by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with items related to the Russia-Ukraine war.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a surprise easing of monetary policy in China and the latest on the U.S. presidential election following New Hampshire’s primary election yesterday.

Russia-Ukraine War:  Reports today suggest a Russian military plane may have been shot down by Ukrainian forces over Russian territory close to the border with Ukraine, with no survivors.  According to Russian officials, the plane was carrying 65 Ukrainian prisoners of war who were about to be part of a Russia-Ukraine POW exchange.  That hasn’t yet been verified, but if found to be true, it could be a major embarrassment for Ukrainian President Zelensky and potentially increase domestic pressure on him to begin peace talks.

NATO-Sweden:  As we flagged in yesterday’s Comment, the Turkish parliament last night approved Sweden’s bid to join the North Atlantic Treaty Organization. Once Turkish President Erdoğan signs the accession protocol in the coming days, the only hurdle left for Sweden would be to gain Hungary’s approval.  Hungarian Prime Minister Orbán has invited Swedish officials to discuss the accession, but a vote still hasn’t been scheduled in the Hungarian parliament.

Israel-Hamas Conflict:  Hamas officials yesterday told international mediators that they would consider trading some of the Israeli hostages the group still holds in return for a significant pause in fighting.  The statement marks a shift for Hamas, as it had previously said it would only consider releasing more hostages as part of a permanent, comprehensive peace deal with Israel.  Nevertheless, it isn’t clear whether the Israeli government will accept the deal, or under what terms.  For now, the fighting is set to continue, as will the risk of a broader regional conflict.

• Separately, the U.S. carried out three different airstrikes last night against Iran-backed Kataib Hezbollah militants in Iraq, just as it has been carrying out strikes on Iran-backed Houthi rebels in Yemen.
• The strikes against Kataib Hezbollah follow multiple attacks the group has staged against U.S. forces in the region, which have caused multiple injuries to U.S. personnel. To reiterate, such strikes and counterstrikes mean there is still a risk that the fighting between Israel and Hamas could spread throughout the region.

China:  The People’s Bank of China today unexpectedly slashed its bank reserve requirement for the third time since last September, cutting the standard to 7.0% from 7.4% previously.  PBOC chief Pan Gongsheng also signaled the central bank will soon cut key interest rates.  The moves may give some boost to the Chinese economy and financial markets, but slightly looser monetary policy is unlikely to overcome the big economic headwinds China is currently facing.

• Separately, technology giant Alibaba (BABA, $74.02) saw its share price jump 7.9% yesterday, and pre-market activity suggests the price gains will continue today. That follows reports that co-founders Jack Ma and Joe Tsai have been aggressively buying shares.
• As we noted in yesterday’s Comment, the Chinese government has reportedly been pressuring state-owned firms to buy shares and buoy the flagging market. It’s not inconceivable that high-profile individual owners and investors could also be under pressure to buy.

South Korea:  Conservative President Yoon Suk Yeol is facing a growing scandal after a left-wing pastor secretly recorded a video of Yoon’s wife accepting the gift of a $2,200 handbag in violation of the country’s anti-graft laws.  The scandal is important because it could complicate Yoon’s effort to ensure his party gains control of the national legislature in the April elections.

Eurozone:  The composite “flash” purchasing managers’ index for January rose to a seasonally adjusted 47.9, marking its highest level in six months and improving from 47.6 in December.  Like most major PMIs, the eurozone’s is designed so that readings above 50 indicate expanding activity.  With its improvement in January, the composite PMI suggests the eurozone’s recent economic downturn is easing a bit, but output is still falling overall.  The improvement in January came as manufacturing improved a bit but service activity weakened.

Germany:  Deutsche Bahn train conductors today launched a six-day strike over working hours, marking the worst labor action at the railroad in thirty years.  The strike is already disrupting freight and passenger service in Germany and could be a further headwind for the country’s struggling economy.

