by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is currently digesting the latest tariff announcements from the president. In sports news, OKC Thunder guard Shai Gilgeous-Alexander scored 51 points in the team’s recent victory, making his team the first in the competitive Western Conference to reach 50 wins this season. Today’s Comment will explore how tariffs are already impacting economic activity, why the Federal Reserve’s independence is being called into question, and other market-related developments. As usual, the report will also cover key domestic and international data releases.

Stagflation Fears Rise: The latest Purchasing Managers’ Index (PMI) from the Institute for Supply Management revealed that manufacturing output growth has stagnated, while prices surged at their fastest pace since 2022. The weak reading has heightened concerns that ongoing trade tensions are starting to weigh on economic output.

• The February ISM Manufacturing Index came in at 50.3, down from the previous month’s reading of 50.9. Although the report remained above the contraction threshold of 50, the expansion was primarily driven by a sharp increase in manufacturing prices, which have reached their highest level since June 2022. Meanwhile, new orders and employment both fell into contraction territory.
• While the recent reading remained above the 12-month average of 48.6, the frequent mentions of uncertainty among respondents suggest that firms are growing more concerned about their economic prospects in the future. Their worries appear to center on navigating US trade tensions with Mexico, Canada, and China, as businesses struggle to determine how to invest in this evolving environment. This challenge is further compounded by fluctuating tariff rates and uncertainty over potential policy responses.
• On Monday, President Trump announced plans to follow through on his threat to impose tariffs as a punitive measure against countries he claims are not doing enough to curb the flow of fentanyl into the US. Mexico and Canada will face a 25% tariff on all goods, with the exception of Canadian energy products, which will be subject to a lower import tax of 10%. Meanwhile, tariffs on Chinese goods will double from 10% to 20%. He is also weighing additional tariffs on steel, aluminum, and food imports.
• In response, Canada has imposed a 25% tariff on $20.6 billion worth of US goods, including orange juice, peanut butter, wine, and coffee. A second round of tariffs targeting cars, trucks, and steel is also expected to take effect in the coming weeks. Meanwhile, China has retaliated by targeting US agricultural products with a 15% tariff, and Mexico plans to announce its response later today.

• Economic data is already beginning to reflect the impact of trade war concerns. Following the report’s release, the Atlanta Fed’s GDPNow forecast for Q1 2025 fell further into contraction territory, dropping from -1.5% to -2.8%. This decline was driven by a rise in imports, as well as a slowdown in consumption and investment, all of which have weighed heavily on GDP growth.
• While it is still too early to assess the full economic impact of the ongoing trade war, US equities may continue to find support as investors attempt to gauge the extent of rising trade tensions. So far, the S&P 500 has fallen by as much as 5% from its all-time high, but a rebound could occur if there are signs that these tariffs are being reversed.

Fed Independence in Focus: A group of Republican lawmakers are turning their attention to the Federal Reserve, aiming to review the central bank’s authority over monetary policy and bank regulation. This scrutiny marks an early sign that the Fed’s independence could be at risk.

• On Tuesday, a House task force that was established to scrutinize the Fed will hold its first hearing. The committee will begin its examination of the Fed’s authority by reviewing its original 1913 charter. This review comes amid the president’s ongoing efforts to test the limits of executive authority, as he seeks to expand his control over government operations.
• While the president has shown relative restraint in his criticism of the Fed — with Treasury Secretary Scott Bessent noting that the administration aims to focus on long-term yields — he has repeatedly expressed dissatisfaction with its reluctance to cut interest rates. Several days prior to the January 28-29 FOMC meeting, President Trump went so far as to claim that he understands interest rates better than the central bank’s officials.
• Currently, pressure on the Fed is likely to undermine the central bank’s ability to maintain autonomy in its decision-making, as it grapples with inflation persistently above the 2% target and an economy showing signs of slowing. New tariffs are likely to add to those challenges as they will further contribute to price pressures at a time in which goods have been a reliable source of drag on the overall index.

• The US dollar may face significant risks from increased scrutiny of the Fed, as a perceived lack of central bank independence could undermine global confidence in investing in the United States. However, this scenario may strengthen the case for gold, as investors could turn to the precious metal as a safe-haven alternative.

US Suspends Aid: President Trump has decided to withhold additional aid to Ukraine following President Zelensky’s reluctance to agree to a peace deal without security guarantees. While the decision was widely anticipated, its potential spillover effects remain unclear.

