Daily Commentary

Providing succinct, entertaining and savvy thinking on global capital markets. Our goal is to provide discerning investors the most essential information and commentary to stay in tune with what's happening in the markets, while providing unique perspectives on essential financial issues. And just as important, Fisher Investments MarketMinder aims to help investors discern between useful information and potentially misleading hype.

It Still Isn’t Easy to Pass a Global Minimum Tax

Editors’ Note: This article touches on politics, so we remind you that MarketMinder favors no politician nor any political party and assesses developments solely for their potential impact on markets, economies or personal finance.

Last fall, when 137 nations including tax havens Ireland, Estonia and Hungary agreed to sign onto a global minimum corporate tax deal, many observers presumed the years-long process had taken its toughest step—the path to passage was now clear! We never really agreed, though, and have long harbored doubts that this process will deliver results. If it does, it won’t happen fast, limiting the market impact. We got more evidence supporting that skepticism Tuesday.

For the uninitiated, the global corporate minimum tax is an Organization for Economic Cooperation and Development-led initiative to ensure countries get a slice of revenue generated within their borders and arrest “a race to the bottom” in which countries try to lure large corporations to domicile within their borders using lower and lower tax rates. The deal signed last fall has two prongs, or “pillars.” The first aims to resolve fairness disputes about which country gets what tax revenue. It exclusively governs companies with global sales exceeding €20 billion ($22 billion) and “profitability” above 10%, transferring taxing rights over these firms from their home countries to those where the sales actually took place.[i] Given the parameters, “Pillar One” would presently affect about 100 companies globally, half of which are US-based.

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The Big Fed News That Surprised Next to No One

They did it! The Fed, we mean—they finally raised the fed-funds target range by a quarter point Wednesday, in perhaps the most telegraphed monetary policy decision of all time. And in response, stocks fell … and then jumped, taking the S&P 500 from about flat on the day an hour and a half before market close to a 2.2% full-day rise.[i] If that isn’t a sign markets already priced the Fed’s action and moved on, we don’t know what is.

Now, don’t read into that short-term wiggle—it reeks of algorithms and traders teeing off on the news. It is just the funky goings-on that stock markets experience daily. Trying to interpret one hour’s worth of movement is bad for your mental health and highly unlikely to yield any useful conclusions. More importantly: Stocks pretty clearly took the news in stride, when all was said and done. We think that is the right reaction. Moving the target range from 0.0 – 0.25% to 0.25 – 0.5% is not exactly draconian tightening. With 10-year Treasury yields also up in recent days, it doesn’t much flatten the yield curve. Interbank liquidity should remain abundant. Annoyingly, savings and checking account rates will probably remain pitiful, as banks are flush with deposits—they don’t need to attract more. Anyone looking at a long-term chart of the fed-funds rate would be hard pressed to even see the change.

Some argued the rally was one of relief that the Fed is still focused on containing inflation despite some stirring fears that the economy is weakening. There, too, we won’t try to interpret two hours’ worth of sentiment, but conceptually, it falls flat. Today’s elevated inflation rate comes from factors outside the Fed’s control. A rate hike won’t increase oil and gasoline supply, straighten out supply chain kinks, fabricate semiconductors or achieve peace in Ukraine. It probably won’t even tamp down demand. At these levels, it is pure symbolism. On the bright side, as we discussed earlier this week, many of those inflation drivers are already sorting themselves out, which points to the inflation rate moderating over the foreseeable future regardless of what the Fed does. But we have a hard time believing the market’s collective wisdom really views the Fed as moving the needle on prices today.

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Energy Inflation, Gas Taxes and Markets’ View

Editors’ note: While inflation is a politically charged subject, our commentary addresses its economic, market and personal finance impact only.

Driven by gas, the US consumer price index (CPI) accelerated to 7.9% y/y in February.[i] Moreover, that read preceded March’s energy spike tied to Russia’s escalating war in Ukraine, which temporarily sent oil as high as $139 per barrel—and US national average gas prices to a record-high $4.33 per gallon.[ii] Many Americans, especially those who drive a lot for work and other responsibilities, may be feeling a pinch. It is also fueling fears of further inflation ahead, prompting some to call for action—like temporarily waiving gas taxes. But for investors, we think it is important not to overrate the effect—or staying power—of these higher prices.