U.S. Politics:  In yesterday’s New Hampshire primary election for the Republican Party, former President Trump won with about 54.5% of the vote, while former UN Ambassador Haley came in second with about 43.2%.  Nevertheless, Haley vowed to fight on, so it looks like the pair will again face off in Haley’s home state of South Carolina, which holds its primary on February 24.

• While it increasingly appears that Trump will be the ultimate Republican nominee, Haley’s performance in New Hampshire and in last week’s Iowa caucuses have highlighted her strength with right-leaning independents and moderate Republicans.
• Resistance from those groups could be a weakness for Trump in his likely rematch with President Biden in November’s general election.

U.S. Cryptocurrency Market:  The price of Bitcoin (BTC, $39,709.17) fell about another 3% yesterday, bringing its total decline over the last two weeks to approximately 15%.  In part, the drop in value reflects investors taking profits after the Securities and Exchange Commission approved spot exchange-traded Bitcoin funds on January 11.  The drop also probably reflects some disappointment as flows into those ETFs haven’t met expectations.

U.S. Entertainment Industry:  The Academy of Motion Picture Arts and Sciences yesterday released its Oscar award nominees, with “Oppenheimer” pulling in 13 different nominations.  Among other top films, “Poor Things” got 11 nominations, “Killers of the Flower Moon” received 10, and “Barbie” got eight.  Release of the nominees often gives a short-term boost to the films and movie attendance.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with signs that European leaders are getting more concerned about future Russian aggression.  We next review a range of other international and U.S. developments with the potential to affect the financial markets today, including a potential new stock-market stimulus program in China and a few words on U.S. politics.

NATO-Russia:  Illustrating how Russia’s invasion of Ukraine has prompted increased defense efforts by European members of the North Atlantic Treaty Organization, the Baltic states of Estonia, Latvia, and Lithuania last week agreed to start building strongpoints, bunkers, and other fixed defensive installations along their border with Russia.  The move mirrors a recent decision by Finland to start building defense works on its border with Russia.

• As we wrote in our recent Bi-Weekly Geopolitical Report, an emboldened Russia may eventually be tempted to grab more territory in Europe despite its mauling at the hands of the Ukrainians so far. The possibility of further Russian aggression means the global investment environment will face elevated geopolitical risks in the coming years, but also potential opportunities in assets such as defense stocks and precious metals.
• Separately, German Defense Minister Boris Pistorius has warned that Russia might attack NATO territory even within the next five to eight years. Swedish officials have also been warning their citizens that a war with Russia could be coming.  (By the way, we note that Turkey’s parliament is set to vote today on Sweden’s bid to join NATO.  If the vote is positive, Sweden would only need a final approval from Hungary to join the alliance.)
• We want to emphasize that we don’t think further Russian aggression is certain. However, these reports do suggest that officials in Europe are becoming more concerned.

China:  Responding to the ongoing slide in Chinese stock values, the State Council yesterday called on authorities to take stronger and more effective measures to stabilize markets and boost confidence.  They also called for better regulations, more transparency, and additional measures to improve the quality of listed companies.  Coupled with a recent surge in stock buying by state-owned firms, the cabinet statement has raised hopes that the government will soon embark on a program to lift prices.  Chinese stocks therefore closed modestly higher today.

Israel-Hamas Conflict:  While Prime Minister Netanyahu has publicly and privately resisted U.S. pressure to tone down Israel’s attacks on Hamas militants in the Gaza Strip, new analysis from the New York Times suggests the intensity of the attacks has indeed declined.  The analysis shows that average Palestinian deaths in Gaza are now down to less than 200 per day.

• Of course, the death and destruction is still high enough to spur anti-Israeli attacks by militants around the region, including in southern Lebanon, keeping alive the risk that the conflict could broaden.
• Nevertheless, reduced violence and a more targeted approach by Israel could help to eventually reduce tensions and risks.

Red Sea Shipping:  Despite the drop in casualties in Gaza, Iran-backed Houthi rebels in Yemen continue to threaten sympathy strikes on commercial ships in the Red Sea.  In response, the U.S. and the U.K. launched a new round of airstrikes on Houthi missile sites and other targets this morning.  The strikes mark the U.S.’s eighth attack on Houthi targets over the last several weeks.

