Daily Comment (March 30, 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, where continued fighting suggests the optimism regarding yesterday’s peace talks was probably misplaced.  We next review several international and U.S. developments with the potential to affect the financial markets today.  We wrap up with the latest news on the coronavirus pandemic.

Russia-Ukraine:  After yesterday’s Russia-Ukraine peace talks in Istanbul, the Russian defense ministry said Moscow will “dramatically” scale back its military activities around the capital city of Kyiv as a trust-building measure and reiterated its intention to focus on consolidating control over the eastern Ukrainian region of Donbas.  The U.S. Defense Department later confirmed that a small number of Russian troops around Kyiv had been moved northward and looked as though they would be deployed elsewhere in Ukraine.  Officials involved in the peace talks reported modest progress built on a series of concrete proposals from the Ukrainian side.  The enticing hints of peace were probably the key reason for yesterday’s jump in global stock prices and the drop in oil prices.  However, in contrast with investors’ optimism, NATO and Ukrainian officials expressed skepticism about the Russians’ intention to scale back their attacks or seriously consider Ukraine’s concessions.  Russian airstrikes and ground attacks continued around much of Ukraine, and for the first time, Russian troops pushed into the key coastal city of Mariupol.  Meanwhile, Ukrainian forces continued to push the Russians back in some places, boosting morale and increasing their confidence.

  • Whatever the situation is on the ground, we believe it is still highly likely that Russia’s stated intention to restrict its invasion is merely a ploy designed to buy time for resupply operations and make the Ukrainians drop their guard. Indeed, continued fighting already appears to be taking some of the wind out of investors, and as of this moment, some of yesterday’s stock gains are being reversed, while oil prices are rising again.  We believe the Russia-Ukraine conflict still has a long way to go, so it’s way too early for investors to be looking for the all-clear sign.
  • Indeed, today has brought new signs of continued economic risks arising from the war. The German government has taken the first formal step towards natural gas rationing as it braces for a potential halt in deliveries from Russia because of a dispute over payments.  Russian officials yesterday said Moscow would not “supply gas for free” to Europe, a day after the G7 countries unanimously rejected Russian President Putin’s directive requiring payment in rubles.  The dispute has boosted European gas prices by almost 10% so far today.
    • In Germany’s energy early warning phase, a crisis team from the economics ministry, the regulator, and the private sector will monitor imports and storage.
    • If supplies fall short and less draconian attempts to lower consumption do not work, the government will cut off certain parts of German industry from the grid and give preferential treatment to households.
  • Even if the Russians and Ukrainians were to strike a ceasefire agreement quickly and achieve a stable peace, it’s important to emphasize that the shock of the Russian invasion and the fear of new aggression will reverberate among world leaders for years to come. We, therefore, still expect to see the “new era of higher defense budgets” as described in our Bi-Weekly Geopolitical Report of March 28.  Indeed, the Biden administration has indicated that the Russian invasion was one reason for the 4% hike in defense spending listed in its proposed federal budget for the fiscal year 2023 released this week.  We suspect Congress will ultimately appropriate even more money than requested for defense, as in recent years, but some key points in the proposed spending plan are as follows:
    • Under the proposal, the Department of Defense would receive $733 billion in the year starting October 1. Counting defense-related spending by other agencies, total U.S. military spending would rise to a record $813 billion.  The increases would include a 4.6% pay raise for military personnel, starting next January, as well as a new basic needs allowance to help military families living near or below the federal poverty line.  Nevertheless, the plan would reduce the total military headcount by several thousand to make way for weapons procurement.
    • For the Army, the proposal would provide $178 billion, equal to a 1.7% rise over the enacted FY 2022 budget. To fund the recruitment of high-skilled, more expensive personnel, the number of active-duty troops would be temporarily cut to 473,000 from 485,000 in FY 2022.  The Army National Guard’s headcount would remain at 336,000, and the Army Reserve would stay at 189,500.
    • For the Navy, the proposal would provide almost $181 billion, representing a 5% rise from the enacted FY 2022 budget.
      • The Navy’s headcount would fall by 10,000 to 346,300 active-duty sailors and 57,700 reserves.
      • Because of the enormous cost of new nuclear-powered submarines and aircraft carriers, the plan would fund just nine new ships and decommission 24. That would put the total fleet on a trajectory to fall from the current 298 ships to 270 in FY 2027, far below the Congressional goal of 355 ships.
    • For the Air Force, the proposal would provide almost $170 billion, an 8% rise over the enacted FY 2022 budget. Active-duty jobs will be cut by 4,900 to 323,400 airmen and 8,600 for active-duty guardians in the Space Force.  Much of the cut in personnel is associated with the planned decommissioning of 269 airframes, including T-1 training aircraft, F-22 fighter jets, and E-3 airborne target tracking planes.  Those cuts would aim to free up funds for more modern, advanced aircraft to provide an advantage over U.S. adversaries.
    • The rest of the defense budget covers a range of civilian administrative and ancillary agencies and programs.