• The order specifically targets military weapons used to prolong the conflict, as President Trump has repeatedly expressed his desire to achieve peace on the continent after years of fighting. He has also stated that he would welcome President Zelensky back to the White House once Zelensky demonstrates a genuine commitment to pursuing peace.
• In response to the US’s reluctance to provide assistance to Ukraine, Europe has swiftly moved to increase its defense spending. European Commission President Ursula von der Leyen announced that the EU will activate a mechanism enabling member states to allocate an additional 650 billion EUR ($685 billion) toward defense over the next four years. Additionally, the bloc plans to issue 150 billion EUR ($158 billion) in loans to further support these efforts.
• The combination of the US’s reluctance to provide financial support and growing doubts about its commitment to global security has sparked widespread concern. Several figures within President Trump’s orbit, including Tesla CEO Elon Musk, have openly questioned the US’s role in NATO. This has prompted European officials to pursue a dual approach with some pushing for reconciliation with the Trump administration, while others are advocating for greater unity among European nations.
• While it is unlikely that the EU will be able to fully assume responsibility for its security in the short term — given budgetary constraints and limited experience — a shift toward greater spending and independence from the US is expected to benefit European defense companies. These firms are likely to see significant gains from increased military expenditures.

Big Beautiful Bill: The Senate is working on revising the House budget bill to align with some of President Trump’s tax promises. However, disagreements have emerged over the figures, as the Senate aims to ensure that the budget impact from the tax changes remains minimal.

• Senate Republicans are working to revise the House budget bill, with a particular focus on the SALT (State and Local Tax) deductions, which have been a point of contention. While the House aims to raise the deduction cap, the Senate prefers to keep it at the current level.
• The two sides will need to resolve their disagreements to pass a tax bill through budget reconciliation, a process that allows them to bypass a Senate filibuster, which would otherwise require 60 votes for passage.
• While the bill is likely to pass, the scale of the tax cuts remains uncertain. That said, a final version could be ready by summer, barring any significant setbacks.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Markets are weighing the threat of new tariffs. In sports news, Bayern Munich secured a Champions League playoff spot with a dramatic last-minute goal. Today’s Comment covers the latest tariff developments, updates on the Ukraine-Russia peace talks, and other key market news. As always, we’ll also spotlight crucial domestic and international data releases.

Tariffs Are Coming? Howard Lutnick has been confirmed as the new Commerce Secretary, just in time to assist the president in imposing new tariff measures. He will oversee the implementation of the president’s tariff and trade policies, with direct responsibility for managing the Office of the US Trade Representative.

• On Tuesday, President Trump unveiled a plan to impose 25% tariffs on automobiles, semiconductors, and pharmaceuticals as part of his strategy to overhaul international trade. The tariffs will be rolled out in stages, with auto tariffs set to take effect on April 2, while tariffs on pharmaceuticals and semiconductors will follow at a later, yet-to-be-determined date.
• These new tariffs are designed to achieve two of the three key trade objectives — restriction and reciprocity — as the president aims to leverage reciprocal measures to pressure Europe into reducing its auto tariffs, which are currently four times higher than those in the US. Additionally, restrictive tariffs are intended to incentivize companies to reshore production of pharmaceuticals and semiconductors to the US, bolstering American manufacturing capabilities.
• As the president begins rolling out tariffs, early signs indicate growing unease among households and businesses. According to CreditCards.com, consumers have already started accelerating purchases in anticipation of the new tariffs. Meanwhile, the National Association of Home Builders has reported that the tariffs are dampening sentiment, driven by fears of rising costs associated with the increased duties on materials such as steel.

• So far, the tariffs have had little meaningful impact on the economy, and their influence on equities appears to be fading. As a result, US stocks may begin to demonstrate greater resilience, provided companies continue to deliver strong earnings. The real challenge, however, lies abroad. International markets, particularly in Europe, have had a strong start, with the Stoxx Europe 600 up 9.11% compared to the S&P 500’s 4.45% gain. US tariffs on EU exports could undermine this trend.

Trump Pressures Ukraine: As the US and Russia continue discussions aimed at resolving the conflict in Ukraine, speculation is growing about the potential terms of a deal. The Trump administration’s efforts to rebuild ties with Moscow have added further intrigue to the negotiations, raising questions about the direction of US-Russia relations and the broader implications for energy prices.

• President Trump has adopted a firm stance toward Ukraine, controversially suggesting that the country bears some responsibility for the Russian invasion. He has also insisted that Ukraine must hold elections before it can participate in peace talks, a position that has drawn scrutiny and raised questions about the administration’s commitment to the region.
• The development comes as the US weighs whether to lift sanctions on Russia’s energy sector. US Secretary of State Marco Rubio has emphasized that the sanctions are likely to remain in place until a final agreement is reached, signaling a cautious approach to any potential easing of economic pressure on Moscow.
• His reluctance may be related to how the reintroduction of Russian energy will impact global markets. Discussions about ending the conflict were held in Saudi Arabia and included both Russia and the US, leading many to speculate that the location was chosen to align all parties on the potential market implications of resuming Russian energy supplies.

• The US would like to push oil prices lower to ease inflationary pressures. However, other key players, particularly major producers, favor keeping prices higher to protect profit margins, creating a delicate balancing act in the energy market. As a result, sanctions are likely to remain in place until all parties reach an agreement on how to reintegrate Russian energy into the global market in a way that balances economic and geopolitical interests.

