by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with concerns about a new El Niño event that could further boost global food prices and other global data showing a decline in alternative investments.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a renewed commitment by the European Union to expand by 2030 and an analysis suggesting the U.S. labor force participation rate is now being held down mostly by demographics rather than the impact of the coronavirus pandemic.

Global Agriculture Markets:  An expected warming of waters in the Pacific Ocean, known as El Niño, has officials and investors bracing for weather disruptions such as increased heat in Central America and increased rain in the Andes.  Importantly, an El Niño event typically distorts crop cycles and could exacerbate today’s existing food supply issues, such as Ukraine’s grain export challenges because of Russia’s invasion and India’s ban on exports after heavy rains damaged its rice crop.  The results could include higher food prices around the world, boosting overall consumer price inflation and interest rates, and might also lead to political unrest in poorer countries.

Global Alternative Investment Market:  Data from Preqin shows that alternative investment funds—which invest in assets ranging from private equity and hedge funds to real estate and private credit—have raised just $740 billion since the start of this year, down 27% from the $1.02 trillion raised in same period last year.  The drop in fundraising reflects the impact of higher global interest rates, weak stock markets late last year, and a tepid market for initial public offerings.

European Union:  European Council President Charles Michel said in a speech that the EU should be ready to admit Ukraine, various Balkan states, and other countries into the bloc by 2030.  Michel argued that setting a specific target date would force current EU members to grapple with the changes needed to admit new members while also galvanizing reforms in aspirant countries.

Germany:  Average wages in the second quarter were up a record 6.6% from the same period one year earlier, slightly beating the consumer price inflation of 6.5% over the same timeframe and accelerating from a wage rise of 5.6% in the year ended in the first quarter.  Amid Germany’s broader, structural economic challenges, the figures suggest that German workers are at least no longer facing a decline in their real purchasing power.  Nonetheless, the figures also bolster concerns about on-going price pressures and the potential for further monetary tightening by the European Central Bank.

Brazil:  Leftist President Luiz Inácio Lula da Silva is reportedly close to striking a deal with two right-wing parties formerly allied with his defeated rival, Former President Jair Bolsonaro, in a move aimed at overcoming Congressional opposition to his initiatives to hike public spending and pass greater protections for workers, minorities, and the environment.  The deal would cede cabinet posts and potentially other roles in return for support in Congress, where the coalition led by Lula and his Workers’ Party does not command a majority.

China:  Photographs on social media show that the Chinese navy has finally launched the first of its Type 054B frigates, which sport an advanced phased-radar system, a stealth mast aimed at allowing it to sail undetected through the seas along China’s coast, an integrated electric propulsion system that will allow it to power a wider range of weapons, and an active towed-sonar system designed to identify U.S. and allied submarines.  The ship is also the largest Type 054 variant, with an estimated length of 482 feet and a width of almost 60 feet.

• As we have mentioned before, China now has the world’s largest navy, with a combat force of approximately 350 ships. The U.S. Navy is now a distant second, with about 295 ships.
• Importantly, as this report illustrates, China also continues to make steady progress in increasing the size and capabilities of its vessels.

United States-China:  Commerce Secretary Raimondo today tried to counterbalance her Monday statements that the U.S. would prioritize national security and protect its workers, saying the country was nevertheless not intending to “decouple” from China.  The reporting on the second day also indicates that U.S. and Chinese officials have agreed to regular information-sharing meetings designed to ease economic tensions.

• While certain members of the Biden administration have taken a tough stance against the geopolitical and economic threat from China, the administration has recently tried to use bilateral meetings to ease tensions. At least in part, that probably reflects pressure from foreign allies and the left wing of the domestic political system.
• Nevertheless, we suspect that bilateral meetings, information-sharing sessions, and the like can only go so far in easing tensions. China’s economic imperatives probably still include steps to boost its trade and investment activity around the world, often at the expense of established Western companies and their workers.  More important, we think China’s increasingly aggressive military activity and the continued build-up in its conventional and nuclear arsenal (see above) will ultimately spoil any benefit from eased economic tensions.

