Traditionally, Labor Day is considered the point when an increasing number of Americans start paying attention to the November elections. As part of our analysis of the candidates, we create dossiers of the candidates and the leading figures with whom they surround themselves. In this report, we will comment on those we see as potentially taking positions in the foreign policy team of a Biden presidency. First-term presidents tend to lean heavily on foreign policy experts, so the people selected to fill these roles would have a hand in shaping policy.
There is an old saying in politics that “personnel equals policy.” Although not completely the case, it does matter who is in the important cabinet and advisory posts. Because this is a geopolitical report, we will focus on foreign policy positions—Secretary of State, Secretary of Defense, Secretary of Treasury, Director of the CIA, and National Security Advisor. We have no insider information about who will get these roles; our predictions are based on open sources and our own analysis. But, based off these conjectures, we will attempt to determine what Biden’s foreign policy would look like.
We will begin with an overview of what we would expect in terms of foreign policy from a Biden presidency. We will follow that discussion with a short biography of who we think are the leading candidates for the aforementioned positions and name other potential candidates for the positions. Using this information, we will attempt to indicate what the sum of these positions would mean for the direction of Biden’s foreign policy. As always, we will conclude with market ramifications.
Next week, we will do the same for President Trump. Second terms are different than first terms. First-term presidents are learning their job and tend to be dependent on the experts they appoint. In the second term, presidents have more experience and the people they appoint to key positions are there mostly to execute the president’s policy preferences, not to offer advice. In addition, by the second term, the party’s leading functionaries have served (and moved on) and the team that replaces them is usually second tier. All that will be covered next week.
It’s Monday and the last full week of August (that month went by fast, didn’t it?)! There is a lot going on this morning. We have twin tropical storms, one already in the Gulf of Mexico and the other on its way. California is suffering through wildfires. The GOP convention kicks off this week. Global equities are moving higher with hopes for COVID-19 treatments. Overseas news leads our coverage this morning; Belarus protests continue, and we are watching the fate of Aleksei Navalny. Economics and markets are next. The pandemic report follows. We also update the China news. Let’s get to it:
So far, Moscow appears to be cool to the idea of intervening. The likely reason being that, unlike in Ukraine, where elections were between a Russia supporter and a Western supporter, there is little evidence among the protestors that they are aligning with the West. Instead, the protests appear to be all about getting rid of Lukashenko for free elections and a less repressive regime.
Such protests are not a threat to Putin. A Belarus without Lukashenko is still under the sway of Moscow. And, Putin has become jaded with Lukashenko. The current leader of Belarus is in trouble and we wouldn’t be surprised if he leaves, but we would not expect a major change in the country’s policies.
Greece has been in a standoff with its nemesis Turkey. The two are at loggerheads over offshore oil properties around Cyprus, and over border activities and Syrian refugees. So far, Greece has been underwhelmed by the support it is receiving from the EU; Germany is the focus of Greek ire.
Brexit talks remain stalled and time is running out. It is possible that an agreement will not be reached. Although we would expect the GBP to fall on a rupture, the decline may not be long-lasting and might present an opportunity.
PM Abe of Japan has returned to the hospital. This is his second trip in two weeks, and it raises concerns that his health may be failing. If Abe does stand down, there is a chance that his policy of keeping the JPY weak may not continue.
Beyond the obvious political problems this situation causes, it also affects how the economy functions. For example, we are seeing a surge in buying used goods—cars, clothing, furniture, etc.—where shoppers are willing to own something less than new to save money. One interesting twist is that in the GDP calculation, used items don’t add to growth.
Money market funds are an important conduit for the non-bank financial system, the so-called “shadow banking system.” This system gets its liquidity via repo instead of deposits. Low interest rates are a serious impediment for money market fund operators; at very low rates, they struggle to earn a profit. Funds are temporarily waiving fees to prevent the generation of a negative yield; in other words, from breaking the buck. The net asset value (NAV) of money market funds is traditionally set at $1.00 per share. While there is nothing to prevent it from reducing the NAV below a dollar, it would undermine the belief that money market funds are as good as cash. Complicating matters, as we note in this week’s AAW, is that money market levels are elevated, further hampering the operators of these funds (if one is losing money on current assets, it’s hard to make up the difference with higher volume). As rates continue to fall, there will be even greater incentive to move funds into higher-yielding assets even at higher risk.
Existing home sales are on a tear. Single-family sales now exceed pre-pandemic levels. Generational adjustments (millennials are reaching their family-building age) and pandemic-driven preference for a home of one’s own are behind the lift. The biggest constraint remains the lack of available homes. Another factor helping home buying is that the mortgage guarantee firms have been granting forbearance during the crisis, which is preserving credit ratings.
