9. So far, lawmakers have sought to limit the gatherings of extreme groups due to concerns that it may lead to more hostilities.
• Recent violent acts in Europe raise questions about a potential link to the ongoing tensions surrounding the Russia-Ukraine conflict. Notably, Fico has publicly supported Russian President Vladimir Putin and is closely aligned with Hungarian President Viktor Orbán. In contrast, the recently targeted German politicians belonged to a coalition government that endorsed sending weapons to Ukraine. Tensions are high following speculation that Moscow has recruited extremists to launch attacks on European infrastructure.

• The potential for rising conflict in Europe, particularly between pro-Moscow and anti-Moscow parties, has been largely ignored. These opposing sides have increasingly resorted to hostile tactics, reflecting the deep divide over Europe’s role in the Ukrainian conflict. While Ukraine’s supporters, particularly those among European leaders, remain vocal, it’s clear that Putin also has allies. As the conflict between Ukraine and Russia extends beyond two years, the situation is likely to deteriorate further. Escalating tensions could weigh heavily on the euro, potentially leading to further supply chain disruptions and raising the specter of a direct confrontation.

In Other News: President Putin and Chinese President Xi Jinping have renewed their vow to cooperate with each other in limiting the US’s influence in the world. While the agreement is nothing new, it serves as a reminder of the two countries’ unshakeable bond. Copper prices surged to a record high in a sign that the global economy may be starting to pick up.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities futures are off to a great start as the consumer price index ended its streak of disappointments. In sports news, the Denver Nuggets took a commanding 3-2 lead in their series against the Minnesota Timberwolves. Today’s Comment will explain why leaving rates unchanged was seen as bullish for investors on Tuesday, why young investors are drawn to risk assets, and why Turkey wants to restore trust that it can contain inflation. As usual, the report includes a summary of international and domestic data releases.

Fed Remains Calm: Federal Reserve Chair Jerome Powell has ruled out the possibility of a hike even as inflation continues to disappoint.

• The head of the Federal Reserve reiterated that inflation remains too high for the central bank to consider cutting rates in the near future. Speaking at the Foreign Bankers’ Association, he acknowledged that disinflation, initially expected this year, hasn’t progressed toward the central bank’s 2% target. However, he surprised markets by indicating that the Fed’s next move wouldn’t be an interest rate hike. Instead, he emphasized the Fed will likely hold rates steady while the effects of current policy restrictions work their way through the economy. This downplaying of future monetary tightening boosted market sentiment, as investors continue to price in two rate cuts starting in September.
• Powell’s comments coincide with the release of a hotter-than-expected producer price index (PPI). The index for input costs rose 0.5% in April, exceeding expectations of a 0.2% increase. Despite the concerning reading, the data offered a glimmer of hope. A downward revision of the previous month’s number, from a 0.2% increase to a 0.1% decline, tempered the impact of the hot report. Additionally, the components feeding directly into the PCE price index, the Fed’s preferred inflation gauge, showed a mixed bag, suggesting consumer inflation may still align with forecasts.

• Even with Powell downplaying the possibility of a rate hike, the threat remains significant. Historically, the Fed has tended to manage market expectations; thus, consistent inflation readings exceeding investor forecasts could force them to act. A positive sign is that core PCE has largely met market expectations and may still fall within the range of the 2.5% terminal rate outlined in the Fed’s summary of economic projections. So far, our worst-case scenario is no rate change at all this year. However, if inflation continues to run hot, we may revise our forecast to include a possible hike at the beginning of 2025.

Meme Rally Back: In an attempt to close the wealth gap with other generations, some younger investors may be turning to riskier assets in hopes of higher returns.

