Daily Comment (January 25, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with an apparent agreement between the U.S. and Germany that will unlock the transfer of advanced tanks to Ukraine.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including some thoughts on how the Biden administration may be hoping to leverage its green energy subsidies from last year’s Inflation Reduction Act.

Russia-Ukraine War:  As we previewed in our Comment yesterday, the U.S. and Germany are set to announce a deal in which the U.S. would reverse its earlier position and donate about 30 of its best-in-class Abrams tanks to Ukraine, while Germany would send a smaller number of its own advanced Leopard 2 tanks and authorize other European countries to send many more.  To get the deal done, President Biden reportedly overruled Pentagon concerns that the Abrams would be too costly and difficult for the Ukrainians to use effectively.

  • The Ukrainians reportedly hope to build an entirely new tank division around the donated Abrams and Leopards. Having those tanks would enhance Ukraine’s firepower and help it defend against a new Russian offensive expected in the coming months.
  • The Abrams and Leopards could also help Ukraine recapture more territory from the Russians. However, they wouldn’t necessarily guarantee a Ukrainian victory in the war.

Russia-U.S. Arms Control:  The new Republican leaders of the House armed services, foreign affairs, and intelligence committees have requested that the Biden administration formally confirm whether Russia is complying with the New Start nuclear arms control treaty.  That treaty, which governs the number of strategic nuclear weapons Russia and the U.S. can have, is the only remaining arms-control treaty in force that traces its origins back to the Cold War period.

  • The congressional concern was triggered by Russia’s decision last November to suspend New Start inspections and its subsequent refusal to participate in the consultations required under the treaty to support its implementation. President Putin’s veiled threats to use nuclear weapons in the war in Ukraine have also raised concerns about Russia’s intentions.
  • If the administration determines that Russia has abrogated the treaty, and if no resolution is reached with Russia, it would free the U.S. to respond to the new geopolitical reality in which it will soon have to deter two major nuclear powers, both Russia and China, given that China is so rapidly building up its force of strategic nuclear weapons. The result could be a global arms race, consistent with our view that the world is embarking on a prolonged period of rising military spending.

United Kingdom:  Not only is the country continuing to deal with strikes across its transport and public sectors, but now workers at an Amazon (AMZN, $96.32) facility in Coventry said they will walk off the job in a dispute over pay.  Leaders of the Amazon union said they plan to widen the strike to other Amazon facilities as well.

Italy:  Gasoline station owners across the country are turning off their pumps for two days to protest government pressure on them to hold down prices following the expiration of a subsidy program at the end of last year.  When the subsidies ended, gas prices jumped, prompting the government to require stations to post average prices along with their own at the pumps.

  • The pump owners’ strike may cause some disruption to the Italian economy and create political headaches for Prime Minister Meloni.
  • On the other hand, some outside observers have praised her for the fiscal discipline she has shown with ending the subsidies after the retreat in energy prices late last year.

U.S.-EU Energy Policy:  Sen. Joe Manchin (D-WV) said he will introduce a bill requiring the Treasury Department to delay issuing its rules governing the $7,500 tax credit for purchasers of an electric vehicle under last year’s Inflation Reduction Act.  Separately, even as top EU leaders float the idea of establishing their own big subsidies to spur investment in European green energy, Dutch Prime Minister Rutte said he would oppose issuing new, common EU debt to fund the effort.  Financing limits could keep the EU subsidies too small to compete with the $369 billion or so of U.S. subsidies available under the law.

  • Responding to European protests against the law’s requirement that eligible vehicles must get at least 40% of their value from countries that have a free-trade deal with the U.S., the Treasury Department tweaked its rules to make it easier for some foreign automakers to qualify for subsidies in December.
  • Manchin is now arguing that the Treasury’s action undermines the aim of the law, which he said was squarely to promote domestic manufacturing and energy security. Manchin’s bill is currently given little likelihood of passage, but it does reflect how nationalist populism is strengthening in both major U.S. political parties.
  • Nevertheless, a final interesting wrinkle is that Treasury Secretary Yellen has revealed that the administration may be planning to use the law’s subsidies as leverage to entice U.S. allies into limited free-trade agreements focused on critical technologies and minerals, such as semiconductors and lithium. U.S. Trade Representative Tai has also suggested that the U.S. wants the EU to adopt aggressive industrial policies to strengthen its economy and reduce its dependence on China.  It appears that the administration’s goal is to create a common, integrated industrial policy for key technologies and natural resources across the entire U.S.-led bloc.  The goal may be to keep the free trade and capital flows associated with the policy limited enough to avoid antagonizing the nationalist populists, but still sufficiently meaningful to strengthen the U.S.-led bloc for its geopolitical competition with China and its bloc.

U.S. Antitrust Regulation:  The Justice Department and eight states yesterday sued Google, a subsidiary of Alphabet (GOOG, $99.21), for abusing what they call monopoly power over the internet ad industry.  The suit alleges that Google’s behavior hurts web publishers and advertisers and seeks to force Google to unwind “uncompetitive” acquisitions such as its 2008 purchase of DoubleClick.  The lawsuit illustrates the Biden administration’s more aggressive antitrust enforcement and the increased regulatory risks faced by the technology sector.

U.S. Labor Market:  Walmart (WMT, $143.02) stated that it will hike its minimum wage to $14 per hour, from $12 per hour currently, beginning in February.  The company said that should boost its average hourly wage to about $17.50 from the current $17.00, helping it compete for workers with rivals that pay even more.  The move points to a continued tight labor market, despite some recent signs of cooling demand for workers.

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