European Union:  Jean-François van Boxmeer, head of the European Round Table for Industry, has issued a complaint that the 800-billion EUR ($869 billion) NextGen EU pandemic recovery fund is far too difficult to access.  According to van Boxmeer, the EU needs to cut the red tape and restructure the fund to get money into its targeted digital and green-tech projects more quickly.

• Indeed, halfway through its planned 2021-2026 life, only about 30% of the fund has been spent on loans and grants.
• That has left the EU with far less fiscal stimulus than the U.S. has had in the same period, which probably helps explain the stronger relative economic growth in the U.S.

France:  Farmers’ union FNSEA is launching multiple road blockades and other measures today to protest government red tape and rising production costs.  The protests follow similar actions recently in Germany, the Netherlands, Poland, and Romania.  They also illustrate some of the rural frustrations that have boosted the support for right-wing populist movements throughout Europe.

Argentina:  Key labor unions have announced that hundreds of thousands of workers will go out on strike this week to protest the libertarian economic reforms pushed by President Milei.  The country’s courts have already suspended some key reforms, and Milei lacks control of the Argentine legislature, so the mass strike could be a further big impediment to Milei’s effort to reform the crisis-prone economy.

U.S. Politics:  New Hampshire today holds the first presidential primary vote of the election season, following Iowa’s caucuses last week.  On the Republican side, the latest opinion polls give former President Trump a healthy lead, but former UN Ambassador Nikki Haley is hoping for an upset and follow-on victory in her native South Carolina later.

• In our geopolitical analysis, we write a lot about the rise of right-wing populists around the world, including leaders such as Trump, Italian Prime Minister Giorgia Meloni, and Hungarian Prime Minister Viktor Orbán. However, we usually focus on the populists’ isolationist policies and how they affect international relations.
• An interesting opinion piece in the Financial Times today explores the economic impact of the populists. Specifically, the article notes that even though populist policies could theoretically be negative for the economy, most of today’s populists have presided over good economic growth.  The article doesn’t give a definitive answer as to why that has happened, but it’s worth reading the author’s exploration of the topic.

U.S. Fiscal Policy:  While it’s widely recognized that expansive federal fiscal policy has been helping buoy U.S. economic growth (reflecting both reduced income taxes and higher spending, especially for various types of entitlements), new analysis reminds us that state and local governments have also been increasing their spending.  Key factors boosting state and local spending (and hiring) include infrastructure investment and stronger teacher hiring as schools get back to normal following the COVID-19 pandemic.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with a short discussion of Japan’s surging stock market and one potential reason for its strong rise.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including an apparent Israeli airstrike in Syria that killed members of Iran’s Revolutionary Guard and multiple developments in U.S. politics and financial markets.

Japan:  Japanese stock prices continue to surge, with the Nikkei 225 price index now up about 9% year-to-date and within easy striking distance of its record high in the bubble of 1989.  In contrast, mainland China’s CSI 300 index is down about 6%, and Hong Kong’s Hang Seng index is down 12%.  The Wall Street Journal today notes that part of the reason for Japan’s strong performance may be that Chinese investors are pouring money into the Japanese market.

India:  Prime Minister Modi today officially dedicated a controversial Hindu temple built on the site of a 15^th-century mosque that was destroyed amid sectarian violence several years ago.  The ceremony was attended by many top business leaders, celebrities, and film stars, highlighting how popular the temple’s construction has been with the 80% or so of India’s population that is Hindu.  The move has therefore further boosted Modi’s political position.  However, the move has been strongly resisted by Muslims and some opposition politicians.

Israel-Hamas Conflict:  An apparent Israeli airstrike on a residence in Syria over the weekend killed five members of Iran’s Revolutionary Guard, raising further concerns that the conflict between Israel and Hamas could broaden to draw in Iran.  Indeed, Iran-backed militants in Iraq later fired missiles at a U.S. military base in that country, causing several minor injuries.

