by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a new report from the International Energy Agency that could further discourage needed investments in fossil fuel supplies and could help drive energy prices even higher in the coming years.  We then review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including additional confirmation that the European Union intends to clamp down on its trade with China and signs of preparations for a partial shutdown of the U.S. government which could begin on Saturday.

Global Climate Change Policy:  The International Energy Agency has issued a new report estimating that global use of fossil fuels would have to fall 25% by 2030 in order for nations to meet their goal of net-zero greenhouse gas emissions and realize their hopes of limiting global temperature increases.  The report comes amid intensifying pushback against the IEA from the world’s oil and natural gas industry, which is accusing the agency of being too alarmist and too reckless in discouraging the fossil energy investments needed to fuel the world until greener technologies are ready for wider use.  We have also noted that many governments around the world, especially in Europe, have started to step back from their most aggressive climate-stabilization policies amid pushback from voters.

• While the report also called for faster deployment of green energy technologies, it warned they may not be ready soon enough. Therefore, “Prolonged high prices would result if the decline in fossil fuel investment in this scenario were to precede the expansion of clean energy.”  In the IEA’s view, an orderly transition is “far from guaranteed.”
• Coupled with potential supply disruptions associated with the U.S.-China geopolitical rivalry, we think the regulatory and financial-market headwinds against fossil-fuel exploration and development will likely crimp supplies going forward. That’s a key reason why we think mineral commodities will be in a prolonged bull market in the coming years, once we get past the soft growth or recession that seems likely in the near term.

Saudi Arabia:  Energy Minister Prince Abdulaziz bin Salman told the annual conference of the International Atomic Energy Agency that the Kingdom of Saudi Arabia will adopt a strict “Comprehensive Safeguards Agreement” with the agency that will allow IAEA inspectors to monitor Saudi nuclear activities.  The move provides more evidence that Saudi Arabia is pushing hard to win a U.S.-run nuclear processing facility as part of its price for normalizing relations with Israel.  Besides the nuclear processing facility, the Saudis are also seeking security guarantees from the U.S.

• Saudi-U.S.-Israeli negotiations toward normalization are continuing.
• In the meantime, it is increasingly clear that the Saudis are holding down crude oil production to boost global energy prices and heap additional pressure on President Biden for concessions.
• Along with the recent dearth in new fossil fuel development, the cut in production by Saudi Arabia and its allies continues to boost global oil prices. So far this morning, Brent crude is trading down 0.7% at $91.29 per barrel, but that’s still up dramatically from only about $71.75 in early summer.
• The rise in energy prices has also increased worries that consumer price inflation will prove stickier than earlier thought, prompting the Fed to keep interest rates higher for longer. As a result, the yield on the benchmark 10-year Treasury note closed yesterday at a multi-year high of 4.541%.

European Union-China:  During a speech in Beijing, EU Trade Commissioner Dombrovskis warned yesterday that China’s “lack of reciprocity and a level playing field [in trade], coupled with wider geopolitical shifts, has [sic] forced Europe to become more assertive.”  Coming so soon after EU Commission President von der Leyen’s recent announcement of an anti-subsidy probe into Chinese electric vehicle exports, and shortly before Dombrovskis was scheduled to meet Chinese Vice Premier He Lifeng, the trade commissioner’s statement helped confirm that the EU has swung around to a more protectionist stance regarding trade and investment with China.

• Dombrovskis also warned today that the EU’s anti-subsidy investigation would include vehicles made by Western companies in China.
• Although Chinese-made EVs currently account for only a modest share of European sales, their rapidly advancing quality and lower costs are expected to help them capture a huge amount of market share in the coming years.
• Almost all of the Chinese-made EVs currently sold in Europe are from Chinese-owned European brands such as Britain’s MG, owned by China’s SAIC (600104.SS, CNY, 14.86), or from joint ventures between European and Chinese companies.

South Korea:  Lee Bok-hyun, governor of the Financial Supervisory Service, said he thinks South Korea has now met most of the conditions to be included in the FTSE Russell World Government Bond Index.  The index managers are expected to meet soon to decide on any changes in index constituents.  If they decide to include South Korea, the country is expected to account for up to 2.5% of the index, which would likely translate into around $65 billion of additional purchases of the country’s government bonds.

United States-South Pacific Islands:  President Biden yesterday hosted the leaders of 16 different South Pacific nations at the White House as part of an effort to keep them from falling for China’s recent diplomatic, military, and economic overtures.  At the meeting, Biden announced several new embassies and aid programs for the region.  However, Solomon Islands Prime Minister Sogavare failed to show up for the meeting, illustrating his increasing alignment with Beijing.