Month-over-month, February’s CPI rose 0.8%, with gas’s 6.6% monthly gain responsible for a whopping one-third of the headline figure.[iii] That is a huge contribution, considering gasoline’s share of the CPI basket is just 3.7%.[iv] With gas now up 18.2% in March, expect a much larger contribution—and further bump in CPI—if pump prices stay elevated.[v] Exhibit 1 shows how much energy has contributed to monthly inflation.

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China Offers a Little Regulatory Clarity

Editors’ Note: In the course of discussing a broader topic, this article touches on a couple of individual companies. As a reminder, MarketMinder doesn’t make individual security recommendations. Those mentioned are merely to support the broader discussion.

What a difference a day makes! On Monday and Tuesday, as investors digested news of a lockdown in Shenzhen—a high-tech manufacturing powerhouse—Chinese stocks fell -13.3%, extending a slide that began over a year ago.[i] This also followed a selloff last week, when a few small, US-listed Chinese firms were put on delisting watch by the SEC. Yet Wednesday was very different. In the early morning US time, the Chinese State Council’s Financial Stability and Development Committee (FSDC) announced several new measures to help calm markets, some of which hit the chief causes of the last year’s slide. Now, the last time they tried a large intervention, in January 2016, it stoked fear, causing a drop. Yet today, markets leapt, suggesting officials have learned from prior mistakes and seem aware of the issues impacting investors’ confidence. Time will tell if this recovery holds, but for now, the direct response to investors’ concerns is encouraging.

By definition, Chinese stocks are in a bear market. Their peak-to-trough decline breached -20% and is now over a year old. But its shape is more correction-like, as the decline occurred in a series of panicky plunges as investors reacted first to some regulatory changes, then defaults of distressed property developers, and now the latest COVID lockdown. Also more correction-like, in our view, sentiment seemed largely detached from reality throughout, with rumors and fears far exceeding the scope of the actual regulatory changes. For instance, as we wrote last year, when Chinese officials disrupted private tutoring firms and jawboned about tightening the strings on giant Tech-like companies, investors responded with a big sell-off in the latter—even though actual measures taken ended up quite small and didn’t much disrupt earnings. But the unpredictability and lack of transparency around the measures stoked many and varied fears. Draconian policies didn’t follow, but the impact on sentiment was understandable.

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Putting China’s ‘Acceleration’ in Proper Context

If ever you needed proof that economic data are backward-looking, China delivered it in spades today. The country’s official economic data for January and February, which the National Bureau of Statistics (NBS) combines to remove skew from the Lunar New Year holiday week’s shifting timing, accelerated and beat expectations across the board. Yet there wasn’t much cheer: Investors remained much more preoccupied with COVID’s resurgence in the country, which has caused stiff new lockdowns in Shenzhen—a high-tech manufacturing hub—and seemingly renewed negative sentiment toward Chinese stocks. Now, we don’t think this is likely to be a huge headwind for the Chinese or global economy over a meaningful stretch of time, but we do think it helps put the latest data in context.

In a vacuum, the January/February numbers were encouraging. Retail sales growth accelerated from 1.7% y/y in December 2021 to 6.7%, while industrial production sped from 4.3% y/y to 7.5%.[i] Fixed investment, measured on a year-to-date, year-over-year basis, sped from December 2021’s 2.3% increase from 2020 to 12.2% versus 2021’s first two months.[ii] The latter is probably easiest to interpret: As growth slowed last year, Chinese officials ramped up fiscal stimulus efforts. That infrastructure spending shows up rather quickly in fixed investment, which is a nice early boost, but it remains to be seen how much fruit this will bear in the real economy. That depends on how the new spending recirculates, which takes time.

As for industrial production, the acceleration from autumn’s figures likely stems partly from the easing of China’s electricity shortage. Back in October, when European wind and natural gas were in short supply, it triggered a run on energy inputs globally, which cut into China’s supply. The resulting brownouts hampered local factories. But those problems have largely evened out, thanks in part to Chinese coal companies’ swift response, which enabled factories to return to their normal production schedules as 2022 kicked off. The easing semiconductor shortage also helped factories that assemble final products. Additionally, the Omicron-related regional lockdown in Xian ended in January, enabling people there to get back to work. It is also noteworthy that the sharp acceleration occurred despite the factory closures associated with the Beijing Olympics.

