Daily Comment (March 7, 2022)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with an update on the Russia-Ukraine War.  The key developments include the U.S. and Poland looking into ways to provide Ukraine with more fighter jets (which obviously would be seen by Russia as exceedingly provocative) and the U.S. considering a ban on Russian oil imports.  Those actions go far toward explaining the dramatic moves in the financial markets so far today.  We also provide a brief overview of other key international and U.S. news.  We wrap up with the latest developments regarding the coronavirus pandemic.

Russia-Ukraine:  Over the weekend, Russia continued to attack civilian targets throughout Ukraine, killing dozens, while Chinese Foreign Minister Wang Yi stressed China’s support and “everlasting friendship” for Russia.  Ukrainian and Russian negotiators are scheduled to meet for their third round of cease-fire talks on Monday, but prospects for a breakthrough were uncertain as the Kremlin signaled its determination to pursue the war.  Meanwhile, Ukrainian President Zelensky continued to press the U.S. and NATO to implement a no-fly zone over Ukraine, even though such an action would likely result in a direct conflict between the West and Russia.  The U.S. and NATO continue to reject that option, and U.S. officials are considering a deal in which Poland would provide Soviet-era fighter jets to Ukraine so it can continue to contest its airspace with the Russians.  Separately, U.S. Secretary of State Blinken said the U.S. is talking with European partners about banning imports of Russian oil, a prospect that has pushed global oil prices up to $130 per barrel or more so far this morning and pushed several European stock indexes down to bear-market levels.  Natural gas, gold, wheat, nickel, and a range of other commodity prices are also surging, while the need to wean Europe off its reliance on Russian energy continues to spark discussions of accelerating the Continent’s switch to renewable energy.  Importantly, even U.S. Treasury yields are rising, suggesting renewed concern about inflation.  Within Russia, domestic protests against the war appear to be growing.  Finally, another important piece of news over the weekend was the leak of a purported letter on the crisis from an official in Russia’s Federal Security Service, the successor of the KGB’s domestic security operation.

  • In an English translation of the letter circulating on the internet, the official claims that:
    • The war against Ukraine is a mistake equal to Russia’s failed war against the Japanese in 1905.
    • Decision-making about the war was too concentrated at the top, leading to most of the Russian shortcomings so far.
    • Russia can’t mobilize militarily now to get control of the situation, since mobilization plus sanctions will implode the economy.
    • Russia will soon face grave domestic instability as the population responds to the hardships brought on by the invasion and the Western sanctions.
    • Use of a tactical nuclear strike in Ukraine is possible, not for any military reason, but to scare the West.
    • Russia’s foreign intelligence service is trying to plant evidence that Ukraine was developing nuclear weapons. [Note: This would explain Russia’s focus on seizing the Chernobyl nuclear site, as well as the Zaporizhzhia nuclear generating station.]
    • The economic implosion from the sanctions and efforts to improve the supply situation in Ukraine will threaten the viability of Russian forces in Syria.
  • While those observations are instructive, we at Confluence have our own capabilities in translating and interpreting the underlying Russian text, and our reading of the document provides several important additional findings:
    • The official who wrote this was probably involved in the Chechnya conflict.  The letter refers specifically to Ramzan Kadyrov, the Russian-imposed leader of Chechnya.  The letter suggests that some kind of Chechen special operations group was sent to Kyiv to assassinate Ukrainian President Zelensky, but they got decimated before they could act.  This is consistent with reports over the weekend that Russia is recruiting Syrian fighters experienced in urban warfare to help counter the Ukrainians’ efforts to defend major cities.
    • In any case, the translation circulating on the internet is not complete.  There are several sentences and paragraphs left out, although most aren’t necessarily critical.  Most of the sentences not translated merely give more color regarding how upset the writer is, and they provide a bit more detail on his view of the fiasco in Syria.
    • However, at the end of the Russian document, there are several important untranslated sentences in which the writer says, “Out of cynicism, I would only add that I don’t think VV Putin will cross the red line of destroying the whole world [i.e., a strategic nuclear strike].”
      • “First, there isn’t just one person that takes that decision.  Although one person starts the process in motion, there’s a lot of people involved.  It isn’t a ‘one-man show.’”
      • “Second, there are many doubts that all that would be successful.  Experience teaches that the greater the transparency and control, the easier it is to show deficiencies.  And where it’s not understood who exercises control, and how, but they always flaunt outcomes, it’s the opposite.  I’m not sure that the nuclear system functions as advertised.  After all, you have to replace nuclear warheads every ten years.”
      • “Third, and this is most disgusting and sad, personally I don’t believe that someone who won’t even allow members of the Federation Council or his own closest representatives and ministers to get close to him would sacrifice himself.  Whether it’s fear of the coronavirus or fear of assassination, it’s not important:  If you’re afraid to allow the most trustworthy people to come close to you [remember the 20-foot-long conference table], how could you decide to destroy yourself and those close to you?”
  • In any case, the risk of a major miscalculation remains high.  In the near term, that is likely to keep boosting prices for energy commodities, grains, and precious metals.  However, if the Russian military ultimately proves to be a paper tiger and Western resolve brings an end to the crisis, or if Russian forces quickly take control of Ukraine and the situation stabilizes, equities and other risk assets may well rebound smartly.

China:  Over the weekend, the Chinese government said it would target an economic growth rate of 5.5% for 2022.  The target is the smallest since China began setting such benchmarks in 1994, but it is actually a much heavier lift than the 2021 target of 6%, given last year’s pandemic-related statistical distortions and the mounting economic headwinds.  The relatively aggressive target signals further government intervention is likely on the way, including an expected ramp-up in government infrastructure spending.

Australia:  One important fallout from the Russia-Ukraine War is that the world’s liberal democracies have been scared into boosting their defense capabilities.  Over the weekend, the Australian government said it would build a $7.5 billion base for nuclear-powered submarines on the country’s east coast.

  • That comes after many other countries, such as Germany and Italy, have said they will boost their defense budgets going forward.
  • Even if the Russia-Ukraine War ends soon, the liberal democracies probably won’t soon forget Russia’s aggression and China’s support.  The boost to defense spending, therefore, is likely to be long-lasting, which could prove to be an opportunity for investors.

U.S. Cryptocurrency Regulation:  Even as the U.S. and other major governments look set to tighten their regulation of digital currencies, Senate Finance Committee Chairman Wyden has warned that clamping down too hard would stifle innovation and ultimately hurt the U.S.  We still expect that digital currencies will face increased regulation going forward, but Wyden’s statement serves as a reminder that there are political forces working in the other direction that could limit or delay some of the regulations.

U.S. Fiscal Policy:  With the ongoing economic recovery boosting tax revenues, a range of state governments are enacting or considering enacting tax cuts.  The states moving in that direction range from Tennessee and Mississippi to Wisconsin and Georgia.  State-level tax cuts would probably not be as economically significant as federal cuts would be, but if they are widely adopted, they could help provide a boost to the national economy and stock prices as consumers face higher inflation and deplete their pandemic-related excess savings.

COVID-19:  Official data show confirmed cases have risen to  446,404,737 worldwide, with 6,000,394 deaths.  In the U.S., confirmed cases rose to 79,271,466, with 958,621 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 216,147,515, equal to 65.1% of the total population.


 Economic and Financial Market Impacts

  • While the U.S. press has published lots of stories about the “Great Resignation,” or the big rise in people switching jobs amid the strong post-pandemic job market, the trend is now spreading to other countries, including Australia and, potentially, even Japan.

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