Daily Comment (July 6, 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 an important indication that Russia still intends to take over or control the whole of Ukraine.  We then review a wide range of other international and U.S. developments with the potential to affect the financial markets today.

Russia-Ukraine:  Now that Russian forces have seized the province of Luhansk and could seize the province of Donetsk as well, it is notable that Russian Security Council Secretary Patrushev yesterday said his country’s military operation in Ukraine will continue until Russia achieves its goals of protecting ethnic Russian civilians from “genocide,” “denazifying” and demilitarizing Ukraine, and obliging Ukraine to be permanently neutral between Russia and NATO—almost exactly the goals President Putin announced in his February 24 speech justifying the war.  The statement seems to confirm that Putin’s public shift to the more limited war aims of defending Luhansk and Donetsk was merely a ruse.  Now that Putin feels emboldened by his military success in those regions (and perhaps because he’s facing pressure from Russian nationalists), he appears to be revealing that he still intends to control all of Ukraine in due time.

  • If Putin hasn’t really abandoned his maximalist war aims in Ukraine, a long, protracted war of attrition is more likely.  Putin may order or allow his military to rest and regroup from time to time, especially if he thinks the Western allies are tiring in their support for Ukraine, or if he thinks that the upcoming elections in the U.S. or elsewhere will produce new leaders more likely to acquiesce in Russia’s invasion.  However, Putin could then order renewed offensives at a future time.
  • If Putin retains his maximalist war aims, another important implication is that it would make no sense for the Ukrainians to concede any territory to the Russians in hope that they would be appeased.
  • New reporting by the Wall Street Journal indicates Russian forces have transformed Ukraine’s massive Zaporizhzhia Nuclear Power Plant into a forward military base, likely hoping that safety concerns will prevent the Ukrainians from attacking it.  The report indicates that the Russians are deploying heavier, longer-range weapons to the plant almost daily, and that the base has therefore become the linchpin of Russia’s control over the surrounding region.

Global Oil Market:  Despite the ongoing supply disruptions from the war in Ukraine, the recent slump in some commodity prices accelerated sharply yesterday.  Crude oil prices fell especially hard, with Brent Crude closing 9.5% lower at $102.77.  Prices have rebounded to some extent this morning, but the sell-off reflects intensifying concerns about rising interest rates, signs of slowing demand, and a growing risk of recession in the coming months.  Other factors pushing down oil prices include the strong dollar and indications of increased production.

  • The fall in crude oil prices and weakening demand already appear to be pushing down gasoline prices as well.
  • According to AAA, average U.S. gasoline prices have now fallen modestly to $4.80 per gallon, compared with more than $5.00 per gallon last month.

Global Digital Currency Markets:  In more fallout from the recent plunge in cryptocurrency values, crypto broker Voyager Digital (VOYG.TO, 0.3350) filed for bankruptcy protection.  The move comes just days after the firm suspended withdrawals and trading on its platform and secured a $400 million emergency credit line from crypto broker FTX.

  • Voyager Digital’s problems stem mostly from a loan that one of its subsidiaries made to crypto hedge fund Three Arrows Capital, which defaulted after taking heavy losses on its investment in multiple cryptocurrencies.
  • FTX has recently played a key role in propping up other crypto firms in trouble, so it will be interesting to see if it takes a significant loss from the Voyager Digital debacle, or whether the debacle forces it to step back from helping other firms.

European Union Digital Markets Regulation:  The European Parliament yesterday gave final approval to two key laws that analysts believe could become models for global digital markets regulation.  The laws aim to rein in anti-competitive behavior and control services on digital platforms, with fines in extreme cases ranging up to 20% of an offending company’s annual revenue.  As we have warned in the past, such legislation reflects the growing regulatory risk facing technology companies in countries around the world.

  • The Digital Markets Act, which is aimed at anti-competitive behavior, will impose new obligations on how a small number of digital giants operate, with rules dealing with online messaging, digital advertising, and the app ecosystem.  For example, the law would bar dominant tech companies from using their platforms to promote their own goods and services over those from other companies.
  • The Digital Services Act, which is aimed at regulating digital content, will require large social-media platforms to take steps to deal with illegal content and other material regulators view as harmful, and give users an avenue to register their complaints about content moderation

United Kingdom:  Prime Minister Johnson suffered a potentially career-ending blow yesterday when both his chancellor, Rishi Sunak, and his health secretary, Sajid Javid, resigned in protest over Johnson’s long string of ethical scandals.  More government members resigned early today.  Johnson has vowed not to resign, and internal Conservative Party issues suggest he could cling to power for months.  However, even if he remains in power for the time being, he may no longer have the political capital to push forward any policy proposals.

  • The U.K. is likely to enter a period of greater political uncertainty, which would likely be a further drag on its economy and financial markets.
  • Reflecting the economic and financial risks, the pound fell further.  As of this writing, it is valued at $1.1909, down 0.4% from yesterday and 11.8% from the end of 2021.

Norway:  The government stepped in to end a strike that threatened to more than halve the country’s natural gas exports, saying the walkout was causing widespread risks to Europe’s energy security.  Nonetheless, the Norwegian strike and similar ones around the globe show that raging consumer price inflation is spurring higher wage demands from workers and threatening to create wage-price spirals.

  • The strikes also reflect falling labor force participation in some major countries, which has reduced the supply of labor and given employees more bargaining power.
  • We continue to think that inflation rates will moderate over the rest of the year, but as we noted in our Comment yesterday, falling labor force participation, reduced labor supply, and workers’ increased bargaining power make up a key reason why inflation rates aren’t likely to return all the way to their low pre-pandemic levels.

Japan-South Korea:  To repair Japanese-South Korean relations as the two countries try to resist China’s rising power, the South Korean government has reportedly launched an initiative to resolve longstanding compensation claims against Japan for its forced labor practices during World War II.  Although South Korean courts have allowed the country’s citizens to sue Japanese firms for compensation, the initiative will try to channel those claims into an alternative process that doesn’t threaten seizures of Japanese corporate assets.

China:  We continue to see nearly constant reminders that President Xi’s Zero-COVID policies could disrupt the Chinese economy at any time, potentially undermining global growth and pushing down commodity prices.

  • Authorities in Shanghai ordered a new round of mass testing for more than half of the city’s districts after 24 new cases were found.
  • Officials in Beijing today announced that people wanting to enter public facilities such as museums, libraries, and gyms will need to show proof of vaccination starting July 11, instituting a vaccine pass for the capital for the first time.
  • Authorities in Xi’an reported the country’s first community outbreak of cases related to the Omicron subvariant BA.5, prompting officials in the city of around 13 million people to shutter entertainment businesses, schools, and dine-in services for a week.

Congo-Rwanda:  The president of the Democratic Republic of Congo has warned that war could break out with Rwanda unless his neighbor stops backing rebel groups fighting in his country.  The statement by President Félix Tshisekedi follows a strong offensive in eastern Congo by the M23 armed group, which he said was backed by Rwanda.

U.S. Environmental Regulation:  A federal judge in California yesterday threw out Trump-era changes to the Endangered Species Act, including one that allowed economic factors to be considered when government officials are deciding whether to list a species as threatened or endangered.  The ruling also voids regulations that made it more difficult to give protections to species threatened by anticipated future events, such as the impacts of climate change.

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