Ukraine-Russia War: Russian Problems & Reactions
The Ukraine-Russia Conflict continued with grinding incremental territorial losses by Ukraine in the east but with gains to north in Russia. In particular, while the Ukrainians faced heavy pressure from the Russians in the Donbas city of Pokrovsk, they saw big wins in Russian Kursk. Ukraine continued to play the strategic game, attacking Russian oil refineries, fuel storage facilities, airfields and radar facilities as F-16s arrived in early August with so far a marginal effect. An example would be Gazprom’s Moscow oil refinery suspending operations at the plant’s Euro+ refining unit following a fire caused by a Ukrainian drone attack, shutting off 50% of its capacity. Also, in the south, Ukrainians sunk Russia’s last rail ferry, a critical transport used by Russia to supply Crimea. Now only the Kerch Bridge is open to deliver large-scale support from Russia. I am thinking Ukrainian glide bombs would avoid the bridge’s elaborate electronic and anti-aircraft defenses. Meanwhile, Russian glide bomb and mass drone strike capabilities continue to outmatch the Ukrainian defenses. Finally, lost amid the news about the current fighting, Germany announced an arrest warrant for a Ukrainian man accused of blowing up the Nord Stream natural gas pipeline along with two divers and a number of other conspirators, including members of the Ukrainian military. President Zelensky was accused of agreeing initially to the scheme but rescinding it at the last minute. All very murky and another reminder that truth is the first casualty of war.
Ukraine’s Grain Exports in the 2024/25 July-June season as of Aug. 14 stood at around 5.26 million metric tons, up from 3.12 million on the same date a season earlier, including 2.4 million tons of wheat, 2 million
tons of corn and 795,000 tons of barley. The USDA also raised its forecast for Ukrainian wheat production by +10.8% to 21.6 million tons for new season, despite drought concerns and Russian army advances. Russia’s seaborne oil flows rebounded to the highest in almost two months, boosted by a recovery in shipments from its Sakhalin Island projects in Asia. The nation’s four-week average crude exports increased to 3.26 MMBPD in the week to August 25th. As the graph left shows, flows look little affected in 2024. The gross value of those shipments was little-changed at $1.58 billion a week. India overtook China as the world’s biggest importer of Russian oil in July as Chinese refiners bought less because of lower profit margins and uncertain demand. Russian crude made up a record 44% of India’s overall imports in July, rising to a record 2.1 million barrels per day, 4.2% higher than in June and 12% more than a year ago. China appeared to have shifted towards Iran as a favored source, skirting sanctions through reflagged tankers.
Macro: Asia
China’s July Exports Gained +7.0% y/y in USD terms, slightly slowing down from a +8.6% y/y rise in June and below a +9.7% y/y growth forecast. Exports were supported by sustained global demand, including higher
exports to the US (+8.1% y/y) and the EU (+8.0% y/y). Meanwhile, in a surprise, Chinese imports increased +7.2% y/y last month, exceeding market expectations of +3.5% growth and reversing a +2.3% y/y decline in the preceding month. Chinese inflation data showed a +0.5% y/y gain in July, versus +0.2% y/y in June. It was a sixth consecutive month of positive inflation after deflation at the end of last year. July retail sales gained +2.7% y/y (vs. +2.0%), with the growth in goods and services converging again. Industrial production was up +5.1% y/y last month (vs. +5.3%), while the unemployment rate ticked up to 5.2% (vs. 5.0%). Chinese property data for July remained weak once again. Floor space completions (important for base metals) have been consistently down on
the year every month in 2024 so far, falling 22.3% y/y last month. As the graph right shows, prices remain in negative territory. The world’s biggest steel producer China Baowu Steel Group sounded the alarm about a crisis in China that carries the potential to send global shock waves, warning of a deeper industry downturn than major traumas in 2008 and 2015. Conditions in China are like a “harsh winter” that will be “longer, colder and more difficult to endure than we expected,” chairman Hu Wangming recently told staff. Meanwhile, China retaliated against Japan and the US, with both sides restricting [or threatening to restrict] chip and electronic raw materials exports to each other (see left for a sense of the magnitude). No matter who gets into the White House, expect more conflict as economies sputter.
