by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning.  Recently, the dollar has been the key indicator of the direction of financial and commodity markets.  A stronger dollar usually signals weaker financial and commodity markets, while dollar weakness indicates the opposite.  This morning, the dollar is weaker but there isn’t much follow through in other markets.  Equities are mostly steady, energy prices, in front of today’s weekly DOE data, are weaker too, and interest rates are mostly steady.  We may be seeing some early position squaring in front of Thanksgiving week and, as we note below, there is a lot of economic data today that may be dampening trading.  There is one area of the market doing rather well this morning, which is precious metals, which are likely reacting to dollar weakness.

In today’s Comment, we begin with Ukraine and the latest on the missile strike in Poland.  China news is up next, where we add color to yesterday’s Biden/Xi meeting.  Crypto bats third as trouble in that space continues.  Batting cleanup is economic and policy news, and after are comments on Mexico.  We close with odds and ends.

War in Ukraine:  The latest on the situation in Poland (quick take: de-escalation).

• Yesterday afternoon, a missile hit Przewodów in Poland, a small town of about 400 people, which appears to be about five miles from the Ukraine/Polish border. Russia had fired a series of missiles at civilian targets in Ukraine following Ukrainian President Zelensky’s terms for talks.  It appears that at least one missile crossed into Poland, killing two people.  Russia has denied any responsibility for the strike.
• The Polish government held an emergency security meeting and has called for consultations with NATO. Poland is a NATO member, and attacking a member could trigger an Article 5 collective defense event, which would pull NATO into the war in Ukraine.  The Polish Army was put on alert after the event.  Pictures said to be from the site suggest a sizable blast.  The G-7 also held an emergency meeting.  Late yesterday, President Biden indicated that the missile didn’t appear to have come from Russian soil.
• Most recent news suggests a de-escalation. This morning, Polish President Duda said that the explosion was an “unfortunate accident” and was not done intentionally.  The missile does appear to be Russian made, but Ukraine, being a part of the former Soviet Union, uses Russian and Soviet-era munitions.  It is possible that the missile was part of an anti-air strike by Ukraine; after all, Russia did unleash a wide missile strike.  Or it could have been an errant missile fired by Russia.  The bottom line is that NATO clearly does not want to turn this into an Article 5 incident.  The fact that Poland is calling the incident an accident suggests that this is not likely to escalate.
• What this situation does remind us of is that whenever an ordnance is in the air, accidents can happen. If the U.S. and NATO wanted to create a pretext for a broader war, they could have used this event for that purpose.  The Gulf of Tonkin incident triggered broader U.S. involvement in Vietnam, for example.  Russia is increasingly using “dumb” bombs and missiles due to its lack of semiconductors to build “smart” ones.  These “dumb” bombs and missiles are less precise and more likely to strike unintended targets.  Thus, there is a risk that the conflict could widen beyond Ukraine.  So far, the reaction of NATO is that they won’t be quick to escalate.  Perhaps the next worry should be that Russia, observing this reaction from NATO, becomes reckless, or perhaps assumes it can attack the periphery around Ukraine to disrupt weapons flow and training areas without repercussions.  For now, though, this situation appears under control, but there is a risk of a broadening of the conflict if Russia views the response as weakness.

China News:  What we see after Biden/Xi[1] and the unwinding of Zero-COVID.

• The Biden/Xi meeting looks like an attempt to stabilize relations, but likely nothing more. Fundamentally, both sides have diametrically opposed policy goals that are probably not reconcilable.
  • China is uncomfortable with a world breaking into blocs.[2] We note direct opposition to the concept in the CPC’s media mouthpieces.  President Xi met with the Dutch PM in a straightforward attempt to get AMSL (AMSL, $597.47) to reject U.S. policy which prevents China from acquiring the company’s semiconductor-etching machinery.  China’s economy is dependent on exports.  If the U.S. creates conditions where some markets are restricted, it will have a negative effect on China’s economy.  Beijing would prefer a world arranged bilaterally, whereas the U.S. would not.
  • Highlighting this issue are reports that China’s semiconductor output posted its largest monthly decline in October.
  • China is dealing with some serious economic issues. Its real estate sector is under great pressure and unwinding that problem will be costly.  Losing export business while addressing domestic issues would be damaging.
  • Treasury Secretary Yellen met with PBOC Governor Yi yesterday. It doesn’t appear that new ground was broken, but at least the two sides are talking.
• It is looking increasingly likely that the Zero-COVID policy is slowly unwinding. Although reported infection rates are rising, we are not seeing widespread lockdowns.  Instead, curbs are being relaxed despite the surges.  Why the change?  In part, it looks like Chinese citizens have had enough of the lockdowns.  Protests against them are increasing, forcing local officials to ease constraints.  We don’t think we will see an official, nationwide relaxation of restrictions but the local easing will likely boost economic activity in the coming year at the potential cost of rising infections.
• At the G-20 meeting, China rejected the term “war” when discussing the war in Ukraine, taking Russia’s narrative on the conflict. Western leaders at the meeting were pushing for China to reject Russia’s nuclear threats.
• U.S. and China are restarting military talks, but we note that on the Chinese side, Wei Fenghe, the current defense minister, will be replaced by Li Shangfu, who is under U.S. sanction for buying Russian arms. It’s not obvious how this will be resolved.
• The FBI is “extremely concerned” about China’s ability to influence social media via TikTok.