U.S. Monetary Policy:  Philadelphia FRB President Harker yesterday said that unacceptable levels of inflation call for an aggressive path of interest rate increases to remedy surging price pressures, including a possible 50-basis-point hike in the benchmark fed funds rate at the Fed’s policy meeting in May.  Harker is serving as a voting member of the rate-setting committee through June because of a temporary vacancy in the presidency of the Boston FRB.

  • Harker’s strong hint at more aggressive rate hikes follows similar indications from Chair Powell and other monetary policymakers.
  • The policymakers are clearly panicked about inflation.  They are gearing up for a series of potentially big rate hikes, although we continue to believe financial fragilities and/or an economic slowdown will ultimately keep them from raising rates as fast or as far as they currently intend.
  • In a sign that bond investors expect the rate hikes soon to feed into an economic slowdown and more muted inflation, the yield curve continues to flatten and briefly inverted yesterday.  As of this writing, the yield on the 2-year Treasury note stands at 2.338%, just 7.4 basis points below the yield of 2.412% on the 10-year note.
  • We also note that trading conditions in the Treasury market have worsened again, exacerbating the volatility arising from factors like inflation and the Russia-Ukraine war.

United States:  By a vote of 414 to 5, the House of Representatives passed a bill yesterday that would allow people to boost their contributions to 401(k) retirement plans and let them grow for a longer time period before being required to take distributions.  If passed by the Senate and signed into law, the “Secure Act 2.0” would raise the latest distribution age over the next decade to 75.

United Kingdom:  A new survey shows the share of older U.K. workers planning to continue working in retirement has nearly doubled to 66% in the last two years, reflecting rising living costs and insufficient pension savings.  The figure suggests the mass retirements seen across developed economies during the coronavirus pandemic could be coming to an end.  If additional older workers stay in the workforce or start working again, it could help relieve today’s labor shortages and help hold down wage rates and inflation.

China-Hong Kong-United Kingdom:  In yet another sign of the decoupling between China and the world’s liberal democracies, two of the United Kingdom’s most senior judges have resigned from Hong Kong’s top court to protest Beijing’s tough new national security law on the territory.  The judges sat on the Hong Kong court as part of an arrangement struck at the time of the region’s handover from British to Chinese rule in 1997 to support the “one country, two systems” framework. Their presence was intended to underpin the rule of law in the region.

Japan:  Consumer price inflation in Japan is expected to exceed the Bank of Japan’s target of 2% as early as April, owing to factors like the weak yen and rising global oil prices.  However, Deputy Chief Cabinet Secretary Seiji Kihara warned the central bank should not take that as a signal to drop its extremely loose monetary policy.  According to Kihara, both monetary and fiscal policy should remain loose until domestic demand pushes up prices.  The statement suggests there will be no near-term change in Japanese economic policy as a result of today’s inflation.  The loose policy will continue to weigh on Japanese bond yields and the yen.

Israel:  Five Israelis were killed by a Palestinian gunman in central Israel last night, the third such attack over the past week amid what Israeli officials described as a wave of terror.

Digital Currencies:  More than $600 million has been stolen from the digital ledger that powers the popular cryptocurrency game Axie Infinity, in one of the largest hacks targeting the booming digital assets sector.  The loss will likely fuel further concerns about the security of digital currencies, on top of their impact on the financial system.

COVID-19:  Official data show confirmed cases have risen to  485,302,038 worldwide, with 6,134,080 deaths.  In the U.S., confirmed cases rose to 80,019,167, with 978,692 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 217,498,967, equal to 65.5% of the total population.


  • In the U.S., the seven-day average of people hospitalized with confirmed or suspected COVID-19 fell to 17,464 yesterday, down 34% from two weeks earlier.
  • Despite the drop in U.S. infections, new infections remain high in China and some other Asian and European countries.  New cases in Shanghai continue to surge, sinking hopes that business and everyday life in China’s financial capital will return to normal in the coming days.

Economic and Financial Market Impacts

  • After Shanghai officials gave only about eight hours’ notice before locking the city down on Monday, reports show life in Shanghai has been massively disrupted.  Bankers are bedding down in their offices, delivery services are struggling to cope with demand, and food prices are soaring—all on top of the economic headwinds imposed on the broader Chinese and global economy.

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