U.S. Government Shutdown:  Some lawmakers are reportedly working on an emergency bill to protect active-duty troops from losing their pay in the event of a partial government shutdown which could start on Saturday.  As during the shutdown of October 2013, the legislation would aim to protect troop morale and avoid imposing financial difficulties on military families.  However, unlike the legislation in 2013, this bill would also apply to members of the Coast Guard.

• Even if troop pay is protected, more than half of the Defense Department’s large civilian workforce would likely be furloughed.
• That illustrates how the economy could face a large hit to demand in the event of a partial shutdown. In addition, Moody’s (MCO, $322.81), the last major credit assessment firm with a AAA rating on Treasury debt, warned yesterday that it would consider a shutdown to be “credit negative” for U.S. obligations.
• As we argued in our Comment yesterday, a shutdown could potentially have a big impact on today’s “slow bicycle economy,” which has likely lost enough momentum to become more susceptible to recession even if there is only a modest hit to demand or confidence.

U.S. Electrical Vehicle Industry:  Ford Motor (F, $12.58) announced it will pause construction of a controversial factory in Dearborn, Michigan, where it planned to make electric vehicle batteries using technology from Chinese green-tech giant Contemporary Amperex Technology, or CATL (300750.SZ, CNY, 206.27).  Ford said the pause was caused in part by the on-going United Auto Workers’ strike, but it also cited unspecified other issues.  That could mean the company has gotten cold feet after being criticized for relying on Chinese technology and seeing how many governments around the world are stepping back from their climate-change regulations.

• Regarding the strike, today both President Biden and Former President Trump will visit the UAW picket lines in Michigan to show their support for the workers. Biden’s visit will mark the first time a sitting president has ever joined the strikers on a picket line.
• Of course, the visits by such high-stature politicians are likely to further encourage the strikers. Despite the UAW being happy with some recent concessions by Ford in the negotiations, it doesn’t look like the work stoppage will end anytime soon.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with the latest on Canada’s allegations that India assassinated a Canadian citizen in British Columbia in June.  The resulting strain on Canadian-Indian relations could have big implications for the U.S.’s effort to use India as an economic and geopolitical counterbalance to China.  We next review a range of other international and U.S. developments that could affect the financial markets today, including an effort by China to boost its stock market by limiting insider share sales and a tentative deal to end the U.S. screenwriters’ strike.

United States-Canada-India:  Reports over the weekend said U.S. intelligence helped Canada conclude that Indian agents were involved in the June assassination of Sikh separatist leader Hardeep Singh Nijjar near Vancouver.  The U.S. information included not only the regular reports provided to Canada as a member of the “Five Eyes” intelligence-sharing partnership that includes the U.S., the U.K., Canada, Australia, and New Zealand, but it also included additional reports specifically aimed at providing further context for the reports related to the assassination.

• Despite the U.S. assistance, the reports indicate that Canada’s conclusion about India’s involvement relied mostly on Canada’s own communication intercepts.
• Nevertheless, the U.S. role could complicate the Biden administration’s effort to draw India closer to the U.S.-led geopolitical and economic bloc as a counterweight against China’s growing power.

China-Philippines:  China’s coast guard and maritime militia forces have installed a 300-meter floating barrier to keep Philippine fishing boats out of a disputed shoal in the South China Sea just 140 miles from the Philippine coast.  The development is additional evidence that China is ratcheting up its harassment of Philippine interests in the area as punishment for Manila’s recent move to rebuild its security alliance with the U.S.

China:  In a further move to bolster China’s flagging stock market, authorities in Beijing have reportedly banned controlling shareholders of listed companies from selling their stock if their firm hasn’t paid a dividend for the last three years or if the company is trading below its initial public offering price or net asset value.  The new rules reportedly apply to more than half of the 5,000 or so stocks listed on Shanghai and Shenzhen.  The rules have also already led to the cancelling of insider share sales at more than 200 companies.

Russia-Ukraine War:  On Saturday, the New York Times revealed that the U.S. Army’s Landstuhl Regional Medical Center in Germany is treating a small number of Americans who were wounded in Ukraine after volunteering to help fight the invading Russians.  According to the report, the Defense Department last summer authorized the hospital to treat up to 18 members of the Ukrainian armed forces at a time, but a substantial percentage of those treated have been Americans who had previously served in the U.S. military or had served as former soldiers of other NATO allies.  The report has the potential to be seen as further evidence of creeping U.S. involvement in the war.

