Daily Comment (November 21, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with a discussion of how the recent cooling in U.S.-China tensions seems to be worrying Russia.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including what is likely to be a painful government spending freeze in Germany, a report showing cooler price inflation in Canada, and an overview of a key U.S. earnings report due out after market close today.

China-Russia-United States:  At an international cultural forum in St. Petersburg last week, Russian President Putin went to extraordinary lengths to tout current China-Russia relations, claiming the relationship has progressed to the point where it is now “truly unique” and had “never reached such a height and quality in the history of our states.”

  • According to experts in China-Russia relations, Putin’s obsequious remarks (technically known as “brown nosing”) were probably an effort to curry favor with Beijing and remind Chinese leaders of Russia’s value as a geopolitical partner, even as President Xi works to cool tensions with the U.S.
  • If so, Putin’s insecurity reflects how dependent Russia has become on China as the junior member of the evolving China/Russia geopolitical bloc. Putin’s insecurity underscores that Russia has much to lose if U.S.-China relations improve.

China-Saudi Arabia:  The People’s Bank of China and the Saudi Central Bank yesterday said they have agreed on a three-year currency swap program totaling up to $7 billion.  The swap facility will support Beijing’s effort to internationalize the renminbi (CNY) and reduce the two countries’ dependence on the dollar for bilateral trade and investment.  In the long run, such efforts may contribute to the ongoing gradual decline in global demand for the greenback.  In the near term, however, our research suggests the dollar will be buoyed by other factors, such as the U.S.’s current innovation and capital investment cycle.

China:  The National Data Administration proposed by Beijing early this year has now been established as a unit of the National Development and Reform Commission.  Taking over some of the responsibilities of the Cyberspace Administration of China, the NDA is expected to play a key role in China’s future digital development.  Its responsibilities include drawing up development plans, establishing common standards for data storage and sharing, regulating digital industries, and promoting the digitalization of public services.

  • Establishment of the NDA shows how China is working feverishly to advance its digital industries and leapfrog the U.S in technology.
  • Nevertheless, based on the Chinese government’s recent record, the NDA is probably just as likely to over-regulate as it is to promote China’s digital economy. If the NDA tightens regulation and state control too much, it could stymie Chinese firms’ innovation.  Greater state control over China’s digital industries could also invite further U.S. limits on bilateral data and technology flows.

Taiwan:  Yesterday, Vice President Lai Ching-te, the current front-runner in January’s presidential election, named the island’s envoy to the U.S. as his running mate.  The move probably helps consolidate Lai’s advantage in the race, especially since the opposition Kuomintang and Taiwan People’s Party have hit a roadblock in their effort to form a joint ticket to better challenge Lai.  Even though the Kuomintang and the TPP last week agreed to explore a joint ticket, they failed over the weekend to agree on which party would get to field their candidate.

Japan:  Early indications suggest corporations will again boost their pay rates in 2024, largely matching the big raises they offered in 2023.  The planned wage hikes reflect both labor shortages and workers’ demand for increased income to compensate for continued high price inflation.  If companies follow through with the planned hikes, the Bank of Japan would be more likely to abandon its longstanding loose monetary policy.

Germany:  The government has announced it will freeze spending for the rest of the year in response to a recent court ruling that the constitutional “debt brake” prevents transferring unused emergency pandemic funds to finance the government’s big green energy program.

  • Chancellor Scholz and his government are now working feverishly to decide how much of the green energy program to retain and whether to fund it by tax hikes, spending cuts elsewhere, or both.
  • In any case, the spending freeze will probably be a further headwind for the German economy, on top of other factors such as high energy prices, high interest rates, weakening global demand for German exports, and poor demographics.
  • Given the huge size of Germany’s economy, its slowing growth will likely be an important drag on the overall European economy in the near term.

Netherlands:  Ahead of tomorrow’s parliamentary elections, new public opinion polling shows far-right, anti-Islam firebrand Geert Wilders and his Freedom Party are now tied for first place with the liberal VVD party of outgoing Prime Minister Mark Rutte.  Under the Dutch electoral system, the polling suggests the most likely outcome of the election will be a right-wing coalition government.

United Kingdom:  Treasury Secretary Trott confirmed that Chancellor Hunt will propose cutting both corporate and personal income taxes when he delivers his “Autumn Budget Statement” on Wednesday.  Although justified as a reasonable move to promote economic growth now that British inflation has come down sharply, the tax cuts are widely seen as an effort to boost the Conservative Party’s lagging support in public opinion polls.  Given the planned rise in other levies, many voters will still likely see their overall tax burden increase in the coming years.

Canada:  Consistent with recent trends in other key developed countries, the October consumer price index was up just 3.1% from the same month one year earlier, slowing from the gains of 3.8% in the year to September and 4.0% in the year to August.  Excluding the volatile food and energy components, the October Core CPI was up 3.4% year-over-year.  That marked a slight acceleration from the previous month’s core inflation; the average of the Bank of Canada’s preferred trimmed mean and weighted median measures for underlying core inflation was 3.55% in the year to October, decelerating from 3.8% the month before.

United States-Israel-Hamas:  Illustrating how there is still a risk that the Israel-Hamas conflict could widen, the Israel Defense Forces and many Israeli citizens are increasingly agitating for Prime Minister Netanyahu to approve stronger attacks on the Iran-backed Hezbollah militants who are launching harassment fire into northern Israel from southern Lebanon.  Meanwhile, in the U.S., the Defense Department and some Congressional leaders are pressuring President Biden to retaliate more strongly against other Iran-backed militants in the region, who have now launched 61 separate attacks on U.S. military bases since the Israel-Hamas conflict began on October 7, injuring dozens of U.S. personnel.

  • If intensifying political pressures in the U.S. or Israel lead to stronger military attacks against the various Iran-backed militants in the region, the militants and potentially even Iran could respond with even stronger attacks.
  • As the U.S. presidential election draws closer, Biden may be especially vulnerable to domestic political pressure. His administration is already gaining a reputation for being excessively cautious in foreign policy, so he may feel compelled to unleash the U.S. military to avoid looking “soft on defense.”

U.S. Artificial Intelligence Industry:  In a continuation of the chaos at artificial intelligence darling OpenAI, virtually all the remaining employees of the for-profit AI unit have warned they will resign and seek to follow former CEO Sam Altman to Microsoft (MSFT, $369.84) unless the nonprofit governing board resigns en masse and brings Altman back.  The employees’ threat underscores how the for-profit AI unit’s brash, risk-on approach to the technology clashed with the nonprofit board’s much more cautious approach.  In broader terms, how societies handle the clashing visions between rapid AI development and cautious regulation could profoundly affect the technology’s progression over the coming years.

  • Meanwhile, major U.S. stock price indexes weighted by market capitalization may be heavily influenced today and tomorrow by AI chip giant and “Magnificent Seven” member Nvidia (NVDA, $504.09), as investors look ahead and then respond to its latest quarterly earnings report, due out after market close today.
  • Wall Street analysts currently expect Nvidia to report quarterly sales of $16.2 billion, almost triple its $5.9 billion in sales for the same quarter last year. The analysts expect the company’s quarterly profit to come in at $7.2 billion, more than 10 times its profit of $680 million one year ago.
  • Despite those projections, it’s important to remember that Nvidia has beat expectations in 19 of the last 20 quarters.  If the firm fails to beat this time around, or if it fails to confirm the market’s rosy long-term expectations, the stock could fall and pull down the indexes.

The Daily Comment will go on hiatus beginning Wednesday, November 22, and will return on Monday, November 27. 

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