Daily Comment (December 12, 2022)
by Patrick Fearon-Hernandez, CFA, and Thomas Wash
[Posted: 9:30 AM EST] | PDF
Our Comment today opens with a major scientific success that could help improve energy supplies in the coming years. We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a scandal over Qatar’s effort to buy influence in the European Parliament. We also provide a preview of this week’s Federal Reserve policy meeting and the looming deadline to prevent a partial shutdown of the federal government.
Global Energy Supply: U.S. government scientists have reportedly achieved a net energy gain in a nuclear fusion reaction for the first time ever. Although industrial-scale fusion is still probably decades away, this breakthrough boosts hope for a future in which energy supply is virtually limitless, emits no carbon, and produces no harmful wastes.
European Union-Qatar: Over the weekend, Belgian police launched a series of raids on EU politicians’ homes, arrested a member of the European Parliament, and seized €600,000 in cash as part of an international investigation into an attempt by Qatar to buy influence in the bloc’s legislature. The scandal has already triggered official resignations and the suspension of a parliamentary vote, due next week, which would have granted Qatari nationals visa-free travel to the bloc.
Eurozone: The European Central Bank has warned that the Eurozone’s banking system is at risk of mounting bad loans and is having a funding squeeze due to rising interest rates, high inflation, and a likely recession. The ECB therefore plans more frequent inspections of bank offices and will carry out more “targeted reviews” of the largest lenders in the zone in order to push them to address those risks. Even though the European economy has recently been holding up better than many observers expected, the ECB statement is a reminder that the zone’s banking system faces both economic and regulatory risk in the near term.
Russia-Ukraine War: Heavy ground fighting continues in northeastern Ukraine along the borders of the Donbas region, while the Russians used an apparently replenished supply of missiles and drones to cripple more of the Ukrainians’ energy infrastructure. Meanwhile, a Ukrainian artillery strike reportedly killed dozens of Russian troops barracked in a hotel complex in Ukraine’s southeastern city of Melitopol. The successful attack, which targeted Russia’s mercenary Wagner Group, illustrated how the Ukrainians are continuing to make highly effective use of advanced weapons provided by the West to inflict high casualties on the Russians.
Iran: In a continued effort to stamp out the recent anti-government protests raging throughout the country, the government hanged a second protestor this morning after he was convicted of stabbing two security force members to death and injuring four others in the holy city of Mashhad. With at least ten other protestors now on death row, the government may hang more protestors in an attempt to intimidate the opposition but doing so could also risk enflaming opponents of the government.
China: New research indicates that China has not only lent some $1 trillion to less-developed countries around the world as part of its Belt and Road Initiative (BRI), but the People’s Bank of China has also loaned hundreds of billions in foreign reserves to those countries via currency swaps. In contrast to the highly transparent, conditional, short-term swaps provided by the Federal Reserve to key U.S. trade partners, the PBOC swaps are highly opaque and often rolled over continuously, making them tantamount to a bailout for countries that have often defaulted on their debts or are likely to have trouble repaying their BRI loans.
- Researchers estimate that the average interest rate on the swaps is about 6%, making them more expensive than the swaps provided by the Fed to other central banks to swap their currencies for dollars. The swaps would also be more expensive than the typical International Monetary Fund loans to poor countries.
- As the world fractures into relatively separate geopolitical and economic blocs, the PBOC swaps illustrate how China’s approach to its evolving bloc is likely to be much more coercive than the U.S.’s traditional cooperative approach to its allies. As the Chinese-led bloc evolves, we suspect Beijing will essentially take a neo-colonial or even neo-imperialist approach to its bloc.
U.S. Monetary Policy: The Fed will hold its latest policy-setting meeting this week, with their decision due to be released on Wednesday afternoon. The policymakers are widely expected to hike their benchmark fed funds interest rate by just 0.5%, to a range of 4.25% to 4.50%, after four straight hikes of 0.75%. They will also release their updated forecasts for key economic indicators and the path of interest rates going forward.
- If the Fed begins hiking rates more slowly, as anticipated, it will confirm a looming divergence between U.S. and European interest rates. Since inflation is expected to be stickier in Europe, its major central banks may well keep hiking their benchmark rates aggressively even as the U.S. central bank hikes begin to slow.
- That prospect probably goes far toward explaining the recent weakening in the dollar versus European currencies. The weakening of the dollar is likely to continue giving a boost to European stocks.
U.S. Fiscal Policy: Congressional leaders will be scrambling this week to reach a deal on a full-year spending bill or to pass a short-term funding measure to avoid a partial government shutdown when the current funding law expires on Friday. Any sign of serious struggles to reach a deal or any display of brinksmanship could well push markets lower before the issue is resolved.
U.S. Energy Policy: In an interview with the Financial Times, top White House energy advisor Amos Hochstein said that Wall Street’s pressure on energy companies to funnel this year’s high profits back to investors rather than investing in new production is “un-American” and hurts U.S. families. However, the interview will do little to reverse energy companies’ complaints about mixed messages from the Biden administration, as Hochstein also argued that firms should eventually help shift the economy away from its dependence on oil and gas.
U.S. Winter Storm: A major winter storm that pummeled California with heavy rain and snow over the weekend is now moving eastward and is expected to create difficult winter conditions throughout the central Great Plains and Midwest in the coming days. While the storm may have helped ease California’s long drought, it is expected to disrupt transportation and other economic activity across much of the country.