The National Association of Business Economists suggests the recovery won’t begin until later this year. We disagree; strictly speaking, the data shows an obvious trough in June and July. At the same time, for most people, this is a difference without a distinction. The recovery is starting from such a depressed level that the difference between recession and recovery is difficult to spot.
COVID-19: The number of reported cases is 23,456,597 with 809,349 deaths and 15,155,418 recoveries. In the U.S., there are 5,704,597 confirmed cases with 176,809 deaths and 1,997,761 recoveries. 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.
Virology:
The media’s focus has remained on a vaccine. However, that is only part of the story. Antiviral therapies may offer greater hope than a vaccine. These therapies tend to make COVID-19 less deadly, reducing symptoms and improving outcomes. Even when we get a vaccine, it may be some time before we know how effective it is. The FDA has approved convalescent plasma for those affected with COVID-19. The plasma comes from persons who have survived the disease and have antibodies; giving plasma to those with COVID-19 tends to improve outcomes. But this isn’t the only therapy on the horizon. Drug makers are working to create antivirals that reduce the risk of contracting COVID-19. If these prove to be effective, they will make managing the disease much easier, even if a vaccine proves problematic.
Although having a vaccine would be positive, it would be less effective if people are reluctant to take it. Russia is reporting rather low acceptance rates due to fears about the vaccine’s safety. There is a tension between getting a vaccine out quickly and determining its reliability.
Happy Friday! Equity futures are mostly marking time this morning. We lead off with foreign news; Iran, North Korea, and Russia are the focus. We also update news on China, followed by policy news and the latest on the pandemic. We wrap up with market details. Being Friday, a new Asset Allocation Weekly is available; you can find it at the end of this report, and through this link. The companion podcast and chart book are available as well. This week’s topic returns to an old favorite, the level of retail money market funds. Here is what we are watching this morning:
Foreign news:
The U.S. officially filed a complaint with the U.N. Security Council to trigger the “snapback” provisions of the Iran nuclear deal. The primary goal of the U.S. is to extend an arms embargo that is set to expire in October. Given that the U.S. suspended its participation, the proposal did not get a warm welcome from the other members. Although it is certain the proposal won’t pass (both China and Russia have a permanent veto and want to sell arms to Iran), the U.S. complaint puts Europe in an uncomfortable position. The European members of the council are siding with Russia and China against the U.S. That isn’t their normal position. In addition, Europe was a supporter of the deal; not supporting the snapback increases the odds it will officially fail. What makes this situation especially difficult is that Iran is clearly violating the agreement. Tehran would argue that the U.S. actions forced it to, but that doesn’t matter all that much. We would look for the European members to do everything they can to delay the vote.
It is always difficult to know what is going on in North Korea. It’s a closed society with a limited number of contacts with the outside world. In a rare admission of failure, Kim Jong-Un, at a party meeting, admitted that his first five-year plan, launched in 2016, has not met its goals. He attributed the failure to COVID-19, flooding, and sanctions. Although the government still claims there are no cases of COVID-19 in North Korea, the virus did close the border with China, choking off trade.
A development we continue to watch is the steady rise of Kim’s sister, Kim Yo-Jong, who is now said to be the “second in command.” This ascension appears tied to other efforts by Kim to delegate greater responsibility to other officials. This decision may be an admission that his government was too centralized or a way to assign failure to other officials.
The flooding crisis shows no signs of abating. The city of Chongqing, with a population of 30 million, is making flood preparations for its biggest flood event in four decades. As water backs up behind the Three Gorges Dam, officials are opening the floodgates. Inflows into the electric turbines are at 75 million liters per second and the floodgates are seeing flows of 42.9 million liters per second, the most since the dam was constructed. The maximum level of the reservoir is 175 meters; the waters are forecast to reach 165.5 meters tomorrow. If the dam is breached, it would not only be a major embarrassment to the Xi government, but it would add to downstream flows and exacerbate flooding. The Leshan Giant Buddha carving, a massive monument carved into the side of a river valley, is “getting his feet wet” for the first time since 1949.
Although the U.S. has essentially implemented a “death sentence” to Huawei (002502, CNY 2.96), Beijing has not, so far, retaliated against U.S. firms operating in China. We suspect there are two reasons. First, China still needs U.S. knowhow and investment, and second, there is probably hope that a Biden government will relax some of the Trump administration’s policies. We suspect the second hope is on shaky ground; Trump could be reelected, and Beijing may be underestimating the degree to which the U.S. policy establishment has turned on China. Once China realizes the trend against it is secular, we would expect retaliation to begin in earnest.
