by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment begins with a discussion on how the expiration of options contracts may place downward pressure on equities. Next, we explain why equity investors are still not convinced that central banks will not cut rates this year. Lastly, we give our thoughts on the latest Bank of Japan policy decision.

Triple Witching: Markets are expected to be down today, but there is evidence that investor optimism could still lift equities higher.

• After six consecutive days of gains in the S&P 500, the simultaneous expiration of stock options, index futures, and index futures derivative contracts, also known as triple witching, threatens to end the streak. Today, $4.2 billion of U.S. and European futures are set to expire, along with the quarterly expiration of index futures and the rebalancing of benchmark indexes. Although the combination of these events does not necessarily lead to a bad day for equities, it does suggest that the day will likely be faced with increased trading volume as well as heightened volatility, particularly in the final hours as investors decide whether to chase recent gains or hedge against potential losses.
• An imminent recession combined with continued optimism regarding generative artificial intelligence (AI) technology may impact investor behavior today. The craze over the machine-learning algorithms has pushed the P/E ratio for the S&P 500 Communication Services and Information Technology sectors to their highest level since the start of 2022. In contrast, the P/E ratio for the Equal-Weight Index has remained relatively stable within that same period. The divergence in performance reflects investors’ expectations that the technology will allow firms to add different sources of revenue. On the flip side, economic fears are elevated as forecasters are still predicting a recession for the second half of the year.

• The decision to hedge or pursue gains may come down to each investor’s recession call. If they believe that a major downturn is imminent, they may be tempted to play it safe and protect gains made for the year. If true, this could sap momentum from the current market rally. On the other hand, if market participants assume that a recession will likely be mild or averted altogether, they may be persuaded to take on additional risk in order to maximize profits. As of right now, we believe that as long as the economic conditions remain positive, equities may offer attractive opportunities for risk-tolerant investors.

Peak Rates: Investors are already looking for the exit to the tightening cycle, even as central banks signal that their job is not done.

• On Thursday, the S&P 500 index rose above 4,400 for the first time since April 2022, a surprise move given that the Federal Reserve is still expected to raise interest rates by another 50 basis points and the economy may be headed for a recession. Although some of the rally can be attributed to the recent surge in generative AI technology, all sectors of the index managed to close higher. The broad performance was likely due to investor optimism that the Fed is nearing the end of its rate-hiking cycle, as it is assumed that recent data showing that consumption is slowing and jobless claims are rising may force policymakers to rethink their current strategy.
  • Additionally, a labor deal to avoid a potential strike among port workers has also likely helped boost investor sentiment.
• The STOXX Europe 600 Index is hovering near a monthly high, despite falling to an intraday low following hawkish comments from ECB President Christine Lagarde. Media and retail related stocks helped fuel a recovery toward the end of the trading period resulting in the index closing slightly below the previous day’s close. The rally was related to doubts that the central bank will be able to raise interest rates significantly while the economy is in recession. Last month, consumer prices rose 6.1% from the prior year, well above the central bank’s inflation target of 2%.

• The strong performance of both indexes shows that investors are not confident that policymakers will be able to maintain their inflation fight during a downturn. This bias is the most prevalent in the United States where traders appear to be looking past the Fed commenting that they are serious about continuing to increase interest rates. The CME FedWatch Tool shows that some traders expect a rate cut this year. At the same time, eurozone overnight index swaps suggest that the European Central Bank will cut rates in December. This confidence could lead to sorrow if the US economy remains resilient and the eurozone economy rebounds in subsequent quarters since inflation would then be unlikely to fall to 2% before the end of the year, which could possibly lead to additional hikes.

Bank of Japan: The Bank of Japan (BOJ) continues to be the only central bank in the G10 not to tighten policy in response to elevated inflation.