Crypto:  Here’s the latest on the continuing crisis in crypto.

• As Sam Bankman-Fried makes a last ditch effort to raise money, U.S. regulators are circling, increasing the odds that he could be facing prosecution. Part of the attractiveness of crypto is the absence of regulation.  Turns out, it’s a downside too.  The U.S. operated with a free banking system from the end of the Second Bank of the United States to the creation of the Federal Reserve (1836-1913).  In this period, banks would issue their own currency, and bank runs were common. Even under a gold standard, financial instability was the norm.  The evolution of regulation was an attempt to stabilize finance.  There is a cost, as an actor can’t do everything they want.  Watching crypto looks a lot like the free banking period since the issuance of money by individual financial institutions is an element of the earlier period.
• Contagion is occurring in the wake of FTX’s collapse. The crypto lender BlockFi has paused withdraws and restricted activity and is preparing for a bankruptcy filing.  BlockFi was rescued by FTX this summer when the plunge in cryptocurrencies threatened insolvency.  It was using FTT, FTX’s own coin, to extend credit.  With the collapse of FTX, BlockFi’s assets are likely worth much less, making the company vulnerable to a run.
  • Although the FTX situation continues to weaken the crypto space, so far, the traditional financial system has not shown signs of trouble. The Fed is working with banks on the crypto custody issue.
• Major players in the crypto industry are turning on Bankman-Fried.
• Binance is proposing an industry recovery fund, most likely to head off further contagion and to fend off the regulators.
• On a related note, the NY FRB is testing a digital dollar.

 Markets, Economics and Policy:  George warns on the economy and childcare remains a problem.

• KC FRB President George noted that it is likely impossible to lower inflation without triggering a recession. We would agree.  George is a traditional hawk but has been an unexpected voice of moderation in this tightening cycle.
• The lack of childcare may be a major reason why the labor markets remain tight. The BLS estimates that 104k members of the labor force were not working due to childcare issues.  These may include problems due to illness or the lack of affordable care.
• Home equity lines of credit are expanding. Collectively, homeowners are still sitting on large amounts of net equity and may not want to buy a new home due to current mortgage rates and weak affordability.  Tapping home equity is a way to acquire funds.  However, if nominal home prices fall, those lines could be at risk.
• As we note below, U.K. inflation hit a 41 year high of 11.1%.
• A bill to limit companies’ use of non-disclosure agreements looks like it will pass soon.

On the international front, Mexico’s President Andrés Manuel López Obrador (AMLO) is facing increasing unrest, with protesters opposing his increasingly heavy-handed rule.  The latest problem is his plan to “reform” Mexico’s election system.  Critics argue it will make his party dominant, creating conditions similar to the PRI’s dominance after the Mexican Revolution.  For years, the PRI operated a single party state.  AMLO seems to want to return to that period and this latest effort is part of that plan.  If AMLO is thwarted, his party is likely to lose influence.

Odds and Ends:  Odd news items that caught our attention this morning.

• In the early days of online purchasing and banking, older friends and family members argued that such transactions couldn’t be safe, and that they would continue to write checks. Turns out that the latest hot criminal scam involves paper checks.  Thieves are rifling through the mail to get checks, which they then add their own names or others in the scam to pull funds from checking accounts by using a chemical processes to erase the original payee and amount.
• Running a marathon is a hard; doing it while chain smoking is even harder.

[1] See what we did there?!

[2] See our bloc analysis in the BWGR section.

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