• Separately, Ukraine continued its recent missile and drone attacks on Russian-occupied Crimea over the weekend, forcing Kremlin-allied authorities there to issue air raid warnings. The attacks appear designed to disrupt Russia’s ability to launch its own air attacks against Ukraine’s grain exports and energy infrastructure.
• Importantly, Ukraine has stepped up use of its newly declared safe corridor for food shipments out of its southeastern ports. Last week, two ships laden with Ukrainian wheat successfully used the corridor, and three more ships are expected to use it to carry Ukrainian food exports in the coming week.  Continued Ukrainian food exports would help preclude a spike in global grain prices.

Japan:  Start-up pharmaceutical company Toregem BioPharma said it’s preparing to start clinical trials for a new drug that would spur the growth of new teeth in people who have lost both their baby and adult teeth.  The drug, which the firm hopes to have on the market by 2030, could help take a bite out of a problem many older people have in aging societies like Japan.

U.S. Economic Data:  As a “heads up,” the Bureau of Economic Analysis will issue updated and corrected figures on Thursday for gross domestic product, price inflation, corporate profits, and other key indicators for the last ten years, along with its third regular estimate of second-quarter GDP growth.  There is a significant chance that the revisions will show recent GDP growth has been weaker than initially reported.  Just as important, the figures for consumer inflation as measured by the price index for personal consumption expenditures could be revised upward, which would likely affect how policymakers at the Federal Reserve approach monetary policy in the coming months.

U.S. Fiscal Policy:  The House of Representatives has again failed to start passing the funding bills needed to avert a partial government shutdown this coming weekend.  Top Republican and Democratic lawmakers yesterday warned that time is running out to pass the appropriations bills that would keep operations funded after the current fiscal year ends on Friday.  Several House Republicans who are insisting on deep spending cuts are the key holdups.

U.S. Labor Market:  The Writers Guild of America and the major Hollywood studios have struck a tentative deal on a new labor contract, potentially ending the screenwriters’ strike that has hobbled movie and television production for months.  The negotiators are still ironing out the final details of the three-year contract before putting it to a vote by the union members, but it looks like the workers will win a number of concessions, such as increased royalties, minimum staffing levels, and protections related to artificial intelligence.  In turn, those concessions would likely encourage the still-striking Screen Actors Guild to hold out for a better deal.

U.S. Energy Market:  Data last week showed the average price for regular unleaded gasoline has reached $3.88 per gallon, up more than 25% from the start of the year.  The increase in cost reflects a recent surge in global crude oil prices stemming from strong demand, low inventories, and production cuts by countries such as Saudi Arabia and Russia.

• The jump in energy costs is especially concerning given that U.S. economic growth is already moderating in response to the Federal Reserve’s interest-rate hikes. When growth is slow, it may only take a small hiccup in demand to push it into recession.
• We call this the “slow bicycle economy,” since it’s so similar to the situation where it becomes very hard to keep your balance on a bike when you slow down too much.
• For all of today’s talk among investors about a hoped-for soft landing (in which growth slows enough to bring down consumer price inflation), that would also be something like a slow-bicycle economy where activity could be at risk if energy prices rise too much, if there is a partial government shutdown, or if there are some other hits to demand.

Global Artificial Intelligence:  If you think the wonders of artificial intelligence are simply divine, you’re going to love this.  Clerics in Iran’s theocracy are reportedly exploring the use of AI to write fatwas, or religious edicts.  Even the country’s supreme leader, Ayatollah Khamenei, has urged the clergy to pay more attention to the possibilities of AI, saying he wants Iran to be “at least among the top-10 countries in the world in terms of artificial intelligence.”

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment is divided into three sections: 1) Why the BOJ may not change policy anytime soon; 2) How the media narrative may either help or hurt strikers; and 3) Why improved relations with Saudi Arabia and Israel may help the U.S. fend off China.

Yen Under Pressure: One year after the Bank of the Japan surprised markets when it intervened to protect its currency, it is currently on standby to do so again following its recent rate decision.

• The Japanese central bank kept interest rates unchanged at their current levels. Following the Bank of Japan’s decision, central bank governor Kazuo Ueda vowed to maintain negative interest rates as a means to support the economy. Despite Japan’s economy experiencing relatively high inflation, GDP growth has failed to exceed 2.0% for eight consecutive quarters. Although Governor Ueda acknowledged that inflation has consistently exceeded the central bank’s target, he said that policymakers are not yet prepared to change their current monetary stance. He added that the BOJ does not foresee inflation sustainably reaching 2%, due to both downside and upside risks.
• The BOJ’s policy decision comes amid concerns that inflation is getting out of control. Last month, Japan’s core inflation index, which excludes fresh food and energy, rose 4.3% from the previous year. It also surpassed U.S. core inflation for the first time since 2014. Rising inflation has sapped investor confidence in the JPY, sending the real exchange rate to an all-time low against its peers. To avert a potential currency crisis, the Bank of Japan has signaled its willingness to intervene in currency markets and is working closely with the U.S. Treasury to prevent major swings in exchange rates.

