by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday!  Schools are reopening, and it’s a risk-on day today.  U.S. equity futures are higher, and gold and oil are rebounding as well.  The Fed’s meeting at Jackson Hole is this week, but like last year, the meeting will be virtual.  Our coverage begins with an active weekend for the weather.  Tennessee had heavy rain, and there was a tropical storm in New England.  An update on Afghanistan is next, followed by China news and the international roundup.  We then discuss economics and policy, and we close with pandemic coverage.

Climate:  It was a busy weekend for extreme weather events.  Tennessee was hit with torrential rain over the weekend, with reports of 15” to 20” in some areas.  Flooding was widespread, as was the damage.  At least 22 people have died, and many more are missing.  Tropical Storm Henri slammed Rhode Island and other parts of New England over the weekend.  Hurricane Grace made landfall in Mexico as a category 3 storm; the storm caused at least eight fatalities.

China:  Taiwan’s reliance on the U.S. for defense is a concern.

• Lithuania has faced the ire of Beijing for allowing Taiwan to open a diplomatic mission in Vilnius. China has retaliated by banning new food imports from Lithuania.
• One worry for U.S. military planners is that Taiwan isn’t really preparing to resist a Chinese invasion. Although the country has bought flashy military hardware from the U.S., it hasn’t actually hardened itself to make an invasion difficult.  Taiwan needs to build shore barriers, lay sea mines, and take similar measures to make an amphibious assault difficult.  Complicating matters is that Taiwan has gone to a volunteer military and is struggling to find recruits.  Taipei’s plan appears to be hoping the U.S. intervenes.  Although we think the U.S. would (and we feel quite certain Japan would) take military action to defend Taiwan, it’s hard to sell that to the U.S. when Taiwan doesn’t appear willing to defend itself.
• As China’s economy slows, iron ore prices are falling fast. Not only does a slowing economy need less iron, but Beijing is also pushing steel producers to use electric arc furnaces to make steel.  The feedstock is scrap and is less polluting.
• As bitcoin mining leaves China, miners are returning to the U.S.

Afghanistan:  Here is what we are following:

• Disorder around the Kabul airport continues. U.S. troops have reportedly expanded the security perimeter, but conditions remain chaotic.  The British military reports that at least seven Afghans have died due to stampedes.  There are growing concerns that Islamic State elements may begin attacking aircraft at the airport, pointing to the fact that the Taliban’s control is far from complete.  Six U.S. air carriers have been ordered to assist in transporting evacuees.  This action is part of the Civil Reserve Air Fleet, created as part of the Berlin Airlift in 1952.  The planes appear to be mostly ferrying evacuees to air bases for processing.
• The U.S. may extend the deadline for troops to be out of Afghanistan past August 31.
• The Taliban have reportedly contacted former officials, including Hamid Karzai and Abdullah Abdullah, to build an inclusive government. It isn’t clear how this would work or why the Taliban is interested.  It could be that the group realizes its hold on the country is tenuous, or it might be to soften or avoid sanctions.  Even without clear sanctions, banks and other financial firms have been cautious about money transfers.  We note that northern Afghanistan, which held out against the Taliban the last time the group held power, appears to be building opposition again.
• EU leaders have been meeting to discuss what to do about the almost certain flood of refugees that will occur because of the collapse of the Afghan government. What is being revealed, yet again, is that the EU has no unified plan for refugees.

Economics and policy:  Budget and infrastructure start to move through the House, and fears of peak growth are upon us.

• Speaker Pelosi is preparing to move both the budget bills and the bipartisan infrastructure package. A moderate bloc of nine representatives is demanding the bipartisan bill go first; this plan is opposed by the populists, who fear that the budget will fail to pass in its current form, and thus, spending goals will fail.  Pelosi usually wins out on these things, but so far, the moderates are holding tight.  Our expectation is that both will eventually pass, but the current budget of $3.5 trillion won’t make it through in its current form; we expect something closer to $2.0 trillion.
• Economic data continue to come in strong but are weaker than expected. This development is leading economists and strategists to suggest we have already seen peak growth.
• Logistical snarls continue, and there are growing worries that there may not be enough container ships to meet demand. Supply constraints tend to trigger inflation, and this sort of inflation is difficult to address.  Policymakers, in the short run, can usually only affect demand, so they are forced to tighten policy, effectively taking spending power away from firms and households as prices rise.  In the longer run, deregulation can increase available supply, but with a rather long lag.
  • The U.K. continues to deal with a severe chicken shortage. One chain restaurant in the country was forced to close 50 shops due to the lack of product.
  • U.S. supermarkets report that supplies have become sporadic, leading to shortages and uncertainty of supply.
• The Arizona election audit is due today. Although we expect it to generate a lot of headlines, any real action (recalls, new elections) must first pass through the courts, where the veracity of the audit will face tests.