• The Bank of Japan has decided to keep its negative interest rates and yield-curve-control policy in place following its two-day meeting on June 14-15, 2023. Governor Kazuo Ueda remained relatively ambiguous as to when the BOJ may alter its policy, but he maintained that officials believe inflationary pressures will moderate as cost-push factors dissipate. He also noted that the group noticed a change in corporate price-setting behavior. In April 2023, Japanese headline inflation rose 4.6% from the previous year, while core inflation rose 4.1%. These figures are well above the BOJ’s target of 2%. However, Ueda said that the central bank is confident that inflation will eventually fall back to its target as the economy adjusts to higher energy prices and other cost-push factors.
• The suspense over when the Bank of Japan will finally decide to remove policy stimulus has started to weigh on the Japanese yen (JPY). The currency sank to a 15-year low against the euro after the central bank announced its policy decision on Thursday. Meanwhile, the JPY traded further above 140 against the dollar, adding to concerns that the BOJ may need to intervene to protect the currency. Going into 2023, investors had speculated that the BOJ would signal an end to the ultra-accommodative monetary policy that has kept interest rates at near zero for years. However, the BOJ has so far resisted calls to tighten policy, even as other central banks have begun to raise rates in an effort to combat inflation.

• Despite elevated inflation, Japanese equities have performed remarkably well to begin the year. The Nikkei 225 is up 31% for the year, drastically outpacing the S&P 500, which is only up 15%. Much has been made about the country’s corporate reforms restoring the confidence of foreign investors. However, we believe some of this performance is related to expectations that the BOJ will end its yield-curve-control policy. In our view, the BOJ will be unlikely to quickly remove this policy, but it could take small steps, such as tweaking the band on its cap on ten-year yields. As a result, we believe that a hawkish BOJ could offer support for dollar-based investors looking for foreign exposure.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment begins with a discussion on the Federal Reserve’s latest interest rate decision. Next, we review the latest central bank policies in the eurozone and China. Lastly, we end with why recent developments in the Middle East and Europe have caught our attention.

Skip or Pause? Fed Chair Jerome Powell is uncertain whether the central bank will pause or hike, but he is adamant that a cut is not being considered.

• The Federal Reserve left rates unchanged for the first time since February 2022. On Wednesday, policymakers announced that they would hold rates at their current levels to give the group time to observe the state of the economy. In its dot plots, Fed officials signaled that they still plan to lift rates an additional 50 bps before the end of the year. Meanwhile, the summary of economic projections showed that members had revised their expectations for real GDP growth and inflation upwards but decreased their estimates of the unemployment rate. In short, the Fed officials have become more hawkish since the February meeting despite their decision to pause.
• During the press conference, Fed Chair Jerome Powell downplayed the importance of the dot plots, which show the individual projections of the Federal Open Market Committee (FOMC) members for the future path of interest rates. Powell insisted that there were no discussions held about rate hikes for the July FOMC meeting. His comments led to a strong recovery in risk assets, which had dipped following the release of the hawkish dot plots. The Nasdaq 100 fell 0.8% within 20 minutes of the Fed announcement but closed the day higher by 0.7% from the previous day. The extreme swings in equities reflect investor confidence that the central bank is finished with its hiking cycle. Fixed-income securities also rallied as bondholders believed that the Fed would trigger a recession in its attempt to fight inflation.

• The opposing reactions from the bond and equity markets suggest that there is still much uncertainty regarding the Fed’s future policy path. Bondholders are confident that policymakers will continue to hike rates until inflation is under control, while equity traders believe that the Fed is leaning toward holding rates at their current levels. The diverging viewpoints suggest that one of the markets may be headed for a correction. It is too early to say which market is wrong, but we are confident that recession will likely be the arbiter.

Other Central Bank News: As the European Central Bank prepares to end its hiking cycle, the People’s Bank of China eases its monetary policy.

• The ECB decided to raise its deposit rate by 25 bps to 3.50%, its highest level in 22 years. During the press conference, ECB president Christine Lagarde insisted that it has no plan to end its hiking cycle anytime soon. The decision to push rates higher comes amidst concerns that inflation is still stubbornly high. The Euro Stoxx 50 index sank following the ECB’s rate decisions as investors worried that the policy would weigh on the regional bloc’s economy, which fell into recession last quarter. However, the hawkish stance did provide a bump in the euro.
• In a contrasting tactic, the People’s Bank of China cut its medium-term lending facility (MLF) rate to 2.65% from 2.75%. The decrease in rates will lower borrowing costs on 237 billion CNY ($33 billion) worth of one-year loans. This move is designed to stimulate the economy as the central bank looks to encourage growth. Earlier this week, the central bank cut interest rates on the standing lending rates by 10 bps, thus pushing down overnight rates to 2.75%, the seven-day reverse repurchase rate to 1.9%, and the one-month rate to 3.75%. The announcement will likely encourage banks to reduce their lending rates over the coming weeks, which may lead to an increase in consumption.