The U.S. isn’t done with actions against China—this coming from an unlikely source, the Home Furnishings Association.
There appears to be a policy shift coming in China. We are hearing more about a “dual circulation” economic policy, which looks to turn China’s economic focus inward. This news would confirm a couple of longstanding factors. First, throughout China’s history, it has cycled from focusing outward to inward. It does the former when it wants to spur growth. The coastal areas become export hubs, leading to much better growth but widening regional income gaps. As these gaps lead to political and social divisions, leaders turn the economic focus inward, which leads to slower growth, but greater political unity and stability. Mao took China inward, while Deng moved outward. Xi has been focusing on political and social unity, and thus shifting the economy to a more domestic focus, which would be consistent with this policy. Second, China’s economic development since 1978 has been investment and export-driven. The distortions from this policy have created a situation where the policy is no longer able to generate growth without excessive debt creation. A shift to consumption has been a longstanding recommendation; this “dual circulation” policy might facilitate that move. If China follows through, it would have significant effects on the global economy.
Earlier this year, we commented on a growing movement away from running corporations solely on the basis of shareholder value. A number of business groups have indicated they support such a move. Under a Biden presidency, such proposals may find government benchmarks for these goals.
COVID-19: The number of reported cases is 22,709, 116 with 794,256 deaths and 14,562,070 recoveries. In the U.S., there are 5,576,089 confirmed cases with 174,290 deaths and 1,947,035 recoveries. 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 Rt data shows that just over 60% of the states are reporting a reading under one, suggesting a slowing infection rate. Alabama has the lowest reading, while Hawaii has the highest.
In a reversal, the CDC will return to collecting COVID-19 infection data. The data was shifted from the CDC to the Department of Health and Human Services last month, but delays have led the government to return to the CDC for data collection.
Although markets are powerful structures, they don’t always supply everything a society wants. When this occurs, the formal economic term for it is “market failure.” Some market failures are simply tolerated because the costs of the failure are not enough for government to intervene. Others are large enough to where government does overrule the market. One classic case of this was universal phone service. Stringing wires into rural America was a money-losing proposition, but government leaders feared that if large swaths of low population areas were denied service, it would adversely affect those regions. Thus, a deal was struck with Ma Bell—provide universal service and the company would be allowed to be a virtual monopoly. The company paid for the money-losing service with high charges on long-distance, which was mostly funded by businesses. Note that no such deal was made with broadband, and this service has not been universally provided to rural and low population areas.
One of the relationships we monitor is retail money market levels (RMMKs). In theory, any available liquidity could conceivably end up purchasing equities. But, RMMKs are used by investors in their brokerage accounts and thus are probably “closer” to equities compared to other forms of “near money,” such as checking accounts, savings accounts and certificates of deposit. The chart below shows the most current reading.
This chart shows retail money market levels on a weekly basis along with the Friday closes of the S&P 500. The gray bars show recessions, whereas the orange bars show periods when retail money market levels fall below $920 billion. In general, when RMMKs fall to $920 billion or below, the uptrend in equities tends to stall. It would seem there is a certain level of desired cash, and when that level falls below $920 billion, households try to rebuild cash by either slowing their purchases of equities or selling stocks to build liquidity.
During the runup to the Financial Crisis, we saw a rise in RMMKs. The peak in liquidity was reasonably close to the trough in the S&P 500. In early 2018, we saw a notable rise in RMMKs that persisted despite the rally in equities. As the pandemic hit and the Federal Reserve aggressively eased monetary policy, RMMKs soared. The rise in RMMKs initially coincided with the sharp decline in stocks, although the pace slowed as equities recovered. It peaked in the second half of May and has been trending lower. When RMMKs fall, that liquidity must go to some other asset, real or financial.
Although scaling RMMK is difficult, we do note that the ratio of M2 excluding RMMK does tend to track the fed funds target with a lag. This makes sense. Holding “cash” outside of a period of crisis is usually driven by interest rates. As rates fall, and hopefully the crisis eases, the current elevated level of RMMK will start to look for higher returns.
The chart suggests that RMMKs should begin to decline in earnest by December; where that liquidity finds a home is uncertain, but we would expect a good portion of it to go into equities if inflation fears remain muted.
We are seeing some reversals of recent trends in the wake of the Fed minutes. Currently, equity markets are lower this morning. Some of the weakness is being attributed to the lack of new fiscal stimulus, but we think a better case can be made that the Fed disappointed, which we discuss below. We update news on China, the pandemic and Belarus. And, being Thursday, the Weekly Energy Update is available. Here are the details.
