Daily Comment (August 1, 2022)
by Patrick Fearon-Hernandez, CFA, and Thomas Wash
[Posted: 9:30 AM EDT] | PDF
Our Comment today opens with an update on the Russia-Ukraine war, including details on the first shipment of grain from a Ukrainian port under the recent Turkish-brokered deal for safe passage of food exports from the country. We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today.
Russia-Ukraine: With Ukrainian forces apparently ramping up their counteroffensive against Russian occupiers in the southern Ukrainian city of Kherson, leaders in Moscow continue to face the dilemma of whether to transfer troops from the occupied Donbas region to reinforce the city. The latest reporting suggests that the Russians may be trying to squirm out of that dilemma by launching new attacks from the Donbas region westward toward the major Ukrainian city of Kharkiv. That attack has the potential to draw Ukrainian forces northward to help defend it, weakening their attacks on Kherson, but it is not at all clear whether the Russians have enough resources to truly threaten Kharkiv and draw the Ukrainians into that battle.
- To the surprise of many who thought Moscow would scuttle the recent Turkish-brokered deal to allow safe passage for Ukrainian grain shipments, today a Sierra Leone-flagged bulk carrier left Odessa with 26,000 metric tons of corn headed toward Lebanon. More ships are expected to depart in the coming days, including many which were loaded before the Russian invasion began in February.
- The flow of Ukrainian wheat, corn, barley, and other food products, which mostly go to less-developed countries, has helped push grain prices lower so far today.
- Nevertheless, it is still too early to know whether Moscow will allow continued shipments. The renewed exports, therefore, may not have a significant impact on global markets in the near term.
- Separately, tensions between Serbia and Kosovo are rising, potentially as a result of the Russia-Ukraine war or Russian efforts to divert attention away from it. The discord has prompted the NATO-led KFOR peacekeeping program to say it will intervene if necessary to keep the tensions under control
United Kingdom: In the race to succeed Boris Johnson as Conservative Party leader and prime minister, Foreign Minister Liz Truss and Former Chancellor Rishi Sunak continue to hammer each other over tax policy. In recent days, Truss, who remains the odds-on favorite to win the race, has pilloried Sunak for his effort to control the government budget deficit by hiking taxes.
- With her insistence that such “stale economic orthodoxy” has hurt the British economy, Truss underscores how today’s populist, more conservative leaders are abandoning the right’s traditional belief in balanced budgets and austerity when necessary.
- We see similar tendencies in other populist, more conservative leaders elsewhere in the world as well.
Chinese Foreign Policy: Many people are now familiar with President Xi’s “Belt and Road Initiative,” which aims to build Chinese influence around the world by providing capital for infrastructure projects, but it’s now becoming clear that Xi intends to supplement this economic program with his newly announced “Global Security Initiative.” Under the program, Beijing offers military training, intelligence sharing, and joint counterterrorism activities to developing countries, ostensibly to build their own independent defense capabilities and avoid Western sanctions.
- In a letter to the China-Africa Peace and Security Forum last week, Xi urged African countries to support the GSI. In May, the GSI also managed to gain the support of leaders from the Latin American countries of Nicaragua and Uruguay. China’s recent effort to build security links with island countries in the Western Pacific Ocean are probably also related to the effort.
- We suspect that the GSI will be an increasingly important part of China’s effort to build comprehensive influence around the world. In turn, that’s likely to exacerbate the current U.S.-China geopolitical competition, with all its negative implications for the global economy and financial markets.
Chinese Economy: As shown in the data tables below (see pdf), China’s official purchasing managers’ index for manufacturing fell to a seasonally adjusted 49.0 in July, missing expectations that it would rise to 50.3 from its reading of 50.2 in June. Like most major PMIs, the Chinese one is designed so that readings below 50.0 point to contracting activity. Separately, a private housing data provider said that July home sales by the country’s top 100 developers were down 39.7% from the same month one year earlier.
- The figures suggest that the Chinese economy is recovering only slowly and fitfully from the government’s spring COVID-19 lockdowns.
- Naturally, weaker demand growth in China will likely weigh on global economic activity and financial markets.
China-United States: Despite China’s effort last week to forestall the U.S. delisting of Chinese firms that don’t meet U.S. auditing disclosure standards, the SEC on Friday said internet giant Alibaba (BABA, $89.37) has been put on a list of firms scheduled to be kicked off U.S. stock exchanges in the coming years. More than 150 Chinese firms are now on that list, prompting Hong Kong Financial Secretary Paul Chan to warn that the financial center should prepare for a “worst case” scenario in which U.S.-China relations rupture definitively. The situation underscores the regulatory risk faced by Chinese companies trading on U.S. exchanges.
U.S. Fiscal Policy: West Virginia Senator Joe Manchin, who last week struck a deal to support the Democrats’ new “Inflation Reduction Act,” insisted the corporate tax hikes in his party’s bill would merely close loopholes and not unduly weigh on corporate investment, as Republicans have charged.
- Besides using some $300 billion from the tax hikes to cut the U.S. budget deficit, the bill would allocate $369 billion toward green initiatives and energy reforms, and $64 billion to shore up the Affordable Care Act.
- The Senate is due to take up the legislation next week before Congress leaves Washington for its August recess.
U.S. Labor Market: Boeing (BA, $159.31) has, at least temporarily, averted a strike which was due to start this afternoon at its defense-related plants in the St. Louis area. Early this morning, the company offered last-minute contract concessions related to changes it wanted to make to unionized workers’ 401(k) plans. The new contract will be subject to a union vote on Wednesday.
- Even if the new contract is approved, however, we still believe the dispute and threatened strike show how today’s tight labor market has emboldened workers and given them increased bargaining power to demand better pay, benefits, and working conditions.
- If it lasts long enough, the increased worker leverage will likely increase costs for companies and weigh on profit margins, potentially dragging down stock prices.
U.S. Apartment Market: In more positive news for inflation, a private data firm says U.S. apartment rents in the second quarter were up “just” 9.4% year-over-year, cooling from annual increases of more than 11.0% in each of the two previous quarters. The firm projects that rental rates will continue this trend through the coming months. Moderating rents will help lower the overall reported inflation rate, although only with a long lag.