U.S. Industrial Sector:  The Wall Street Journal’s “Heard on the Street” column has recently run at least few stories extolling U.S. industrial and basic materials firms as likely beneficiaries of the re-industrialization and factory building boom that we’ve been writing about.  Last week, the column featured industrial machine maker Rockwell Automation (ROK, $309.05), and today it features steelmaker U.S. Steel (X, $29.92).  We don’t necessarily endorse the specific analyses or recommendations regarding those stocks.  All the same, we do think the articles illustrate how the investor class is swinging around to our view that the industrial sector is attractive as the world fractures into relatively separate geopolitical and economic blocs, and as more production is shifted out of China and back to the U.S. or to U.S. allies.

U.S. Labor Market:  Analysis from Axios shows the labor force participation rate has recently been exceeding the Congressional Budget Office’s early-2022 forecast for this period.  The LFPR (the share of adult, non-institutionalized civilians who are working or seeking work) has stood at 62.6% for several months, versus a CBO forecast of 62.4%.  The coronavirus pandemic certainly drove the LFPR way below forecast for almost three years, sparking big labor shortages across the economy.  Nevertheless, the new analysis suggests that today’s labor shortages are largely the result of long-standing trends in population aging and high levels of retirement.

• Today’s labor shortages, strong wage growth, and high consumer price pressures, therefore, look to remain in place for the foreseeable future.
• Of course, that will also tend to make today’s high consumer price inflation “sticky” and encourage the Federal Reserve to keep interest rates high for an extended period.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a review of Federal Reserve Chair Powell’s address to the Kansas City FRB’s symposium in Jackson Hole on Friday.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including signs that U.S. private investments in China are already starting to fall sharply while China launches a new cut in securities transaction taxes to spur more demand.

U.S. Monetary Policy:  At the conference in Jackson Hole on Friday, Fed Chair Powell suggested that the monetary policymakers would likely hold interest rates steady at their upcoming meeting in September, but that they would be prepared to hike rates further if economic growth accelerates and pushes price pressures higher.  He also reiterated his warning that the Fed is likely to hold interest rates “higher for longer” in order to make sure consumer price inflation comes down to the policymakers’ 2% target.

• Based on market indicators, it appears that investors have bought into that view. We also believe the policymakers will try to hold rates at a high level for an extended period, although it is unclear whether they could maintain that discipline if a financial crisis were to erupt or if the economy starts to slow precipitously.
• Investors’ focus on the likelihood of a pause in the Fed’s rate-hiking campaign allowed risk assets to appreciate in value on Friday, while bond yields rose. So far today, however, the yield on the benchmark 10-year Treasury note has fallen back to 4.201%.

United States-China:  Based on new data, the U.S.’s move to restrict investors from privately funding certain advanced-technology startups in China has already begun to discourage private equity and venture capital investments in the country.  The restrictions, which were confirmed in a recent executive order, are apparently freezing investment flows not only into the targeted industries, but also into related industries that the funds and their investors fear could be restricted in the future.  Separately, in her visit to Beijing today, U.S. Commerce Secretary Raimondo warned that the U.S. would not compromise its national security to maintain trade and investment flows, but she argued that there would still be opportunities in non-sensitive areas.

• It’s important to remember that the private investment restrictions don’t just cut the amount of funding available to Chinese firms. Private-equity and venture-capital funds also tend to take a hands-on approach to the companies they invest in, including providing strategic and operational guidance or consulting from the funds’ network of experts.  If the funds stop investing in China’s high-tech startups, the Chinese firms as a whole are likely to develop more slowly than they otherwise would.

• The development is therefore just the latest example of how U.S.-China tensions are exacerbating the other factors weighing on Chinese economic growth, including weak consumer demand, high debt levels, and poor demographics.

Russia-China:  Now that China has banned all food imports from Japan in response to the country’s release of treated radioactive water from the stricken Fukushima nuclear plant, Russia’s food safety agency said it will try to sharply increase Russian food exports to China.  The move comes as Beijing is also whipping up popular boycotts against Japanese imports.  The statement shows how China and Russia are drawing closer to each other amid their various disputes with the West.

• More broadly, the move illustrates how the evolving geopolitical and economic blocs that we’ve written so much about are coalescing, with countries pulling back from their ties with other blocs but deepening ties with countries in their own bloc.
• We count Japan as a key member of the U.S.-led bloc, while we see Russia as the junior partner in the China-led bloc.

Russia-Ukraine War:  In a report that suggests Kyiv’s counteroffensive may now be making more substantial progress, Ukrainian forces are said to have penetrated the first line of Russian defenses at the village of Robotyne, in Ukraine’s eastern Zaporizhzhia region.  The Ukrainian defense ministry says its forces are now driving southeast despite fierce Russian resistance.