Fed policy: The Fed released the minutes of its July 28-29 meeting. Let’s get to the point—the sentence that has roiled the market is this one: “Many participants judged that yield caps and targets were not warranted in the current environment but should remain an option.” Financial markets have been building in the idea that the Fed was going to engage in financial repression. Specifically, the expected policy mix was fixing interest rates across the yield curve, a slow reaction to rising inflation and continued policy accommodation. This has led to low Treasury yields, higher gold and equity prices and narrowing credit spreads. As the above quote indicates, there was a surprising degree of reluctance to embrace the idea. Some of this hesitancy was due to the lack of upward pressure on interest rates (of course, part of the low rate situation is due to market expectations of yield curve control). It was a decided minority (“a couple of participants”) who seemed to express support for the idea. It won’t really be tested until rates rise. But, in the end, it appears the FOMC is in a “wait and see mode,” keeping current policy in place but seems unlikely to add additional stimulus unless there is a decided decline in economic activity. This is not what financial markets wanted to hear. Our take is that Chair Powell is supportive of the concept of yield curve control, but the lack of support suggests the rest of the FOMC isn’t on board yet. At the same time, we think the market’s assessment of the Fed’s future policy is correct; financial repression is likely. The continued process to avoid preemptive rate hikes to quell inflation, the move to average inflation targeting and extensive forward guidance are all part of this policy. It’s just that markets like clarity, and the Fed has little reason to provide it when the financial markets are already enforcing that policy. The real test will be when there is a whiff of inflation; if long-end yields begin to rise, will the Fed tolerate it? We doubt it will. But we don’t know for sure and, apparently, neither do FOMC members.
In the rest of the minutes, the assessment of financial markets and the economy suggested that there was some improvement in economic and financial market conditions, although both were said to be sensitive to pandemic developments. The staff economic outlook was generally upbeat, expecting stronger GDP and higher inflation in 2021 and 2022. However, they did express concerns about a slowdown in H2 2020. Participants were more guarded, noting the unequal dispersion of economic weakness caused by COVID-19. They also expressed that the economy’s path was still highly uncertain; it is not clear if this uncertainty was due to their own analysis or from comments the regional presidents are hearing from their local business contacts. They also expressed concern about the potential lack of fiscal support. The committee members also noted continued risks to financial stability. Overall, this meeting’s tone was “wait and see.” Markets rarely like such indecision.
Apparently, Phase One trade talks are not off. When the president said he didn’t want to talk to China, it wasn’t meant to signal that these specific talks were scuttled. Thus, they are delayed for now, but they will occur.
It is apparent that China is trying to cool tensions. This may be due, in part, to hopes that it will be dealing with a different president after January. In addition, Beijing may fear that tensions could be used as an election issue, and thus is trying to avoid escalation. At the same time, the U.S. is avoiding provocative actions in other areas. For example, Taiwan was not invited to participate in recent large-scale military exercises. Taipei has expressed interest in joining such events.
The WSJ reports on China’s global efforts to recruit scientists through a network of 600 recruitment stations.
COVID-19: The number of reported cases is 22,427,939 with 788,030 deaths and 14,349,696 recoveries. In the U.S., there are 5,530,247 confirmed cases with 173,193 deaths and 1,925,049 recoveries. 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.
One of the key goals to reducing the impact of COVID-19 and returning the global economy to some semblance of normal is the development of herd immunity. Immunologists generally argue that if 70% of a population is immune, the risk to those who are not immune is insignificant. Essentially, at the point of herd immunity, the virus can’t find enough people to infect and it dies out. For older Americans, we saw this firsthand with diseases like measles, mumps and chicken pox; our classmates tended to lose class time in the early grades, but by fifth grade, enough people had suffered these maladies that losing time to them was uncommon. New modeling work suggests that herd immunity might be met with only 50% of the population immune. That may mean we are close to herd immunity in some communities. For example, reports indicate that about a third of people tested in the Bronx are carrying the antibody.
The mask debate isn’t just a U.S. issue. The Scandinavian countries have provided very loose guidelines for using masks, citing that the benefits from using them do not offset the social issues of face coverings.
Economics and Markets
As interest rates decline, it is becoming increasingly difficult for financial firms that usually generate revenue from interest rate spreads to survive. They are increasingly turning to extra fees and slow responses to rate declines. Although these actions support their profitability, they undermine the power of monetary policy.
One interesting twist to the Belarus saga is that the country was a participant in China’s belt and road project. Although investment levels were not all that large, China did arrange a line of credit to Minsk. Lukashenko tried to diversify Belarus’s economy away from its deep dependence on Russia and thus cultivated China’s interest. It isn’t clear if this investment will be secure if Lukashenko is ousted.
