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

[Posted: 9:30 AM EDT] | PDF

It’s employment Friday!  We cover the data in detail below, but the quick view is that the data came in better than forecast.  It’s a modest risk-off morning, with weaker Chinese stocks.  Our leadoff this morning is China as tensions rise further.  Policy coverage is next as Congress looks like it won’t get a deal done.  We update the market and economic news followed by our foreign update.  The pandemic “bats ninth.”  We have a new Asset Allocation Weekly, with accompanying podcast and chart book.  Let’s get to work!

China news:

• President Trump has issued an executive order that targets Chinese social media apps. The order limits the ability of these firms to operate in the U.S. and gives Microsoft (MSFT, 216.35) 45 days to complete its purchase of the American operations of TikTok.  The order also targets Tencent Holdings (TCEHY, 72.57).
  • Microsoft is apparently considering buying all of TikToK.
• The administration is also considering measures that would force Chinese-listed firms to either comply with U.S. audit requirements or lose their listings in the U.S. It would also require any firms who want to list in the U.S. to comply before they can issue securities on U.S. markets.  The actions being considered will further weaken U.S./China relations and most likely boost Hong Kong stock markets, which would be the likely destination for Chinese firms that delist from the U.S.
• In another executive order, the U.S. is requiring the government to purchase “essential” drugs from American manufacturers.
• Interestingly enough, despite U.S. actions against Chinese companies, Beijing has mostly left American companies operating in China alone and they are benefiting from the recovery in China’s economy. Two items to consider: first, Beijing has tended to use American companies to weaken the case of the China hawks, and second, U.S. firms already face a less open environment in China.
• Google (GOOGL, 1504.95) has pulled more than 2,500 channels tied to China which were thought to be conduits of disinformation.
• Despite continued deterioration of relations, Beijing continues to try to diffuse the situation. China’s foreign minister Wang Yi indicated he is willing to restart talks.  That doesn’t apply to Canada, which continues to bear the brunt of Beijing’s anger.  A second Canadian citizen has been condemned to death for alleged drug trafficking.
• Gold is considered the safest of safe havens. However, to be safe, a holder must have it in a safe place.  Hong Kongers are increasingly moving their gold out of the former colony on confiscation fears.

Policy news: 

• It doesn’t look like a stimulus bill is going to be passed today. Both sides are at an impasse and positions have hardened.  Negotiators did meet for three hours yesterday but were unable to resolve anything.  Clearly, there are political angles being spun; we won’t go into those but there is potentially negative fallout to the economy from the lack of an agreement.  We do expect executive orders to offset some of the potential losses.

Market and Economic news:

• The U.S. has applied tariffs on Canadian aluminum. We note that the Beer Institute has criticized the decision.
• Despite Federal aid, farm bankruptcies have hit a new record. The pandemic has disrupted supply chains (processors who service restaurants saw demand plummet, while retail demand soared) and the trade conflict with China has hurt as well.
• Over the years, we have noted that coastal real estate markets have benefited from foreign capital flight. Recent data suggests this source of buying has diminished.  Not surprisingly, the largest decline in foreign buying came from China.
• That loss of foreigners isn’t hurting the housing market all that much. Lumber prices are soaring on strong building demand.
• It was expected that U.S. economic weakness would lead to a decline in foreign remittances. These are flows that foreigners working in America send home.  At least for Mexico and Central America, that has not been the case.  The most likely reason is that these workers are heavily represented in jobs considered essential and thus stayed employed during the downturn.  At the same time, outflows to Asia appear to have declined.
• As retailers enter bankruptcies, landlords are bracing for the widespread breaking of leases.
• The drop in electric vehicle sales has weakened lithium demand.

Foreign news:

• The Turkish lira has fallen to new lows. The Turkish central bank has been cutting interest rates despite elevated inflation.  Turkey’s CPI is 11.7%, while the benchmark policy rate is 8.25%, meaning the real policy rate is negative.  President Erdogan has pressed the central bank to cut rates, but it appears the financial markets are passing their judgement.
• Over the last couple of days we have discussed the tragic explosion in Lebanon. The next issue will likely be a surge in refugee flows from the country to Europe.  It should be noted that Syrians have emigrated to Lebanon to escape the Syrian civil war.  The current collapse in Lebanon will likely lead those Syrians to try to follow the Lebanese out of the country.
• A reminder—Belarus holds elections on Sunday.
• Brian Hook, the U.S. special envoy to Iran, announced his resignation. Hook has been hawkish on Iran, but his presence did offer a conduit for talks.  His exit almost guarantees that there will be no diplomatic movement on Iran before November’s election.