International roundup:  Sweden’s PM is stepping down, and Merkel met with the leader of Ukraine.

• Sweden’s PM announced he is stepping down in November. Stefan Löfven, who lost a no-confidence vote in June only to form a new government in July, has decided he has had enough.  His decision has increased political turmoil in the country.  Sweden must hold elections by September 2022.
• Chancellor Merkel met with Ukraine’s leader over the weekend. The latter is still unhappy with Germany’s decision to support and complete the Nord Stream 2  pipeline.  Merkel tried to assure President Zelensky that Russia won’t be able to use the pipeline as a weapon against Ukraine, but we doubt Kiev believes that.
• Meanwhile, the CDU/CSU continues to languish in the polls. The SDP continues to surge; although the average still shows the conservatives holding a majority, individual polls show the SDU tied with the CDU/CSU.

COVID-19:  The number of reported cases is 211,925,410, with 4,433,615 fatalities.  In the U.S., there are 37,711,989 confirmed cases with 628,504 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high-frequency data on various factors.  The CDC reports that 428,531,345 doses of the vaccine have been distributed, with 362,657,771 doses injected.  The number receiving at least one dose is 201,425,785, while the number receiving second doses, which would grant the highest level of immunity, is 170,821,621.  For the population older than 18, 62.4% of the population has been vaccinated.  The FT has a page on global vaccine distribution.

• In this most recent wave of infections, the affected population has tended to be younger, with more children being hospitalized. Breakthrough infections are becoming more common, although the majority of those hospitalized are unvaccinated.  The Gulf Coast is being especially hard hit, straining medical resources.
• As cases rise, companies are returning to work from home arrangements. The longer such arrangements are in place, the more likely they will become lasting.
• Britain is starting an antibody surveillance program; the goal is to see how long antibodies last, what impact breakthrough infections have on antibodies, and determine how long natural immunity lasts.
• Israel is starting a vaccine booster program due to rising infection rates.
• Jesse Jackson and his wife have been hospitalized with COVID-19.

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by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Good morning.  Risk markets are weaker this morning.  Fears of slowing global economic growth, the persistence of the pandemic, and the unsettling images from Kabul are weighing on sentiment.  Our coverage begins with the events in Afghanistan.  Up next is economics and policy, followed by China news and our international roundup.  We close with pandemic news.

Afghanistan:  We continue to monitor events in the country.  Over the weekend, the government of Ashraf Ghani has collapsed as he has fled the country.  Over the past month, the Taliban has captured key cities amid almost non-existent resistance in most areas.  By taking Kabul, the Taliban has effective control of the country.  The U.S. era in Afghanistan has come to a rapid and chaotic end.  The last land route out of Afghanistan has been taken by the Taliban, leaving air evacuation from Kabul airport as the only remaining exit.  The airport has reportedly come under fire, so leaving the country may not be possible at some point.  Scenes at the airport, similar to the iconic ones observed in 1975 Saigon, will become a lasting memory.  Crowds have packed the airport, hoping for a flight out.  Western nations are scrambling to pull embassy personnel out of the country.  U.S. embassy officials were ordered to destroy sensitive materials, and most personnel are being evacuated.  It appears that U.S. forces control the Kabul airport, but it is unclear how long that will last.  The State Department has told remaining employees to stay at the embassy.  Helicopters have been ferrying workers out, as it has become too dangerous to escape by car.  European embassies will remain in Kabul to process visas for local employees who would be in great danger from the Taliban government.  Germany is sending its military to evacuate its embassy.

Unfortunately for the Taliban, taking territory is one thing, but governing is another.  Afghanistan is divided along tribal and ethnic lines, and once outside powers are ousted, the country will likely spiral into civil conflict.   When the Taliban was in control before 2001, it was a brutal regime; although we expect a return to such governance, it is possible the group may govern with a lighter hand this time around.  The old leadership is mostly gone, and the lesson from before is that harsh conditions trigger opposition.