Navalny poisoned: Russian opposition leader Alexei Navalny is in a coma after an apparent poisoning. His condition appears grave. Poisoning is an oft-deployed tactic of Russian security agencies against political enemies. There is always a risk that such a blatant attack will backfire and lead to unrest; however, we believe that risk is low.
Coup in Mali: Mali has had its share of troubles in recent years. There has been a constant fight against Islamist groups that has drained resources and displaced millions. And, the government was seen as corrupt. Although President Ibrahim Boubacar Keita was elected to office twice, he initially took control after a coup in 2012. Yesterday, elements of the armed forces staged a coup, and the president has left office. The coup leaders are promising to hold new elections soon. Mali is Africa’s fourth largest gold producer; several gold mining companies with operations in Mali suffered a selloff in light of the news.
Brexit: Although talks continue, negotiators are stuck on the degree to which British truck drivers can traverse the EU and conduct business. The U.K. wants drivers to have the ability to move across Europe and make multiple stops and deliveries. The EU sees that as too close to being a member and wants to grant less freedom. Although this issue probably won’t completely derail talks, it does suggest that a number of contentious issues remain; if talks fail, the GBP could decline.
Going postal: No, this isn’t about the recent mail controversy. One of the proposals we have seen circulate would be for the Fed to offer limited banking services to the general public. The banking system appears incapable of providing basic banking services to low-income households, leaving them to the tender mercies of payday check cashers and money orders. The idea is that the Fed could provide basic services, but they would need a venue for such services. In other countries, the venue has been post offices (Japan’s Postal Savings system is perhaps the most famous). Of course, this would be a major expense for the Fed and perhaps for the USPS. However, we note that JP Morgan (JPM, 98.55) has offered to install branch offices in postal stations. This may be a way to head off the threat of competing directly with the Fed or it may offer the Fed a path to providing basic services but use the infrastructure that JP Morgan would provide. We will continue to monitor this idea.
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA | PDF
Here is an updated crude oil price chart. The oil market has stabilized at higher levels after April’s historic collapse.
(Source: Barchart.com)
Crude oil inventories fell less than anticipated, declining 1.6 mb compared to forecasts of a 2.9 mb decline. The SPR declined 2.7 mb as oil that was placed in the SPR for temporary storage is now being put back into the commercial system. Taking the SPR into account, storage dropped 4.2 mb.
In the details, U.S. crude oil production was steady at 10.7 mbpd. Exports plunged 1.0 mbpd, while imports rose 0.1 mbpd. Refining activity fell 0.1%.
Unaccounted-for crude oil is a balancing item in the weekly energy balance sheet. To make the data balance, this line item is a plug figure, but that doesn’t mean it doesn’t matter. This week’s number is -421 kbpd. Although the volatility of this number is elevated, the trend is slowly stabilizing.
(Sources: DOE, CIM)
The above chart shows the annual seasonal pattern for crude oil inventories. This week’s data showed another decline in crude oil stockpiles. We are approaching the end of the seasonal withdrawal period. Although the declines of the last few weeks are supportive, stockpiles remain well above seasonal norms and remain a bearish factor.
Based on our oil inventory/price model, fair value is $36.48; using the euro/price model, fair value is $64.08. The combined model, a broader analysis of the oil price, generates a fair value of $50.41. The wide divergence continues between the EUR and oil inventory models. As the trend in the dollar rolls over, it is bullish for crude oil. Any supportive news on reducing the inventory overhang could be very bullish for crude oil.
Gasoline consumption remains stalled. Although we probably won’t see the usual seasonal decline in consumption (there wasn’t much of a vacation season), the slowing of consumption does suggest a weaker economy.
In oil news, the Trump administration is postponing a politically fraught decision on ethanol. There is a mandate from the EPA on ethanol blending. The original law mandated that 36MM gallons of biofuels would be part of the transportation fuel mix by the early 2020s. The industry has not been able to hit that number; last year, there was 15.8MM gallons produced, down slightly from the prior year. The farming industry wants to force the mandate, whereas the petroleum industry, especially refiners, want to avoid it. What happens in practice is that the government maintains the mandate but liberally grants waivers to refiners, meaning that the growth in ethanol production has been flat. When the bill was signed by President Bush in 2007, it was assumed that gasoline demand would continue to rise. In that way, the mandate could have been met without increasing the percentage of ethanol blended into gasoline. But, the 2007-09 recession and the sluggish recovery that followed led to flattening gasoline consumption, meaning the only way to achieve the law’s goals is by increasing the blend percentage.