• The return of Roaring Kitty has led to another frenzy in the markets. The social media icon helped lead a charge of retail investors to squeeze hedge funds looking to profit from shorts. He has become a cult figure following the GameStop fiasco and the movie documenting it called Dumb Money. This return has led investors to flock to GameStop and AMC, with those stock prices each rising 30% on Tuesday. Despite the attractive yields offered by traditionally safe assets like Treasurys, Roaring Kitty’s return highlights that risk appetite remains relatively high among investors.
• Limited savings, coupled with rising interest rates and home prices, may be pushing some investors, particularly millennials, towards riskier assets. The stock market appears to be an attractive option for faster financial growth, since it offers an alternative to traditional homeownership, which has become increasingly difficult to achieve for millennials. Supporting this trend, a 2023 National Association of Realtors survey shows the average first-time homebuyer is 35, while a World Economic Forum survey reveals that 70% of retail investors are under 45. Thus, preference for risk assets may be a generational trend.

• While Roaring Kitty’s return might be a temporary market ripple, his influence highlights the ongoing investor appetite for stocks as a store of value. The lack of savings suggests younger generations may be more willing to take on risk to build their retirement funds. This could lead to less sophisticated investors having a greater impact on market prices compared to in the past. While strong fundamentals remain the key to sustainable growth, investors should be aware that bubbles may still form even in a rising interest rate environment.

Turkey’s Inflation Fight:  The country is looking for ways to win back investor confidence as it tackles surging inflation.

• On Tuesday, Turkish Finance Minister Mehmet Şimşek hinted that the government may be willing to implement tough fiscal measures to restore price stability. During an interview at the Qatar Economic Forum, he implied that President Recep Tayyip Erdoğan may be willing to tolerate slower growth as he looks to place the Turkish economy on a sustainable path. His comments come a day after investors shrugged off the government’s announcement of a series of cuts to public spending of about 100 billion liras (TRY) ($3.1 billion) over the next three years. The response was due to doubts that the government would tolerate such a hit to its economy.
• The country’s move to rein in its deficit stems from a decision to return to conventional economic policy. In the past, Erdoğan dismissed the idea that lower interest rates could bolster inflation, suggesting it might actually have the opposite effect. His logic hinged on the notion that higher rates would put more money in the hands of government bondholders, potentially leading to increased spending. To ensure that policymakers would follow his direction, he sacked and replaced the members of the central bank to get the policy that he desired. As a result, the annual change in inflation that year accelerated from 36% to over 80%, leading to a significant depreciation of the TRY.

• Despite concerns over inflation, Turkey continues to boast one of the world’s best-performing stock markets. The MSCI Share Price Index for Turkey is up nearly 40% year-over-year. The rally has been driven by investors seeking to protect their cash holdings from debasement, leading them to invest in stocks. However, this doesn’t necessarily mean that containing inflation won’t have benefits. Foreign investors still believe there may be opportunities if the country can get its fiscal house in order. As a result, it may be worth keeping an eye on Turkey as it may still have a lot of upside.

In Other News: The US announced additional funding for Ukraine in a sign that the war is likely to continue for the foreseeable future. Additionally, there is speculation that China may allow local governments to enter the housing market by purchasing homes, in a bid to reverse the country’s property slump. President Biden is set to provide $1 billion in new arm sales to Israel, as tensions between him and Israeli Prime Minister Benjamin Netanyahu deepen.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equity futures are off to a slow start due to a hotter-than-expected PPI report. In sports news, the Boston Celtics were able to snatch a 3-1 lead in the series against the Cleveland Cavaliers. Today’s Comment will explore why white-collar workers are facing a tough job market, explain the rise in demand for used electric vehicles despite weakening overall demand, and discuss China’s potential economic stimulus measures ahead of its July Politburo meeting.

Labor Losing Leverage: While the labor market remains tight for the broader population, there are signs that certain sectors are struggling.

• Walmart, the country’s largest employer, is set to lay off hundreds of corporate jobs and ask many of its work-from-home staff to return to the office. This shift aligns with a broader trend within the company. In April, the company announced that it plans for 65% of its stores to be serviced by automation by the end of 2026. Last year, it closed three of its tech hubs, requiring workers to relocate to other hubs in the country. This shift comes as the firm looks to shrink its workforce as a way to cut costs and improve its profitability.
• The recent cooling of the labor market has been unusual in that it has disproportionately impacted the services sector. Hiring for white-collar jobs is up 0.6% from the previous year, while the overall job market is up 1.8%. The reason for the slowdown may be related to costs. Proprietary data from Vanguard shows that the greatest demand for workers comes from jobs that pay less than $55,000 a year. This preference for low-wage workers may be related to some firms’ reluctance to hold onto higher-paid workers whose skills are not essential for their current needs.