• Despite hawkish comments from the ECB, European assets may be able to benefit from a revitalized Chinese economy. As the chart above shows, European countries are becoming increasingly integrated with the Chinese economy. Germany, in particular, may be uniquely positioned to benefit from a Chinese economic recovery since China is a significant market for Germany, accounting for nearly 10% of its GDP. The majority of these sales come from German subsidiaries in China, such as Volkswagen (VWAPY, $14.14) and BASF (BASFY, $12.63). As a result, the PBOC stimulus for the Chinese economy may provide support to European equities.

Rising Uncertainty: Geopolitical risks are increasing as tensions escalate over Iran’s nuclear program, and Europe’s access to LNG is more vulnerable than originally thought.

• The U.S. has been holding talks with Iran over an agreement to limit Tehran’s nuclear program. An agreement has not been reached, but it appears Washington is prepared to release billions of dollars of frozen Iranian funds and conduct a prisoner exchange. The discussions come amidst rumors that Iran has been able to enrich uranium to 60% purity, a level at which experts say has no civilian use. Israel, also considered to have nuclear capabilities, has vowed to prevent Iran from becoming a nuclear power. If the United States and Iran are unable to reach an agreement, it is possible that Israel will take military action against Iran. This would be a major escalation of tensions in the region and could lead to a broader conflict.
• Meanwhile, benchmark futures for European natural gas prices spiked as high as 24% on Thursday. The price surge was in response to an announcement that the Dutch government plans to permanently shut down Europe’s biggest gas field later this year. Gas price volatility was already elevated following forecasts of hotter weather coupled with a possible pickup in Asian demand which threaten to strain global stockpiles. Uncertainty over supply and demand for natural gas raises concerns over energy availability for the winter. Consequently, this may make it harder for countries to reduce their dependency on Russian supplies due to the conflict in Ukraine.

• Geopolitical risks remain one of the biggest threats to the global economy. As the chart above shows, the Economic Policy Uncertainty (EPU) index remains well above its long-term average of 100. The EPU index tracks the relative frequency at which local newspapers use words associated with economic policy uncertainty. The index has been elevated since Russia began its invasion of Ukraine and has remained high. Although the EPU index does not suggest that the financial markets will suffer, it does signal that the chances of a fat-tail event are elevated meaning investors should continue to pay close attention to ongoing geopolitical conflict.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with updated oil demand and supply forecasts from the International Energy Agency.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including more signs of faltering Western investment in China and a preview of today’s Federal Reserve decision on interest rates.

Global Oil Market:  In its monthly report, the International Energy Agency raised its 2023 forecast for global crude oil demand to 102.2 million barrels per day, an increase of 2.4 mbpd from 2022.  The organization also raised its 2023 supply forecast to 101.3 mbpd, suggesting a tight market that could mitigate some of the downward pressure on oil prices as the U.S. and other major economies post weaker economic growth or look set to enter recession.  So far this morning, Brent crude is trading up approximately 0.7% to $74.80, but that remains far below the level of almost $120 per barrel one year ago.

China – Inbound Portfolio Investment:  In the latest sign that Western investors are losing their appetite for Chinese assets, U.S. investment banks such as Goldman Sachs (GS, $342.50) have reportedly been pulling out of initial public offering deals involving companies based in China.  Even when the investment banks take part in a Chinese IPO, reports indicate they are sometimes having trouble selling the deals.  As we have often argued, geopolitical tensions between China and the West, along with slowing Chinese economic growth, have raised the risks involved with investing in China.  It is now becoming increasingly clear that investors are responding to those risks.

China – Monetary Policy:  The People’s Bank of China cut another set of policy interest rates yesterday, following its earlier cut in its seven-day reverse repo operations.  This time, the central bank cut the rate on its overnight Standing Lending Facility to 2.75% from the previous 2.85%.  The institution also cut its SLF rate for other maturities.  The rate cuts have spurred expectations of more monetary easing in the coming weeks.