This year’s recession is likely to weaken demand further. Not only was the drop in growth historic, the work from home trend that the pandemic triggered could fundamentally alter commuting. Although public transportation demand has slowed, it is likely that at least some workers will work from home at least part time. That means the mandate will become even more difficult to meet. The administration is faced with displeasing two constituents—farmers and the oil industry. There is really no solution that will please both. So, we would not expect a resolution before November.
Often in political trends, we see an emerging development that faces a counter movement. In other words, “the Empire strikes back.” During the Reformation, for example, there was a counter-Reformation that eventually led to a kind of cold peace within Christendom. Sometimes, the countertrend only slows the emerging one. We may be seeing something in the latter with regard to oil energy. The current administration is pro-petroleum, but the broader societal trend is heading in the opposite direction. One item that tends to support this idea is that drilling activity remains soft even with the recovery in oil prices. Major oil companies are rethinking their long-term strategies and governments are nudging them in this direction. Whenever we observe potential inflection points, we try to look for items that both support and dispute the potential change in trend. For example, the U.S. has taken steps to open more of Alaska for drilling. If oil companies jump at the chance, the “death of oil” is probably premature. On the other hand, if no actions are taken, it would bolster the case that the oil industry is on a long-term downtrend. Here’s another bit of evidence contrary to the death of oil. Chevron (CVX, 89.48) is looking to invest in Iraq. If one thought that oil demand was going to decline, it is highly unlikely they would take the risk of drilling in a volatile political environment like Iraq. So, the jury is still out, although the weak performance of oil stocks overall would suggest that the death of oil trend may still win out. Another item supporting oil’s continued dominance is that the Democrats have removed language calling for the end of fossil fuel subsidies and tax breaks from the final party platform. At the same time, we have seen a surge in “green” equity performance, suggesting the trend against oil may be gaining momentum.
Working in the oil industry, like any profession, has its good and bad points. To the former, the work often pays very well. It also can be interesting, taking its workers to different parts of the world in challenging environments. Cutting edge technology is also part of the business. On the downside, it is brutally cyclical; when its good, its great, but the troughs can be difficult.
This chart shows the percentage of oil and gas workers to total non-farm payrolls compared to inflation-adjusted oil prices. As the chart shows, employment is sensitive to the price of oil.
A number of commodity industries are struggling to attract younger workers. The average age of farmers has been rising for some time. The reputation of the oil industry has been under pressure over the issue of climate change; it appears that younger workers are shunning the industry over those concerns. If this trend continues, the industry can only survive by improving productivity.
Although reducing carbon emissions is helpful in offsetting the potential impact of climate change, in reality, even if all carbon emissions stopped today, the existing levels will continue to affect the climate for decades. To truly reverse the impact of carbon in the atmosphere, we would need to remove the carbon that already exists. Scientists and engineers have been working for some time on such technologies. We note reports that Occidental Petroleum (OXY, 13.95) is working with privately held Carbon Engineering to build a carbon capture plant in the Permian basin. If this technology develops, it is probably the most promising route to dealing with climate change.
The Trump administration is attempting to trigger the “snapback” provisions of the Iran nuclear deal even after its withdrawal from it. The U.S. is claiming that it is still a “participant” despite its withdrawal and thus can request a return to earlier weapons embargoes that were part of the original agreement if Iran failed to comply. We doubt this will go anywhere, meaning that the conventional weapons ban will likely expire in October. It remains to be seen how the administration will react if states begin selling arms to Iran. Russia and China could both decide to sell arms to thwart U.S. goals with Iran.
On this, the 29th anniversary of the August 1991 coup in the Soviet Union, it looks like the U.S. equity market will follow through on its rise yesterday to a new record-high close. Today’s apparent follow-through comes despite very little coronavirus news…or perhaps because of it? Most of today’s key news is political, as we outline below.
China: President Xi has reportedly launched a major purge of the country’s security personnel. Since the purge commenced last month, dozens of high-level police and judicial officials have been arrested, fired, or sent for “ideological training,” including the Shanghai chief of police. Xi has often purged officials in order to stamp out corruption or remove opponents and overly ambitious rivals, especially early in his tenure. However, reports indicate this purge is much more sweeping.
Some commentators suggest the new firings merely represent another anti-corruption effort, but it’s likely that such a broad move also reflects growing political opposition against Xi within the Communist Party establishment.
That opposition is hard to see from the outside, but various reports by knowledgeable China observers, including former Australian Prime Minister Kevin Rudd, indicate Xi has generated considerable discontent within the Communist Party for several of his policy initiatives. For example:
Many party officials dislike Xi’s abandonment of collective rule and his attempt to build a cult of personality in which he alone holds all power as an autocrat.
Xi’s reputation has also been heavily damaged by his failure to keep a lid on the novel coronavirus when it first surfaced last year.
