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.

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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Into Perspective: America and Russian Oil

Editors’ Note: This article addresses some political developments, so please note that MarketMinder is intentionally nonpartisan, favoring no party or any politician. We assess such matters solely for their potential economic, market and/or personal finance impacts.

While the West’s response to Russia’s war in Ukraine so far lets the world continue buying Russian energy, a bipartisan coalition led by Senators Joe Manchin and Lisa Murkowski is attempting to change this. New legislation, if passed, would ban US imports of Russian fossil fuels, including crude oil, refined petroleum products, natural gas and coal. Beltway observers think the legislation has a decent shot of passing and—while the vast majority of the country is probably behind this from a humanitarian and geopolitical standpoint—there has long been concern that the US, like Europe, now relies on Russian energy. If that is indeed true, then banning Russian oil would potentially cause a severe shortage, driving prices even higher. Yet a quick look at some US oil production data should quash this fear.

Now, much of this fear stems from politics, tied to some outlets’ over-simplified portrayals of the Biden administration’s energy policy. As the story allegedly goes, the US was energy independent[i] until January 2021, when Executive Orders canceling the Keystone XL pipeline and halting leases and permits to drill on Federal lands quashed US oil production, leading to high imports from Russia to fill the shortfall. That is the background, which we present so that all of you, dear readers, are on the same page.

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January Pointed Positively for the US Economy

In some non-Russia-Ukraine financial news, January numbers came out for several widely watched US economic datasets last Friday. Despite worries ranging from rising prices to Omicron, the results largely exceeded expectations. January’s growthy figures suggest the US economy is on solid footing and remains more resilient than many appreciate—useful perspective given all of today’s alleged economic headwinds.

The latest personal consumption expenditures (PCE) price data led most headlines, as the Bureau of Economic Analysis’s (BEA’s) headline price index is the Fed’s preferred gauge. That measure rose 6.1% y/y in January, its fastest rate since 1982.[i] The “core” PCE price index (which excludes volatile food and energy prices) accomplished a similar feat, rising 5.2% y/y—its quickest pace since 1983.[ii] On a monthly basis, the PCE price index climbed 0.6%, in line with its growth rate over the past three months.[iii] Now, the BEA’s price data don’t reveal much new since other gauges, including January’s CPI and PPI, paint a similar picture.

However, the BEA did find January consumer spending held up despite rising prices. January retail sales (3.8% m/m) hinted at this, though some questions remained. The Census Bureau doesn’t apply inflation adjustments to retail sales, and retail trade doesn’t include most services spending, which comprise the lion’s share of household expenditures.[iv] PCE rounds out the picture. January’s real (i.e., inflation-adjusted) PCE rose 1.5% m/m, with goods spending (4.3%) stronger than services (0.1%).[v] The split isn’t a big surprise, given the Omicron variant kept workers and consumers home. That weighed on people-facing services industries in particular, including restaurants and bars (-1.3% m/m), hotels and motels (-3.5%) and air travel (-0.9%).[vi] While one month of data, positive or negative, doesn’t make a trend, growth in the face of higher prices reveals strong consumer demand—and counters worries elevated prices are an automatic negative for a large swath of US economic activity.  

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Big Speech, Little News

President Joe Biden delivered the State of the Union address last night, and if we are judging purely on the mechanics, we must give his speechwriters demerits for committing a cardinal offense: saving the thesis for the end of the speech.[i] But aside from taking an hour to say the state of our union is strong, the message was overall what most observers expected. It started with a rousing statement of support for Ukraine and ode to the fearless people defending their country and way of life, which earned thundering—and well-deserved—bipartisan applause. We, too, were moved when Americans stood as one to support courageous people fighting for freedom. Yet that first section was really about the only fresh content. Everything that followed—the traditional, homeland-focused discussion—was a rehash of old initiatives and stalled legislation. Whether you find the proposals beneficial or counterproductive, there was nothing new, nothing markets haven’t already chewed over to death—and nothing that looks likely to become law anytime soon. In our view, nothing in this speech should be jarring—or rocket fuel—for stocks.

As always, whenever we discuss politics, please bear in mind we are approaching the issue as markets do. Stocks aren’t partisan and don’t focus on personalities, tone or any of the other subjective trappings. They also don’t really deal in “good” and “bad,” which are often just opinions anyway. For stocks, we think there are generally two main questions. One, do policies that risk creating winners and losers have a realistic chance of passing? Two, are they likely to pass in a form that is more extreme than what markets have already priced in? In other words, is there any surprise power? This is the lens through which we examine the State of the Union’s economic discussion.