Germany:  Hundreds of thousands of people staged protests around the country yesterday after reports indicated the far-right populist Alternative for Germany party has been exploring a plan for mass deportations of people of foreign origin if its rising popularity puts it in power.  Separately, AfD leader Alice Weidel said in a Financial Times interview that the party would hold a Brexit-style referendum on leaving the European Union if it comes to power.  These developments show how populism is fracturing societies in the EU as well as the U.S.

U.S. Politics:  Yesterday, Florida Governor Ron DeSantis said he is suspending his campaign to be the Republican nominee for president, leaving tomorrow’s New Hampshire primary a two-person race between former President Trump and former UN Ambassador Haley.  Although DeSantis endorsed Trump in his statement, one key question is how many of his supporters will now shift their votes to Haley.  As we’ve said before, it still looks like Trump will eventually be the Republican nominee, but Haley probably can’t be counted out just yet.

U.S. Stock Market:  The S&P 500 price index closed at a new all-time high on Friday, meaning the uptrend that began in late 2022 now meets the conventional definition of a bull market.  Since its low on October 12, 2022, the index is now up 35.3%.  Importantly, the upswing has recently broadened beyond the “Magnificent 7” large-cap growth stocks that had dominated the market last year.  For example, 70.8% of the stocks in the S&P 500 are now trading above their 200-day moving average.

• Momentum indicators also point to possible further gains in the near term.
• Nevertheless, as we noted in our recent “2024 Outlook” publication, moderating growth will leave the U.S. economy at greater risk of a recession this year. A recession, concern about the November elections, or negative geopolitical developments could all push stock prices lower again later in 2024.

U.S. Bond Market:  A report in the Financial Times reveals that investment-grade corporate bond sales have topped $150 billion so far in 2024, marking the strongest year-to-date issuance in three decades.  The strong pace of issuance so far reflects both the big decline in yields since last autumn and extraordinarily strong demand by investors.  Because of the strong demand, the spread between high-grade corporate bond yields and 10-year Treasury note yields has fallen to its lowest since before the Great Financial Crisis.

U.S. Commercial Real Estate Market:  RXR, one of New York City’s biggest property developers, and alternative investment manager Ares Management (ARES, $116.43) are reportedly teaming up to launch a $1-billion fund to invest in the city’s distressed office buildings.  Officials involved in the fund say they now sense an opportunity because building owners have finally accepted that they will have to accept losses to restructure or unload their assets, while the fund officials think they can assess where interest rates are going and what assets offer good value.

• The new office fund illustrates one benefit from the vast sums of money that have flowed into U.S. private equity and private debt funds in recent years. The bespoke deals and hands-on management of these investments may give private funds the confidence to seize evolving opportunities more quickly, channeling funds into the office sector and potentially helping to put a floor underneath it before it causes broader economic harm.
• Of course, it could also be the case that such investments are too early. Investing in distressed office properties is likely to be very risky as the market continues to adjust to work-from-home dynamics and high interest rates.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning! Tech stocks are soaring on chip optimism, while La Liga giants Atlético Madrid and FC Barcelona are gearing up for a Copa Del Rey clash! Today’s Comment dives deep into the Fed’s rate cut whispers, the Red Sea crisis, and why U.S. oil is the crude market’s kryptonite. Plus, we’ve got your U.S. and international data roundup.

Fed Black Out: As the Fed enters its pre-meeting quiet period, expectations for a March rate cut have dimmed, but the possibility of adjustments remains on the table.