• Although the central bank has maintained its ultra-accommodative monetary policy stance, economists expect it to hike rates starting around March 2024, according to a Reuters poll. This transition is poised to result in a strengthening of the JPY against the U.S. Dollar. Furthermore, this policy shift may exert an influence on yields for long-term U.S. Treasuries. The weaker JPY has benefited Japanese automakers by allowing them to increase car exports to the United States due to improved terms of trade. Japanese automakers’ stocks, such as Mazda (MZDAY, $6.00), Honda (HMC, $35.30), and Toyota (TM, $188.39), have outperformed the market, returning 30.0% in USD over the past six months.

Labor Comeback: One union strike appears to be nearing its end, while another is escalating.

• Hollywood writers are nearing a deal with studios on a new labor contract, after holding marathon talks for 10 hours on Thursday. While a final agreement was not reached, there are rumors that a deal is in sight, and the sides are expected to meet again on Friday. Meanwhile, tensions are rising in the auto worker dispute, after leaked messages from a top aide to UAW president Shawn Fain provided fresh fuel to critics of the union’s strike strategy. The leaked messages reveal that union leaders had long planned a protracted and disruptive dispute with automakers, suggesting that they were not negotiating in good faith.
• Labor disputes are often settled in the court of public opinion, rather than behind closed doors. As Robert Schiller points out in his book Narrative Economics, the drop in support in the 1960s and 1970s coincided with the fall of Teamster leader Jimmy Hoffa, who was sent to prison for jury tampering, mail fraud, and bribery. While the current leader, Shawn Fain, might reap the benefits of a resurgence in union support, he could also face heightened scrutiny for quoting controversial civil rights leader Malcolm X. That said, this dispute is far from over as the UAW is considering expanding the strike to Ford’s Chicago assembly plant on Friday.

• The rise in labor union popularity is related to a shift in economic preferences away from efficiency and towards equality. This shift will benefit workers through stronger wage increases and better working conditions, but it is likely to come at the expense of higher inflation, as firms may be encouraged to cut back production or increase prices. The transition to a more equitable economy will not be fast or smooth, and it will probably face many hurdles. However, firms with monopoly power may prosper from this shift, as they are likely to be better positioned to make adjustments in the changing landscape.

Saudi Arabia-Israel Normalization: Diplomatic normalization talks between the two major Middle Eastern powers are gaining momentum.

• Saudi Arabia’s Crown Prince Mohammed bin Salman (MBS) has expressed optimism that his country and Israel can overcome their differences and build a more cooperative relationship. This potential breakthrough comes on the heels of a visit to Washington by Israeli President Benjamin Netanyahu, where he mended ties with his American counterpart, Joe Biden. The potential arrangement between Saudi Arabia and Israel includes a possible security guarantee similar to the one between Japan and South Korea, a show of support by Israel for the development of a Saudi uranium enrichment program, and concessions to the Palestinians. The arrangement will be a major win for Biden but is far from certain.
• Lawmakers are likely to be hesitant to accept the proposed terms of the Saudi-Israeli peace deal for a number of reasons. Democrats have long raised concerns about Saudi Arabia’s human rights record, especially following the 2018 killing of Washington Post journalist Jamal Khashoggi. Meanwhile, the Republican Party remains divided on the issue of security guarantees for other countries, with some conservatives advocating for a more Jeffersonian approach to foreign policy, in which the military is less involved in the affairs of other countries. The contentious nature of the proposed Saudi-Israeli peace deal could complicate negotiations and make a final agreement less certain.

(Source: Chinamed.it)

• The potential security guarantee between the U.S. and Saudi Arabia could undermine China’s efforts to draw Saudi Arabia into its sphere of influence.
• A diplomatic relationship between Saudi Arabia and Israel would benefit the United States in its competition with China for influence in the Middle East. While China often uses its economic clout to win friends, it is less willing than the United States to make security commitments. Therefore, the deal would likely prevent Saudi Arabia from completely aligning itself with China, as some feared following Riyadh’s talks with Beijing regarding a petroyuan and its invitation to the BRICS group. Additionally, it could provide a blueprint for how the United States plans to win over emerging countries without offering access to its consumer base.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment is split into three sections: 1) How the Federal Reserve’s latest rate decision will impact its policy for next year; 2) Why governments may be forced to moderate some of their climate goals; and 3) Why support for Ukraine may face more resistance as the war rages on.