COVID-19:  The number of reported cases is 19,127,091 with 715,555 deaths and 11,590,138 recoveries.  In the U.S., there are 4,884,406 confirmed cases with 160,111 deaths and 1,598,624 recoveries.  For those who like to keep score at home, the FT has created a nifty 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 R_t data shows that just over 60% of the states are >1, suggesting increasing infection rates.  Midwestern states are experiencing a rising rate of positive tests.

• The pandemic has probably had the most devastating impact on South America.  GDP is expected to contract 9.4% this year.

View PDF

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

[Posted: 9:30 AM EDT] | PDF

It’s the 75^th anniversary of the bombing of Hiroshima.  U.S. equity markets are a bit weaker after a strong showing yesterday.  We lead off with an update on policy progress (or lack thereof), followed by foreign news, with an update on Lebanon.  We also check in on the pandemic, followed by China.  Being Thursday, the Weekly Energy Update is available.  Here are the details:

Policy news: 

• Congressional leaders remain far apart on the next round of stimulus/support. The White House is threatening to take executive actions in lieu of legislation, although there will be limits to how much this can accomplish.  Although the process looks unsettling, this messiness is very common in democracies.  As Otto von Bismarck is attributed to have said, “There are two things no one should ever watch, the making of sausage and laws.”
  • The lack of agreement has probably already affected the economy. Even if the funds are returned, households will note the fragility of the moment and likely save additional amounts of any new stimulus.
  • Here’s a twist—dead people may get a stimulus check after all.
• As Congress continues to work on a support package, worries about a rise in evictions are starting to develop. The previous support package had put a moratorium in place, but that measure has expired.  At present, the decision to evict is a local issue, unless another moratorium is established.
• The National Guard has provided support for COVID-19 testing and other measures. The funding for these soldiers to participate in this mission will expire on August 21 without new authorization from the White House.  However, the demobilization is set to start tomorrow to allow the soldiers to quarantine for 14 days.  Some states have vowed to pay for the National Guard personnel to remain, but others lack the available funding.
• The WSJ has a detailed report on the Fed’s foreign swap lines. The decision by the FOMC to expand these lines was critical in maintaining global financial stability.
• In a recent AAW, we discussed monetary policy and social goals, specifically, what the Fed could do to improve the lot of disadvantaged groups. For African Americans, the evidence suggests the best way to narrow the unemployment gap (the gap between racial groups) is by extending the business cycle.  Congressional Democrats have introduced new legislation that would give the Fed a mandate to reduce racial inequality.  Here are a couple of thoughts:
  • The original Humphrey/Hawkins bill was designed to give the Fed the mandate to bring about full employment. Much of this thrust came from the civil rights movement, as leaders of that movement noted that having rights mattered little if one didn’t have work.  So, this legislation isn’t anything new; in fact, it is already part of the Fed’s mandate.
  • What is being lost here is that the inherent tradeoff is efficiency versus equality. When a society favors efficiency, it gets low inflation at the cost of higher inequality.  When it favors equality, it pays for that goal with higher inflation.  As we have been saying for nearly a decade, the U.S. is embarking on a cycle shift toward equality and away from efficiency.  That will eventually lead to higher inflation, but, given the level of slack in the economy, it will take a long time before that inflation becomes an issue.  Part of the reason the Humphrey/Hawkins bill never really did much is that it passed in 1978 when inflation was becoming a crisis.  The focus on inflation meant that most of the Humphrey/Hawkins law was ignored.  In fact, the most visible vestige of that bill is the fact that the Fed chair has to go to Congress biannually to testify about monetary policy.  This used to be known as the “Humphrey/Hawkins testimony.”
• One of the consequences of the TikTok issue is that it is further evidence that the World Wide Web is rapidly going regional, or becoming a “splinter-net.” Europe, China, Russia, and the U.S. are all taking measures designed to limit the global scope of internet traffic.  The potential impact on globalization is significant; if data can’t be moved easily anymore, The Great Convergence discussed by Richard Baldwin will reverse itself.