ECB to Hold Steady? The European Central Bank is considering pausing further interest rate cuts after its next meeting as it evaluates whether its current policy stance is sufficiently restrictive following six consecutive rate cuts since June 2024.

• The ECB’s current rate stands at 2.75%, roughly 100 basis points above the estimated neutral rate or the level at which rates neither stimulate nor restrict growth. ECB officials have been gradually cutting rates in an effort to prevent further economic slowdown.
• The decision to reassess the pace of easing follows growing concerns over the central bank’s ability to achieve its 2% inflation target. Recent data from January showed overall price levels rising by 2.5% year-on-year, further complicating the path to reaching its goal of hitting its target by 2026.
• While the ECB is anticipated to announce another rate cut at its March meeting, a potential pause in further easing measures could lend some support to the euro against the dollar. This is because it would prevent the interest rate differential between Europe and the US from widening further.

BOJ to Pay for Schools? Japan’s opposition party is calling on the Bank of Japan to sell its exchange-traded funds (ETFs) to finance free high school education nationwide. The proposal emerges amid ongoing uncertainty about how the central bank plans to unwind its massive balance sheet.

• The focus on ETFs arises as the central bank nears the completion of offloading stocks acquired during the financial crisis. BOJ policymakers have proceeded cautiously with the sell-off, staggering the process to avoid potential market disruptions that could have occurred if stocks and ETFs were sold simultaneously.
• Under the proposal, the BOJ would sell its ETFs to the government in exchange for grant bonds, and the dividend income from those shares would be used to fund policy initiatives aimed at reversing declining birth rates and education.
• The Japanese proposal highlights how lawmakers are increasingly exploring unconventional methods to fund policy initiatives, particularly as they seek to manage the country’s substantial government debt burden.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is currently assessing the implications of Republican control over both chambers of Congress. In sports news, the Cleveland Cavaliers are experiencing their best start to an NBA season since 2015-2016. Today’s Comment will cover the impact of the so-called “Trump trade” on cryptocurrency, provide our insights on why the recent market rally could indicate an equity market bubble, and discuss European defense spending. As always, the report will end with a roundup of international and domestic data releases.

Trump Trade Resumes: Risk assets continue to rally as investors price in the impact of a second Trump term.

• The news of a Republican sweep has sparked a surge in risk appetite, especially among retail investors, with cryptocurrencies leading the charge. According to the latest results, Republicans now hold 53 Senate seats compared to 46 for the Democrats, and the Republicans have surpassed the 218-seat threshold for a House majority, with nine races still undecided. This strong showing has fueled investor optimism, as the Trump administration is expected to face minimal obstacles when pursuing favorable tax policies and regulatory reforms. Bitcoin, the world’s leading cryptocurrency, surged past $88,000 following the result.
• Crypto is emerging as a potential competitor to gold as the preferred hedge against dollar debasement. While concerns over rising debt and inflation have traditionally driven investors toward gold, bitcoin has surged 20% since the election, while gold has dropped around 4%. This shift reflects growing confidence in bitcoin as a safe haven, especially as trust in government-backed assets wanes. With key figures in the incoming administration likely to champion broader crypto adoption, optimism is mounting that bitcoin could reach $100,000 by year’s end.

• While Trump’s recent victory is viewed as a win for cryptocurrency, it’s too early to gauge how effectively he will champion digital assets. Despite bitcoin’s growing popularity, its usage remains limited, and benefits of the increased adoption of bitcoin are unclear, particularly with the US dollar still acting as the global reserve currency. Given this uncertainty, investors may be wise to wait and see how the administration approaches the cryptocurrency, as its current valuation appears somewhat inflated.

Bubble Brewing: Market euphoria continues to drive equities higher, but concerns about future inflation have led to rising bond yields.

• The S&P 500 and Dow Jones Industrial Average have scaled new heights, surpassing 6,000 and 44,000 points, respectively. This milestone is likely to attract increased investor interest in equities, potentially shifting funds from money markets to the stock market. However, the surge in market optimism has led to a flattening of the yield curve. The two-year US Treasury yield has climbed nearly 10 basis points since the Federal Reserve’s 25-basis-point rate cut last Thursday, while the 10-year Treasury yield has declined 12 basis points.
• Concerns about a potential market bubble have resurfaced as the Magnificent 7 tech giants have been the primary drivers of the S&P 500’s performance over the past two years. This trend has continued over the last five days, with these mega-cap tech stocks significantly outperforming the broader market index. This outperformance has led the S&P 500 market cap index to its widest premium over its equal-weight counterpart since the dot-com bubble. The high market concentration has also led to concerns of a potential bursting of the tech-stock bubble.

• We remain optimistic about the US economy’s ability to avoid a recession absent a major external shock. However, we believe the market remains overweighted in a few sectors. The recent flattening of the yield curve is a concern, as it has historically been associated with economic downturns. Nonetheless, as long as inflation continues to moderate and corporate earnings remain robust, we expect market concentration to gradually normalize. As a result, we suspect that investors may begin to shift their focus toward sectors offering better value and solid fundamentals over the coming weeks.