Although it’s still a bit early to tell, our read is that the chaotic end to the U.S.-sponsored government in Afghanistan will have serious political ramifications.  The administration was caught flat-footed by the speed of the Taliban offensive.  SoS Blinken was on the Sunday news shows arguing that what was happening in Afghanistan “was not Saigon.”  It’s arguably worse.  What is going on in Kabul is being described as “Saigon on steroids.”  The U.S. had effectively withdrawn in 1973, and the government of South Vietnam held power until 1975.  Establishment figures are calling the decision to leave Afghanistan and the collapse of the government an intelligence and planning failure.   What went wrong?  The president appears to have made up his mind early on to exit Afghanistan.  As a policy, this is defensible.  Although it has been argued that a failed state in Afghanistan could be a breeding ground for international terrorism as it was with al Qaeda, there are many failed states in the world and the U.S. can’t occupy all of them.  Afghanistan, by itself, is not central to U.S. foreign policy interests.  However, what happened over the past two weeks shows a clear lack of preparation.  According to reports, the president didn’t take the advice of military leaders.  Again, this isn’t a shock; the military rarely wants to abandon missions.  Leaving like this isn’t in anyone’s playbook and suggests a lack of planning.  After all, the administration knew we were leaving.  The lack of preparation will have political costs.  It can be argued that the Trump administration left Afghanistan as unfinished business, and “leftover” issues are always part of transitions.  In any case, once you are sworn in, they become your problems.

Whenever an event like this occurs, questions are raised about America’s reliability as an ally.  The human tragedy of Afghans who supported the war effort and are left behind reflects badly on the U.S.  History shows that if an area of the world is considered a vital interest, the U.S. has remarkable staying power.  The security support for Europe and Japan can attest to this.  However, areas that are not vital can be abandoned rather quickly.

All presidencies face unexpected crises.  The George W. Bush administration wanted a “humble” foreign policy…until 9/11.  President Obama took power into the teeth of a deep recession and a financial crisis.  The pandemic clearly affected the Trump administration.  The Biden government has been aggressively pushing for major fiscal policy actions; Afghanistan will almost certainly become a serious distraction and could potentially derail the process.  To allow such chaos raises concerns about competence.

Economics and policy:  The FOMC is leaning toward policy tightening, and the House is starting to prepare for the budget and infrastructure bills.

• We will have more to say on this topic in the next couple of weeks, but we are seeing unmistakable momentum for monetary policy tightening, despite Chair Powell’s insistence that it will be a while before the stimulus is reduced. Rising inflation and a rapid rebound in economic growth all support policy tightening.  However, while we are watching this trend toward reducing stimulus, we couldn’t help but notice last Friday’s plunge in consumer sentiment.

This chart shows the monthly percent change in the index; declines seen in August (the data is preliminary and will be finalized at the end of the month) are unusual, and more often than not, are tied to recessions.  What is depressing consumers?  It’s probably a lot of things, such as rising inflation, the lingering pandemic, political strife, etc.  This data suggests the FOMC should exercise caution.  We don’t have much experience with pandemic recoveries, and the Fed could get “wrong-footed” here.

• Freight rates remain elevated, exacerbating inflation. It is not obvious when bottlenecks will be resolved.
• House leadership is trying to finesse the two infrastructure measures. Progressives want the budget deal first, followed by the bipartisan package.  Moderates want them reversed.  We expect both will pass, but the budget deal will be well below the $3.5 trillion that is the current bill.
  • The U.S. is making the largest permanent increase in food stamps.
• The pandemic accelerated the work from home movement. Firms are scrambling, trying to determine what to do with office space.  State Street (STT, USD, 90.79) has decided to vacate two of its New York City locations.

China:  The Chinese economy is slowing, and there is growing evidence of Xi’s concentration of power.

• There is a clear slowdown occurring in the Chinese economy. Although the Delta variant has played a role, monetary policy is also tight.  Since the Great Financial Crisis, China has tended to stimulate the economy whenever there was a slowdown.  Given the recent crackdowns on credit, it is possible that the Xi government has accepted slower growth.
• For the past several months, investors have seen a whole series of edits from Beijing that have rattled several industries. One analyst suggests bureaucrats are acting swiftly on instructions or comments from General Secretary Xi in a fashion similar to the way they reacted to Chairman Mao’s instructions or comments during the Cultural Revolution.  If that is the case, predicting behavior will be exceedingly difficult.  It also reflects the growing concentration of power by Xi and the undermining of the CPC’s institutional framework created by Deng.
• U.S. corporations are getting antsy about the continued constraints on doing business with China.   The Biden administration is conducting a review of tariffs and other constraints but appears to be in no hurry to relax anything.
• U.S. higher education is facing a myriad of threats.  Weakening U.S. demographics and a backlash against high tuitions are part of the problem.  Another one is falling international student enrollment, especially from China.

