Daily Comment (December 6, 2022)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning on the Feast of St. Nicholas!  It’s actually a rather quiet morning after yesterday’s risk-off day.  U.S. equity futures have been vacillating this morning, mostly trading inverse the dollar.  Gold is higher this morning, but oil is trading lower.  Equities have been taking on a tone of bad news is good news.  Yesterday’s ISM services index, coming in well above the expansion line of 50, raised fears that monetary policy won’t be as easy as hoped.  We note that the WSJ’s latest “Fed whisperer,” Nick Timiraos, published an article yesterday reiterating Chair Powell’s recent comments about moving to slower rate hikes but also signaling that tightening was far from over.  Last week, when that speech occurred, the financial markets viewed the talk as dovish.  The Timiraos article suggests that isn’t the narrative that the FOMC preferred.

In today’s Comment, our coverage begins with China news.  Economics and policy are up next, and an update on the North Carolina substation attack follows.  Our war in Ukraine briefing comes next, and we close with the international roundup.

China News:  The state funeral for Jiang Zemin has begun, as the CPC does its best to project unity.  We also update the COVID situation.

Markets, Economics and Policy:  The economic picture is mixed.  Business leaders are worried but still see a soft landing.  Supply chains are improving, but layoffs are rising.

  • Recent CEO surveys suggest that business leaders are becoming more concerned about the economy, but still expect a soft landing. It’s not obvious if these leaders have a great track record on forecasting the economy (to be fair, no one else is all that good either) but their attitudes likely reflect present business activity.  Thus, we see it as confirmation that we are not currently in a recession.
  • At long last, supply chains appear to be improving. Freight rates have been easing, and we note that in the recent ISM data, there is growing evidence of improvement.

North Carolina:  Although authorities are not calling the weekend attack on substations in North Carolina domestic terrorism, the actions were clearly targeted, suggesting that it wasn’t just a random attack.  Utilities are steadily bringing power back online, but it probably won’t be until Thursday before power is fully restored.  Our worry is that if similar attacks become common, not only will it cause disruptions, but mitigation efforts (backup generators, diesel stocks, extra food, etc.) will tend to be costly and could boost inflation.

War in Ukraine:  Ukraine strikes inside Russia which could expose divergences in goals among allies.

  • Although Kyiv hasn’t fully accepted responsibility, it appears that Ukrainian drones attacked three Russian airfields inside of Russia proper, including one that houses some of Russia’s strategic air assets[1]. A drone also hit a Russian oil depotUkraine’s ability to strike inside Russia is a new development, and one that the U.S probably isn’t pleased about.  We note that the U.S. “modified” its HIMARS systems given to Ukraine to reduce its range and lessen the likelihood that Ukraine could strike within Russia.
    • This development could mark a serious escalation of the war. First, if Ukraine now has the ability to strike targets deep inside Russia, then Putin’s conduct of the war will come under further scrutiny.  Second, Ukraine’s Western allies are mostly willing to support this war as long as it stays contained, since the West has no interest in seeing this conflict expand.  Attacking Russia proper changes the nature of the war and could prompt Russia to take more aggressive steps, such as engaging tactical nuclear weapons.
    • We will wait to see the U.S./allied response. Since the drones appear to be of Ukrainian origin, the U.S. and its allies can argue that it wasn’t Western arms that attacked Russia.  We doubt the Kremlin will accept this argument.  We look for the West to restrict weapons sales further to discourage this development.
  • Meanwhile, polls show some reduction in support among Americans for “indefinite” aid to Ukraine. And Germany is balking on sending the arms it promised earlier.
  • As the war continues, the Kremlin is increasing its commandeering of private companies to support the war effort. This action will tend to reduce available supply; if money supply isn’t restricted, then inflation will worsen.

International News:  The EU awakens to the change in U.S. policy.

[1] In other words, it houses an element of its nuclear weapons delivery.

[2] Which is a bit rich, given that numerous policies, such as regulations on food, are clearly protectionist.

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