• If the report from Kyiv is true, and if the Ukrainians can maintain or build their momentum, it would revive optimism that they can push the Russian forces out of more territory and perhaps even sever the important “land bridge” linking Russia proper with the occupied Crimean Peninsula.

• That kind of progress could also help maintain Western resolve to keep sending arms and supplies to the Ukrainians without putting undue pressure on Kyiv to go to the negotiating table.

China:  In a further move to shore up the local stock market, the Ministry of Finance and the State Tax Administration said the stamp duty of 0.1% on securities transactions will be halved starting today.  The China Securities Regulatory Commission also said it will cut the margin requirement for securities purchases from 100% to 80% starting September 8.

• The moves aim to give a boost to Chinese securities markets, but we suspect buying activity will remain weak in the face of slowing economic growth and increased regulatory risk because of the worsening in U.S.-China trade tensions.
• In fact, Chinese stocks initially jumped some 5% on today’s news, but then they gave up most of those gains and closed up only about 1%.

Taiwan:  Terry Gou, the founder of iPhone assembler Foxconn Technology (HNHPF, $6.72), announced he will run as an independent candidate in January’s presidential election.  The move will further split the relatively pro-China opposition parties on the island.  According to recent polls, current Vice President Lai Ching-te of the anti-China, pro-U.S. Democratic Progressive Party maintains a comfortable lead over the Kuomintang Party and a smaller third party.  Since Gou argues that the government is needlessly stirring up tensions with Beijing, his candidacy is expected to draw further support from the Kuomintang.

Eurozone:  In a release today, the European Central Bank’s key measure of the money supply showed an annual decline for the first time since 2010.  The new data showed that M3 (which encompasses deposits, loans, cash in circulation, and various other financial instruments) was down 0.4% in the year ended in July, after being up 0.6% in the year to June.  The figures illustrate the impact of the ECB’s monetary tightening over the last year, which has helped reduce price pressures but also threatens to further weigh on economic growth going forward.

Japan:  At the Kansas City FRB’s conference in Jackson Hole, Bank of Japan Governor Ueda said he and his fellow policymakers are maintaining their basic yield-curve control strategy because they still see underlying inflation running below their target of 2.0%.  Even though Japan’s core consumer price index for July was up 3.1% year-over-year, Ueda said he expected core inflation to fall back before the end of the year.  Since the statement suggests it’s still too early to expect the BOJ to abandon its yield-curve control strategy, the news helped boost Japanese stocks by about 1.7% today.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment will be split into three main topics: 1) What investors will be looking for in Fed Chair Jerome Powell’s speech at Jackson Hole; 2) How China is using BRICS as a way to challenge the U.S. and its allies; and 3) Why the export ban on semiconductors is making companies uneasy.

 Powell’s Moment: Investors will be glued to Fed Chair Jerome Powell’s every word as he delivers his views on the future path of monetary policy at Jackson Hole.

• Federal Reserve Chair Jerome Powell is likely to remain tight-lipped about the future of monetary policy in his upcoming speech. Last month, Powell indicated a shift toward reduced guidance and increased data dependence regarding the Federal Open Market Committee’s next rate decision. Consequently, investors are still speculating about what he might say, given recent economic data that suggests the Fed may need to be more hawkish in its efforts to combat inflation. The latest nowcast from the Atlanta Fed shows that the GDP likely accelerated in the third quarter of the year. Meanwhile, the latest jobless claims data suggests that the labor market remains stubbornly tight.
• In the lead-up to Powell’s speech, Fed officials have expressed a range of views on the appropriate path of interest rates. Boston Fed President Susan Collins and former St. Louis Fed President James Bullard have both expressed support for additional rate hikes. At the same time, Philadelphia Fed President Patrick Harker has suggested that interest rates do not need to be raised further. The divergence in views among Fed officials suggests that there is still uncertainty about the appropriate path of monetary policy. Despite their differences, there is a growing consensus that interest rates are close to peaking.

• The prevailing view is that interest rates will remain elevated for an extended period of time. The median long-term federal funds rate is still near 2.5%, but the average rate has begun to outpace it. This has led investors to revise their expectations upwards of future interest rates, as they believe that the central bank may not cut rates as quickly or aggressively as it did in the past. In fact, investors have already purchased protection against any sell-off that could occur if Powell reinforces this hawkish stance.