• Atlanta Fed President Raphael Bostic was the latest member of the Federal Open Market Committee to cast doubts about a cut within the next three months. During an event hosted by the Atlanta Business Journal, Bostic stated that he suspects that the central bank will lower its benchmark rate in the third quarter but maintained that he would be persuaded to move sooner if inflation falls faster. His comments follow a group of other policymakers such as Federal Reserve Board Governor Christopher Waller and New York Fed President John Williams, who are also looking to rein in investor expectations of an imminent rate cut.
• Though the Fed insists the market is misreading its March intentions, the Bank Term Funding program (BTFP), established after the collapse of Silicon Valley and Signature Bank, may offer a different story. Set to expire on March 11, the program, which allows banks to borrow at discounted rates in exchange for discounted bonds valued at par, is unlikely to be renewed. In the lead up to the end of the program, banks have looked to ramp up their borrowings. The program’s closure could force the central bank to look for alternatives to help ease some of the financial stress, which may include policy rates or possible changes to its quantitative easing program.

(Source: Bloomberg)

• The Federal Reserve’s first meeting of the year on January 31 will be crucial in setting the stage for its 2024 policy approach. While some policymakers have hinted at further interest rate hikes, the Fed’s primary focus will be on lowering rates, albeit at a pace dictated by economic conditions, inflation, and financial stability. The upcoming election adds a layer of complexity, potentially influencing the Fed’s communication and policy decisions as it does not want to be seen as favoring a particular party or candidate. Nevertheless, with inflation in check, policymakers’ three-cut projection could be seen as a minimum rather than a maximum.

Red Sea Escalation: Western efforts to counter Houthi rebels in Yemen raise concerns of a broader Middle East conflict and potential supply chain disruptions.

• The U.S. launched its fifth round of airstrikes against the Iranian-backed Houthis in the Red Sea on Thursday, following a drone attack near Yemen that struck a third oil tanker. White House National Security Council member John Kirby insisted the attacks would continue as long as necessary to deter further attacks on commercial shipping while acknowledging the potential for escalation in the region. While the U.S. maintains it is not seeking conflict, the continued airstrikes raise concerns about the long-term stability of the region.
• Houthi attacks and international military responses in the Red Sea, by some accounts, are causing greater shipping delays than the early COVID-19 pandemic. The chart below reveals significant fluctuations in a key indicator of global trade flows, the Trade Capacity Index, which was developed by Sea-Intelligence CEO Alan Murphy. Notably, since Houthis started attacking ships, the average weekly deviation in shipping capacity from its annual average has dropped to levels last seen when the Ever Given blocked the Suez Canal in 2021, highlighting the dire situation for global supply chains.

(Source: Sea-Intelligence)

• Amid escalating tensions, Arab nations are actively engaged in mediating efforts to broker a cease-fire agreement and pave the way for the establishment of an independent Palestinian state. The overarching agreement seeks not only to diffuse current tensions but also to set the stage for normalized relations between the involved Arab countries and Israel. In exchange for this normalization, there is a mutual commitment to undertake “irreversible” measures that contribute to the realization of a sovereign Palestinian state. Although it currently seems like a long shot, if successful, it could pave the way for lower commodity prices.

Shale’s Comeback: Even as geopolitical tensions in the Middle East threaten to disrupt supply and drive up crude prices, U.S. shale production continues to act as a dampener, reminding us of its lasting impact on the oil market.

• The International Energy Agency predicts a global oil surplus driven by a projected surge in production from the U.S. and other non-OPEC countries despite production cuts agreed upon by OPEC. This production surge, exemplified by the U.S. surpassing Iraq’s exports in November, is expected to outpace the moderating effect of OPEC cuts throughout the year. The surplus could lead to lower oil prices, impacting investments and potentially affecting energy security in countries reliant on oil imports. While OPEC’s cuts may slow the initial production boom, its influence is likely to wane later in the year.
• After a shaky start following Russia’s invasion of Ukraine, U.S. oil production is demonstrating impressive resilience. The U.S. Energy Information Administration (EIA) noted that the United States reached a record-breaking 13.2 million barrels per day as of October 2023, with a slight moderation later in the fourth quarter. The strong performance is expected to continue, with record production figures anticipated in both 2024 and 2025. In a recent move, Saudi Arabia lowered its crude price, likely an attempt to maintain market share in the face of rising U.S. competition.