• The selectivity of the labor market may complicate the Federal Reserve’s ability to balance its price stability and maximum employment mandate. Since many of these roles are relatively high-paying, laid-off workers may rely on savings before turning to government assistance. This could delay their appearance in unemployment figures and potentially raise the chance that the Fed may keep rates higher for longer than the economy can tolerate. While a hard landing is not our base case for this year, we do believe the risks are elevated given the signs of sticky inflation.

Renewable Comeback: While electric vehicle (EV) sales are hurting the bottom lines of major automakers, the used car market is seeing an uptick in the sales of EVs.

• A report from used car retailer Carvana showed that demand for EVs has more than doubled from the previous year. The demand rose by 4.8% in the last quarter, which is more than double the rate observed in the same period of 2023. The increase in sales comes amidst a surge in supply in the used car market, which has helped push the price of EVs down, making them more accessible to the typical consumer. According to the sales data, the difference in selling price for an EV and an internal combustion engine has dropped from $13,000 to $7,000.
• The rising demand for EVs comes at a time when automakers are struggling to contain a drop in profitability. Major US automaker Ford announced that it is losing $100,000 on every EV it sells, while a Kelley Blue Book report showed that new EV sales were down in the first quarter of the year. This weakness in the sector is likely driven by two factors: a surge of new EVs entering the market and waning demand from consumers. Consumers who cannot afford the high sticker price or who don’t see the need for an EV due to relatively low gasoline prices are contributing to the slowdown.

• The improved affordability of EVs will likely serve the US’s needs both geopolitically and domestically. The US government is promoting a switch away from combustion vehicles as a way to wean households off their reliance on energy sources increasingly dominated by countries with hostile governments. At the same time, the drop in used car prices has been a major contributor to the decline in overall inflation. As the world fights for market share in the green energy space, we can expect volatility in the electric vehicle market.

China Boom: Beijing may use fiscal and monetary policy to help boost the economy in time for the Third Plenum.

• On Monday, China’s Ministry of Finance announced plans to raise over 1 trillion CNY ($138 billion) in its fourth such issuance of long-dated bonds in 26 years. The new funds will be used to finance national strategies, including improvements to its defense capabilities and the semiconductor industry. Additionally, there is speculation that the People’s Bank of China (PBOC) could use its tools to improve market liquidity by buying and selling bonds. The recent collaboration between the central authority and monetary policymakers paves the way for improved policy coordination as Beijing seeks to reassure skeptics that it can address the country’s ongoing economic challenges.
• China’s first-quarter economic growth surpassed expectations, but challenges persist. The prior quarter witnessed a slowdown in consumption and investment spending, fueled by a reluctance to lend by banks. The PBOC has required banks to have the capacity to absorb 16% of risk-weighted assets by 2025 and 18% by 2028. This requirement is designed to protect the broader economy from the ongoing property market meltdown and prevent it from leading to a broader financial crisis. However, this change is likely behind the unprecedented contraction in aggregate financing seen in April.

• The lack of lending by banks may explain why the government is taking a more proactive role in stimulating the economy. It likely needs to take the lead until banks improve their balance sheets. The increases in bond issuance may be a prelude to a much larger announcement at the Third Plenum. While the exact nature of the announcement remains unclear, there is a strong possibility that the government could use the funds to help stabilize the real estate market. If true, this may help give the economy an extra jolt but could also weigh on the yuan.

In Other News: The US and China are set to meet to discuss AI as the two sides look to prevent a possible miscalculation. The return of Roaring Kitty has led to a surge in GameStop shares, a sign that retail investors are still willing to take on risk.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equity futures are higher as investors await this week’s economic releases. In sports news, the Indiana Pacers were able to tie up the series with the New York Knicks. Today’s Comment explores why declining consumer sentiment may spell bad news for some companies and why small-cap companies are eager for a Fed pivot. We also provide an update on the war in Ukraine. As usual, our report ends with a summary of the latest international and domestic data releases.