 BRICS United: China is using the BRICS summit to consolidate its influence and build a bloc of emerging economies that can challenge the Western-led order.

• On Thursday, the BRICS countries (Brazil, Russia, India, China, and South Africa) extended invitations to Saudi Arabia, Egypt, United Arab Emirates, Iran, Argentina, and Ethiopia to join their bloc. The possible admission of these countries appears to be an attempt to create an emerging markets bloc to counter the U.S.-led bloc in the G7. That said, it is unclear whether these countries are interested in joining the group, as many of them still have strong military and trade ties with the United States. Prior to the announcement, Indonesia asked not to be named. It is also possible that some BRICS countries may not support the expansion of the bloc, as it could dilute their own influence.
• Despite suspected differences within the bloc, there are indications that China is willing to compromise with the members in exchange for cooperation. During the summit, Chinese President Xi Jinping and Indian Prime Minister Narendra Modi pledged to work towards a peaceful resolution of the border dispute between their two countries. The two sides have been at odds over the territory ever since a 2020 clash between the countries’ militaries. Modi was the one who initiated the discussion on the border dispute, suggesting that India’s decision to welcome new members may have been made for transactional purposes.

• Together, the BRICS countries compose 37% of the global GDP and nearly half of the world’s population, and its potential expansion will undoubtedly increase its influence on the world stage. However, it is still unlikely that China will be able to exercise the same level of influence over the BRICS countries as the United States has over the G7 members. The United States’s ability to maintain open capital markets means it will continue to be an attractive trade and investment destination for other countries, especially emerging markets. Therefore, the rise of the BRICS countries is a potential challenge to U.S. dominance, but it is not yet a real threat.

Chips Everywhere: Semiconductor companies worry that trade restrictions targeting China could hurt their bottom lines.

• Chinese companies imported a record amount of semiconductor equipment in June and July as they scrambled to secure supplies ahead of the implementation of export curbs by the United States and other countries. Trade data from China showed that the country’s import of chip production tools increased by 70% compared to the same period last year. Chinese companies are looking to stock up before export restrictions come into effect on September 1. The surge in semiconductor imports by Chinese companies reflects Beijing’s determination to maintain its technological advancement despite Washington’s attempts to slow it.
• Semiconductor firms that view China as an essential market are worried about the harsh restrictions on exports. Chipmaker Nvidia (NVDA, $471.63) warned that additional curbs would further hinder their ability to compete in the world’s second-largest economy. The company reported earlier this week that sales of its popular AI chips more than doubled from last year, and it expects demand to continue to grow. The news initially caused a surge in the PHLX Semiconductor Index, but investors later sold off as they remained uncertain about the full impact of the regulations on profits.

• The U.S. government’s policy of asking businesses to “de-risk” their operations in China has been met with confusion and uncertainty. Some businesses have interpreted this policy as a call to completely sever ties with China, while others believe that it is simply a request to take steps to mitigate risk. This lack of clarity has made it difficult for businesses to plan for the future and has created anxiety among investors. Although we suspect that the U.S. and China are heading for a break-up, we believe that lobbying by firms will make it a long and drawn-out process.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment focuses on three major themes: 1) Why mixed data shows that it is too soon to rule out the possibility of a recession; 2) How the GOP debates may be more important than people realize; and 3) Why Russian President Vladimir Putin will look to burnish his reputation going into the 2024 election.

Bad News Is Good News: Recent economic data has raised concerns about the possibility of a recession.

• Economic activity in the United States and Europe appears to be slowing, according to a preliminary survey. The August S&P Composite PMI for the United States came in at 50.2, just above the 50 threshold that separates expansion from contraction. The eurozone and the U.K. also saw their PMIs fall into contractionary territory, with readings of 47.0 and 47.9, respectively. While the manufacturing sector has seen the worst of the slowdown, there are also signs that the service sector is starting to feel the pinch.
• Surprisingly, the market responded positively to the disappointing results as it added to speculation that central banks will pause at their next meetings. The S&P 500 had its best day since June, closing the day higher by 1.1%. Meanwhile, the yield on the 10-year Treasury, which hit its highest level since 2007 earlier this week, fell 13 bps. The rise in optimism is related to investors’ beliefs that the central bank may not make matters worse by raising benchmark interest rates. The CME FedWatch Tool predicts that there is an almost 90% chance that the Federal Reserve will stand pat at its September meeting.