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$100+ Oil Isn’t a Tipping Point

With the tragic events unfolding in Ukraine right now, financial market and budget impacts may seem small in comparison. Nevertheless, the conflict and the international community’s response have spurred oil prices to climb, and with them, gasoline prices—a real financial concern to many Americans as oil sits above $100 and some outlets forecast the national average gas price will soon hit $5 per gallon. As we wrote a few weeks ago, oil’s latest spike seems mostly sentiment-driven, and longer-term supply and demand drivers still suggest prices should stabilize sooner rather than later, even with uncertainty surrounding Russian oil supply roiling markets. However, some pundits speculate elevated oil prices will tip the economy into recession. While oil’s record prices did coincide with 2008 – 2009’s recession, coincidence isn’t causality. Oil’s hitting any level has no direct bearing on broader economic activity. Oil’s rise and recent surge don’t automatically foretell weaker growth.

The US economy doesn’t have a set relationship with oil prices. When oil spent much of 2011 – 2014 above $100, no recession ensued. Conversely, while high oil coincided with recession in 2008 – 2009, the issue then was mark-to-market accounting rules’ incinerating bank capital unnecessarily and the government’s haphazard, panic-sowing response—not oil. Counterintuitively, falling oil prices created a US economic headwind in the last decade. When oil prices collapsed in 2014, it caused US producers to cut back. One of the largest GDP detractors over the next two years was oilfield machinery investment. In 2015’s second half, it caused GDP’s sharp slowdown. Higher oil prices have the opposite effect on GDP, incentivizing more investment.

Second, the popular reason why oil allegedly dictates the economy’s direction is flawed. High oil prices hit households in the pocketbook, diverting consumer spending from more fun destinations—but from an overall economic perspective, fuel costs still count as spending. That means they contribute positively to GDP. Not that GDP is the be-all, end-all, but it shows casting high oil prices as an automatic economic negative isn’t accurate. High gasoline prices create winners and losers within consumer spending and can shift activity, but non-fuel spending is pretty resilient. Exhibit 1 shows personal consumption expenditures (PCE) excluding energy and retail sales excluding gasoline stations (a narrower measure focused on goods). They hit record highs in January, even with oil’s climb to $89 that month from $48 per barrel starting 2021.[i]

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What to Make of Today’s Dour Surveys

You don’t need us to tell you moods are down right now. Inflation is elevated, oil prices are up and all eyes remain on Ukraine. As ever, though, a key challenge for investors is to tune that down long enough to look forward and ask, “How much of this dour news do markets already reflect?” In our view, stocks’ drop since January largely reflects these factors. There is no silver bullet that will give you a perfect view of the extent to which prices reflect sentiment. But looking to what people have said in recent surveys can help reveal the magnitude of sentiment’s plunge following Russia’s invasion—helping illustrate what markets have pre-priced.

Even before Russia’s invasion of Ukraine on February 24, polls found consumers and businesses feeling dour. The main reason: inflation. In the US, both The Conference Board and the University of Michigan’s sentiment surveys of American consumers dipped in February. The former reported fewer consumers plan to make big-ticket purchases (e.g., cars or vacations) in the next six months, while the latter fell to its lowest level in 10 years. Per a February Gallup poll, 42% of Americans described the economy as “poor” and “getting worse,” up from January. Interestingly, only 2% called the “situation with Russia” an important problem facing the country—likely a reflection of the pre-war survey period, as responses were taken from February 1 – 17.

Similar themes emerged overseas before Russia’s barbaric act. Research firm GfK found consumer confidence in both the UK and Germany worsened in February, with rising prices cited as the main concern. However, surveys weren’t universally negative. The ZEW Indicator of Economic Sentiment for Germany improved in February as respondents anticipated easing COVID restrictions and an ongoing economic recovery. In Australia, a National Australia Bank survey of business conditions rebounded in February, with firms crediting a slowdown in Omicron cases and an easing of supply bottlenecks. Even a Financial Times/University of Chicago survey of macroeconomists conducted on the eve of war, February 21 – 24, put “geopolitical tensions tied to Ukraine” fourth on the list of things that could pause Fed interest rate hike plans. Not that it will do so, but we think those answers would be radically different in a poll taken today—a point more recent surveys illustrate well.

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Detailing the West’s Russian Oil Plans and Bans

Editors’ note: This article touches on politics and policy. Please note that MarketMinder favors no party nor any politician. We assess policy solely in terms of how it may (or may not) affect markets and the economy.