Feeling the Squeeze: May saw the biggest one-month drop in consumer sentiment since 2021; however, the pain was not evenly spread.

• The University of Michigan Survey of Consumer Sentiment fell from 77.2 to 67.4, missing expectations of an increase to 78.0. This disappointing report was driven by rising inflation expectations, as households grew increasingly pessimistic about price increases moderating to pre-pandemic levels. The survey showed that consumers expected inflation to increase to 3.5% next year and eventually to moderate to 3.1% in the next five years. Although there is a lack of strong correlation between inflation expectations and indexes like CPI or PCE, the change in sentiment reflects a broadening trend of weak economic data.
• The recent drop in consumer sentiment reinforces concerns about slowing consumer spending — a trend that many companies hinted at in their latest earnings reports. Despite exceeding expectations, corporate earnings suggest executives are noticing that households are tightening their belts. This cautious spending is particularly evident among discretionary purchases, since companies like McDonald’s, KFC, and Starbucks have reported significant pushback against higher prices. The impact is felt most acutely by low-income households, while higher-income earners have shown greater resilience. In Q2, mentions of low-income consumers by companies have more than doubled when compared to the highest level seen in the past five quarters.

• Although consumer surveys suggest that households are under pressure, it is unclear whether that will lead to a broader consumption pullback. A breakdown by income shows consumer expectations remain relatively optimistic among middle and high-income households. Notably, attitudes of middle-income earners improved from the previous month. However, the sizeable decline in the overall index suggests that low-income earners are feeling less confident in dealing with rising prices. In the short term, there might be a more significant impact on the upcoming election than on the broader economy, but this trend could have long-term consequences.

Small Cap Risk: Despite attractive valuations, investors remain wary of smaller companies, perhaps until the Fed signals an interest rate cut.

• Over 75% of the debt held by companies within the Russell 2000 index needs to be refinanced within the next five years. This is a significantly higher proportion compared to the S&P 500, where nearly 50% of the debt is due at that time. These companies are particularly vulnerable to changes in interest rates because they rely more heavily on floating-rate debt compared to their larger, investment-grade counterparts. As a result, these companies have a heightened dependence on monetary policy decisions as a decrease in policy rates could drastically improve their financial performance.
• Small-cap investors stand to benefit significantly from a successful soft landing by the Fed. These companies are also highly sensitive to fluctuations in the business cycle and real interest rates. Thus, the possibility of declining borrowing costs and improved growth led these companies to outperform their large-cap counterparts toward the end of 2023, for the most part. This relationship is not just a US phenomenon. European small caps have also been able to take off this year due to interest rate cut expectations and signs of an impending economic recovery. The Stoxx Europe Small 200 Price Index has surged 7.5% year-to-date, nearing its 2023 return of 10%.

• Despite some economic setbacks, a strong case can be made for US small and mid-cap companies. Not only do these firms have better valuations when compared to their large-cap counterparts, but their strong domestic focus likely protects their revenue from being significantly impacted by currency fluctuations and geopolitical events. Additionally, while Fed Governor Bowman’s recent comments dampen hopes for a rate cut, the possibility remains for one if inflation eases and unemployment keeps climbing. Nevertheless, this week’s release of the PPI and CPI reports for April could provide crucial clues on the Fed’s path, as inflation is expected to cool from the previous month.

Next Phase in Ukraine: Russian President Vladimir Putin is seeking a new approach as his country faces growing financial pressure from the West.

• Putin replaced Defense Minister Sergei Shoigu with Andrei Belousov, an economist and former first deputy prime minister. This reshuffle highlights Putin’s attempt to re-evaluate Russia’s military strategy, as Russian forces aim to consolidate their gains before Ukraine can leverage additional Western funding. The apparent uneasiness in these moves may also be reflected in Russia’s consideration of lowering the threshold for activating its nuclear weapons and its decision to ramp up recruitment as it recently brought female convicts to serve on the battlefield. These efforts have become more pressing as Putin gets closer to taking over Kharkiv.
• The Russian need for a victory in Ukraine comes amidst growing signs that it is becoming increasingly more costly for Moscow to maintain its war efforts. The European Commission has proposed the first-ever sanctions on Russia’s liquefied natural gas industry, signaling a significant escalation in efforts to sever economic ties with Moscow. Although it would not affect imports, it would prevent EU countries from re-exporting Russian LNG. The measure would complicate purchases of Russian gas for Asian countries like China and India, which have become key buyers since the war began in February.