(Source: Wall Street Journal)

• The war in Ukraine has accelerated Europe’s growing reliance on the U.S. for energy, raising concerns about potential geopolitical risks. This shift comes as Russia’s ostracization forces it to lean towards China and India for its own sales, potentially creating new power dynamics in the global oil market. This dominance could pave the way for a potential ceasefire in Ukraine as Russia and Europe look to find ways to strengthen their position as they try not to be overrun by the two major superpowers.

Other News: The Federal Reserve is proposing a new rule that would require banks to borrow from the discount window at least once a year. This move aims to encourage banks to become more familiar with this emergency lending facility and lessen their reliance on backstops during times of crisis. Japan is aiming to become the fifth country to land an aircraft on the moon. Japan’s space exploration showcases its ambition to compete alongside established players.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning! Chip optimism is electrifying the market, while a potential trade could heat up the Pacers’ playoff hopes. In today’s Comment, we dive into the latest topics: the semiconductor surge, the central bank pivot, and the Basel III Endgame controversy. Plus, we provide our usual roundup of global and domestic economic data.

Chips Making a Comeback? Despite the waning enthusiasm for AI-related services, semiconductors are blazing back, rebounding from their 2023 lows.

• Taiwan Semiconductor Manufacturing Company (TSM, $111.71)), the main manufacturer of chips for Apple (AAPL, $186.80) and Nvidia (NVDA, $571.99), expects to have a strong first quarter in 2024 and plans to raise its capital expenditure. The optimistic outlook suggests that the company is confident that demand for smartphones and computing should rebound from the previous year and anticipates that its revenue will increase by at least 20%. Additionally, according to data collected by the Semiconductor Industry Association, chip sales rebounded toward the end of 2023.
• Throughout 2023, fueled by AI ambitions, software ruled the tech world. Investors flocked to companies promising the next big algorithm, leaving chipmakers in the dust. However, the tide may be turning. The “Magnificent 7” (AMD, Nvidia, and their peers) have surged in 2023, outpacing the PHLX Semiconductor Sector by nearly tenfold. This recent surge suggests a renewed interest in hardware, the very foundation on which software thrives. While the broader market remains cautious, the two indexes are now roughly in tandem, hinting at a potentially strong year for chipmakers.

• The surge in chip stocks signals a broader market tilt, with investors on the hunt for hidden gems. Predicting the top dog is still a crapshoot, but last year’s champions could face a reckoning. Lofty valuations hinge on major tech companies meeting ambitious earnings projections, and any stumbles could leave them vulnerable to a sell-off. However, falling interest rates could be a boon for companies with strong fundamentals, potentially giving mid- and small-caps, last year’s neglected stars, their moment in the spotlight.

Market Takes a Breather: Uncertainty over global rates has spooked investors, but guarded risk appetite could offer pockets of opportunity.

• Central bankers have looked to rein in investor expectations of interest rate cut expectations. On Wednesday, European Central Bank President Christine Lagarde ruled out the possibility of a pivot in the spring in favor of summer. Meanwhile, officials from the Federal Reserve have cautioned the market that this easing cycle will not be as aggressive as previous cycles. Their skepticism was reinforced by incoming data that showed that the headline in inflation in the U.S. and the European Union accelerated in December. Although market expectations show that traders do not expect the ECB to cut in the spring, that is not true for the Fed. Implied overnight swaps suggest there is a 56% chance that U.S. policymaker will lower rates in March, down from 83% a week ago.
• As interest rate expectations shifted recently from anticipating six Fed rate cuts by year-end to a more modest stance due to push back from several Fed officials, investors rushed to unwind their earlier bullish positions in small- and mid-cap stocks. These companies had previously attracted significant inflows as investors sought higher returns in anticipation of a dovish Fed-fueled rally. However, a change in rate expectations has led investors to position their portfolios to protect against the possibility that policymakers may be preparing to hold rates at their current levels for a longer-than-expected period.