European Defense: Trump’s win of the US presidency has forced the European Union to accept that it will have to drastically increase its defense spending.

• European defense stocks rallied after the European Union opted to relax spending restrictions in anticipation of rising costs related to the Ukrainian conflict and NATO spending following the return of Donald Trump to the White House. The EU intends to reallocate funds previously earmarked for reducing income inequality among member states to directly support defense purchases and military funding. Moreover, these investments will be used to bolster critical infrastructure in Germany, given its geopolitical importance, and in Eastern European countries bordering Ukraine.
• This policy shift has boosted the pan-European Stoxx 600, which closed up 1.1% on Monday, marking its best day in six weeks. Investors are optimistic that increased spending will benefit European defense companies which have already been on a strong run. Many of these defense companies have already reaped record profits from supplying equipment and services to support the war effort in Ukraine. A significant portion of these windfall gains has been used to reward shareholders through share buybacks.

• The push to bolster European defense companies is likely to encounter significant political obstacles. Public sentiment generally opposes profiteering from war, and this could lead to increased scrutiny and potential backlash against defense companies. While the sector is poised to benefit from rising government defense spending, this could also trigger calls for greater corporate responsibility. As a result, these companies may face pressure to contribute a portion of their increased revenue back to society through higher taxes or other forms of public investment.

In Other News: Tesla CEO Elon Musk has started the push to end the Fed following Fed Chair Jerome Powell’s decision not to step down, in a sign that the central bank is becoming more politicized. Germany agreed to hold snap elections on February 23, as the country readies for a no-confidence vote.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with a preview of tonight’s presidential debate and the latest major economic policy statement from former President Trump. We next review several other international and US developments with the potential to affect the financial markets today, including new European court decisions against major US technology companies and the broadening impacts from the re-industrialization of the US.

US Politics: Presidential candidates Donald Trump and Kamala Harris are scheduled to have their televised debate tonight on the ABC network, starting at 9:00 pm ET. Former President Trump and Vice President Harris have never met in person, so the battle could be as interesting as two unbeaten prize fighters meeting for the first time. The Wall Street Journal last night published a useful overview of the likely strategies the two candidates will use in their meeting.

• Separately, Trump made a confusing vow over the weekend to impose a 100% import tariffs against any country “leaving” the dollar. Based on the context of the statement, Trump was apparently saying that he would impose the tariffs against countries reducing their use of the dollar in international trade or investment.
• Many people are fearful that if other countries reduce their use of the dollar, its value will decline, undermining its purchasing power and boosting consumer price inflation. But Trump and his aides have previously indicated that they want to depreciate the dollar in order to bolster US exports and discourage imports. The contradictory statements suggest Trump wants to both keep demand for the dollar high and drive down its value.
• Tracking and measuring all the different ways that the greenback is used in trade and investment is difficult, so economists look at the dollar’s share in global central bank foreign exchange reserves as a proxy. The dollar’s share in those reserves has actually been declining gradually for two decades, and yet the currency has been in a bull market and is now close to a record high.
• In our latest Bi-Weekly Geopolitical Report, published yesterday, we look at the prospects for the dollar as the world fractures into relatively separate geopolitical and economic blocs. The report notes that strong economic growth and better investment prospects in the US continue to draw in foreign capital, boosting the dollar’s exchange rate despite its reduced share in global trade and investment flows. For the time being, those factors could continue buoying the dollar.

European Union-United States: The European Court of Justice today overturned an appeals court decision and reinstated a 2016 court ruling that Ireland provided US tech giant Apple with illegal subsidies. The ruling today subjects Apple to 13 billion EUR ($14.3 billion) in back taxes. The ECJ today also affirmed a 2.4-billion EUR ($2.6 billion) fine against Google for antitrust violations. The rulings are likely to worsen US-EU economic tensions, especially if Trump is re-elected. The rulings also illustrate the growing regulatory risks for large US tech firms operating around the world.

Germany: Interior Minister Fraser yesterday said the government will extend and strengthen its border controls to reduce “irregular” migration and lower the risk that Islamist terrorists could enter the country. The move is likely a response by the centrist coalition government to the recent surge in political support for populist, anti-immigrant parties. It also illustrates how illegal immigration has become a political issue for many developed countries around the world.

United Kingdom: During the three months ended in July, average earnings excluding bonuses were up just 5.1% from the same period one year earlier, marking the weakest wage gains in two years. Average earnings in the service sector alone were up just 3.8%. The figures suggest the Bank of England’s tight monetary policy is continuing to wring price pressures out of the economy, although the policymakers are still expected to cut interest rates only slowly.

Russia-Ukraine Conflict: New polling shows the share of Ukrainians who want to compromise with Russia to end the war has risen to 26%, with younger people more inclined to negotiate. However, those in the military are least likely to want compromise. According to the report, enlisted personnel, who are influential in Ukrainian society, see any talk of compromise as an affront to those who have died resisting the Russians. They also argue that the Kremlin would only use a truce to rearm and prepare for a new attack.