Xi has generated pushback against his aggressive geopolitical moves in places like the South China Sea and the Himalayas. Those moves represent an abandonment of Deng Xiaoping’s dictum to “hide your strength, bide your time.” Many Communist Party officials are probably also uncomfortable with Xi’s failure to avoid an economic, political, and technological conflict with the U.S. In simplistic terms, these concerns center on the possibility that Xi has misjudged China’s strength and has embarked on moves that are generating strong pushback from the U.S. and other Western democracies before China really has the power to follow through on them.
If the purge really does turn mostly on Xi’s need to stamp down burgeoning internal political opposition, his past success with purges suggests he will probably be successful. All the same, if the breadth of the purge reflects how broad the political opposition has become, it also raises the risk of political instability at some point in the future. That possibility, in turn, suggests that one thing missing from current U.S. policy toward China is an effort to play to Xi’s opponents, perhaps by offering a softer policy again if Chinese geopolitical or economic policy becomes less aggressive.
In any case, if Xi’s opponents were to gain power and the country became politically unstable, it would naturally be disruptive for global markets. On the other hand, increased opposition to Xi overseas and a burgeoning political opposition at home could chasten Xi and lead him to cool his geopolitical and economic ambitions, at least temporarily. That reaction might help cool global tensions and create a more favorable investment environment.
United States-China: As if to illustrate the U.S. pushback that Xi’s policies have generated, President Trump said he ordered the cancellation of last weekend’s planned U.S.-China meeting on the implementation of the “Phase I” trade deal, which the countries signed in January. His administration has also urged university endowments to divest their holdings of Chinese stocks ahead of the companies potentially being delisted from American exchanges. Those developments help explain today’s drop in the Chinese and Hong Kong stock markets.
Japan: Just months after his last regular checkup, Prime Minister Abe unexpectedly spent an entire day in a Tokyo hospital this week for unspecified medical tests. Abe only has one year left in his final term as leader of the ruling Liberal Democratic Party, but the visit has led to growing speculation about his political future. It also intensified maneuvering by his rivals for the chance to succeed him. His main potential successors are Fumio Kishida and Shigeru Ishiba, both former ministers and leaders of party factions. Separately, the Democratic Party for the People is expected to approve a merger today with the Constitutional Democratic Party of Japan, forming a more organized, numerically viable opposition to Abe and raising the prospect of snap elections.
Canada: A day after his previous finance minister quit, Prime Minister Trudeau named his deputy, Chrystia Freeland, as the country’s new finance minister and said he would suspend parliament until September 23 in order to develop a new plan for addressing the coronavirus pandemic and economic recovery. That plan, which Mr. Trudeau hinted would include aggressive spending measures, would be subject to an immediate vote, giving the opposition parties—which hold a majority of seats in the legislature—a chance to defeat the Liberal government and trigger an election.
United States-Russia-China: After two days of U.S.-Russia meetings on extending the New START nuclear arms treaty, which is due to expire in February, administration officials signaled they are no longer insisting on China’s participation in a follow-on deal. The change of approach should help ensure that the key arms limitation agreement will be extended.
European Union-Belarus-Russia: Ahead of today’s emergency EU summit to discuss the political crisis in Belarus, Russian President Vladimir Putin warned German Chancellor Merkel and French President Macron that he would not tolerate any outside pressure on the Belarusian leadership. At the meeting, EU leaders are expected to discuss imposing sanctions on Belarusian leaders and officials who oversaw the recent election and the brutal response to the initial protests, which led to thousands of people being detained.
At Notre Dame, where students were already back on campus and attending classes in person, a surge of infections spurred by off-campus parties prompted the school to move to online classes only for at least two weeks. The administration also warned that if the outbreak isn’t contained quickly, the school will send students home to learn remotely, similar to the campus closure that happened last spring.
At Michigan State, an outbreak of cases prompted the administration to ask students not to return to campus just yet.
Responding to the resurgence of infections around Europe, German Chancellor Merkel said her country would stop easing virus restrictions for the time being. The comments serve as a reminder that Europe’s encouraging recovery to date remains fragile, since failure to keep easing restrictions could short-circuit the recent improvement in activity and in European stocks.
The modest uptick in risk assets so far today comes despite new U.S. moves to punish Chinese companies on national security and economic policy grounds, as well as the continued stalemate over a new U.S. coronavirus relief bill. We review all the key news below.
United States: The Democratic Party opened its virtual convention last night with a theme of “We the People,” seeking to emphasize national unity while at the same time celebrating U.S. diversity. The program included surprise appearances by several high-level Republicans, including former Governor John Kasich of Ohio and former Governor Christine Whitman of New Jersey, who argued for Republicans to support the presumptive Democratic candidate for president, Joe Biden.