Japan’s Economy Expanded by a much-faster-than-expected +3.1% y/y in the second quarter, rebounding from a slump at the start of 2024, thanks to a strong rise in consumption and backing the case for another near-term interest rate hike. The increase in gross domestic product compared with a median market forecast for a +2.1% gain, and followed an upwardly revised -2.3% contraction in the first quarter. The Bank of Japan indicated further rate increases are likely, although at a very modest pace. Note that its balance sheet is a massively bloated 130% of GDP from its aggressive and long-running quantitative easing policy (now recently to reverse), about 5x the comparable ratio for the US (Japanese federal government debt is about 240% of GDP as reference). Reducing this monstrosity will be a long and likely painful ride as the resulting increase in government interest rates would rapidly become unaffordable. Therefore, the Japanese Yen may continue to strengthen versus the US Dollar as its interest rates slowly increase while the US Federal Reserve cuts rates – setting up a second round of carry trade unwind to roil markets this or early next year.
Macro: US
Looking for Cuts in September as the market interpreted Chair Powell’s commentary at the Federal Reserve’s annual conference as a guarantee for a 25-basis point cut at the September 17-18th meeting, though
traders also placed many bets for 50. However, Q2 GDP was revised upward to 3.0% annualized although the Atlanta Fed’s Q3 GDP expectations have declined to +2.1% annualized. US inflation fell to 2.9% with the core rate above at 3.2%, both lower but still above the stated 2% target. While goods prices have basically stopped going up, service costs were still increasing for consumers. What is going on with Transportation (see graphic right)? Surging auto insurance rates have been the primary factor, increasing by over 50% in the past 3 years. That’s the biggest 3-year spike since 1975-78. The average annual cost of auto insurance in the US has moved up to $2,329 from $1,550 three years ago. Payrolls expanded by a lower-than-forecasted 142,000 in August, and unemployment fell to 4.2%. Average hourly earnings rose +3.8% from a year ago, decent but basically at inflation.
Americans Still Struggled as housing payments (including taxes and various forms of insurance) are still a high 43.1% of median income, levels last seen back in
2007, right before the mortgage crisis. The median down payment for US homebuyers moved up to a record $67,500. That’s 116% higher than the median down payment 5 years ago ($31,250). However, mortgage rates continued to fall, reaching to 6.5% for the standard 30-year fixed mortgage. An interesting graph marks the change of where Americans spend their money – in short NOT at department stores. The largest department store operator still in existence, Macy’s, has closed more than a third of its stores in the last 10 years. The downsizing is expected to continue, with Macy’s announcing plans to close 150 more stores by early 2027 from 503 at the end of 2024. However, at the low end, Dollar General warned that poorer consumers are running out of money as it missed numbers and its stock was correspondingly punished. The retail layoffs will continue. Meanwhile, commercial real estate continued to struggle with foreclosures on the rise (see graph right). Office mortgage securities delinquencies follow a similar pattern, recently hitting 8.1% versus the highs around 10.5% back in 2012.
Macro: Europe
European Central Bank Expected to Lower Interest Rates in September as Eurozone inflation fell to +2.2% annualized in August. Wage growth also slowed with pay +3.6% more than a year ago versus almost +5% a quarter ago. Consumers in the Eurozone scaled back spending on food, beverages and tobacco in June, driving overall retail sales volumes -0.3% lower on both a monthly and an annual basis with these figures below negative expectations. Finally, the latest blow for Europe came after German auto giant Volkswagen warned it was considering historic plant closures and layoffs in a bid to save billions of euros because of slower sales and higher energy costs. Two factories in particular were cited as obsolete. Volkswagen is one of the world’s largest employers with roughly 680,000 staff. I expect that the ripple effects on governments, industry and consumers will be profound.
All the best in your investing!
David Burkart, CFA
Coloma Capital Futures®, LLC
www.colomacapllc.com
Special contributor to aiSource