• Separately, top officials are also reportedly considering a broad economic stimulus program that would help areas such as personal consumption and real estate.
• Nevertheless, it is not clear if President Xi would be willing to abandon his plans to rein in debt and other economic imbalances engendered by the government’s past stimulus programs.

European Union:  The European Commission today issued fresh antitrust charges against Google (GOOG, $124.43), alleging that the company illegally distorts competition in the bloc’s advertising technology sector.  The document includes a call for Google to divest some of its online advertising business.  The charges illustrate how major U.S. technology firms continue to face heightened regulatory risks, both in the U.S. and in Europe.

• Separately, the European Parliament today advanced a draft law called the AI Act that aims to impose the West’s first comprehensive regulation of artificial intelligence. If passed into law, the legislation would:
  • Regulate how companies train their AI models to ensure the models don’t create illegal content.
  • Require companies to publish summaries of the copyrighted data used to train their models, potentially giving content creators a way to share in their profits.
  • Require companies to disclose when content is generated using AI.

North Atlantic Treaty Organization:  Members of the NATO military alliance are struggling to agree on a successor to Secretary General Jens Stoltenberg when his term ends in October.  As a result, the members are leaning toward extending the former Norwegian prime minister’s mandate for a fourth time.  That would not only allow more time for the NATO members to agree on a new leader, but it would also allow for some continuity in the midst of Russia’s invasion of Ukraine.

• Separately, reports indicate the U.S., the U.K., Germany, and France are drafting a multilateral political declaration that would allow individual countries to provide bilateral security assurances to Ukraine in lieu of NATO membership.
• However, neither the framework document nor the bilateral agreements would have the status of legal treaties. They also would not involve any formal NATO commitments.

Russia-Ukraine War:  Speaking of the war, yesterday Russian President Putin publicly backed Defense Minister Shoigu’s demand that the Wagner Group of mercenaries be brought under central control.  Wagner chief Yevgeniy Prigozhin has so far refused to do so, but Putin said formalizing Wagner’s relationship to the Defense Ministry would be necessary to ensure veterans’ benefits for the mercenaries—an argument that likely aims to undermine Prigozhin’s popularity with his troops and short-circuit his political ambitions.

United States-Iran:  Reports today say the Biden administration has quietly restarted indirect talks with the Iranian government in a bid to ease tensions.  After giving up last November on its effort to reinstate the international agreement limiting Tehran’s nuclear program, the administration now appears to be seeking better behavior from Iran through talks and the easing of some international financial flows that had been frozen by U.S. sanctions.

U.S. Monetary Policy:  Officials at the Fed today wrap up their latest policy meeting, with their decision due to be released promptly at 2:00 PM EDT.  Market indicators suggest investors now expect the policymakers to pause their interest-rate hikes and keep the benchmark fed funds rate steady within a range of 5.00% to 5.25%.  The officials are also expected to signal an option to resume their rate hikes in the future if consumer price inflation doesn’t moderate as expected.

U.S. Military Leadership:  In a surprise move, Defense Secretary Austin has recommended U.S. Pacific Fleet Commander Samuel Paparo to be the new Chief of Naval Operations.  The move was a surprise because Austin had been widely expected to name the current Vice CNO, Admiral Lisa Franchetti, to be the Navy’s top officer.  President Biden will have final word on the matter, but Austin’s support for Paparo suggests that growing U.S.-China tensions have put a premium on top-level experience in the Pacific theater, even if that means missing a chance to name the first female leader of the Navy and the first female member of the Joint Chiefs of Staff.

U.S. Defense Industry:  Defense giant Lockheed Martin (LMT, $452.37) and semiconductor maker GlobalFoundries (GFS, $62.89) announced a deal that will secure the supply of computer chips used in Lockheed’s weapons in return for investments in new GlobalFoundries production capacity.  The agreement will also help make GlobalFoundries eligible for capacity funding from last year’s CHIPS and Science Act.  The deal serves as a reminder that the legislation aims to spur domestic production of not only advanced computer chips, but also the less-advanced chips used in military equipment.