• Despite waning media attention, the war in Ukraine remains a critical issue, which demands close monitoring. French President Emmanuel Macron’s emphasis on the potential need to send troops to Ukraine underscores the possibility of a wider European conflict. Furthermore, the growing push by the West to restrict Russia’s ability to get help from other countries is likely to exacerbate the trend toward global fracturing and undermine supply-chain security. Therefore, the recent reprieve in gold and oil prices may not hold if European threats continue to escalate.

In Other News: China is expected to hold a major bond sale as it looks to boost its economy. This is a sign that global growth may pick up this year. Meanwhile, more Americans are eying retirement, indicating that the labor market may remain tight for some time. In Spain’s Catalonia region, the Socialist Party dominated recent regional elections. This suggests that the pro-independence movement is losing favor.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities are off to a great start as investors welcome signs of an economic slowdown. In sports news, the Cleveland Cavaliers scored an upset victory over the Boston Celtics last night. Today’s Comment explores how decisions by foreign central banks to cut rates before the US Fed will influence the dollar’s strength. We also explain how recent changes to money market redemption rules will affect bond yields. Finally, the report explores the specific difficulties Canada is facing with immigration. As always, our report concludes with a summary of recent international and domestic data releases.

Lead from Behind: Most central banks in the West are set to cut policy rates this summer, while US monetary policy remains in limbo.

• Central banks around the world are signaling a shift toward looser monetary policy. This week, the Bank of England joined the Bank of Canada and the European Central Bank in hinting at potential interest rate reductions in June. These follow the Swiss National Bank’s recent rate cut, with further easing expected from it this year. In contrast, the Federal Reserve in the United States is on a different path. It is expected to hold rates steady at least until September, with most market participants anticipating cuts only later in the year, likely November or December.
• A Federal Reserve which is hawkish compared to its global counterparts could buoy the dollar, particularly given the robust growth of the US economy. In 2023, GDP growth in the US accelerated to its fastest pace in two years, while the eurozone and UK economies stagnated. This strong performance has attracted investors to the dollar, especially as the Fed signaled a more cautious approach to potential interest rate cuts earlier in March. If this trend holds, the dollar’s strength against other currencies could accelerate, especially if Fed officials continue hinting at the possibility of holding rates steady or even raising them by the end of 2024.

• Nevertheless, there is still a good chance that the dollar’s rise will face some resistance. Despite the Fed likely holding off on rate cuts in June, tapering quantitative tightening could ease financial pressures and lower Treasury yields. This would narrow the interest rate differential for longer-term government bonds compared to other countries. Additionally, recent data suggests a potential slowdown in US GDP growth, while some peer economies appear to be gaining momentum. As a result, the divergence between interest rate and growth may narrow later this year.

Regulatory Shift: New SEC guidelines may help the government resolve some of its Treasury supply problems.

• In 2023, the SEC implemented new rules requiring liquidity fees for investors redeeming shares from certain money market funds during periods of financial stress. This regulation aims to prevent a repeat of the liquidity issues seen in March 2020 and will take effect in October of this year. To avoid these fees, some money managers are exploring strategies to navigate the rules, while others have chosen to close their funds altogether. The new regulations are expected to impact roughly $6 trillion in money market fund assets and will likely have some spillover effect into the fixed-income market.
• This rule change arrives at a critical juncture, coinciding with rising fiscal debt and a hawkish monetary policy stance. Money market funds have surged in popularity as investors seek to capitalize on both the potential for higher short-term interest rates and daily redemptions. However, with fees now attached to withdrawing funds during times of market stress, institutional investors may be forced to park more of their money at the Fed overnight facilities. This shift should allow the Treasury to tap into additional funds as it seeks to finance government expenditures.

