Daily Comment (May 5, 2022)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s report begins with a discussion on yesterday’s FOMC meeting and other central bank news. Next, we give a roundup of the latest news regarding the Russian invasion followed by international developments, with a focus on U.K. local elections. Lastly, we end with the latest COVID news.

The Fed: The Federal Reserve raised its target rate for the federal funds by 50 bps on Wednesday, the most significant increase in 20 years. Investors had anticipated a possible 75 bps rate hike. The market responded favorably to the decision as it suggests the Fed has become less hawkish. Following the announcement, equities rose, Treasury yields fell, and the dollar weakened. In addition to raising rates, the central bank also decided to start its balance sheet reduction on June 1 but at a slower pace than expected. The March meeting minutes indicated that the Federal Reserve planned to reduce its balance sheet at a maximum rate of $60 billion in Treasuries and $35 billion in mortgage-backed securities. However, the recent announcement shows that the Fed will wait three months before reducing it that fast. In the meantime, the Fed will reduce its balance sheet by $30 billion in Treasuries and $17.5 billion in mortgage-backed securities.

The Fed’s reluctance to raise rates by 75 bps and reduce the balance sheet at the maximum rate suggests that members still suspect that inflation will prove to be transitory. Their confidence is likely related to the latest CPI report. Although core CPI rose 6.6% from the year in March, well above the Fed’s 2.0% target, the monthly change was 0.3%, barely above its long-term average. Next week’s CPI report will provide further insight into whether inflation is indeed transitory. Finally, the modest walk back from monetary tightening increases the possibility that the Fed may be able to avoid causing a recession.

Other Central Bank News:

  • The Bank of England warned that the economy could slip into recession later this year as higher energy prices push inflation upward. However, the central bank appears to be committed to tightening its monetary policy. On Thursday, it voted to raise its policy rate by 25 bps to 1%, its highest level since February 2009.
  • ECB board member Fabio Panetta told Italian newspaper La Stampa that the central bank should not raise rates in July. He added that the euro area economy is “de facto stagnating” and that the bank should hold off until it has seen GDP numbers for the second quarter. Panetta is considered a dove, and his opinion is not in line with some of his colleagues. His comments signal that policymakers are finding it more complicated to determine whether they should prioritize economic growth or inflation.
  • The Reserve Bank of India raised rates by 40 bps to 4.40% and the reverse repo by the same amount as the central bank tries to rein in inflation in India.

Russia-Ukraine Update:

  • After refusing Russian demands to pay for natural gas using the ruble, Poland received fuel from its allies. The Russian energy company Gazprom has threatened to reduce gas transit from countries that have helped supply Poland. It is not clear how Gazprom will respond; however, it could mean that other countries will face a reduction of gas from Russia.
  • Ukraine is preparing for the possibility that Belarus will help Russia in its invasion. Armed forces in Belarus have been holding military drills along the border of Ukraine. The potential involvement of Belarus raises the likelihood that the war could spread further into Europe. However, it is unclear whether the Belarusian government can convince its public to support the effort. One poll from a British think tank suggests that most Belarusians are opposed to their country’s involvement in the war.
  • The Kremlin has rejected rumors that Russian President Vladimir Putin will declare war against Ukraine in his speech on Monday. May 9 marks the anniversary of Germany’s surrender in World War II. There is speculation that Putin will use the day to make a big announcement, such as declaring war on Ukraine or declaring victory. Since the invasion began on February 24, Putin has described the conflict as a “special operation.” A declaration of war could mean that Russia is prepared to escalate the amount of force in its quest to take Ukraine.
  • The war in Ukraine is having an impact on the German economy. In March, factory orders fell by 4.7% from the prior month as factories faced soaring costs and input shortages due to the war. The slowdown in orders suggests that Germany may be headed toward an economic contraction.
  • The EU’s proposed ban on Russian oil has been met with pushback from smaller member countries. Hungary would like to change the timing of the phase out, while Greece, Malta, and Cyprus voiced concerns about restrictions regarding shipping oil to third-world countries. The pushback suggests that the EU ban will be complicated as countries try to adapt to life without Russia.
  • Israel has expressed willingness to support Ukraine in its war efforts against Russia.

International News:

  • Brazil’s presidential front-runner Luiz Inacio Lula da Silva has criticized the West for not doing enough to prevent Russia from invading Ukraine. In an interview with Time magazine, he argued that the reluctance of Western leaders to negotiate with Putin is what caused the war and warned that sanctions on Russia would hurt the global economy. Lula da Silva’s remarks are another example of how developing countries have primarily sided with Russia in its invasion of Ukraine.
  • North Korea launched a ballistic missile toward its eastern waters. The launch comes six days before a new South Korean president is set to assume office. North Korean leader Kim Jong-un has pledged to accelerate his nuclear program and has threatened to use it against rivals. The increased hostilities will likely create unfavorable market conditions for risk assets in North Korean rivals Japan and South Korea.
  • In the U.K., voters are headed to the polls for local elections. The results will gauge the popularity of PM Boris Johnson. Scandals have plagued the Johnson administration for several months, but the war in Ukraine has helped reshape his image. As a result, the Tories are expected to lose as many as 548 seats in England and Wales.
    • In related news, Northern Ireland is expected to elect a majority of its seats to Sinn Féin, a nationalist Irish party. If true, this would be the first time the country’s First Minister seat will be held by someone that is not loyal to the throne. This outcome could affect the Brexit agreement as the NI protocol remains a contentious issue for the U.K. and the EU. The protocol removed the need for a hard border between Northern Ireland and Ireland by allowing British goods to transfer through checkpoints into Northern Ireland. Unionists, a group loyal to the throne, have pleaded with the U.K. to eliminate the protocol as they believe it could pave the way for the region’s exit from the commonwealth. Assuming Sinn Féin wins, it will likely create unfavorable conditions for risk assets in the U.K. In addition, it raises the likelihood of a return to the Troubles, an ethno-nationalist conflict in Northern Ireland that lasted from 1960 to 1998.
  • OPEC+ is expected to maintain its policy of raising production by 430,000 barrels per day for June. The decision comes as oil prices remain above $100 per barrel. The Senate is considering anti-trust legislation to allow members of the oil cartel to be sued. However, it is unclear whether such a law would impact countries’ willingness to produce more oil.
  • India is considering placing limits on wheat shipments due to concerns of a shortage resulting from the war between Russia and Ukraine. However, the move could worsen inflation in global food prices.

COVID-19: The number of reported cases is 515,416,787 with 6,244,507 fatalities. In the U.S., there are 81,620,610 confirmed cases with 996,694 deaths. For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics. The CDC reports that 729,623,415 doses of the vaccine have been distributed, with 577,306,842 doses injected. The number receiving at least one dose is 257,881,623, the number of second doses is 219,902,417, and the number of those who have had the third dose, granting the highest level of immunity, is 100,901,425. The FT has a page on global vaccine distribution.

  • COVID-19 cases are surging again in South Africa. The country was the starting point for the Omicron variants. As a result, scientists have been paying close attention to rising cases within the area.
  • In April, lockdowns in China have led the country to a severe slowdown in services activity. The latest CAIXIN China Services PMI fell to its lowest level since the pandemic began in February 2020.
  • In positive news, the newer variants of COVID-19 have faded away faster than previous variants. If true, this could mean that the virus is becoming less lethal.

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