• It is not uncommon for a flurry of positive economic data to be released in the run-up to a recession. In fact, prior to the 2001 recession and the Great Financial Crisis, there was talk among experts that a downturn had been averted. Looking even further back, government data released before the Great Depression also did not provide much warning of the impending downturn. While we do not believe that the U.S. is currently in a recession, we are hesitant to say that the worst is over especially as central banks continue to raise interest rates.

First Face Off: GOP candidates had their first debate in Wisconsin on Wednesday in a test to see whom the new face of the party could be.

• The Republican presidential debate kicked off without much fanfare, as the candidates played it safe and avoided controversy. However, Nikki Haley stood out from the pack by highlighting her international experience and offering a different perspective on the country’s problems. In a surprising move, she blamed her own party for the inflation crisis and accused her rival Vivek Ramaswamy of being soft on China by supporting Russia. Former President Donald Trump, who was not in attendance, is likely to keep his front-runner status, as no candidate was willing to directly take him on in the debate.
• President Trump’s decision to skip the debate may not have been in his best interest. Debates are a chance for candidates to shape the national conversation on important issues, connect with voters, and defend their records. By not attending, Trump missed an opportunity to control the political narrative and shape the conversation on issues such as U.S. economic policy and border security. Trump has been a vocal critic of U.S. interventionism and is unlikely to support fiscal reforms that would disproportionately burden his voter base. As a result, President Trump may be forced to play defense when he finally enters the political arena.

(Source: New York Times)

• One of the most pressing issues facing the next U.S. president will be how to deal with the global shift towards regional blocs. At the recent BRICS summit, Beijing and other members of the bloc pushed for emerging markets to join their group as a counter to the G7. In addition to dealing with China, the next U.S. president will also need to address the issue of how to navigate toward an economy built around resiliency as opposed to efficiency. The 2024 U.S. presidential election is still a long way off; therefore, investors have not priced in its potential outcome. If the candidates are perceived as being more hawkish towards China, or less committed to free trade, then financial markets could become more volatile.

 Putin’s Positioning: Russian President Vladimir Putin is seeking to position himself as a capable and decisive leader as he prepares for reelection in March 2024.

• Yevgeny Prigozhin, a potential rival to Russian President Vladimir Putin, died in a plane crash on Wednesday. Prigozhin was the leader of the mercenary Wagner Group that launched a failed mutiny in June. He was also formerly a close ally of Putin. The plane crash occurred as Prigozhin was traveling from Moscow to St. Petersburg. The cause of the crash is still under investigation, but it is believed that a Russian anti-aircraft defense system may have shot down the plane. Prigozhin’s death is a significant development as he was seen as a potential threat to Putin’s leadership.
• However, Putin still has a lot to worry about as he looks to boost his leadership credentials. The Russian economy is in freefall, with the ruble (RUB) down nearly 30% against the dollar since the start of the war in Ukraine. Also, Russia’s current account balance has deteriorated considerably, and interest rates have surged. The country’s oil and gas revenues have kept the country afloat, but they have shrunk by almost 50% in the first six months of the year. These poor economic indicators are likely to dampen sentiment among the Russian populace, especially as the pain of economic sanctions continues to hurt households. Putin will need to find ways to address these economic challenges if he wants to maintain his high approval ratings.

• In the face of a prolonged war effort, an attempted coup, and increasingly challenging economic conditions, Russian President Vladimir Putin appears poised to secure a fifth term in office come March 2024. Yet, lingering uncertainties persist regarding the extent of his support within the military ranks. Approaching the upcoming election, Putin is likely to adopt a more daring approach to reaffirm his strongman image, taking calculated risks to fortify his credentials. This dynamic environment introduces the potential for trade disruptions as the conflict continues to unfold, posing a significant risk to regional stability and economic activities.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning from a blistering hot St. Louis!  It’s the “dog days” of August, and as we noted above, U.S. equity futures are pointing to a higher open.  Unfortunately, we have been experiencing this pattern recently, where we see stronger futures overnight only to see the gains fade as the day wears on.  Overall, August has been a tough month for equity investors as global stocks are having the worst month so far in over a year.  Meanwhile, the early signs of the political season are upon us—tonight is the first GOP debate.  The leading candidate, Donald Trump, is sitting this one out.