Hawkish Pause? The Fed held rates steady at its September 19-20 meeting but signaled the possibility of another hike before the year’s end.

• The Federal Open Market Committee (FOMC) kept rates unchanged at 5.25%-5.50% at its September 19-20 meeting, pausing its aggressive rate-hike campaign. Fed Chair Jerome Powell said the committee will look at the data before deciding whether to adjust policy. The latest FOMC dot plots showed that policymakers are divided on whether to hold rates at their current level or increase them again. Traders, though, are optimistic that the Fed has ended its tightening cycle, projecting a nearly 54% likelihood of a pause in rates, according to the latest forecast from the CME FedWatch Tool.
• Policymakers are more optimistic about the economy in 2024, revising up their June projections for GDP growth from 1.1% to 1.5% and the unemployment rate down from 4.5% to 4.1%, according to the Summary of Economic Projections (SEP). However, the Fed statement acknowledges that it expects the tighter financial conditions on households and businesses are likely to weigh on economic activity and hiring. During the press conference, Powell suggested that the central bank’s goal is a soft landing and implied that the committee may adjust policy if conditions change. This cautious optimism may explain why officials left inflation expectations largely unchanged for 2024.

(Source: Bloomberg)

• The improved outlook for 2024 likely explains the Federal Reserve’s hawkish tilt in the latest dot plots. The median fed funds targets were revised upwards for 2024, 2025, and the longer-term, reflecting policymakers’ belief that the economy is still too hot for comfort. Additionally, this may suggest that Fed officials are willing to keep interest rates restrictive for longer in order to bring inflation under control as long as the economic data remains positive. It is possible that if economic conditions start to deteriorate, then the Fed may pivot. That said, Fed officials still project that rates will be 25 basis points below their current levels by the end of 2024, while the market projects a decline of 50 basis points.

Net Zero Reality: The United Kingdom walked back its climate change plans, and we suspect other countries may follow.

• British Prime Minister Rishi Sunak is delaying key green initiatives, citing concerns about over-ambitious targets. Sunak has delayed the ban on new petrol and diesel cars and oil boilers until 2035, relaxed the phaseout target for gas boilers, and abandoned efficiency rules for landlords. These policy reversals appear to be a way for him to distinguish himself from the opposition ahead of elections in late 2024 or early 2025. The Conservative Party plans to portray the Labour Party as out of touch with everyday households after the Labour Party vowed to reinstate the target once elected, despite the potential costs it will have on consumers.
• The U.K. is not alone in its reconsideration of climate change policy, particularly when it comes to electric vehicles. In the United States, Republican frontrunner Donald Trump has criticized his rival Joe Biden’s EV mandate, believing that it will kill the auto industry. Meanwhile, the countries in the European Union are struggling to cope with the influx of Chinese EVs as it aims to ban the sale of combustion engine cars in a little over a decade. To contain the fallout, the EU Commission has launched a probe into Chinese dumping claims.
• The green transition, particularly towards electric vehicles, is a key part of achieving energy independence and reducing reliance on authoritarian governments for resources. The recent production cuts by Russia and Saudi Arabia have shown the dangers of importing oil. The quickest way to reach energy independence would be to import Chinese vehicles, but this would lead to a greater dependency on another potential rival. The other alternative is to develop electric vehicles domestically, which would provide greater stability but is a slower and more arduous process. We believe that the latter option is more likely to succeed in the long term, but it will require significant political will and investment.

War in Ukraine: The ongoing row between Ukraine and several Eastern European countries highlights flaws in the West’s support for Ukraine.

• Ukraine announced that it will sue Poland, Hungary, and Slovakia over their bans on Ukrainian agricultural goods, which were imposed after the EU allowed bloc-wide restrictions to expire. The three countries claim that the bans are necessary to protect their local producers from foreign competition, but Ukraine argues that they are illegal and could undermine a key source of revenue for the country as it defends itself from Russia. In retaliation, Poland has signaled that it may halt weapons transfers to Ukraine and is considering additional protectionist measures.
• The dispute comes at a perilous time for Ukraine. Its counteroffensive has yet to achieve significant victories, and outside countries are finding it harder to justify the cost of the war as they try to control their budget deficits. The United States has given Ukraine nearly $80 billion in aid since the invasion began in February 2022, while the EU has given nearly $30 billion. Ukrainian President Volodymyr Zelensky is set to meet with Congressional leaders on Thursday to convince Republicans to back away from their demand to reduce security aid as a condition of passing a new government budget. Although Zelensky is likely to receive a warm reception, he is unlikely to sway some of the hawkish lawmakers.

