Daily Comment (June 28, 2022)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment opens with an update on the Russia-Ukraine war, including a discussion regarding the actions taken against Russia by leaders at the Group of Seven summit, which ended today.  We next review other international and U.S. developments with the potential to affect the financial markets today, including the latest comments by European Central Bank President Lagarde.  We wrap up with the latest news on the coronavirus pandemic.

Note:  Because COVID-19 has become more endemic and in most countries isn’t disrupting the economy or politics as much as it did previously, we will drop our dedicated COVID-19 section beginning July 1.  We will continue to cover pandemic news as needed within our main text.

Russia-Ukraine:  As Russian forces continue making slow, plodding progress in their effort to seize the eastern Ukrainian territory of Donbas, we have noted in recent days that they have also increased their broad, indiscriminate artillery and missile attacks on infrastructure and civilian targets throughout the country.  Those attacks, including a strike on a shopping mall that killed dozens of civilians, are probably designed to taunt and intimidate Western leaders meeting this week at the G7 and NATO summits.  Meanwhile, Russian military authorities continue to seek ways to replenish their increasingly exhausted force capabilities without announcing general mobilization. One U.S. defense official stated yesterday that Russian forces are likely running low on senior military leaders and are relying more heavily on retired officers and reserves to replace officer casualties.

North Atlantic Treaty Organization:  General Secretary Stoltenberg announced that a new “strategic concept” due to be approved by NATO leaders at their summit starting today would dramatically strengthen the alliance’s force structure to better protect it against Russian aggression.

  • Under the new plan, NATO’s quick-reaction force would expand seven-fold to 300,000 troops, which would be ready to deploy quickly to specific territories on the alliance’s eastern flank from the opening hours of any attack.
  • The plan would also increase permanent NATO deployments close to Russia, shifting their focus from deterring any invasion to a full defense of allied territory.

Eurozone Monetary Policy:  ECB President Lagarde ratcheted up her inflation-fighting rhetoric with a vow that the central bank will act in “a determined and sustained manner” to tackle surging prices in the eurozone, especially if there are signs of price expectations rising sharply among consumers and businesses.  While not abandoning her preference to tighten policy gradually, Lagarde stressed it is now important to have “optionality,” or the option to tighten policy more sharply if necessary.

  • Despite her stronger statements regarding the severity of inflation in the Eurozone and the policymakers’ determination to get prices under control, Lagarde also indicated she is sticking by her plan to boost the central bank’s benchmark interest rate by just 0.25% in July before a potentially bigger move in September.
  • The ECB also still plans to stop buying more bonds on Friday, which has boosted government bond yields for weaker economies like Italy relative to the yields for stronger countries like Germany.
    • The ECB has tried to limit those spreads with vague promises to develop a new “anti-fragmentation” program that would likely involve preferential ECB purchases of government bonds from Italy, Spain, Portugal, Greece, and other weaker Eurozone economies.
    • Lagarde offered no additional details on how the anti-fragmentation program would work other than insisting it would be separate from the ECB’s main policy framework.
    • Even if Eurozone leaders can agree on such an anti-fragmentation program, we suspect it would essentially work at cross purposes with the ECB’s tightening policy.  We, therefore, think it would probably be negative for the euro.

Australia:  While the world focused on the coronavirus, Australians have concentrated on a different pandemic, this time among their bees.  The country has managed to contain the varroa mite, a parasite that is wiping out bee colonies around the world, but a new variant discovered in the port of Newcastle has prompted a lockdown of bee colonies reminiscent of COVID-19 restrictions to preserve the bees’ availability to pollinate important food crops.

Emerging Market Currencies:  Many emerging market stocks and currencies held up relatively well in early 2022 when the Russia-Ukraine war and supply disruptions boosted commodity prices.  Some of those assets are now sliding sharply as investors focus on the negative impact of the strong dollar and rising interest rates.  The South African rand and the Brazilian real have fallen particularly hard this month.

U.S. Bond Market:  New data from the Municipal Securities Rulemaking Board indicates households held just 40% of outstanding municipal bonds in the first three months of the year, down from 46% in 2020.  Stripping out separately managed accounts, households only hold about 20% of all munis.  The data reveals that asset managers now hold the large majority of munis, potentially making the market more volatile than it was in the past.

COVID-19:  Official data show confirmed cases have risen to  544,555,638 worldwide, with 6,330,745 deaths.  The countries currently reporting the highest rates of new infections include the U.S., Taiwan, Germany, and France.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  In the U.S., confirmed cases have risen to 87,092,384, with 1,016,208 deaths.  In data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 222,123,223, equal to 66.9% of the total population.

  • In the U.S., the latest wave of infections appears to be topping out, but hospitalizations are still accelerating with their usual lag.  The seven-day average of newly reported cases stands at 108,215, up 1% from two weeks ago.  The seven-day average of people hospitalized with confirmed or suspected COVID-19 came in at 31,720 yesterday, up 6% from two weeks earlier.  New COVID-19 deaths are now averaging 333 per day, up 3% from two weeks earlier.
  • In China, officials today said they would shorten their mandatory quarantine period to 10 days from 21 days for both international travelers entering the country and residents who have come into close contact with COVID-19 patients.  In addition, they said they would ease testing requirements for people in quarantine.
    • By now, investors deeply understand that strict zero-COVID rules have become a drag on growth in the world’s second-largest economy and threaten further disruptions in global supply chains.
    • Because of that, news of the eased requirements has given a boost to equities and commodity prices so far this morning.  For example, Brent crude oil is currently trading up 1.9% to $113.02 per barrel.
    • All the same, we stress that President Xi remains committed to his strict pandemic policies, so there can be no guarantee that he won’t impose new, disruptive restrictions again, even if only small outbreaks occur in China.

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