Daily Comment (March 29, 2022)
by Patrick Fearon-Hernandez, CFA, and Thomas Wash
[Posted: 9:30 AM EDT] | PDF
We open our Comment today with an update on the Russia-Ukraine war, which remains broadly stalemated as a new round of negotiations start in Istanbul. We next review a range of international and U.S. developments with the potential to affect the financial markets today. We close with the latest news on the coronavirus pandemic.
Russia-Ukraine: Despite Russian hints late last week that it would start to focus only on seizing the eastern Ukrainian region of Donbas, attacks and fighting continued throughout the country yesterday and into today. Meanwhile, Russian and Ukrainian officials are scheduled to hold ceasefire negotiations today in Istanbul. Recent reports indicate both sides have softened their positions somewhat. For example, Russia is no longer demanding that Ukraine demilitarize and stay out of the European Union, and Ukraine is no longer demanding the right to join NATO. Nevertheless, prospects for those talks don’t appear bright at present, in part, because of new reporting that militant nationalists in the Kremlin have been actively trying to scuttle any negotiations that might end the war early and keep Russia from securing a complete victory. Reports yesterday said those operatives in early March went so far as to poison Russian oligarch Roman Abramovich, who has been serving as a go-between for Russian President Putin and Ukrainian President Zelensky. If true, the incident illustrates the extent to which infighting within Putin’s administration will complicate decision-making. It also underscores the chance that Putin is being kept in the dark about the true conditions of Russian forces on the battlefield. Either way, the infighting is yet another reason to think there will probably be no swift conclusion to the war.
- In another sign that Russia is not yet ready to step back from its attacks, the internet service provider for Ukraine’s military said it suffered a major cyberattack yesterday. The company said it repelled the attack and was working to restore service.
- Separately, the war-inspired trend toward higher defense spending around the world showed up in the Biden administration’s proposed federal budget for the year starting October 1, released yesterday. Under the proposal, U.S. military spending would rise about 4% to a record $813 billion (counting defense-related expenditures outside the Defense Department). For a discussion of the rise in defense spending throughout the whole NATO alliance, see our latest Bi-Weekly Geopolitical Report, published yesterday.
- In the near term, the U.S. and other allied governments continue to explore further sanctions against Russia. Besides warning Russian oligarchs that they shouldn’t try to hide their assets to shield them from the sanctions, a high-ranking U.S. official yesterday said new sanctions are being developed to disrupt Russia’s defense industry and military supply chains.
- The World Bank’s director for macroeconomics, Marcello Estevão, warned that up to a dozen developing countries face an increased risk of debt defaults in the coming year as the war boosts commodity prices and adds to existing pressures from the coronavirus pandemic.
Taiwan: Ukraine’s unexpectedly strong resistance to Russia’s invasion continues to inspire changes to Taiwan’s planning on how it would resist a potential Chinese invasion. Not only does the Taiwanese military regularly practice countering a “decapitation” strike aimed at killing or capturing the country’s political leadership, as Russia tried, but it is also now incorporating into its strategy the strong messaging and demonstrations of leadership that President Zelensky has shown.
United Kingdom: The Russia-Ukraine war and Prime Minister Johnson’s response to it have been top-of-mind in the U.K. for the last month. However, there has still been some movement in the “partygate” scandal involving Johnson administration officials holding gatherings that broke the government’s own pandemic rules. London police today will issue 20 fines related to the gatherings, although it will not identify the specific persons fined. Reports say more fines are likely to follow in the future.
- All the same, the fines will pose a challenge for Johnson, who has insisted that his staff followed coronavirus restrictions.
- The prime minister told the BBC last year that “all the guidelines were observed” and followed “at all times.”
United States-China: In recent days, various reports have suggested Beijing is now prepared to meet U.S. regulators’ demands that Chinese companies make their audit records available if they want to be listed on U.S. exchanges. If so, it would remove one of many points of contention that have threatened to block capital flows between the two countries.
- Importantly, however, U.S. regulators have downplayed the prospect of resolving the matter.
- The U.S. regulators have already identified the first tranche of Chinese firms that could be delisted if they don’t share their audit records.
U.S. Technology Regulation: The Justice Department yesterday gave its official endorsement to the proposed “American Innovation and Online Choice Act,” prohibiting large digital platforms from favoring their own products and services over competitors’.
- The bill has already been passed by the Senate Judiciary Committee with bipartisan support, but the Justice Department action marks the Biden administration’s first full-throated support of the antitrust measure.
- The broad support for the measure in Washington highlights the continued regulatory risk facing large technology firms and their stock values.
U.S. Labor Market: With available workers in very short supply, a new study by compensation analysis firm PayScale shows that some 92% of U.S. businesses plan to increase employee pay this year, up from 85% in 2021. The study found that pay hikes are especially notable in the services industry. In any case, the intense competition for labor and big, broad-based wage increases are feeding into inflation and further pressuring the Fed to hike interest rates.
U.S. Yield Curve: With inflation pressures high and monetary policymakers continuing to talk up the prospect of big interest-rate hikes, the U.S. yield curve continues to flatten dramatically. As of this writing, the yield on the 2-year Treasury note stands at 2.391%, just 8 basis points below the yield on the 10-year Treasury note at 2.471.
- An outright inversion, with the 2-year yield rising above the 10-year yield, would likely boost concerns the Federal Reserve will hike rates too aggressively, which would throw the economy into a recession.
- After a long period of ultra-low interest rates, we suspect fragilities have developed in some sectors of the financial market. We continue to believe that the Fed can’t hike rates too much before exposing those fragilities and causing economic problems, with negative consequences for asset prices.
Brazil: President Bolsonaro has decided to replace the chief executive of state-owned oil giant Petrobras (PBR, $14.18) for the second time in a year, following a dispute over rising fuel costs that are hurting Bolsonaro’s prospects of re-election. The CEO, a reserve army general, will be replaced by economist Adriano Pires, an energy expert with experience as the oil sector regulator and as an academic.
- At one level, replacing the army general with an expert in the oil sector is probably a positive move.
- On the other hand, the replacement is also stoking concerns that Bolsonaro will take more populist steps to curry favor with voters ahead of the presidential elections in October.
COVID-19: Official data show confirmed cases have risen to 482,417,195 worldwide, with 6,128,071 deaths. In the U.S., confirmed cases rose to 79,995,544, with 977,688 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 who are considered fully vaccinated now totals 217,448,365, equal to 65.5% of the total population.
- In the U.S., the seven-day average of people hospitalized with a confirmed or suspected COVID-19 fell to 17,856 yesterday, down 35% from two weeks earlier. Nevertheless, many countries in Asia and Europe continue to suffer from a major new wave that has the potential to eventually drive up infections again in the U.S.
Economic and Financial Market Impacts
- After the Omicron wave suppressed travel volumes in January, transactions are up significantly over the past nine weeks, according to SAP Concur, a travel and expense software provider. Small and medium-sized companies are driving much of the acceleration.
Foreign Policy Responses
- In China, the Shanghai municipal government said it will try to support businesses affected by its massive new lockdowns. The city will offer 140 billion yuan ($22 billion) in tax cuts, fee reductions, and rent exemptions for three months.
- The package will include cuts to Shanghai’s value-added tax (VAT) and corporate income tax.
- Nevertheless, the major shutdowns in Shanghai and elsewhere in the country threaten to slow economic activity not only in China but potentially globally. That could be one headwind to help bring down commodity prices, although it would also likely be a headwind for global stock values.