In today’s Comment, we open with a recap of the BRICS meetings being held in South Africa.  Up next is a quick look at the upcoming Jackson Hole conference.  A roundup of economic news follows, including a look at the U.S. housing market. The China update is next as the U.S. Commerce Secretary makes her way to Beijing.  We close with the international roundup and a look at the critical Suwałki Gap.

BRICS Meeting:  The five official nations of the BRICS—Brazil, Russia, India, China, and South Africa—are considering expanding the group.  China’s President Xi, who caused a bit of a stir when he failed to show up at a business meeting, met with South African President Ramaphosa to discuss expanding the group.  Xi’s vision for BRICS is to create a counterweight to the G-7.  Although China wants to expand the group (with Iran and Indonesia expressing interest in joining), India and Brazil are more cautious, worried that additional members will dilute their influence.  We suspect that Xi’s support for expanding the body is designed to enhance China’s clout.

Perhaps the biggest concern comes from rumblings that BRICS will create an alternative to the dollar system.  The body has ties to the New Development Bank, which is lending in local currencies to members.  Although there has been talk of creating a BRICS currency, the idea it would emerge from these meetings was mostly scotched by President Ramaphosa, who flatly stated that there would be no discussions about a common currency.  All members have expressed interest in trading in their own currencies, which makes sense.  The problem is that without a reserve asset to hold surpluses, the utility for the exporter to hold the local currency of another country is rather low.  A classic example is that Russia, who is selling oil to India, is now holding billions of INR that it can’t do much with, since it doesn’t want imports from India, and India restricts capital inflows.  There has also been talk of using gold as the reserve asset.  Although this might work (and could be profoundly bullish for gold), a gold standard is inflexible and thus tends to lose its allure for trade.

Our take is that there will be more talking, but we are not likely to see the membership group expand yet.  Also, the expectation of a BRICS currency is probably premature.

Jackson Hole:  Later this week, the KC FRB annual meetings in Jackson Hole will be held, with Chair Powell’s speech due on Friday.  Last year, Powell ditched his prepared remarks and kept it simple—expect higher rates and get used to them.  We don’t expect a repeat this year.  If anything, he will likely be non-committal on further increases, and will probably signal that a rapid decline in the policy rate is unlikely.  The contours of the debate are framed between two poles.  On the one side is that the economy is too strong and inflation too hot so the policy rate needs to rise further.  In his first interview since leaving the St. Louis FRB, Jim Bullard laid out the case that the state of the economy warrants higher rates.  The other side was discussed by the current “Fed whisperer” Nick Timiraos of the WSJ, who begged the question…is the 2% target worth the pain necessary to get there?  We suspect this is what Powell will need to address on Friday.

Economic Roundup:  Housing woes continue, labor unrest does too, and the Biden administration looks to help student loan borrowers.

• Later today, we will get new home sales data, with a modest rise expected. Yesterday, existing home sales came in weaker than expected.  Compared to last year, sales are down 16.3% for single family homes.  However, despite weak sales, prices for existing single family homes rose 1.6% from last year.  In our affordability study, which measures how many weeks a worker earning the median wage for non-supervisory workers to service a mortgage at the prevailing wage, median home price, and mortgage rate, the level reached nearly 2.8 weeks, the highest level since 1985.

• So far, this development hasn’t hurt the economy because most existing home borrowers are simply not selling their homes, reducing supply.  We expect to see new home sales rise relative to existing homes when the data comes out later this morning.
• United Parcel Service (UPS, $166.86) workers, represented by the Teamsters Union, announced the two parties had come to an agreement, averting a strike. Terms suggest about a $7 per hour jump in the average hourly pay.  Next up is the UAW, which is trying to claw back earlier concessions.  Meanwhile, the labor market news is somewhat mixed.  Pay for new hires is reportedly stabilizing after rising rapidly in recent years.  At the same time, tech layoffs are falling, suggesting an improvement for those workers.  Later today, we get benchmark revisions to the payroll data which could result in about a 600k reduction in reported jobs.
• The Biden administration has launched the SAVE Plan which is designed to scale student loan payments to incomes and cap interest costs. The courts struck down earlier efforts to cancel some student loans, so the administration is taking another path, essentially reducing debt service costs.  There have been concerns that when households with outstanding student debt begin paying on these loans in the fall, the economy would suffer.  This plan will likely blunt some of that negative pressure.
• Margin protection has been an element in keeping inflation elevated. There is evidence we have reached the end of that protection as firms are signaling that they probably won’t be able to pass along further cost increases.  However, there is no evidence to suggest a rollback in prices is likely.
• On the battered commercial real estate side, it’s a “good news, bad news” story. The good news is that office tenants are renewing their leases, but the bad news is that they are doing so while taking less space.
• The Bank for International Settlements warns that cryptocurrencies seem to be increasing financial fragility in emerging markets.