• The recent market rule change for money market funds, coupled with the observed market reaction, suggests the government may be seeking to cultivate banks and institutional investors as a primary source of demand for government debt. This shift in dynamics implies that lawmakers might be strategically using regulations to maintain the attractiveness of bonds, particularly as government issuance is expected to increase over time. If this is the case, it could help the government control yields, particularly as it prioritizes short-term debt issuance. Theoretically, this approach could help mitigate the overall rise in government borrowing costs, which should improve financial conditions.

Build It, They Will Come: A Canadian solution to its demographic problem has mixed results as the government looks for a middle ground.

• This year, Canada is adjusting its immigration approach to address strains on social services and housing. The government is taking steps to manage immigration levels by limiting student visas, reducing admissions of temporary foreign workers, and capping the number of permanent residents. This shift marks a change from Canada’s previous focus on attracting immigrants to offset its demographic challenges caused by an aging population and low birth rates. Notably, immigration fueled a significant portion of Canada’s population growth in 2023, with nearly 98% of the 3.2% increase coming from newcomers.
• Despite recent adjustments to its immigration policy, Canada’s focus on attracting skilled workers has yielded positive results. Immigration in the first quarter of 2024 significantly boosted the workforce in skilled trades, with 13 occupations seeing their numbers double the average of the previous year. This influx of skilled labor has helped address the shortage of construction workers, a crucial factor in Canada’s plans to ramp up residential construction and tackle the housing shortage. The Royal Bank of Canada predicts that it will need an additional 500,000 workers by 2030 to help balance the housing market.

• Canada’s recent adjustments to its immigration policy highlight the demographic challenges facing many developed nations. Strict immigration policies, coupled with low birth rates, could strain government finances in the future. As a result, repaying the debt might necessitate unpopular measures like austerity or higher taxes. To address these challenges, governments might explore coordinated monetary policies. However, this approach could lead to unintended consequences like inflation or lower consumption. The market environment has generally benefited commodity assets as investors look to real goods during times of uncertainty.

In Other News: President Biden is preparing to impose tariffs on Chinese EVs as he seeks to prevent Beijing from dumping its overcapacity into the US. Separately, Israeli Prime Minister Benjamin Netanyahu has vowed that his country is willing to stand alone as it looks to defend itself from Hamas.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities are trading lower following a weaker-than-expected bond auction on Wednesday. However, in a thrilling turn of events, Real Madrid secured a comeback victory against Bayern Munich, booking their spot in the Championship Final against Borussia Dortmund. Today’s Comment explores how the earnings outlook from Intel reflects the US-China rivalry’s impact on tech companies. We’ll also examine why the Federal Reserve might hold off on further interest rate hikes and how Germany is working to lessen its dependence on China. As usual, the report concludes with a wrap-up of international and domestic data releases.

Rubber Meets Road: Intel’s earnings outlook offers a real-world example of how the shifting geopolitical landscape can harm corporate profits.

• Semiconductor giant Intel exceeded first-quarter earnings expectations but cautioned about a revenue dip due to a new US ban on chip exports to China. While Intel is maintaining its revenue forecast within its $12.5 billion to $13.5 billion range, it anticipates falling short of the midpoint. This revised outlook follows the US Commerce Department’s decision to revoke the licensing rights of Huawei Technologies to purchase semiconductors from both Intel and Qualcomm. The announcement triggered stock price declines for both companies. However, Qualcomm later clarified that its business with Huawei was already limited and will likely cease entirely.
• The weak outlook comes as the US tightens the screws on China’s chip access. In 2022, the Biden administration, along with allies like Japan and Europe, limited chip sales to certain Chinese companies to prevent their use in military weapons. These efforts proved inadequate, though, as Chinese firms continued to improve the quality of their semiconductors. Last month, US lawmakers were angered that Huawei’s new AI laptops were powered by American-made Intel chips, leading to calls for more chip restrictions. This episode highlights the tightrope that tech companies must walk as they are caught between escalating geopolitical tensions and government policy shifts.