Russia-Kazakhstan-China: Meirzhan Yussupov, chief of Kazakhstan’s state mining company Kazatomprom, said in a Financial Times interview that Western sanctions after Russia’s invasion of Ukraine have forced his company to favor uranium exports to Russia and China, even though it would prefer to maintain a more diversified customer base. The company, which is now the world’s largest uranium producer, earlier warned that its output would be crimped by supply shortages and delays in building new mining facilities.

• Yussupov’s effort to blame Western sanctions for crimped uranium exports, along with the firm’s statement about production challenges, may aim to mask Russian and Chinese pressure to reserve Kazatomprom’s low-cost uranium for themselves.
• As we noted in our Bi-Weekly Asset Allocation Report from April 15, 2024, the Chinese government is likely using enormous volumes of uranium as it works to massively expand its arsenal of strategic nuclear weapons. We suspect Chinese weapons demand has been a significant reason for the run-up in spot uranium prices since 2022. Beijing would want to hide where it’s getting its uranium supplies, and the statements by Yussupov and his company could be a part of that effort.
• To the extent that Russia and China can sew up Kazakhstan’s low-cost uranium ore, the result would be increased upward pressure on spot uranium prices in the West. That’s one reason why we are currently maintaining our exposure to uranium and uranium miners in Confluence’s Asset Allocation Strategies.

US Re-Industrialization: As the US-China rivalry and global fracturing continue to spur re-shoring and a boom in US factory construction, new data shows the long-awaited secondary effects are also becoming noticeable. The data, from real estate analytics firm Green Street, shows that investors are ramping up their plans to acquire or build warehouses, hotels, office buildings, and apartments near coming factories across the Sunbelt and Rust Belt, where most of these so-called onshoring projects are under way.

• The planned real estate development around emerging factories are an example of the “multiplier effect” of new investment.
• Although parts of the real estate sector, such as office buildings, are still broadly challenged by today’s high interest rates and the work-from-home trend, the multiplier on re-industrialization is a reminder that other types of real estate and particular localities continue to have good prospects.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with an important new speech by former Australian Prime Minister Kevin Rudd, who warns that Chinese leaders are more ideologically driven than most in the West realize and also more apt to use military aggression. We next review several other international and US developments with the potential to affect the financial markets today, including an important new report on European competitiveness and a note on last week’s record-breaking corporate bond issuance in the US.

China: Kevin Rudd, the former Australian prime minister and Canberra’s current ambassador to the US, warned in a must-read speech in Washington last week that Chinese leaders are more driven by ideology than most Westerners believe. Rudd, a Mandarin speaker with an extensive background dealing with Beijing, emphasized that because of Chinese leaders’ Marxist-Leninist view of the US and their conception of deterrence, they could soon launch what they would view as a “small war” to deter the US and its allies from further efforts to contain China.

• In Rudd’s view, Chinese General Secretary Xi has fully embraced the Marxist-Leninist view that China is at the vanguard of historically determined social revolution, and that the “East is rising, while the West is falling.” According to Rudd, this makes Xi prone to over-confidence in dealing with the US and its allies.
• Although we have been warning for some time that the worsening US-China rivalry could potentially spill into military conflict of one sort or another, it hasn’t happened yet. Rudd’s warning suggests that investors should remain aware of the risks. That mindset is consistent with our current positioning in our asset allocation strategies of keeping exposure to gold, commodities, and defense firms, which are designed to act as hedges against a potential conflict.

China-Southeast Asia: As the US and other developed countries rush to impose tariffs against the new wave of subsidized Chinese exports, new reporting shows many cheap Chinese goods are being diverted to the relatively poor, developing countries of Southeast Asia. With prices kept extremely low by Beijing’s subsidies and the massive excess capacity in China’s industrial sector, the flood of Chinese goods is putting companies out of business and destroying jobs in countries such as Thailand, Malaysia, and Indonesia.

• Just as in the developed countries, several Southeast Asian nations have responded by imposing new tariffs and other trade barriers against Chinese goods, but the effort is constrained by regional free-trade agreements and fear of retaliation from China.
• Importantly, Chinese firms are also undercutting local logistics companies, such as trucking and warehouse firms. Once Chinese competition has driven a Southeast Asian manufacturer or logistics firm into bankruptcy, a Chinese company will often swoop in to buy the business at fire-sale prices. The Chinese buyer will sometimes use a local front company to hide its ownership, and it may leverage funds from Chinese organized crime groups (a very underappreciated problem throughout the region).
• As Chinese firms take over more local producers and logistics firms, they are reportedly forming “zero dollar” supply chains in which both imports from China and exports to China and beyond are warehoused and carried by Chinese firms with no reliance on the US currency.
• This growing Chinese influence over Southeast Asia is consistent with our view that Beijing will seek to control its evolving geopolitical and economic bloc using a form of neo-colonialism, as discussed in our Bi-Weekly Geopolitical Report from January 9, 2023. In this system, Beijing will offer the countries in its bloc the opportunity to export commodities, basic materials, and low-value factory components to China, but it will treat those countries as a captive market for Chinese exports.