U.S. Labor Market:  Officials in the Biden administration have started trying to ease tensions between the West Coast dockworkers’ union and port employers, who have been struggling to agree on a new labor contract for the last year.  With patience wearing thin on both sides, the dockworkers have reportedly begun to stage informal work slowdowns, raising the risk of broader disruptions or even an outright strike that would snarl supply chains and potentially boost inflation again.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with plenty of China news, including signs of an investor exodus from the country and efforts by the central bank to boost economic growth.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including signs of re-industrialization in the European Union and an overview of the latest Federal Reserve policymaking meeting, which begins today.

China – Inbound Portfolio Investment:  Major asset managers around the world report they are being deluged by client requests for “Asia Ex-China” products, as global investors react to China’s slowing economic growth and increasing geopolitical tensions with the West.  As a corollary, the fund managers say they’ve seen an uptick in requests for “Asian ally” products that would invest in Asian countries that are friendly toward the U.S., such as Japan and South Korea.  Some clients are also requesting funds that would invest in Asia excluding both China and Japan.

• As we have been arguing for some time now, worsening geopolitical tensions are likely to prompt both the U.S. and China to clamp down on investment flows between the two countries. Tightened rules could come from out of the blue at any time, leading to losses for investors.
• We continue to believe that a safer approach may be for U.S. investors to focus their exposure on the evolving U.S. geopolitical bloc, which will likely consist mainly of today’s rich, highly advanced industrialized countries that are liberal democracies and provide good protections for property rights. The U.S. bloc will also include a number of tightly related emerging markets, such as Taiwan, South Korea, and Mexico.

China – Monetary Policy:  Today, in a sign that officials now feel they must address the economy’s slowing growth, the People’s Bank of China unexpectedly cut the interest rate it charges on seven-day reverse repo operations to 1.9%, versus 2.0% previously.  The central bank also injected 2 billion CNY ($280 million) into the banking system at the new, lower rate.  Analysts expect that China’s other key lending rates will also be cut soon.  Nevertheless, faltering confidence by businesses and consumers and weak loan demand mean the policy easing may have little positive effect on growth.

China – Military Policy:  According to a recently declassified Intelligence Community report, China’s actual military spending is now equivalent to about $700 billion per year, even more than the $516.1 billion that we estimated in our recent report on Chinese military power and almost three times that of China’s official defense budget.  As the Soviets did during the Cold War, the Chinese use a range of budgetary shenanigans to under-report their actual defense spending.

• The Chinese spending of $700 billion still doesn’t match the U.S. defense budget of $824.4 billion in 2022, but China’s spending is concentrated on only about one-quarter of the earth’s surface, whereas the U.S., as the global hegemon, must spread its budget over virtually the entire world.
  • With total actual military expenditure of $700 billion per year, China would be spending about $14,200 for every square mile of its core defense sphere (basically, the eastern half of the Northern Hemisphere).
  • In contrast, the U.S. defense budget equates to just $4,302 for every square mile of the Earth’s surface excluding Antarctica (which is supposedly neutral).
• Along with China’s aggressive military operations and intensive investment in its weapons arsenal, the lack of transparency in its defense spending should be a major concern for Western defense officials and will likely be an argument against the cooling of tensions being advocated by Western business elites seeking to protect their commercial interests.

European Union:  On top of the recent construction data indicating a massive jump in U.S. factory construction, new data suggests re-industrialization is also happening in Europe.  The data shows global businesses acquired or leased 9.6 million square feet of industrial space in the region in 2022, marking a 29% increase over the previous year.  The uptake of factory buildings comes even as weak consumer growth in the region pushes down contracts for retail and warehousing space.

• Re-industrialization in Europe is probably being driven by many of the same forces as in the U.S. Faced with slower growth in China and the risk that geopolitical tensions will sever their critical global supply chains, firms are cutting their risks by “near shoring” production.
• Nevertheless, the Europeans are probably still not seeing the level of re-industrialization that they could have if they adopted U.S.-style subsidies for green technology, advanced semiconductors, and other key industries. As in the U.S., the EU also probably hasn’t yet seen the full impact of defense spending increases, which will require a build-out of the region’s defense industrial base.
  • Illustrating the allure of the new U.S. industrial policy, German semiconductor firm Infineon (IFNNY, $40.84) said it may start producing more of its products in the U.S. so that they would be eligible for subsidies included in last year’s Inflation Reduction Act.
  • Infineon is the world’s largest producer of semiconductors for the auto industry.

