by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

In today’s Comment, we open with news related to President Biden’s trip to Europe.  Not only is there a lot of political news in Europe, but European stocks have posted a string of records.  We also discuss the start of the latest policy meeting at the Federal Reserve and other noteworthy U.S. and international developments.  We end with news related to the coronavirus pandemic.

NATO-Russia-China:  At the end of their big summit meeting yesterday, President Biden and the other NATO leaders issued a lengthy communique highlighting their intent to stand up to both Russia and China.  In the background, however, much of the discussion revolved around how to balance the alliance’s response to the traditional, longstanding threat from Russia versus its response to the more novel and recent issue of China’s geopolitical and economic aggression.  In an important innovation, the communique also stated that Article 5, the principle of collective defense enshrined in the treaty that established NATO in 1949, can be invoked on a case-by-case basis in response to a cyberattack.

• Regarding Russia, the communique criticized Moscow’s military buildup, cyber and disinformation attacks aimed at the West, and its annexation of Crimea from Ukraine.  Biden also warned of consequences if jailed Russian opposition politician Alexei Navalny dies. In a news conference at the end of the summit, Biden said, “Navalny’s death would be another indication that Russia has little or no intention of abiding by basic fundamental human rights . . . . It would be a tragedy. It would do nothing but hurt his relationships with the rest of the world, in my view, and with me.”
• Regarding China, the communique said China presents “systemic challenges to the rules-based international order.”  The communique also highlighted concerns over Beijing’s rapidly expanding nuclear arsenal and military cooperation with Russia.
• Over time, it appears that the Biden administration is heading toward an updated version of the 1990s-style doctrine of being able to defend against two major regional conflicts at the same time.  The major difference is that Russia and China don’t just represent regional threats.  They both have the power to represent true global threats, and they are increasingly finding themselves very much aligned in terms of international security goals and perspectives.  Although Biden is probably oversimplifying when he casts today’s geopolitics as a competition between liberal democracies and authoritarian leaders, it is probably true that Russian President Putin and Chinese President Xi perceive an opportunity to make the world safe for authoritarians.  The U.S. and the other liberal democracies have their work cut out for them in terms of figuring out how to balance their responses to those two threats.

China-Taiwan-United States:  In an apparent show of defiance against the U.S. push for a stronger stance against China in Europe, the Chinese military yesterday sent 28 warplanes into Taiwan’s air defense identification zone — the largest-known incursion to date.  According to Taiwan’s defense ministry, the latest mission included 14 J-16 and six J-11 fighter jets and four H-6 heavy bombers, capable of carrying nuclear weapons, as well as various surveillance and early warning aircraft.

• The ministry said Taiwanese aircraft were dispatched to warn away the Chinese warplanes, while missile systems were also deployed to monitor them.
• Separately, a U.S. aircraft carrier group led by the Japan-based USS Ronald Reagan has entered the South China Sea in what the Navy said is a routine mission.

United States-European Union:  At their summit today, President Biden and EU leaders are expected to sign off on a deal to end the 17-year-old U.S.-EU dispute over aircraft subsidies.  Although details are still sketchy, earlier reporting suggests it will involve a five-year agreement to limit the types of financial support each side can give to its major aircraft manufacturers.  Of key importance, the deal would also lift the punitive tariffs each side has imposed on each other.  If it is indeed confirmed, the agreement would remove a major irritant in the U.S.-EU relationship and help unify their positions on other important global issues, even if the two sides have other disagreements.

U.S. Monetary Policy:  The Fed kicks off its latest policy meeting today, with a decision scheduled to be released when the meeting ends tomorrow.  The officials are widely expected to leave their benchmark interest rate unchanged at essentially 0% and make no immediate adjustment to their asset purchase program.

• However, investors will be looking for any hint that the policymakers might bring forward their plans for policy tightening.
  • Importantly, the officials will release an update of the “dot chart” laying out when they think they will have to implement policy changes in the coming few years.  The last update, in March, showed the policymakers expected to hold policy steady through 2023.

• • Tomorrow’s update may reveal that the policymakers now expect to lift interest rates somewhat earlier.
  • Naturally, equity and bond markets could face a bout of volatility if investors get confirmation that the policymakers now expect to hike interest rates and cut their bond purchases earlier than expected.  Nevertheless, we still expect the officials to stay on the sidelines for some time.  For the time being, monetary policy will remain loose, which should tend to support risk assets.