China update:  Gina Raimondo is off to China where the economy continues to struggle.

• Commerce Secretary Raimondo is on her way to China, part of a parade of administration officials trying to at least stabilize U.S./China relations. As part of the trip, the U.S. has eased come controls, removing 27 Chinese entities from the “unverified list.”  We doubt this action will make much of a difference.  We note that National Security Director Sullivan warned China to be more “transparent” about its economic data, reacting to news that Beijing won’t publish youth unemployment data anymore.
• Due to concerns about the Chinese financial system, policymakers are moving cautiously on potentially reducing rates, likely worried that aggressive cuts will trigger capital flight and a rout of the CNY. Unfortunately, without stimulus, the Chinese economy will continue to struggle.
• As geopolitical tensions rise between China and the U.S., American financial firms are seeing reduced opportunities in China.

 International Roundup:  Here are other news items of note.

• There are reports of local fuel shortages in Russia. Between the reconfiguring of supply chains, resources being diverted for the war effort, and sanctions, the domestic economy is bound to have periodic supply issues.  What remains uncertain is if these outages will result in a drop in production or civil unrest.  So far, there isn’t much evidence of either.
• The State Department has warned Americans in Belarus to “leave immediately.” The government notes that the presence of Russian troops is rising in the country and local law enforcement can be “arbitrary.”  The department also notes that European nations bordering Belarus have been closing borders.  Last week, Lithuania closed two border crossings, and Poland and Latvia are considering closing crossings as well.  Direct flights out of Belarus are limited.
  • There is a growing concern that Russia might forcibly take the Suwałki Gap which separates Belarus from Russian-controlled Kaliningrad.

 (Source:  The Baltic Times)

• • If this gap were seized, there would be no land bridge between NATO and the Baltic state, making their defense difficult.  The vulnerability of this area isn’t anything new, but the reported build-up of Russian troops in Belarus has raised alarms.  The State Department’s warning adds to this concern.
• We also note that Russia has reportedly placed nuclear weapons in Belarus. In the context of the increasing threat to the Suwałki Gap, this is a further Russian provocation.
• Russia may be considering annexing the regions in Georgia it seized in 2008.
• It’s settled—Srettha Thavisin will be the next PM of Thailand. Thailand has been under a caretaker government since March.
• Spain’s king has asked the conservative party leadership to form a government. Given that the coalition isn’t a majority, this effort will likely fail and so new elections later this year are increasingly likely.
• Azerbaijan is essentially blockading the disputed region of Nagorno-Karabakh. The region, which has an Armenian majority, is beginning to see shortages of essential items develop.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment opens with a curtain-raiser for the BRICS summit starting today in South Africa.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including news of growing trade ties between China and Russia, a vote for a new prime minister in Thailand, and the latest developments in the U.S. labor market.

Brazil-Russia-India-China-South Africa:  The latest summit of the BRICS countries will start today in Johannesburg, with appearances by top leaders ranging from Chinese President Xi to Indian Prime Minister Modi.  Leaders from a number of other emerging markets will also be attending, although Russian President Putin will not.

• One key agenda item is Xi’s push to expand the group to countries such as Indonesia and Iran. However, Modi and Brazilian President Luiz Inácio Lula da Silva are resisting that move out of fear it would give Xi too much power and dilute their influence.
• The leaders reportedly also plan to discuss how the countries can reduce their reliance on the U.S. dollar, especially after seeing how Washington and its allies were able to freeze hundreds of billions of dollars of Russia’s foreign reserves following its invasion of Ukraine.
  • Some observers think the summit will also discuss the creation of a new BRICS currency to replace the dollar, sparking fears of a sudden weakening in the greenback. However, other reporting suggests an alternative currency will not formally be on the agenda.
  • In any case, even though the greenback’s dominance in international trade and foreign reserves has been falling gradually for years, we and other observers doubt the renminbi (CNY) or any other proposed alternative could suddenly and sharply displace it. At least for now, we think there are big political, economic, financial, and technical hurdles that would likely preclude the BRICS countries from a wholesale abandonment of the dollar.