United Kingdom:  The unemployment rate in February through April fell to a seasonally adjusted average of 3.8%, rather than rising to 4.0% as anticipated.  That means joblessness declined further from the 3.9% rate in January through March.  Even more alarming for the Bank of England, average weekly earnings in April were up 7.2% year-over-year, surpassing the expected increase of 7.0% and accelerating from the rise of 6.7% in the previous month.

• The strong labor market data suggests the central bank will be even more inclined to keep hiking interest rates.
• In response, U.K. bonds are slumping so far this morning, driving yields higher. The yield on two-year Gilts has now reached its highest level since 2008.

Global Oil Market:  In its monthly market report, the Organization of the Petroleum Exporting Countries said their producers as a whole cut oil production by 464,000 barrels per day in May, down to a total level of 28.07 million bpd.  Although the cuts were largely concentrated among a few of OPEC’s biggest producers, the figures suggest the organization is following through with its “voluntary” effort to boost prices by restricting supply.  Nevertheless, output increases by some OPEC members will likely mute the impact on global supplies, especially as demand falters in the face of slowing economic growth.

• So far this morning, Brent crude is trading up 2.5% at about $73.60 per barrel.
• All the same, that is sharply lower than the price of $120 per barrel one year ago.

Nigeria:  In a sign that he will continue to shift economic policy in a more orthodox direction, newly elected President Bola Tinubu has suspended central bank chief Godwin Emefiele, who had spent billions of dollars of the country’s foreign reserves to prop up the currency.  Tinubu has also ended a program of fuel subsidies that cost Nigeria some $10 billion per year.  The moves have given a significant boost to Nigerian bonds.

U.S. Monetary Policy:  Officials at the Fed begin their latest two-day policy meeting today, with their decision to be released tomorrow at 2:00 PM EDT.  Market indicators suggest investors now expect the policymakers to pause their interest-rate hikes and keep the benchmark fed funds rate steady within a range of 5.00% to 5.25%.  The officials are also expected to signal an option to resume their rate hikes in the future if consumer price inflation doesn’t moderate as expected.

• On a related note, new data shows U.S. junk-loan defaults are surging as more financially challenged companies with floating loan rates find they can’t meet their debt payments.
• The data shows 18 such defaults in January through May, for a total of $21 billion. That’s more than in the full-years of 2021 and 2022 combined.

U.S. Apartment Market:  New figures from rental-listing and property-data companies show that asking rents for new leases have hit a plateau and in some cases are declining.  That marks a big slowdown from the double-digit increases one year ago.  Of course, the slowdown in asking rents is a positive for apartment dwellers and could soon start pushing down overall consumer price inflation.  Nevertheless, weaker-than-expected rent rates could also cause problems for building owners, potentially making the apartment sector another source of concern in the commercial real estate market.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a couple of quick notes on the war in Ukraine and Russia’s relationship with the United States.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including the death of Italian right-wing firebrand Silvio Berlusconi and a preview of this week’s policy meeting at the Federal Reserve.

Russia-Ukraine War:  The latest reporting suggests the Ukrainian counteroffensive remains in its probing and feinting phase, with some thrusts being stopped but others managing to gain some territory.  So far, it appears that Ukraine’s losses have been moderate for this type of operation, including the loss of some advanced Western tanks and other equipment.

Russia-United States:  Moscow police have arrested a U.S. citizen living in Russia and charged him with dealing illegal drugs.  Travis Leake, a 51-year-old musician, has been living in Russia since 2010 and had refused to leave despite State Department warnings that U.S. citizens should get out of the country.  His arrest will probably be a new point of friction between Russia and the U.S. and could morph into another prisoner exchange like the one in December that freed WNBA star Brittney Griner.