• The dispute over imports is the most visible sign of disunity regarding the backing of Ukraine. Despite largely urging countries in the European Union to reverse their bans on Ukrainian products, the EU is also considering helping to defend these governments from Ukraine’s lawsuit. At the same time, U.S. policy toward Ukraine is increasingly in disarray, with more politicians urging for a more domestic shift in policy. While it is unlikely that the West will pull its support anytime soon, it is becoming evident that patience is wearing thin. A potential end to the war could lead to a boost in equities as it reduces market uncertainty over commodity prices.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with the evolving relationship between the European Union and China.  We next review a range of other international and U.S. developments with the potential to affect the financial markets today, including a short military operation in the Caucasus country of Azerbaijan that has apparently thwarted ethnic-Armenian separatists who had been supported by Russia, and a preview of the Federal Reserve’s interest-rate decision today.

China-European Union:  Jens Eskelund, president of the EU Chamber of Commerce in China,  issued a statement defending the European Commission’s decision last week to launch an anti-subsidy investigation into China’s exports of electric vehicles.  Because of the past experience when the EU’s solar panel industry was decimated by cheap Chinese imports, Eskelund said it should be “understandable” that the EU now wants to prevent the same thing from happening with EVs.

• Eskelund suggested the problem is excess EV manufacturing capacity in China, which the government should address by supporting domestic consumption.
• That’s consistent with the analysis of many economists, including us at Confluence, who believe the Chinese economy is riddled with excess capacity and high debt. In contrast, Chinese consumer spending remains weak, and savings rates are very high.
• All the same, Communist Party ideology and political habits find it difficult to countenance policies aimed at greater consumption and increased consumer choice. President Xi, therefore, is unlikely to give up on China’s export-led, neo-colonialist economic policies anytime soon.

China:  While China’s excess capacity in sectors such as EVs and residential real estate is widely recognized, the country also has a lot of excess office space.  Recent data shows office vacancies in 18 major Chinese cities reached almost 24.0% in June, even worse than the U.S. vacancy rate of 18.2%.  The difference is that China’s excess office space simply reflects massive over-building by developers and tepid uptake as economic growth slows.  The U.S. problem is more tied to the rapid shift toward employees working from home following the coronavirus pandemic.

European Union:  EU lawmakers this week will start negotiating over the final text of their proposed “Platform Work Directive,” a law that would designate gig workers as de facto employees.  In response, officials from ride-hailing giant Uber (UBER, $47.59) warned that if the law isn’t sufficiently flexible, it would force the company to pull out of many smaller cities in Europe and raise prices as much as 40%.

France:  The Rassemblement National Party, led by right-wing populist Marine Le Pen, announced that it has paid back the remaining 6 million euros ($6.4 million) or so that it owed to a Russian company.  The loan has been a political liability for the party since it was taken out in 2014, as it has raised concern that the party was under the influence of Russia and President Putin.  Paying off the loan, therefore, puts the party in a better position to contest future elections, especially as right-wing sentiment grows throughout Europe.

United Kingdom:  The August consumer price index was up 6.7% from the same month one year earlier, much better than the expected increase of 7.0% and down from 6.8% in July.  The August “core” CPI—which in the U.K. excludes food, energy, alcohol, and tobacco—was up just 6.2% year-over-year, beating expectations that it would be up 6.9%, just as it was in the year ended in July.

• The better-than-expected figures have boosted hopes that the Bank of England can pause its interest-rate hikes at its next policy meeting on Thursday.
• In turn, that has driven down British bond yields today, with the yield on the two-year Gilt falling to 4.84%.
  • That has given a boost to interest-sensitive sectors of the country’s stock market today, such as homebuilders and real estate firms.
  • The drop in bond yields has also driven down the attractiveness of the pound (GBP). At this writing, the GBP is trading at $1.2379, down about 0.1% for the day.

Russia-Ukraine War:  Two weeks after Ukrainian President Zelensky fired his former defense minister for corruption, the government sacked six deputy defense ministers who were apparently involved in the scandal.  The effort to clean house suggests Zelensky is intent on presenting the Ukrainian government in the best possible light as he works to maintain foreign military support from the U.S. and other allies and keep up domestic political support at home.