• The policymakers are also likely to address growing concerns that the flood of money in the financial system may drive U.S. interest rates into negative territory.  Resurgent flows into money market funds coupled with reduced issuance of short-term Treasury securities have pushed many fund managers to turn to the Fed’s reverse repo, which pays no interest at all.
  • Some market participants want the central bank to jolt short-term rates higher by agreeing to pay more than zero on the RRP.
  • It could also raise the rate it pays banks on excess reserves that they hold at the Fed.

United Kingdom-Australia:  British Prime Minister Johnson and Australian Prime Minister Morrison signed off on the broad terms of a post-Brexit trade deal.  In addition to lowering tariffs and quotas between the countries, including agriculture, the deal would make it easier for individuals to work and travel between the two countries.

• If the trade deal can be finalized and signed before the end of the year, it would mark the first substantial bilateral agreement entirely negotiated by the U.K. since it left the EU in early 2020.
• Deals announced with Japan and Norway were built upon existing arrangements negotiated while the U.K. was a member of the EU.

Belarus-Lithuania:  The foreign minister of Lithuania has accused the Belarusian government of weaponizing illegal immigration in retaliation for Lithuania’s welcoming political dissidents from Belarus and supporting EU sanctions against Minsk.  According to the official, Belarus is enticing migrants with package deals from a state-owned tourist agency that includes flights from Baghdad or Istanbul, as well as travel to the Lithuanian border.  So far this year, Lithuania has detained almost double the number of migrants who crossed the frontier from Belarus than the combined total for the three previous years.

COVID-19:  Official data show confirmed cases have risen to 176,329,887 worldwide, with 3,813,679 deaths.  In the United States, confirmed cases rose to 33,475,305 with 599,960 deaths.  Vaccine doses delivered in the U.S. now total 374,398,105, while the number of people who have received at least their first shot totals 174,234,573.  Finally, here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• According to the latest CDC data, 52.5% of the U.S. population has now received at least one dose of a vaccine, and 43.7% of the population is fully vaccinated.
• In the U.K., Prime Minister Johnson pushed forward England’s planned economic reopening to mid-July due to resurgent infections stemming from the Delta mutation first identified in India.  That variant, which is much more transmissible and dangerous than the original coronavirus, has been spreading rapidly among young, unvaccinated Britons and those who have only had one dose of a vaccine.
  • The decision to push out the reopening for one month illustrates the risk from the Delta variant, even in countries with high vaccination rates.  It also shows the downside of Britain’s decision early this year to delay the second dose of the vaccine in order to maximize the number of people receiving at least one dose.
  • Scientific advisors recommended the U.K. government delay vaccinations to younger age groups to ensure older people have received the double dose needed for maximum protection.
  • Separate studies from researchers in England and Scotland published Monday found that while protection against the Delta infection was somewhat diminished compared with more established variants, two doses of the vaccine offered considerable protection against severe illness and hospitalization.
• Meanwhile, the COVID-19 antibody treatment under development by AstraZeneca (AZN, $58.76) failed to meet targets in its latest trial, even though it did show that it could prevent people exposed to the virus from developing the disease if administered early enough.
• In Japan, the government is considering placing Tokyo under a quasi-state of emergency during the Olympic Games starting there on July 23, given that a number of health experts have expressed concern over a potential spike in COVID-19 cases resulting from the influx of participants and spectators.

 Economic and Financial Market Impacts

• Although it seems like just yesterday that we were reporting on record-high prices for lumber, the cost of wood has now plunged by almost half since the beginning of May.  Some market participants are even suggesting prices could fall much further as supply bottlenecks get resolved and some hoarding behavior reverses.  The rapid change in course is a reminder that today’s inflation pressure could well prove transitory, as the Fed suggests, once companies and consumers adjust to the normalizing post-pandemic economy.
• Although many economic sectors, such as travel and leisure, are facing boom times as the economy reopens, office towers and nearby businesses in central business districts are missing out on the strong economic recovery, largely because the rise in vaccinations and easing of mask restrictions haven’t propelled most employees back to work.
• On a more positive note, the chief of the entertainment division at NBCUniversal, a unit of Comcast (CMCSA, $57.28), said pent-up demand for major sporting events could make the company’s broadcast of the Tokyo Olympics its most profitable ever.
• Despite the positive progress on reducing infections and boosting vaccinations in many countries, the pandemic and its negative impact on oil prices, until recently, has produced an intense strain on Algeria’s economy.

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