Given the dominance of U.S. technology in certain segments of chipmaking, the new rule reportedly amounts to a blanket ban on any chip sales to Huawei, hitting its 5G equipment and handset businesses.
By further crimping Huawei’s ability to operate, the moves will escalate the administration’s tough-on-China policy, highlighting the risk of even more bilateral tension and economic disruption down the road. In fact, President Trump also signaled that his administration is considering similar moves against other Chinese firms on national security and economic policy concerns.
China: According to a new study by law firm Baker McKenzie and economic consultancy Silk Road Associates, Chinese exports had already started losing global market share last year, before the coronavirus pandemic hit. The study showed that Chinese exports of 1,200 products accounted for 22% of the world’s exports, 3 percentage points lower than in the previous year. For consumer goods, the country’s global market share fell by 4 percentage points to 42%. The study found that the decline in China’s market share stemmed mostly from the U.S.-China trade dispute, the rise of new technologies, and corporate governance demands.
European Union: As EU member countries continue working to implement the bloc’s big, new coronavirus relief and mutualized debt program, the so-called “frugal four” countries that agreed to the program in return for higher rebates from the EU budget are now demanding that those rebates be increased by 2% per year to offset price inflation—despite expectations that inflation is likely to remain minimal in the EU for the foreseeable future.
Belarus: In a sign that President Lukashenko continues to lose support after the apparently fraudulent elections earlier this month, the autocrat was booed by workers at a major defense factory he was visiting. The booing was notable because workers at the plant, which produces key components for Russia’s military, are probably among the best paid and highest privileged workers in the country. It was also noteworthy because Lukashenko was using the occasion to announce he is preparing a referendum on a new constitution that could eventually lead to him handing over power. Obviously, the workers weren’t buying it.
Canada: Finance Minister Morneau said he will step down, the biggest casualty to date from a scandal tying the Liberal government to a charity with close links to the family of Prime Minister Justin Trudeau.
Newly confirmed infections in the U.S. rose by only about 35,000 on both Sunday and Monday, marking the lowest two-day tally since late June and bringing the seven-day rolling average down to its lowest level since early July. Of course, some locations continue to see resurging cases and deaths, such as Texas, Louisiana, Tennessee, and Florida. The region with the lowest infection rates continues to be New England.
Overseas, Australia and New Zealand have also shown progress on capping their infection resurgence. However, in a worrying development, both countries have reported that the staff at designated quarantine hotels have tested positive for the virus and, in at least one instance, have infected a quarantined person.
The move illustrates how hard it will likely be for organizations to resume anything like normal operations before a viable vaccine is available for the disease.
With China closing in on a coronavirus vaccine, Beijing’s top officials and some of its pharmaceutical firms have started to promise early access to countries of strategic interest, including Brazil and Pakistan. In contrast with the U.S. approach of prioritizing shots for U.S. citizens before any domestic vaccine is made available internationally, China’s promise of doses is designed to draw the targeted countries into Beijing’s orbit and split them off from the West.
Economic Impact
While the pandemic has hurt real estate properties of all types, it’s having an especially heavy impact on New York’s iconic Empire State Building as more companies embrace remote work or cheaper satellite offices outside city centers. Some in the industry say the building is worse off than many peers because it relies on smaller office tenants, which tend to be more at risk during a downturn.
In the longer term, one little-discussed implication of the pandemic is that the disease and the associated economic disruption will likely push down birthrates and further slow population growth. That’s starting to be an especially important concern for Japan, which already had one of the most rapidly aging societies even before the pandemic.
Even though China was able to minimize infections when the pandemic first broke out late last year, and has been staging an impressive economic recovery since then, it turns out that the recovery has widened income inequality, just as it has in many Western democracies.
Financial Market Impact
While the pandemic has helped touch off a sustained depreciation of the dollar versus other major currencies, key emerging market currencies continue to suffer even more. The Brazilian real, the South African rand, and the Turkish lira have lost about 20% of their value against the dollar this year, putting the former two on course for their biggest annual declines since 2015. The Russian ruble and the Mexican peso have dropped roughly 15%.
U.S. Policy Response
Senate Majority Leader Mitch McConnell has warned that the ongoing discussions on a new coronavirus relief bill may not lead to a deal. Media reports also say Republicans are considering further reducing their proposed stimulus amount. Both developments are raising concerns that the fiscal rug could be pulled out from under the economy before a solid and sustainable recovery is in place. Those concerns appear to be a key reason for the muted tenor of the risk markets so far today.
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