G7 commits €50B to Ukraine, Trump or not

Welcome back to SovereignBeat!

In this publication:

• Treasury yields on a rollercoaster: weak retail sales but robust manufacturing

• Euro stabilizes after France's political turmoil

• UK maintains high rates despite 2% inflation

• Oil prices surge with stronger demand forecasts

• G7 wraps up with $50bn issuance for Ukraine: Russian frozen assets finally in play

Let’s dissect

Markets Snapshot

Developed Markets

• US: Neel Kashkari, the president of the Federal Reserve Bank of Minneapolis, expressed strong confidence in achieving the 2% inflation target within one to two years. He emphasized that future rate decisions will be data-driven and highlighted the importance of clear communication regarding the Fed’s response to economic indicators. The implied market probability of the Fed’s first rate cut in September currently stands at around 65%.

• US Treasury yields declined following the latest retail sales data on Wednesday. The value of retail purchases, unadjusted for inflation, increased by only 0.1% in May following a downwardly revised 0.2% drop in the April. In contrast, sales rose 0.6% and 0.9% in March and February, respectively. These figures highlight a notable slowdown in consumer spending after stronger readings earlier in the year. In a reversal of recent trends, however, manufacturing data released the same day showed that industrial production expanded by 0.9% in May, well above consensus expectations and the fastest pace in nearly a year. Factories were operating at 78.7% capacity, also slightly above expectations and the highest level since last November.

• Nonetheless, U.S. yields recovered much of their losses, with the 10-year Treasury note closing the week higher at 4.26%. This came after S&P Global's report indicated that overall output growth hit a 26-month high, stronger than initially thought, based on preliminary readings of activity among U.S. manufacturing and services businesses. More importantly for Wall Street, this strength may be happening without a concurrentus rise in inflationary pressure.

• Investors are closely monitoring Federal Reserve officials for future rate guidance and the upcoming release of the Personal Consumption Expenditures (PCE) price index this Friday. Bloomberg economists predict that May's inflation data will show the core PCE deflator adjusting to 0.15% for the month, potentially lowering to 2.6% year-over-year.

• EU: The euro stabilized around USD 1.07, remaining close to a seven-week low after a recent 0.8% decline due to increased political scrutiny in France. Despite the ECB's recent rate cut, inflationary pressures persist in the Eurozone, evidenced by a 5.3% wage increase in Q1 2024, the highest since late 2022.

• UK: On Thursday, The United Kingdom’s central bank maintained its key lending rate at 5.25% for the seventh consecutive meeting, though policymakers indicated potential rate cuts in the coming months. The decision follows the announcement that overall inflation reached nearly 2% in May, while core inflation, excluding food and energy prices, eased to 3.5%, its lowest since October 2021. Nonetheless, inflation remains a challenge for the Bank of England (BoE), with services inflation at a stubborn 5.7%, exceeding the Bank’s 5.3% forecast for May. BoE Governor Andrew Bailey has repeatedly emphasized the need for strong evidence that inflation will not only reach the 2% target but also remain at that level. Policymakers will be closely watching the outcome of the General Election next month, with the potential first rate cut now expected in August.

Equity Markets

• Despite posting only marginal gains, The S&P 500 and NASDAQ reached new record highs, marking their eighth positive week in the last nine. The Dow Jones increased by over 1% but is still more than 2% below its record high set a month ago. On a year-to-date basis, the information technology sector leads with an average return of nearly 29%, followed by communication services with a 25% return.

• On June 19, 2024, Nvidia surpassed Microsoft to become the company with the highest market cap in the world at $3.34 trillion. However, the AI chip giant lost the top spot the next day after its shares declined nearly 3.4%, handing the title of the world's most valuable company back to Microsoft.

Commodity Markets

• Oil: Crude oil prices continue to rise, fueled by geopolitical tensions in Eastern Europe and the Middle East, including a drone strike in Russia and escalating conflicts involving Israel and Hezbollah. These factors, along with strong demand projections from OPEC, IEA, and the US EIA, and strict adherence to production quotas by key OPEC+ members, have led to a second consecutive week of gains, closing 2% higher at $84.2 per barrel.

Global Finance

G7 Meetings Spark Hope for Ukraine

• On June 13th, during the G7 meetings in Italy, leaders of the Seven countries agreed to provide approximately $50 billion in loans to Ukraine. This funding aims to ensure Ukriane has financing for all of 2025, regardless of the outcome of the U.S. presidential election on November 5th.

• Around 260 billion euros of Russian central bank funds are frozen globally, but most of them in the Euroclear depositary in Belgium, generating 2.5 to 3.5 billion euros in annual profit. The EU considers this profit a windfall, not contractually owed to Russia. The U.S. has proposed using this profit to service around $50 billion loan, which would be raised on the market and given to Ukraine as a grant. The $50 billion headline figure reported by various news sources is derived by calculating the present value of annual windfall profits over 20 years from the $280 billion in frozen Russian assets, assuming a constant interest rate of around 3.2%. The technical details will be finalised in the coming weeks, with the funds expected to reach Kyiv by year-end. It is expected that either the U.S. or the EU would create a special purpose vehicle to issue so-called 'freedom bonds' on behalf of Ukraine.

• Option 1: United States would raise the money on the market and the European Union would give Washington assurances the windfall profits would be available to service the U.S. borrowing

  Advantage: Quick implementation without creating new joint debt obligations for EU countries.

  Disadvantage: Washington needs clear assurances about who will guarantee the repayment of any borrowed funds, particularly if Ukraine undergoes debt restructuring again or if interest rates change unexpectedly. Additionally, potential vetoes from Hungary could impact sanctions, given that Russian assets are frozen in Europe and the EU requires unanimous renewal of the sanction regime every six months by all 27 members.

• Option 2: EU Borrows, guaranteeing the repayment of bonds with money from the EU budget.

  Advantage: Keeps the process within the EU, bypassing the need for unanimity and Hungarian vetoes, as loans under the EU's Macro Financial Assistance framework are decided by qualified majority, not unanimity.

  Disadvantage: The lengthy process requires consent from the European Parliament, placing all borrowing risks on EU countries and jointly holding them responsible for repayment—a stance particularly disliked by Germany.

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