Italy:  Former Prime Minister Silvio Berlusconi died today, creating a leadership vacuum in his conservative Forza Italia Party and likely taking some of the energy out of Italy’s right-wing political forces.  The most immediate issue is who will take over Forza Italia, which is a member of current Prime Minister Meloni’s three-party coalition.  More broadly, since Berlusconi was sympathetic to President Putin, his death could help ensure that Meloni’s government has a free hand to keep supporting Ukraine as it tries to defend against Russia’s invasion.

United Kingdom:  Former Conservative Party Prime Minister Boris Johnson resigned from his seat in parliament on Friday after seeing a new Privileges Committee report that accuses him of lying to the Commons about holding illegal parties during his government’s pandemic lockdown.  At least two of Johnson’s allies have also resigned, setting the stage for three by-elections that will be a challenge for current Prime Minister Sunak’s government to defend.  As a result, political instability looks set to continue in the U.K. in the near term.

• Separately, former Scottish First Minister Nicola Sturgeon, who resigned in February, was arrested yesterday by police officers investigating the finances of her Scottish National Party (SNP).
• The SNP’s focus is gaining independence for Scotland. The arrest of Sturgeon and the investigation into the SNP will likely take the wind out of that effort for the near term.

Turkey:  Late last week, newly re-elected President Erdoğan named Hafize Gaye Erkan as the new chief of the central bank.  Erkan, a Princeton-educated economist who used to be a banker at Goldman Sachs (GS, $336.02), is a specialist in building complex financial models to uncover the risk in bank balance sheets.  That classical skillset suggests she will take a traditionalist approach to policy, much as Erdoğan’s new finance minister seems to be doing.

• Taken together, the appointment of the two officials suggests Erdoğan will tone down his loose, unorthodox economic policies now that he has been safely re-elected.
• If monetary and fiscal policy do shift toward a more orthodox stance, it would likely be a positive for Turkish assets going forward.

China-South Korea:  The South Korean government has arrested a former executive of Samsung Electronics (005930.KS, KRW, 71,000.00) on charges that he illegally stole the chipmaker’s manufacturing technology with the intentions of building an entire copycat factory in China.  We suspect the near miss will force South Korean officials to confront the risk that the country’s most important technology secrets could flow to China, or be acquired by China, which would eventually harm South Korea’s leading tech companies.  In turn, that will likely force a clampdown on trade, investment, and technology flows with China, bringing South Korea more in line with the policies of the U.S. and the rest of the evolving U.S. geopolitical bloc.

United States-China:  The Biden administration has requested that the U.S. be reinstated as a member of the United Nations Educational, Scientific, and Cultural Organization (UNESCO) so that it can start pushing back against China’s dominance of the group which began after President Trump’s withdrawal in 2017.  Reinstatement would require the U.S. to pay several hundred million dollars in arrears on its membership dues, but the administration sees that price as worth it to reduce Beijing’s impact on UNESCO’s work on issues ranging from press freedoms to artificial intelligence.

U.S. Monetary Policy:  Officials at the Fed begin their latest two-day policy meeting tomorrow, with their decision due to be released on Wednesday at 2:00 PM EDT.  Market indicators suggest investors now expect the policymakers to pause their interest-rate hikes and keep the benchmark fed funds rate steady within a range of 5.00% to 5.25%.  The officials are also expected to signal an option to resume their rate hikes in the future if consumer price inflation doesn’t moderate as expected.

• In a Financial Times opinion piece today, former PIMCO bond guru Mohamed El-Erian argued that the more prudent course would be to hike rates again this week, since pausing until July wouldn’t give the Fed much additional data on the impact of previous hikes and since recent economic data has been strong enough to justify a June hike.
• On the other hand, El-Erian argues that a pause, potentially followed by cuts, could be in order if the global supply side of the economy has changed to the point where the Fed’s 2.0% inflation target is too low. Such a pause could also help reduce the risk of more financial instability like the bank crisis this spring.

U.S. Military:  As China’s military buildup and increasing aggressiveness create a need to beef up U.S. deterrence, independent auditors at the Government Accountability Office said the Navy’s submarine contractors can’t find enough workers to meet their planned schedule of building one Columbia-class ballistic missile submarine and two Virginia-class fast attack submarines each year.  According to the report, staffing for the attack subs is about 25% below what would be necessary to meet the planned schedule.  The staffing problems and construction delays are expected to produce significant cost increases for the new subs.

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