• Despite their strong start this year, semiconductor companies face potential headwinds from rising US-China tensions. This is because tech companies, as measured by the Invesco QQQ ETF, have a greater exposure to China than the broader S&P 500 index. However, there are safer alternatives to large cap tech companies. Midcap companies, with their focus on the US domestic market and strong financials, might offer a hedge against those risks due to their lower exposure to trade disputes.

Restrictive Enough: As the Consumer Price Index continues to disappoint, central bankers are increasingly concerned about whether monetary policy is sufficiently tight.

• Minneapolis Fed President Neel Kashkari weighed in on the current state of monetary policy in a Wednesday note. While acknowledging current policy is stricter than it was prior to the pandemic, Kashkari pointed to a robust housing market as evidence that more action might be necessary to get inflation back to its 2% target. This aligns with recent comments from Fed Governor Michelle Bowman. Over the weekend, she expressed concern that rising immigration might be putting upward pressure on shelter price inflation, as supply struggles to keep pace with demand.
• Anxiety about tightening credit conditions is emerging despite a seemingly easier residential mortgage market. The latest Senior Loan Officer Opinion Survey (SLOOS) shows banks are indeed tightening lending standards for commercial real estate and consumer loans. However, for residential mortgages (excluding subprime), the survey indicates a slight easing in the previous quarter. This divergence suggests the Fed’s policy may not be having a consistent impact across all loan sectors. It’s important to note, though, that despite this easing of financial conditions, demand for home purchase loans remains well below pre-pandemic levels.

• The Federal Open Market Committee (FOMC) minutes, due to be released in two weeks, could provide key insights into the ongoing debate regarding the Fed’s monetary policy stance. During the press conference following the recent decision to hold rates steady, Fed Chair Powell remained tight-lipped when questioned about the possibility of another hike. The minutes from this past meeting may reveal whether any committee members advocated for a rate increase. This, if confirmed, could significantly alter interest rate expectations, especially if the upcoming April CPI data continues the trend of high inflation as seen in the past three months.

Berlin’s Shift: Germany aims to build a closer relationship with the US as it increasingly views China as a threat to its interests.

• Germany’s trade winds have shifted dramatically. The US has surpassed China as Germany’s top import partner for goods and services in the first quarter of 2024, ending China’s eight-year reign at the top. This change reflects China’s sluggish economic growth, but also likely stems from Germany’s growing reservations about its reliance on Chinese imports. German businesses are facing a mounting challenge in China. Soaring compliance costs, coupled with Beijing’s policies that favor domestic companies, are creating a difficult operating environment. While German Chancellor Olaf Scholz has tried to assuage these concerns, there have been few signs of success or improvement.
• In 2023, Germany formally designated China as a “partner, competitor, and systemic rival,” reflecting a strategic shift meant to reduce its dependence on the Asian nation. This attitude change comes as Germany has expressed concern that Beijing may look to resolve its overcapacity problem by dumping its excess goods into Europe. Furthermore, Germans have become sharply critical of China’s backing of Russia. Last week, a cyberattack, which breached emails of the Social Democratic Party, was linked to Russia. Additionally, allegations surfaced that China and Russia may have offered financial incentives to a German lawmaker in order to influence policy in their favor.

• Germany’s economic slowdown has been heavily influenced by its exposure to China, and this fact could play a major role in its shift towards the US. A change could offer long-term advantages for German companies. A potential turn inward by China might prioritize domestic firms at foreigners’ expense. At the same time, the US, with its strong dollar and commitment to open markets, could favor allies like Germany. However, the transition will likely be slow. German firms, especially carmakers with deep ties to China, will likely lobby their government to manage the deteriorating relationship and mitigate potential disruptions.

In Other News: The Bank of England signaled a potential rate cut in June following its policy meeting. This could be a sign that it believes inflation is under control and will likely lead to further weakness in the pound (GBP). Separately, President Joe Biden warned Israel that the US would halt arms sales if it invades Rafah, in a sign of growing friction between his administration and Israel. Political tensions are also on the rise in Germany, with a recent attack on a former German mayor.

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