Last Friday, we discussed draft legislation circulating in Washington that would ban US imports of Russian oil products, noting that it had some bipartisan support and could pass. Tuesday, President Joe Biden rendered that aspect of our coverage rather irrelevant, issuing an executive order that bans the US from importing, “Russian crude oil and certain petroleum products, liquefied natural gas, and coal.”[i] UK Prime Minister Boris Johnson unveiled a relatively similar action the same day. The EU? Well, it issued a plan—not a ban. That last point is crucial, in our view. While the US and UK bans are mostly symbolic, the EU-Russia energy relationship runs deep. In our view, speculation over it likely explains much of oil prices’ volatility lately, making developments there worth watching. However, it is worth noting that nothing announced to date fundamentally alters EU-Russia energy trade.

The Biden administration’s ban immediately bars firms from entering into new contracts involving Russian oil. The move establishes a 45-day grace period for deliveries of previous purchases to reach US ports.[ii] The UK ban is a bit different. It doesn’t take effect immediately, permitting Russian oil and gas to flow into the country through yearend. As UK Business Secretary Kwasi Kwarteng put it, “This transition will give the market, businesses and supply chains more than enough time to replace Russian imports.”[iii] So it is a ban that bans in roughly nine months.

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Russian Default’s Limited Financial Fallout

All eyes continue to track the horrific war in Ukraine this week. But a related factor is also gaining prominence: Chatter over a Russian sovereign bond default is rising after the country failed to complete an interest payment to foreign holders of Russian bonds last Wednesday. The miss starts the clock ticking on a 30-day grace period. If that expires and bondholders don’t receive their money, it will be in technical default. Although this prospect seems to be stirring some fears—and memories of 1998’s Russian default, part of a larger Emerging Markets (EM) debt crisis—we don’t think a chain reaction is likely to stem from this.

Interestingly, Russia’s debt service failure initially appeared to be mutual. While Russia’s Ministry of Finance sent coupon payments to foreign holders of ruble-denominated sovereign debt, known as OFZs, the Central Bank of Russia (CBR) halted Russia’s National Settlement Depository from making payments to foreign clients.[i] Russian “President” Vladimir Putin overruled this policy on Monday, stating that he would permit the payments to go through—even to creditors in nations he considers hostile.[ii] However, another issue remains: Western clearing systems used to settle these payments stopped accepting them due to sanctions.

While such a default is unusual—Russia has plenty of rubles in its coffers to pay if allowed—it doesn’t change the effect on bondholders. Foreign investors in Russian OFZs could face substantial losses, if not complete write-offs—on top of the huge ruble depreciation they have already felt. The same fate could await foreign holders of dollar- and euro-denominated Russian debt, too. Payments on such bonds are scheduled for March 16, and markets reflect a high likelihood they will go unpaid.

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The Fed’s ‘Average’ Is More ‘Flexible’ Than ‘Target’

Here is an assignment that, in theory, should be simple: Compute the average of an economic data series over the medium term. Just pick one—retail sales, industrial production, inflation, whatever! The data are pretty easy to find—and freely available—at the St. Louis Fed’s data tool, FRED. But here is the thing: You can’t do it. Why? We didn’t give you enough information. “Medium term” is a fuzzy, unspecified period. Which brings us to the Fed and inflation. The Fed has come under fire for the inflation rate far exceeding its 2% (ish) target. Some suggest it should chuck that target outright, lest it lead the central bank to overreact to spiking oil prices and risk hiking rates aggressively as the economy slows. What they miss: The Fed did that in August 2020. We argued this at the time, and it bears repeating, as knowledge is power for investors.

When Congress established the Fed’s dual mandate with 1978’s Humphrey-Hawkins Full Employment Act, there were no numerical targets—just marching orders to pursue maximum employment while promoting price stability. No one interpreted “price stability” as zero inflation, as most everyone accepts that some inflation is a healthy side effect of a growing economy, which usually means more money in circulation. Conventional wisdom globally eventually zeroed in on a 2% annual inflation rate as reasonable, and many central banks have long had that rate as their target. The Fed followed suit officially in 2012, establishing a target of 2% y/y for the headline Personal Consumption Expenditures Price Index (PCE).

Between then and August 2020, the Fed managed to hit that target all of three times.[i] For most of that span, inflation undershot 2% y/y, despite all the alleged “stimulus” sloshing around courtesy of quantitative easing (QE). Thus, there developed a view that the target itself was the problem—that the Fed was still acting as if 2% were a hard ceiling and thus keeping policy tighter than it otherwise could be. One school of thought argued central banks should target a certain level of nominal GDP growth instead. Another claimed that if central banks merely targeted an “average” inflation rate, it would give them more latitude as periods of higher inflation would cancel out periods of below-target price increases, thus enabling the Fed to step on the gas.

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