Daily Comment (September 7, 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, including the latest on the Ukrainian counteroffensive to retake Kherson and an apparent new counteroffensive in the country’s north. We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, with a particular emphasis on the energy and economic challenges in China and Europe.
Russia-Ukraine: Ukrainian forces continue to press their counteroffensive to retake the Russian-occupied city of Kherson in the country’s south, although with an emphasis on surgical missile and artillery strikes against logistics nodes, communication lines, and command centers rather than massed attacks to seize large swaths of territory. The Ukrainian counteroffensive appears to be progressing methodically around Kherson, but it is also creating opportunities for the Ukrainians elsewhere. As Russia redeploys its forces from occupied areas in the north and east of the country, the Ukrainians have made some gains against the remaining troops in those areas. For example, reports indicate that yesterday the Ukrainians seized some territory north of Kharkiv.
- Separately, Russian President Putin has threatened to curtail the export of grain from Ukraine again, falsely charging that the West has been deceiving the developing world by largely keeping the Ukrainian grain exports set in motion by a recent Turkish-brokered deal for itself. So far, the statement has had little discernible effect on global grain markets. However, trading on those markets could turn volatile again if it begins to look like Russia will follow through on Putin’s threats.
- While the war has been devastating to much of Ukraine’s industrial base, one industry is benefiting from the country’s unexpected success in standing up to the Russian military. New reports say Ukraine’s defense industry is enjoying a spike in demand from foreign customers interested in securing weapons proven in combat against Russia’s invasion. The Ukrainian weapons being exported include the very successful “Skif” man-portable anti-tank missile and the Corsar light portable missile system.
European Energy Crisis: As part of its effort to manage Russia’s cutoff of natural gas supplies and spiking energy prices, the European Commission plans to recommend that EU governments impose a windfall levy on revenues generated by non-gas electricity producers when market prices exceed €200 per MWh, less than half the current market price. The funds raised by the levy would then be redistributed to help companies and households deal with the crisis.
- EU leaders hope the threshold price is high enough to incentivize further investment in alternative energy sources and encourage energy conservation by businesses and households, while also limiting the politically dangerous price hikes for end users.
- Channeling the funds raised by the levy may be especially important for Europe’s industrial users, as we continue to see reports of production facilities being shut down because of the high cost of energy.
United Kingdom: In contrast with the EU’s approach, newly minted Prime Minister Truss said in her first parliamentary question-and-answer session that she continues to oppose additional windfall taxes and promised that her government would unveil its energy support package this week. Truss’s plan is expected to involve a cap on household energy bills of around £2,500 and include some sort of mechanism for the government to make up the difference for energy producers.
Chinese COVID-19 Lockdowns: To give a sense of how extensive China’s latest COVID-19 lockdowns have become, the country’s media is reporting that 33 cities and an estimated 65 million people were under some sort of lockdown as of Saturday, making this the broadest outbreak since early 2020.
- The new lockdown is also likely to intensify ahead of the Communist Party’s pivotal 20th National Congress starting in early October. In all likelihood, the restrictions will further weigh on Chinese economic growth, presenting additional headwinds for the global economy.
- The prospect of weaker demand in China continues to weigh on global commodity prices, along with the impact of rising interest rates and the strong dollar.
Chinese Trade: The August trade surplus narrowed to just $79.4 billion, far short of the expected surplus of $92.7 billion and down from a surplus of $101.3 billion in July. Exports in August were up just 7.1% year-over-year, slowing markedly from their gain of 18.0% in the year to July and illustrating how weak demand overseas is weighing on the Chinese economy. Perhaps more importantly, imports in August were up just 0.3% year-over-year, reflecting how factors like constant COVID-19 shutdowns and government clampdowns on sectors like technology and real estate are sapping the country’s own domestic demand.
Japan: The yen continues to depreciate rapidly so far this morning, with the currency down some 1.9% from its close yesterday to trade at 144.77 per dollar. If sustained, the drop in the yen today will be its biggest since June and will leave the currency down 19.8% year-to-date. As long as the Federal Reserve and other major central banks continue to hike interest rates while the Bank of Japan holds rates steady, the yen could keep losing value.
U.S. Monetary Policy: In an interview with the Financial Times, Richmond FRB President Barkin insisted that the Fed must lift interest rates to a level that restrains economic activity and keep them there until policymakers are convinced that inflation is subsiding. Barkin’s statement underlines the message in Chair Powell’s recent speech at Jackson Hole.
- Barkin’s statement suggests investors should not discount the possibility that U.S. interest rates will be hiked much further and stay at high levels longer than many observers expect.
- Indeed, it is looking increasingly likely that the policymakers will implement another 75 bps rate hike at their next policy meeting occurring September 20-21.
U.S. Health Policy: The federal government plans to recommend that people get COVID-19 boosters once a year, starting with the new shots that are rolling out right now. The new guidance is a shift from the government’s current practice of issuing new advice every several months. Authorities hope that coordinating COVID-19 shots with people’s annual flu shots will boost the number of people getting boosters.
U.S. Travel Industry: According to the Transportation Security Administration, Labor Day 2022 was the first post-pandemic holiday in which airline travel surpassed its pre-pandemic high. The TSA said 8.76 million travelers went through its checkpoints between Friday, September 2 and Monday, September 5, compared with 8.62 million passengers over the long holiday weekend in 2019. The figures underscore how the travel industry in particular, and the service sector in general, continue to recover well on the back of pent-up demand.
U.S. Oil Industry: In a public letter, conservative activist investor Vivek Ramaswamy has urged Chevron (CVX, $157.12) to be less beholden to ESG sentiment, slow its transition to renewable energy, and pump more oil to take advantage of today’s high prices. Despite the influence Ramaswamy wields, it’s not clear whether Chevron or any other oil company will heed his call. Nevertheless, it will be interesting to see if his call marks the beginning of stronger pushback against ESG investing orthodoxy.
U.S. Electricity Industry: California Governor Newsome has warned that the state’s current heatwave is taxing the electricity grid and could lead to rolling blackouts. According to Newsome, the state will maintain a number of emergency measures to reduce demand. He also called on consumers to continue conserving electricity, a move that could have some negative impact on California’s economy this month.