Azerbaijan-Armenia:  The former Soviet republic of Azerbaijan yesterday launched what it called “anti-terrorist” military strikes in its breakaway region of Nagorno-Karabakh, where the largely ethnic-Armenian population has long worked to join neighboring Armenia.  The strikes follow several weeks in which Azerbaijan carried out a military buildup on the region’s borders and imposed a blockade apparently aimed at forcing ethnic Armenians out.  With the Armenians’ Russian supporters distracted by the war in Ukraine, reports this morning say they have already capitulated, likely setting the stage for Nagorno-Karabakh to be re-integrated into Azerbaijan.

• In international political terms, Russia’s unwillingness or inability to protect the Armenians is a further blow to Moscow’s prestige and influence. That will also likely push the country of Armenia closer into the embrace of the U.S.
• The outcome is also probably a positive for Turkey, which has longstanding disputes with the Armenians and has supported Azerbaijan.

U.S. Monetary Policy:  The Federal Reserve will wrap up its latest policy meeting today, with its decision on interest rates due at 2:00 PM EDT.  The officials are widely expected to hold the benchmark fed funds rate steady at its current range of 5.25% to 5.50%.  The question is whether they’ll provide any guidance on future policy changes.  Many investors continue to look for rate cuts in the coming months, but we think they’ll be disappointed.  We think the Fed will try to keep policy tight for an extended period to make sure consumer price inflation is dead.

• As investors increasingly come around to the idea that the Fed will likely keep rates higher for longer, they continue to sell longer-maturity obligations.
• The yield on the benchmark 10-year Treasury note yesterday closed at 4.366%, reaching its highest level since 2007. The yield on the two-year Treasury rose to 5.109%, for its highest level since 2006.

U.S. Regulatory Policy:  Ahead of a new zero-emissions rule in California for commercial trucks that kicks in January 1, truckers are accelerating their shift to electric trucks and stocking up on diesel rigs they soon won’t be able to buy.  Since California’s market is so large, the buying activity could spur a noticeable increase in the national demand for electric trucks, charging stations, and even diesel rigs.

• Specifically, the rule will require that trucks purchased in 2024 and later can serve the state’s ports only if they are zero-emission vehicles.
• Diesel rigs won’t be able to serve California ports at all starting in 2035.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with updated forecasts for global economic growth from the Organization for Economic Cooperation and Development.  The OECD report also urged central banks to keep hiking interest rates and keep them high to snuff out consumer price inflation.  We next review a range of other international and U.S. developments with the potential to affect the financial markets today, including an apparent assassination carried out by Indian agents in Canada and the prospect of tighter U.S. regulations on the naming of investment funds.

Global Economic Growth:  In its interim Outlook report, the OECD scaled back its forecasts for global economic growth to 3.0% in 2023 and 2.7% in 2024.  While the organization increased its forecasts for U.S. gross domestic product to show growth of 2.2% in 2023 and 1.3% in 2024, it cut its forecasts for other key economies.

• Importantly, the organization now sees much weaker growth in the eurozone, which will be held down by Germany and Italy in particular, and in China, where the economy is being held back by issues such as weak consumer demand, high debt levels, poor demographics, and decoupling policies in the West.
• Despite cutting its growth forecasts for many key economies, the OECD argued forcefully for central banks to raise interest rates further and keep them high for long enough to be sure consumer price inflation is vanquished.

United Nations General Assembly:  The annual meetings of the UN General Assembly began in New York this week, but the proceedings so far have been rather sleepy.  The top news to date is probably the announcement of a new “Partnership for Atlantic Cooperation” led by the U.S. and encompassing dozens of countries that touch the Atlantic Ocean in Europe, Africa, and the Americas.

• To wean countries from China’s embrace, the pact offers improved economic, environmental, and scientific ties among the signatories.
• The agreement also contains pledges to support territorial integrity and political independence, although it doesn’t include any security or military ties.

China-United States:  The American Chamber of Commerce in Shanghai said an annual survey of its members showed that only 58% were optimistic about their business prospects in China over the coming five years.  That marked the lowest level of optimism in the survey since it was launched in 1999.  As we have warned previously, companies that export to China or participate in its markets are likely to face headwinds because of issues like worsening U.S.-China tensions; clampdowns on trade, technology, and investment flows; and China’s own domestic economic challenges.

China-Germany:  The Chinese government on Sunday called in the German ambassador to complain about Foreign Minister Baerbock’s recent description of  President Xi as a dictator.  The incident highlights the increasingly frosty relationship between China and Germany as some German officials take a harder line on China while others keep trying to maintain good relations in the interest of trade and investment.  Ultimately, we suspect the hardliners in Germany will win the day, with negative consequences for the trade-dependent economy.