Japan: After stripping out price changes and seasonal impacts, second quarter gross domestic product grew at a robust annualized rate of 2.9%, just enough to offset the 2.4% decline in the first quarter. Japan’s GDP in April through June was still lower than in the same period one year earlier, but the rebound, which was driven by consumer spending and corporate investment, is an encouraging sign that the economy is regaining momentum. The rebound will probably also keep the Bank of Japan on track to keep raising interest rates later this year.

European Union: Former European Central Bank chief Mario Draghi, who was tapped by the European Commission last year to study the EU’s lagging economy, today issued his analysis and recommendations. According to Draghi, the EU needs a massive increase in public and private investment, financed in part by joint EU debt. To spur private investment and innovation, he calls for aggressive industrial policies and subsidies, financial market deregulation, and easier competition rules to let companies grow bigger and more powerful.

• Reporting so far suggests Draghi’s recommendations are consistent with the growing trend toward industrial policies around the world, including measures such as protectionist tariffs and tax breaks or other subsidies for favored industries.
• All the same, it is unlikely that Draghi’s entire list of recommendations will be implemented. At the very least, EU countries that are smaller and more open to trade for growth will likely resist those policies that favor bigger countries and companies or threaten trade wars that could hurt their exports.

Greece: In the latest pushback against tourists in Europe, the Greek government has proposed a series of measures to reduce visits from foreigners, including limits on cruise ship dockings, hefty increases in cruise ship disembarkation fees, and increases in lodging taxes. The moves follow similar restrictions put in place by Italy and Spain as post-pandemic wanderlust and a strong dollar encouraged waves of tourism in recent years. According to locals, excess tourism has driven up prices and disrupted communities in certain areas.

United Kingdom: Prime Minister Starmer’s government today admitted it is mulling ways to soften the blow from Starmer’s plan to reduce fuel subsidies for millions of Britons this winter. Although the government hasn’t yet decided how to soften the impact, any modification to the original plan would likely mean more spending and make it harder for the prime minister to rein in the UK’s expanding budget deficit.

Venezuela: Opposition presidential candidate Edmundo González, whom the US and other key countries consider the rightful winner of July’s election, left Venezuela on a Spanish military plane over the weekend after a Venezuelan court issued a warrant for his arrest. Venezuelan security forces have also surrounded the Argentine embassy’s residential compound, where six Venezuelan opposition leaders have decamped to avoid arrest.

• The developments show President Maduro is consolidating his power again after falsely claiming he won re-election.
• If Maduro retains power, as now looks likely, US sanctions on Venezuela’s petroleum industry are likely to remain largely in place. In turn, much of Venezuela’s oil resources will remain off the global market.

US Politics: As presidential candidates Donald Trump and Kamala Harris prepare for their televised debate tomorrow night, the Wall Street Journal today carries a detailed and useful comparison of their positions on key issues ranging from taxes to healthcare. The debate on the ABC network is Tuesday, September 10, at 9:00 pm ET.

US Bond Market: New data from LSEG show a record 60 corporate bond deals were completed last week for a total of $82 billion in borrowing. According to market participants, the flurry of deals reflects a desire by company managers to sew up their debt issuance ahead of any market volatility that could come as the economy slows, the Federal Reserve starts cutting interest rates, and the presidential election approaches.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is closely parsing through the latest jobs data. In sports news, Patrick Mahomes of the Kansas City Chiefs surpassed Len Dawson as the team’s all-time passing leader while securing a victory over the Baltimore Ravens. In today’s Comment, we discuss why the recent Services PMI data should relieve recession fears, consider the potential impact of the ECB’s reluctance to address weak GDP figures on the dollar, and explore how the coalition collapse in Canada aligns with a broader trend of dissatisfaction with ruling parties in the West. As always, the report includes a comprehensive overview of domestic and international data.

Good News, Finally! Days after the Purchasing Managers’ Index (PMI) for manufacturing raised concerns of a potential economic slowdown, the services component offered reassurance.

• Both the S&P Global and ISM Purchasing Managers’ Indexes (PMIs) for August showed an increase in service sector activity, challenging the narrative of an impending recession. The S&P Global PMI rose from 55.4 to 55.7, while the ISM PMI increased slightly from 51.4 to 51.5. The stronger pace of new orders, indicating continued demand for firms’ offerings, was the primary driver of the overall improvement. However, both PMIs showed declines in their employment components, reaffirming concerns about the cooling labor market.
• The rise in the PMI services index strongly indicates that the economy remains in expansion. Unlike manufacturing, service consumption represents nearly half of all economic output, making the economy particularly sensitive to shifts in this sector. The ISM services index, specifically, has proven to be a reliable economic predictor, explaining about half of the GDP variation over the past three decades. As a result, the latest reading suggests that, despite market concerns about an imminent downturn, the economy has enough momentum to avoid a recession.