COVID-19:  The number of reported cases is 18,835,986 with 708,278 deaths and 11,381,042 recoveries.  In the U.S., there are 4,824,175 confirmed cases with 158,268 deaths and 1,577,851 recoveries.  For those who like to keep score at home, the FT has created a nifty 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.  Axios has updated its state map; there is clear evidence of improvement.

• There is growing consensus that once a vaccine is developed, supplies will be limited. This means some form of triage will be necessary and the protocol for who gets vaccinated and who must wait will be controversial.  Meanwhile, vaccine developers are starting to float pricing schemes.
• One of the common themes we continue to monitor is that societies are struggling with the balance between reopening and virus control. What we are seeing globally is that lockdown rules are eased.  In response, people congregate, relieved from the pressures of following guidelines.  Shortly thereafter, cases rise, and governments attempt to implement restrictions again.  We haven’t yet mastered the balance between the level of interaction and disease proliferation.

Foreign news:

• Here is what we are watching on Lebanon:
  • Although the initial reports from Lebanon were so horrific that it seemed logical that it must have been a bombing, the general consensus is that the cause was catastrophic negligence.
  • After such events, there is a drive to blame someone. Currently, port officials are under house arrest.
  • The Lebanese public is rightfully furious. For this dangerous material to be stored, essentially unsecured, for several years is unfathomable.
  • Ultimately, this is a problem of governance. Lebanon has the characteristics of a Middle East post-colonial state.  The colonial powers tended to create “states” that were not naturally composed.  Instead, they were borders that ignored conditions on the ground.  Peoples, religions, and ethnic groups that would not have naturally congregated were put together.  When the Europeans left, these essentially ungovernable entities remained.  Iraq, Syria, and Lebanon are all classic examples of this phenomenon.  The current government structure, which emerged from the 1990 agreement that ended a 15-year civil war, is no longer functioning.
  • Even before this catastrophe, Lebanon was in deep trouble. It was in the midst of a currency and debt crisis with no clear path to resolution.  The state is trying to avoid direct involvement in the Syrian debacle and has persistent tensions on its southern border with Israel.  What this blast lays bare is that the government probably can’t cope with all the pressures it faces.
  • We would not be surprised to see fighting break out between rival groups and another refugee crisis emerge.
• Azerbaijan and Armenia have been at loggerheads since the breakup of the Soviet Union.  Outside powers, including Iran, Russia, and Turkey, have routinely intervened to support one side or the other.  Recently, Turkey has been sending signals that it is willing to support Azerbaijan as tensions rise.
• Liam Fox, the former U.K. trade secretary, admitted that classified documents related to U.K./U.S. trade talks had been leaked after Russian hackers broke into his account. The episode highlights the risk of Russian technology infiltration.
• It is likely that Belarus is Russia’s closest ally. President Lukashenko is an autocrat much like President Putin.  In addition, Belarus’s close proximity to Russia means that the former needs to get along with the latter, although Lukashenko has tended to follow the small nation handbook of playing Russia against the West for aid. Recently, relations have been strained as Lukashenko faces a real election threat and he has accused Russia of interfering in the election.  The latest is that Belarus claims Russian agents have penetrated the country; it is not clear what the goal was, although intimidation is likely.  The Russians have been detained, which won’t sit well with President Putin.

Markets and Economic news:

• Gold prices have broken above the $2,000 per ounce line with little resistance. Negative real interest rates, currency debasement fears, and societal stability fears are all combining to lift the yellow metal.
• Housing has always been a difficult asset to value. Total return is calculated by the price change of the asset plus any benefits derived from ownership.  Calculating total return from a financial asset is usually straightforward.  How much did the price change over the period of ownership and was other income, interest or dividends, captured?  Housing is different because the benefits can be difficult to calculate.  It is possible to estimate the price gains of a property, although given the characteristics of the market (homes are not universal in quality and thus prices are best estimates), one doesn’t know for sure until the house is sold.  At the same time, there are benefits of living in a home.  And, if we are stuck at home, getting more benefit from the house becomes important.  We are seeing ample anecdotal evidence that homeowners are undertaking remodeling projects.  In the hard data, if we look at retail sales of building supplies and restaurants, it is evident that we are seeing a massive divergence.  The WSJ has a nice reflection piece on the benefits of homeownership; although they can be difficult to value, they are nonetheless real and enhanced under current conditions.