India-Canada:  In an emergency meeting with lawmakers, Canadian Prime Minister Trudeau said his government is investigating “credible allegations” that Indian agents may have helped kill an exiled Sikh leader near Vancouver in June.  The Sikh leader, Hardeep Singh Nijjar, was a Canadian citizen, prompting Trudeau to call the violation of Canadian sovereignty especially heinous.  In response, Ottawa yesterday expelled a senior Indian diplomat.

• The incident will further strain Indian-Canadian relations, with potential economic consequences. The Canadian government recently cancelled a trade mission to Mumbai set for October.
• If true, the incident also points to an ominous shift toward brazen, extraterritorial measures by Indian Prime Minister Modi, who many accuse of becoming increasingly authoritarian. If Modi really is adopting the extraterritorial “justice” practiced by authoritarian leaders such as Chinese President Xi, Russian President Putin, and Saudi Crown Prince Mohammed Bin Salman, it may become more politically difficult for the U.S. to embrace New Delhi as a partner in its geopolitical competition with China.

Poland:  Ahead of national elections next month, the ruling right-wing Law and Justice Party is reeling from a scandal in which officials are accused of selling Polish visas at foreign consulates despite the government’s assurances it is being tough on illegal immigration.  The political threat from the scandal is probably a reason why the government this week clamped down on Ukrainian food imports to bolster its largely rural voter base.  The Law and Justice Party is still leading the opinion polls, but if its support declines further and it falls out of power, Polish rule-of-law issues would probably no longer be a thorn in the side of the European Union.

Libya:  In the aftermath of last week’s floods, which killed thousands in the coastal city of Derna, hundreds of citizens yesterday participated in a violent demonstration demanding an investigation into who was responsible and why the government’s response has been so poor.  A key issue is why two nearby dams burst amid torrential rainfall.  Some reports say the dams hadn’t been maintained for 20 years, despite the provision of government appropriations.

• Derna lies in the territory controlled by Khalifa Haftar, a warlord who is supported by Russia and some Persian Gulf monarchies.
• At least for now, the demonstrators are focusing their ire on civilian authorities in the provincial government. However, if they start to target Haftar and his forces, they could spark a bloody crackdown and perhaps even international intervention.

U.S. Monetary Policy:  The Federal Reserve will begin its latest policy meeting today, with its decision on interest rates due tomorrow at 2:00 PM EDT.  The officials are widely expected to hold the benchmark fed funds rate steady at its current range of 5.25% to 5.50%.  The question is whether they’ll provide any guidance on future policy changes.  Many investors continue to look for rate cuts in the coming months, but we think they’ll be disappointed.  We believe the Fed will try to keep policy tight for an extended period to make sure consumer price inflation is really dead, as recommended by the OECD.

U.S. Regulatory Policy:  The Securities and Exchange Commission tomorrow will take up a proposal to tighten its “names rule” to crack down on deceptive fund descriptions.  The new truth-in-advertising rule would require that at least 80% of the assets held by mutual funds and other investment vehicles match the fund’s description as presented to investors.  Financial industry officials warn that the rule could discourage stock picking, violate free speech protections, and force funds to sell assets at a loss when markets are volatile.

U.S. Defense Industry:  At a conference last week, Defense Department Undersecretary for Acquisitions and Sustainment Bill LaPlante unexpectedly announced that the U.S. is now far ahead of schedule on the Pentagon’s goal of boosting production of 155-mm artillery shells.  According to LaPlante, output of the shells has already doubled versus just six months ago, to 28,000 shells per month.  Production is now expected to reach 57,000 per month next spring and 100,000 per month by fiscal year 2025, which begins next October.  The military’s original goal was 85,000 per month by fiscal 2028.

• The surge in production for 155-mm shells will help replenish U.S. stockpiles and allow for the continued support of Ukraine as it tries to defend itself against Russia’s invasion.
• Although the 155-mm shell is just one of many different types of ammunition and weapons systems that are important to the U.S. military, the surge in its output is welcome evidence that the U.S. defense industry may be able to generally boost production faster than previously thought. That would be a critical capability as the U.S. works to quickly rebuild its armed forces in response to China’s rapid military buildup and increased geopolitical aggressiveness.
• The surge in 155-mm shell output also helps confirm our view that we will see a bigger, re-invigorated industrial sector as companies bring production back home from China or elsewhere, and as U.S. and allied defense budgets are ratcheted upward. We continue to believe that industrial firms and defense contractors, in particular, will offer attractive investment opportunities in the coming years.

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