International roundup:  Haiti, Beirut, and Canada are in the news.

• Late last week, Haiti suffered a major earthquake. The 7.2 magnitude event has killed at least 1,300 people and injured thousands.  And now, sadly, TS Grace is bearing down on the island today.  The storm is expected to reach the Gulf of Mexico by the week’s end.
• Just over a year ago, a massive explosion at the Port of Beirut and the government’s inability to respond has tipped the country into chaos. One problem that has emerged is that centralized electrical power has become intermittent, leading households and businesses to use portable generators.  The use of generators has increased the demand for fuel oil, leading some to hoard fuel.  The military was seizing fuel allegedly being hoarded when a fuel tank exploded, killing at least 28 people.
• PM Trudeau of Canada has called for snap elections set for September 20. Trudeau has been managing a minority government since 2019 and is looking to gain a majority.
• Wildfires have been hitting European countries in the Mediterranean. There are reports that suggest some of them in Italy may have been set by the Mafia in a bid to gain access to government relief funds.
• Russia is expelling a BBC reporter as tensions with foreign journalists increase.

COVID-19:  The number of reported cases is 207,278,035, with 4,364,473 fatalities.  In the U.S., there are 36,680,793 confirmed cases with 621,636 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high-frequency data on various factors.  The CDC reports that 415,957,645 doses of the vaccine have been distributed with 356,433,665 doses injected.  The number receiving at least one dose is 198,088,722, while the number receiving second doses, which would grant the highest level of immunity, is 168,362,058.  The FT has a page on global vaccine distribution.

• As we noted above with the consumer sentiment data, the Delta variant is affecting the economy, increasing costs and weakening demand.
• The earlier variants of COVID-19 were most deadly for older people. Younger people could be infected but usually had cases that could be managed at home.  However, the Delta variant has been causing a surge in hospitalizations for the 30-39 age cohort.
• In Indonesia, the Delta variant is adversely affecting children.
• Iceland has one of the world’s highest vaccination rates. It is also dealing with a surge in infections.  So far, the rate of hospitalizations has been low, confirming that vaccines for COVID-19 don’t grant sterilizing immunity.  They protect you from severe illness but not from getting infected.  If this is a permanent condition (and we suspect it is), we will live with this virus, much as we do with influenza.
• On August 24, U.S. intelligence agencies will provide their assessment of the Wuhan lab leak theory for the origin of COVID-19.

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by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Good morning, all! U.S. equities appear to be headed for a higher open this morning. Our report begins with a discussion about inflation. Next, we provide a round-up of international news, including the Taliban’s advancement in Afghanistan and Bolsonaro’s attempt to undermine the electoral process in Brazil. U.S. economics and policy news are up next, including details about the latest Census survey. China news follows, and we end with our pandemic coverage.

Let’s talk about CPI: The Bureau of Labor Statistics released the latest price figures this week and it offered some reassuring news. The month-over-month rise in CPI decelerated to its slowest pace in five months. In July, headline CPI rose 0.5%, down from the previous month’s reading of 0.9%. Additionally, core CPI slowed from 0.9% in June to 0.3% in the latest report. The deceleration was led by a steep decline in the pace of price increases for used cars. The report showed that the rise in used car prices slowed from 10.5% in June to 0.2% in the following month. Despite the moderation in CPI, inflation fears may still be warranted.

The chart above shows the geometric mean of the two-year change in the producer and consumer price indexes. This chart is designed to improve the year-over-year comparability of the indexes by averaging the change over the last two years, thereby limiting the pandemic distortions. That being said, the data suggests that despite the moderation in consumer prices in July, price pressures are still building throughout the economy. At this time, it appears that this pressure may be related to a lack of inventory. As a result of material shortages, demand for goods and services remains high as firms attempt to rebuild their inventories to meet growing demand. As of June, retail inventories for motor vehicles and clothes are still well below their pre-pandemic levels, while sales appear to be very strong. Over time, we believe as production capacity expands inventories will return to their normal level and this should relieve the economy of some inflationary pressure. Therefore, the most recent report has not changed our view that inflation is likely transitory.

