Battleground Preparation

By Philip Marey, Senior US Strategist at Rabobank

Battleground Preparation

Yesterday, battleground preparation in Ukraine took a new turn with the destruction of the Kakhovka dam. In addition to the flooding, this will restrict the water supply and Ukraine’s agricultural output, pushing up global prices of grains and other produce. The Zaporizhzhia nuclear power plant is also dependent on water supply from the dam reservoir, but is said to have sufficient reserves and could be supplied by other means. Both sides, Ukraine and Russia, are denying responsibility, but Western intelligence agencies are leaning toward Russia. The flooding definitely reduces Ukraine’s options for its long-awaited counteroffensive.

This morning, the 7.5% decline (year-on-year) in China’s exports beat the Bloomberg consensus of a more modest 1.8% decrease. This adds to concerns about global demand as higher interest rates and persistent inflation are eroding purchasing power. The decline in China’s imports by 4.5% was smaller than the 8.0% consensus expectation, but still points to domestic economic problems. As our Teeuwe Mevissen summarizes, there are multiple reasons why China’s economy is struggling and most of them are factors that have been plaguing China’s economy for quite some time. On top of the ongoing weakness in the real estate sector and high levels of debt, regulatory uncertainty and geopolitical tensions are increasingly weighing on China’s weakening recovery.

Euro zone inflation expectations for the next 12 months fell to 4.1% in April from 5.0% in March, according to the ECB’s monthly survey, released yesterday. Expectations three years ahead declined to 2.5% from 2.9%. This could bolster the case of the doves in the Governing Council. However, ECB President Lagarde said on Monday that there is no clear evidence that underlying inflation has peaked and hawkish GC member Knot warned yesterday that the euro area is now observing second round effects from higher energy prices.

US voters think the debt limit deal reflects slightly more favorably on Democrats than on Republicans. According to a Reuters/Ipsos poll published yesterday, 50% of the respondents thought that neither party emerged as a winner and 20% decided that both sides won. However, 20% saw the Democrats as the winners, and only 11% thought the Republicans won. More good news for Biden is that 80% of Democrats liked his performance in the debt limit negotiations. In contrast, House Speaker McCarthy has a more difficult – because divided – audience as only 44% of Republicans approved of how he handled the debt limit. As we discussed in our Debt Limit Wrap Up, this may be the start of a more centrist course from President Biden, leading to more bipartisan legislation.

In fact, the House Republicans have shifted their focus to tax cuts. They are working on a bill to reverse limitations on the deductions companies can claim for interest, research costs and capital expenses from a 2017 law. Democrats may be willing to discuss these tax cuts, especially those related to R&D, but they are likely to demand a restoration of the expanded child tax credits that were in place during the pandemic year 2021 in exchange. The House Republicans could introduce their tax bill as soon as this month. Looking further ahead, Republicans have not indicated yet whether later this year they would go for an extension of the 2017 individual tax cuts that are set to expire at the end of 2025. Biden has already said he wants to extend these tax cuts only for people making less than 400K.

Day Ahead

Today, it is decision day for the Bank of Canada. Our expectation is for the Bank to keep the policy rate unchanged at 4.50%. As our Christian Lawrence summarizes, Canadian macroeconomic data released during May continued to paint a picture of slowing inflation, albeit at a very gradual pace, slowing activity, and low unemployment. We expect to see the labor market to start loosening, but this will likely be very gradual. We also expect the data will continue to support our view that rate cuts are unlikely in Canada over the course of the next year.