• While recent data suggests slowing growth, it’s important to consider the historical context. The past four recessions were all triggered by unforeseen events: the 2020 pandemic, the 2008 Lehman Brothers collapse, the 9/11 attacks in 2001, and the Gulf War in 1990. Hence, a slowdown doesn’t necessarily foreshadow an immediate downturn. While the economy faces challenges, we remain cautiously optimistic that it can weather these headwinds, absent any major disruptions such as a mass mobilization war, commodity supply shock, or pandemic.

The Flat Dollar: As the global economy anticipates a convergence in interest rate differentials, the US dollar has begun to depreciate against foreign currencies.

• The Eurozone’s second quarter GDP was revised downward to 0.2% from 0.3%, indicating continued economic stagnation. This latest data is likely to fuel concerns that the region’s tight monetary policy is beginning to dampen economic activity. Household consumption and investment spending both declined, with investment spending falling by a more significant 2.2%. Germany, the bloc’s largest economy, contracted by 0.1% as its industrial sector remains under pressure. However, there were some bright spots: France and Italy both grew by 0.2%, and Spain’s economy expanded by a robust 0.8%.
• Despite growing economic concerns, there is skepticism that recent economic data will prompt the European Central Bank (ECB) to accelerate its easing policy. A survey of economists indicates that respondents anticipate the ECB will maintain its current monetary policy stance, even in the face of weakening economic indicators. As growth slowed, the region’s unemployment rate fell to a new low in July, and core inflation has shown signs of stalling. The ECB’s reluctance to respond to the slowdown mirrors the Bank of Japan’s decision to maintain its current policy path.

• The reluctance of central banks to respond to economic changes is likely to accelerate interest rate convergence. Historically, global developed central banks have been hesitant to follow the US Federal Reserve in raising rates and they have also been less willing to cut rates as aggressively. This narrowing interest rate differential, coupled with growing concerns about the US economy, is expected to weigh on the US dollar in the short to medium term. This trend has already begun to manifest itself this year, with the Bloomberg Dollar Spot Index falling from its 2024 peak in June to levels close to its value at the start of the year.

Trudeau in Trouble: As voters across the West express increasing discontent with incumbent leaders, the impending collapse of Trudeau’s coalition threatens to end his party’s nine-year reign.

• Jagmeet Singh, leader of Canada’s New Democratic Party, has ended the agreement to support the minority Liberal government, raising the likelihood of snap elections. While this doesn’t technically strip the Liberals of their position, his refusal to uphold the deal could leave PM Justin Trudeau vulnerable to a no-confidence vote, potentially triggering an early election. Additionally, Singh still requires his party’s approval to formally withdraw from the arrangement. That said, federal elections must be held by October 2025, with current polls showing the ruling Liberals trailing the Conservatives by 17 points.
• The Liberal Party is facing increasing criticism over the rising cost of living, particularly housing. While overall inflation is 2.5%, which is within the Bank of Canada’s target range of 1-3%, shelter inflation remains stubbornly high at 5.7%. Unlike in the US, where 30-year fixed mortgage rates are common, most Canadian mortgages are locked in for five years or less. This difference directly impacts inflation as mortgage interest costs account for 13% of Canada’s shelter inflation. In contrast, the US removed housing costs from its CPI measure in 1983, opting instead for owner-equivalent rent.

• One of the key issues facing Western nations as they approach elections in the coming months is public sentiment regarding inflation. While price increases have moderated substantially in recent years, consumers have found it challenging to adjust to current price levels as many had anticipated a decline. This dissatisfaction with prices is likely to influence election outcomes as voters may attribute the problem to their current leadership. As a result, we should not be surprised if opposition parties see a strong performance this election season.

In Other News: The US is growing less confident in a Gaza peace plan and is looking for alternatives, another example of the difficulty of resolving disputes in the Middle East. Republican presidential candidate Donald Trump proposes a 15% corporate tax rate as he looks to bolster his support from big business. The pledge is another sign that neither candidate will be able to solve the deficit matter. Japanese prime minister candidate Yoshimasa Hayashi is holding out hope that the Nippon Steel acquisition of US Steel can be salvaged.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with some new research confirming our positive view on the global defense industry going forward. We next review several other international and US developments with the potential to affect the financial markets today, including some notes on the Israel-Hezbollah attacks over the weekend, a shut-off of petroleum exports from Tunisia, and a wrap-up of the Federal Reserve’s conference at Jackson Hole, Wyoming.

Global Defense Industry: New research by Vertical Research Partners suggests the world’s top 15 defense contractors will log total free cash flow of $52 billion by 2026, double the amount they generated in 2021. Half the free cash flow in 2026 will come from five top US defense firms (excluding Boeing), while much of the rest will come from top European producers. The analysis is consistent with our often-stated view that today’s increased geopolitical tensions will prompt higher defense budgets around the world in the coming years.