• Over the last thirty years, the Fed hiked rates gradually but cut them aggressively. Recent comments suggest a different approach this time. While a March cut is still possible, recent comments from Fed policymakers indicate a less aggressive pace than markets anticipate. This shift could be due to concerns about inflation or financial stability. A slower pace of cuts might delay investor’s shift toward stocks with more value. That said, the ECB’s lower relative rates give it room to wait before following the Fed’s eventual cut. Thus, it is likely that European policymakers may be more patient before they decide to lower their benchmark rates.

Regulatory End Game: U.S. federal banking regulators closed public comment on the Basel III Endgame framework this week as they reconsider a key provision related to capital requirements.

• The proposed capital requirements remain a major sticking point in the wake of the Silicon Valley Bank and Signature Bank collapses. These rules would force banks with over $100 million in assets to boost their capital cushion by 16%, aiming to protect against future financial crunches. However, Federal Reserve Governor Michelle Bowman warns that the current requirement miscalculates the actual cost of new capital and could push lending activity to the riskier shadow banking system. In a sign of potential compromise, Vice Chair of Supervision Michael Barr acknowledged the need for changes and his openness to industry feedback.
• Looming regulatory changes cast a dark cloud over financial stocks. New regulations threaten to handcuff major banks, forcing them to ditch risky bets and hoard more cash than they’d like. This could stifle lending, especially for riskier borrowers, as early signs are already suggesting. American banks could face a competitive disadvantage compared to their British and European counterparts who have less stringent rules.

• Despite the anticipation of watered-down regulations, banks are already tightening credit, casting a shadow on future economic growth. The Senior Loan Officer Survey reveals that banks are already starting to reduce loans due to perceived economic headwinds. This year could see even tighter credit, as banks bolster capital reserves to weather the still-distant regulatory storm of late 2025. While the full impact won’t be immediate, this preemptive tightening casts a long shadow on economic activity.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with new data showing slowing wage growth in major developed countries, which should eventually allow the major central banks to start cutting interest rates (though probably not as soon as many investors expect).  We next review a range of other international and U.S. developments with the potential to affect the financial markets today, including the latest signs that the Middle East conflicts could broaden and worsen and increased regulatory action in the U.S. as the Biden administration gears up for the November election.

Global Labor Markets:  New cross-country figures from recruiting site Indeed show average wage growth slowed markedly in major developed countries over the last six months.  In the U.S., for example, the report shows advertised wages and salaries in December were up just 3.8% year-over-year, down from a peak of 9.5% year-over-year in late 2021.  Advertised wages and salaries in the eurozone were also up 3.8% on the year, compared with a peak of 5.2% in 2022.  Pay increases also moderated in the U.K.

• The figures from Indeed help confirm that consumer price pressure is likely to keep moderating in the near term.
• In turn, that should help encourage the major central banks to eventually start cutting interest rates, although policymakers continue to caution that any rate cuts will likely come later than investors currently seem to expect (see the latest statements in this regard in our discussions below).

Middle East Conflicts:  One day after launching missile strikes against regime opponents in Syria and Iraq (including an alleged Israeli “intelligence center”), Iran’s Shiite-led government said yesterday that it launched missiles and drones against a Sunni jihadist group in Pakistan.  Separately, the U.S. launched a strike against Iran-backed Houthi rebels in Yemen for the third time in the last week, preemptively destroying four anti-ship ballistic missiles the rebels were preparing to launch against commercial and military ships in the Red Sea.

• The latest attacks come on top of Israel’s continuing ground invasion against Hamas militants in the Gaza Strip, its effort to control rising unrest among Palestinians in the West Bank, and sympathy attacks against Israel by Iran-backed militants in Lebanon, Syria, and Iraq.
• Outside of Gaza, it appears that all these entities are trying to calibrate their attacks to sufficiently weaken or dissuade their targets without sparking an even stronger response. With so many different countries and groups launching weapons, we see an increasing risk that one of them will miscalculate and spark an even broader, more intense, and more dangerous escalation.
• It’s true that even safe-haven assets such as gold and crude oil sold off today (probably on concern that interest rates won’t be cut as aggressively as investors had hoped), but the growing risk of a broader conflict in the Middle East will likely keep them relatively well bid in the near term.