It started with a verbal victory lap over last year’s American Rescue Plan and bipartisan infrastructure bill, touting all the money the latter will inject into the US economy and the long-term fruit improving roads and bridges will bear. Fair enough, but stocks are already quite familiar with this, and as we showed last year, the funds deploy too slowly to have much of a cyclical economic impact. Whatever your opinion of its merits, we don’t think it qualifies as economic stimulus.

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Ukraine’s Fog of War and the Correction

Filtering information is one of investors’ most important tasks. It is hard enough in the best of times, but right now, the fog of war is making it all but impossible—and we aren’t talking about the myriad reports of fake images and video footage coming out of Russia and Ukraine. The fog is also engulfing a lot of the economic commentary, obscuring a clear assessment of developments’ impacts over the weekend and on Monday and stoking a lot of this time is different-style commentary. But as tough as it may be to see, we don’t think much has changed for investors since our discussion of sanctions late last week. The latest measures still don’t inflict enough damage to wallop global markets.

Yes, we know the US, UK and EU agreed to expel some Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, which facilitates international financial transactions. We know this theoretically complicates Russian banks transacting with the developed world, effectively freezing commerce and overseas assets even for entities that aren’t under sanctions. And we know several Western leaders have referred to this, however unfortunately, as the “nuclear option.” Now they are patting themselves on the back, promising their actions will create a deep Russian recession.

Perhaps. But there are reasons to doubt this outcome will be so clear. That isn’t an ideological statement, mind you, nor a political one. Rather, our job is to assess these things coolly and rationally, as markets do. Those who argue the SWIFT expulsion will kneecap Russia’s economy point to the deep economic pain in Iran after US sanctions effectively barred all Iranian banks from SWIFT. Thing is, those sanctions included measures targeting Iran’s oil and gas exports, which is what actually crippled Iran’s economy. So far, the West has done no such thing to Russia—the SWIFT ejection applies only to some (heretofore unspecified) banks, meaning there are other banks that still have access and can process oil and gas transactions. Some officials told the press Monday that they are doing so to avoid interfering with the oil trade.

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The Direct and Downstream Impact of the Latest Sanctions on Russia

In the aftermath of Russian “President” Vladimir Putin’s full-scale invasion of Ukraine, the free world’s leaders announced fresh—and much tougher—sanctions Thursday. What have the US and its allies announced thus far, which institutions are most exposed, and is there much risk of a downstream impact for the US and Europe? Read on for the details.

Now, to be clear, this article is a discussion of the intended effects of Western sanctions based on trade statistics and the announcements to date. However, sanctions’ real impact rarely matches the intent. Even rogues like Vladimir Putin will find some third-party nation willing to trade with them, avoiding the sanctions for a small fee. Hence, sanctions’ likely economic impact—on Russia and the world—is smaller than the estimates that follow.

Until Thursday, the Western powers and their allies had refrained from some of the toughest measures in their arsenal, including banning Russia from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, which facilitates international financial transactions, and cutting off semiconductor shipments. Instead, they opted for a gradual initial approach, promising to ratchet the punishment up if Putin didn’t back down. He didn’t, and now global leaders are starting to follow through on their earlier warnings.

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Weighing the Crypto Threat to the Global Financial System

Do cryptocurrencies threaten global financial stability? The Financial Stability Board (FSB), an international body of financial authorities and regulators, released a report last week voicing worries—adding to murmurs in the financial press. While the FSB’s findings aren’t a call to action, examining how the crypto space could impact broader global markets can help investors weigh the likelihood of the discussed fears actually coming to pass.

The FSB focused on vulnerabilities in private sector crypto assets, from “unbacked crypto” (e.g., bitcoin) and “stablecoins” (an asset-backed crypto with a fixed value) to decentralized finance (DeFi) and crypto-asset trading platforms. Think of unbacked tokens and stablecoins as your general cryptocurrencies—i.e., something trying to be electronic cash—while DeFi and crypto-trading platforms aim to provide financial services (e.g., lending) using private-sector crypto assets. With digital coins expanding rapidly and becoming a larger part of the financial system, the FSB worries more regulation and oversight are needed, or else cryptos’ problems could spill into global capital markets—with potentially dire consequences. For example, the FSB posits that a major stablecoin failure could roil short-term funding markets if the coin issuer had to liquidate its reserve holdings in a disorderly fashion—especially if it triggered a run on other stablecoins.

But as the FSB and many pundits have pointed out, to harm global markets, crypto markets need a transmission mechanism. Throughout cryptos’ limited history, no link existed: Hence, bitcoin’s busts in both of the bull markets occurring during its existence didn’t derail stocks. But with cryptos’ rising prominence, some see new potential transmission mechanisms.

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