China-Russia:  New data shows that total trade between China and Russia in the first seven months of 2023 jumped to $134 billion, up 36% from the same period one year earlier, putting Russia just behind Australia and Taiwan in the list of China’s largest trading partners.  The figures illustrate how Russia’s invasion of Ukraine and the resulting Western sanctions have pushed China and Russia closer together economically, helping coalesce the evolving China/Russia geopolitical bloc.  We think the continued war and the continued common interest of the two countries will lead to a further coalescing of the bloc in the coming years, making it even more difficult for U.S. investors wanting to invest in the members of the bloc.

• While China’s overall exports from January through July were down 5% on the year, its exports to Russia were up 73%. That means China now accounts for almost half of all Russian imports.  Importantly, China appears to be sending Russia many products with dual military/civilian uses that could help support Moscow’s invasion Ukraine, such as semiconductors and heavy equipment.
• Russia’s exports to China in the same period were up 17% on the year, boosting Russia’s share of China’s imports to 4.8%

China-United States:  For the second time this month, the Chinese Ministry of State Security reported that it has arrested a Chinese citizen on charges of spying for the Central Intelligence Agency.  The announcement came just a month after CIA Director William Burns said his agency was making progress in rebuilding its spy network in China.  That suggests the MSS statements may be as much public relations as anything else.

• In any case, the CIA evidently recruited both spies while they were studying abroad, one in Japan and the other in Italy.
• To do so, it appears that the CIA borrowed the very same techniques the MSS has used to recruit U.S. citizens to spy for China, i.e., it buttered them up with compliments, dinners, gifts, and offers to pay for written “research.” (We think that’s hilarious.)

Japan:  The government stated today that on Thursday it will start releasing tritium-laced water from the Fukushima No. 1 nuclear power plant that is being decommissioned following its inundation and nuclear accident due to a tsunami in 2011.  Release of the stored radioactive water is opposed not only by local residents and fishers, but also by a number of neighboring countries.  Importantly, some countries have threatened to ban imports of Japanese seafood because of concerns about radioactivity.

Thailand:  Today, parliament picked real-estate tycoon Srettha Thavisin as the country’s next prime minister, marking a modest democratic advance after almost a decade of military rule.  Even though Thavisin had to rely on military-backed parties to be elected, the return of civilian rule and the fact that Thavisin is seen as pro-democracy will likely help the U.S. strengthen ties with Thailand again after it had drifted closer to China in recent years.

U.S. Labor Market:  Unionized pilots at American Airlines (AAL, $15.16) ratified a new labor contract that will boost wages by more than 40% over its four-year term.  The eye-popping wage increase reflects not only today’s general post-pandemic labor shortage, but also a shortfall in the number of available aviators and surging demand for leisure travel.  Such lucrative new labor contracts will likely keep investors concerned about continuing inflation pressures and the likelihood that the Federal Reserve will keep interest rates “higher for longer.”

• All the same, other signs point to some cooling in labor demand. For example, new data from ZipRecruiter (ZIP, $16.66) shows that most of the postings for some 20,000 different job titles on its site are offering less pay than just one year ago.
• The biggest drops have been in technology, transportation, and other sectors that had hiring frenzies in 2021 and early 2022.

U.S. Bond Market:  The rare “bear steepening” in the Treasury yield curve has continued this week, with the yield on the 10-year Treasury note rising yesterday to a 16-year high of 4.339% while the yield on the two-year obligation rose to 4.990%.  The difference between the two has now narrowed to just 65 basis points, compared with 93 basis points as recently as the end of July.  We believe the rise in longer-term yields primarily reflects a realization that the Fed is not likely to cut interest rates in the near term.  Since the yield curve’s inversion remains quite large, we think there is plenty of room for longer-term yields to keep rising.

• Meanwhile, new data shows that the average interest rate on a 30-year, fixed-rate mortgage has jumped to 7.48%, reaching its highest level since November 2000.
• That will likely continue to discourage current homeowners with ultralow mortgage interest rates from putting their homes on the market. That could make the supply of existing homes even tighter and push their prices higher, while also creating further incentives for new home construction.

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