Chinese Economic Growth:  As flagged by Premier Li Qiang in a speech yesterday, the government issued official data today showing Chinese gross domestic product rose by an inflation-adjusted 5.2% in 2023.  That was slightly better than the government’s target of 5.0% for the year, but excluding the extraordinary swings during the COVID-19 pandemic, it was the slowest official growth rate since 1990.

• Going forward, we expect Chinese economic growth to remain challenged by what we call the “Five Ds”: Weak consumer demand, high corporate and local government debt, poor demographics, economic disincentives from the Communist Party’s increasing intrusion into the economy, and decoupling as foreign countries shift their trade, investment, and technology flows away from China.
• Since China accounts for so much of the global economy and world trade, its continued weakness is likely to weigh on output in countries around the world, retarding profit growth and presenting headwinds for financial markets.

Chinese Demographics:  Highlighting China’s demographic challenges, data today shows births in the country fell to slightly more than 9 million in 2023, down from more than 9.5 million in 2022 and less than half the nearly 19 million as recently as 2016 (see graph below).  That means China’s fertility rate — the number of children a woman has over her lifetime — has fallen to just above 1.0, far below the “replacement rate” of more than 2.0.  The figures therefore portend further population declines and increasing average ages in the future.

 

Eurozone:  At the World Economic Forum in Davos, Switzerland today, European Central Bank chief Lagarde said her institution would probably wait until summer before cutting interest rates, rather than cutting in the spring as some officials and observers expect.  Coupled with a surprise acceleration in U.K. consumer price inflation announced today, Lagarde’s statement is further evidence that bond investors around the world have gotten ahead of themselves in expecting near-term rate cuts.  Global stock and bond prices have therefore fallen so far today.

France:  In an effort to undercut the rising popularity of right-wing populists, President Macron has announced that his new cabinet will focus on law and order, easier regulations for businesses and workers, and reduced budget deficits.  In theory, the pro-business policies should be attractive to investors, but it is important to remember that Macron’s centrist alliance no longer has a majority in parliament, so getting the program into law will be challenging.

U.S. Monetary Policy:  In a speech yesterday, Fed Governor Christopher Waller warned that the monetary policymakers want to be sure consumer price inflation has indeed been subdued, so they would “take [their] time” before cutting interest rates.  With the statement, Waller appeared to be taking back the dovish views he shared last November, which helped spark the recent rally in bonds and drove yields back down to what we consider excessively low levels.  In response, investors dumped bonds, and the yield on the 10-year Treasury note jumped to 4.0660%.

U.S. Energy Regulation:  Under pressure from climate-change activists, the Biden administration is reportedly considering whether to review the government process for approving export terminals for liquified natural gas.  Since the U.S. opened its prolific shale patch in recent years, the country has become the world’s top exporter of LNG.  Any eventual new regulations could throttle the growth of the industry and boost energy prices abroad, although bottling up gas in the U.S. market could bring down prices — and profits — here at home.

U.S. Financial Services Regulation:  Stepping up the Biden administration’s attack against “junk fees,” the Consumer Financial Protection Bureau today is expected to propose a cap on overdraft fees at banks with $10 billion or more in assets.  Reports indicate the proposed cap could be as low as $3 per instance, compared with as much as $39 today.  If implemented, the cap could greatly reduce the $9 billion or so of overdraft fees that major banks pull in annually.

U.S. Artificial Intelligence Industry:  Microsoft (MSFT, $390.27) announced today that it will offer new subscription-based AI tools for individuals and small businesses that would include the ability to develop custom chatbots.  The move is consistent with our previously expressed view that AI would likely evolve from enormous, broad-based generative AI systems to more highly focused, customized AI tools for specific purposes or which could perhaps be trained on an organization’s specific data.  In any case, the announcement points to continued rapid innovation in AI.

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