International news: 

• The Venezuelan government and its opposition will meet in Mexico City on Friday to discuss how to resolve their differences. The discussion will be mediated by international observers such as Norway. At this time, there are no expectations of a breakthrough.
• On Sunday, Canadian Prime Minister Justin Trudeau is expected to announce a snap election on September 20 as he attempts to gain approval for his COVID-19 response. PM Trudeau is currently working with a minority government and relies on smaller parties to get legislation passed.
• Brazilian Supreme Court Justice Alexandre de Moraes opened a probe into President Jair Bolsonaro for posting documents from a sealed investigation. Bolsonaro has been trying to undermine the integrity of the election as he remains widely unpopular within the country. The documents that he posted were related to an investigation into the hacking of a federal election court. Over the last few months, he has been spreading unsubstantiated claims about election machines being targeted by foreign hackers. Bolsonaro’s behavior suggests that he may not accept the results of the election if he were to lose. Given the country’s history and Bolsonaro’s recent comments, we would not be surprised to see another military takeover in Brazil following the election. In this event, it would likely be very bad for Brazilian equities as Brazil would be hit by sanctions from the U.S. and Europe. However, in the long run we think conditions could become more favorable for stocks.
• The Taliban has edged closer to taking over the country of Afghanistan. The rebel group has taken several major cities throughout the country at a much faster pace than originally anticipated. On Thursday, it took control of its 10th provincial capital as it edges closer to surrounding Kabul, the capital of Afghanistan. In response to the Taliban’s advancement, EU Foreign Policy Chief Josep Borrell suggested that the Afghan government should attempt to reach a settlement with the group. The U.S. and U.K. have deployed troops in Afghanistan in order to expedite the evacuation of staff from embassies within Kabul.

Economics and policy:

• Details from the latest Census survey were released on Thursday. Here are a few takeaways from the report:
  • Over the last decade, the population grew 7.4%, the slowest pace since the Great Depression.
  • For the first time in history, the number of people who identify as White decreased.
  • People identifying as being more than one race were the fastest growing group. This change was partially due to adjustments made by the Census Bureau.
  • Additionally, almost half of the country’s children are nonwhite, suggesting the country will become more diverse over time.
  • Lastly, it appears more people have left rural areas in favor of cities. The change in demographics may have an impact on the makeup of Congress. An increase in urbanization generally favors Republicans’ ability to win more seats in the Senate.
• Bill Gates announced that a fund run by his investment firm will commit $1.5 billion to the Department of Energy if Congress enacts a program aimed at developing technologies that cut carbon emissions. The initiative is meant to attract other investors to raise an additional $15 billion.
• Home prices have risen in almost every part of the country according to the National Association of Realtors. The rise in home prices has likely been spurred by low interest rates.
• The Supreme Court lifted a ban on New York State’s eviction moratorium as litigation over the dispute continues.

China:

• Several provincial cities in China have declared a red alert following floods throughout the country.
• The population in Hong Kong declined at its fastest pace ever in 2020 as many people left the region following the passage of the national security law.
• A combination of the pandemic and worsening U.S./China relations have made Chinese students more hesitant to study at American universities.

COVID-19: The number of reported cases is 205,462,557 with 4,335,111 fatalities.  In the U.S., there are 36,306,917 confirmed cases with 619,093 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high-frequency data on various factors.  The CDC reports that 411,253,925 doses of the vaccine have been distributed with 353,859,894 doses injected.  The number receiving at least one dose is 196,505,543, while the number receiving second doses, which would grant the highest level of immunity, is 167,354,729.  The FT has a page on global vaccine distribution.

• On Thursday, Supreme Court Justice Amy Coney Barrett turned down a challenge to Indiana University’s vaccine mandate. The school requires that all students be vaccinated unless they have a religious or medical exemption. Students who are not vaccinated would have to submit to testing. The students that sued the school in order to block the mandate argued that it violated their constitutional rights. This was the first vaccine mandate-related suit to be turned down by the Supreme Court.
• The Food and Drug Administration expanded the emergency use of the COVID-19 vaccine to include a third dose for certain immunocompromised people. Although the third dose has yet to be expanded to the broader population, the country’s leading infectious expert, Dr. Anthony Fauci, stated that people will eventually need to receive the third dose.
• Rising COVID-19 cases in China have led to a closure of shipping ports at the Yantian Port and Ningbo-Zhoushan Port. The port closures could exacerbate price pressures as it will be harder for firms to maintain inventories.
• More job postings are requiring applicants to be vaccinated. The push for vaccination highlights growing fears about the spread of the delta variant.

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