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 the latest on how the conflict is driving up global energy prices.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including news that consumer price inflation in the U.K. has now reached 10.1%, its highest level in more than 40 years.

Russia-Ukraine:  Russian forces continue to make small, incremental territorial gains in Ukraine’s eastern Donbas region, while seeking to reinforce the territories they occupy around the southern city of Kherson, all while launching missile and artillery strikes against other parts of Ukraine.  Meanwhile, the Ukrainians continue to gradually ramp up their counteroffensive to retake Kherson, which includes attacking Russian logistical nodes in Crimea with Western-supplied long range artillery and/or sabotage operations.

• Separately, the U.S. Agency for International Development announced it will spend more than $68 million to purchase and ship Ukrainian grain for the UN’s World Food Program.  The grain will be used as aid for poorer countries around the world that are struggling with disrupted food supplies and spreading hunger.  Ukraine has also been ramping up its grain shipments to other customers under the recent Russia-Turkey-Ukraine safe-passage deal.
• On the energy front, Europe’s intense heatwave is exacerbating its evolving energy crisis, as the Continent gobbles up energy for air conditioning.
  • Futures for natural gas at a trading hub in the Netherlands, the benchmark in northwest Europe, rose 3.2% yesterday to an all-timer record of €233.56 a megawatt-hour, and they’ve risen another 6.0% so far this morning.
  • Sky-high energy prices are now starting to force the closure of European mining and manufacturing operations, which will further weigh on the Continent’s economic activity and financial markets.
  • Although it is less recognized in the press, China is also undergoing a painful heatwave and drought.  As in Europe, the resulting drop in hydroelectric output has forced the government to ration electricity in the southwestern province of Sichuan, shutting down some industrial activity, including lithium output.

Germany:   Officials in Berlin have confirmed that the government will temporarily postpone the planned year-end closure of the country’s last three nuclear power plants in order to deal with Russia’s cut-off of natural gas supplies, although the decision will likely need to be ratified by the German parliament.  The decision confirms how desperate Europe’s energy supply situation could get this winter, even if U.S. investors haven’t fully recognized the risks.

United Kingdom:  The July consumer price index was up a whopping 10.1% from the same month one year earlier, accelerating from the 9.4% gain in the year to June and marking the U.K.’s highest inflation rate in more than 40 years.  To make matters worse, inflation is likely to accelerate further if energy price caps are lifted as planned in October.

• The high inflation rate is likely to pile more pressure on the Bank of England to keep hiking interest rates.  In response, British government bonds have sold off modestly so far this morning, driving the yield on the benchmark 10-year Gilt to 2.242%.
• The inflation numbers could also lead to more generous consumer assistance offerings from the two Conservative Party candidates set to replace Boris Johnson as party leader and prime minister, Foreign Minister Liz Truss and Former Chancellor Rishi Sunak.  Although polls suggest Truss remains in the lead, she has taken some heat for offering stingier responses to the cost-of-living crisis.

China:  More than a dozen Chinese ministries and departments have released a joint policy statement aimed at boosting fertility and childbearing in order to arrest China’s collapsing birthrate and impending population decline.  China’s declining workforce and population aging are key reasons we expect the country’s overall economic growth to keep moderating in the future.

Kenya:  As we warned in our Comment yesterday, opposition leader Raila Odinga has rejected the official count in last week’s presidential election that showed him losing to Deputy President William Ruto.  Odinga has indicated he will fight the results in court, likely setting up weeks or months of political uncertainty in the key African country.

Global Supply Chains:  Even though global shipping rates have started to retreat, it appears that port congestion, dockworker strikes, and other challenges are still disrupting exports and imports in many countries.  The continuing supply disruptions are likely to keep inflation from falling back as soon as it otherwise would.  In turn, that will likely keep the world’s major central banks in rate-hiking mode, potentially prompting a pullback in risk assets.

U.S. Fiscal Policy:  Yesterday, President Biden signed his Inflation Reduction Act into law, which will hike corporate taxes and increase funding to the IRS in order to rein in the federal budget deficit and fund some additional spending in areas such as healthcare and climate stabilization.

U.S. Drought:  For the first time ever, the Bureau of Reclamation has declared a Tier 2 water shortage for the Colorado River basin in seven southwestern states and Mexico.  In addition, the Bureau has ordered those entities to cut their water use by a total of 721,000 acre-feet (each acre-foot is about the amount that a family of four uses in one year).  The resulting water use restrictions will likely be a drag on agricultural and industrial activity in the region over the coming months.

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