• Separately, the head of the International Atomic Energy Agency, Rafael Grossi, warned in a Financial Times interview that more countries are feeling pressure to develop their own nuclear weapons. According to Grossi, “There are all these tensions, this possibility of alliances being weakened and countries having to fend for themselves. This is where the nuclear weapon factor, and attraction, comes back in a very unexpected way.”
• Grossi’s analysis echoes our view that factors such as the geopolitical aggressiveness of key authoritarian countries and weakening alliances within the US bloc could spark a new, global nuclear arms race in the coming years. From an investment standpoint, that suggests that there could be opportunities not only in defense stocks, but in commodities such as uranium.

Israel-Hezbollah: On Sunday, after US and Israeli intelligence suggested the Hezbollah militants were preparing a major attack on Israel, the Israel Defense Forces launched a large number of airstrikes against the militant group’s rocket launchers in southern Lebanon. Hezbollah later said it had gotten off about 300 missile launches against Israel, but it tried to signal no more attacks would be coming for now.

• It’s not yet clear if the Hezbollah attack was meant to be the main retaliation for Israel’s recent assassinations of Islamist militants in Lebanon and Iran. If it was, it may suggest that Iran wanted to limit its direct involvement to insulate it from further hostilities with Israel. In any case, reports say Hezbollah’s rank-and-file were disappointed with the relatively small scale of the attack.
• In any case, it’s still impossible to rule out further attacks on Israel by Hezbollah, Hamas, or their Iranian benefactors. With Israel’s war on the Hamas government in Gaza continuing, the risk of dangerous escalation into a broader regional conflict remains.

China-United States: Some artificial-intelligence developers in China are reportedly getting around the US ban on selling advanced AI computer chips to the country by remotely and secretly accessing computer power based on top-of-the-line Nvidia chips in foreign facilities. These “decentralized GPU” services apparently aren’t illegal right now, but the US government may well take steps to clamp down on the practice as the US-China technology rivalry continues.

China-Philippines: Yesterday, Chinese navy and coast guard vessels again harassed a Philippine government ship bringing supplies to Philippine fishermen near Sabine Shoal, an area inside Manila’s exclusive economic zone claimed by both countries. The Philippine ship may have been intending to bring supplies to one of Manila’s coast guard ships, which has been anchored in the area since April, much to the chagrin of Beijing.

• As we’ve noted previously, Sabine Shoal is developing into another potential flashpoint between China and the Philippines, after the two sides recently agreed to cool tensions over the disputed Second Thomas Shoal.
• To reiterate, any Chinese-Philippine military confrontation has the potential to draw in the US, which has a mutual defense treaty with Manila.

China: New data from Dealogic shows the world’s top private-equity firms have virtually given up on new acquisitions in China as the country hits structural economic headwinds and geopolitical tensions with the West are making such deals riskier. The data is consistent with our view that slowing growth, worsening international tensions, and the world’s fracturing into relatively separate geopolitical blocs will make Chinese investments riskier going forward.

Tunisia: The government controlling Tunisia’s eastern half today said it will stop all petroleum production and exports to retaliate for the rival western government’s effort to take over the country’s central bank. The eastern government has declared force majeure over all oil fields, terminals, and export facilities, closing them down. The news has pushed global oil prices sharply higher today, with near WTI futures currently up 3.0% to $77.06 per barrel and Brent up 2.5% to $80.13.

Canada-China: Canadian Prime Minister Trudeau today said his government will impose new anti-dumping tariffs on a range of imports from China, including a 100% tariff on Chinese electric vehicles and 25% tariffs on Chinese steel and aluminum. The tariffs, which Trudeau said were aimed at “leveling the playing field” for Canadian workers, are another example of how the US geopolitical bloc is decoupling from China and its bloc. The spread of anti-Chinese tariffs is bound to anger Beijing and complicate its effort to re-ignite economic growth.

US Monetary Policy: As we previewed in our Comment on Friday, Fed Chair Powell used his speech at the opening of the central bank’s summer conference in Jackson Hole to confirm the policymakers will begin cutting interest rates in September. In a line for the ages, Powell said, “We do not seek or welcome further cooling in labor market conditions . . . The time has come for policy to adjust.” The most likely scenario is for the Fed to cut the benchmark fed funds rate by a modest 25 basis points to a range of 5.00% to 5.25%.

• Even though investors had long been expecting an interest-rate cut in September, the confirmation by Powell gave a boost to stocks and bonds on Friday. The S&P 500 price index jumped 1.15% to a near-record 5,634.61, while the yield on the 10-year Treasury note fell to 3.8070%.
• Going forward, there is still some question about the pace of any further cuts. Unless there are more signs of real stress in the economy, the policymakers could well prefer a slow, steady series of 25-basis-point cuts extending into 2025. With investors holding massive amounts in money market accounts, an erosion of the yield on those accounts coupled with a soft landing in the economy could potentially prompt a massive rotation back into stocks and a melt-up in equity prices.

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