Although inflation has generally been modest, one area that has seen rapidly rising prices is food.  Such divergences are not unprecedented, but rising food prices do have distributional effects, harming lower income households.  Historically, rising food price inflation is not generally persistent and we would expect this episode to end fairly soon.  However, it highlights that any disruption in income support could have an increasingly adverse effect on lower income households.

• Commercial banks are notoriously procyclical. They tend to be too easy during expansions and too tight during recessions.  The most recent Senior Loan Officer Survey suggests a dramatic tightening of lending standards, which will tend to hamper the recovery.

China news:

• SoS Pompeo indicated the U.S. is prepared to expand its crackdown on Chinese tech firms by expanding into cloud-computing companies.
• Globalization and the drive for efficiency rested on an assumption of geopolitical stability.  Specifically, it needed the U.S. to act as global hegemon, reliably providing security and a reserve currency and the rest of the world accepting that condition.  As China has threatened this assumption, it is starting to expose previously unforeseen risks.  Simply put, under conditions of efficiency, there is little worry about where one produces a good.  The only thing that matters is whether production is cost-effective.  However, as the assumptions that underpinned globalization come under question, the U.S. finds itself in a position where it has supply chain risks it hadn’t acknowledged before.  The pandemic has revealed that the U.S. is dangerously exposed to China when it comes to pharmaceuticals.  That vulnerability isn’t a problem when the U.S. is the hegemon and China agrees, but it’s a big problem when the U.S. doesn’t know whether it wants to be the hegemon and China would like to remove our influence from that part of the world.

View PDF

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

[Posted: 9:30 AM EDT] | PDF

Moderating coronavirus infections in the U.S. and continued progress in vaccine and treatment studies are helping buoy risk assets so far today, despite a major explosion in Beirut that initially raised fears of terrorism.  Another important positive today is that White House and congressional negotiators say they’re hoping to reach a deal on the next coronavirus relief bill by the end of the week.  We review all the key news below.

COVID-19:  Official data show confirmed cases have risen to 18,570,858 worldwide, with 701,316 deaths and 11,163,388 recoveries.  In the United States, confirmed cases rose to 4,771,846, with 156,839 deaths and 1,528,979 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• New coronavirus cases in the U.S. climbed above 50,000 for the first time in three days, but the tally remained lower than during recent peaks.  In addition, there are now only 18 states where the seven-day average of new confirmed cases is above the 14-day average, compared with 48 states a month earlier.  The data appear to confirm a continued moderation in new U.S. infections, even if some states and some foreign countries continue to face accelerating cases.  The figures should therefore be supportive for risk assets today.
• In contrast with the good news in the U.S. and many other major developed countries, the pandemic is still buffeting many large developing countries.  The Bolivian government has canceled its entire school year, worrying there isn’t enough internet reach across the country to make virtual classrooms feasible.  Longer term, there is also increasing concern that the pandemic will make it even harder for less developed countries to reach advanced country status.
• Novavax, Inc. (NVAX, 157.17) said its experimental coronavirus vaccine induced promising levels of both neutralizing antibodies and T-cells in an early-stage human trial of the shot.  The company also said the vaccine was generally well-tolerated.  That means the Novavax vaccine is in the current horserace of almost half a dozen vaccine candidates that have either moved into a final Phase III trial or are preparing to do so.  The news should help keep alive the current market optimism that a shot can be approved around the end of the year.  There would still be many challenges to be met before the global population can be broadly immunized, but the vaccine progress to date is encouraging, which should be positive for risk assets.
• In the search for treatments, researchers running a large national study found that hospitalized COVID-19 patients who received transfusions of blood plasma rich with antibodies from recovered patients reduced their mortality rate by about 50%.

Economic Impact

• June retail sales in the Eurozone rose by a seasonally adjusted 5.7%, following a revised 20.3% gain in May.  That left sales slightly higher than in February, before the pandemic took hold in Europe, and it left sales 1.3% higher than in June 2019 (see tables below).
  • Clothing and footwear sales rose especially strongly in June, while fuel sales also continued to rise.
  • However, in a sign of what may happen in other advanced economies as they recover from the pandemic, online purchases and mail orders dipped after four months of growth, suggesting consumers were beginning to return to stores rather than relying on home deliveries.
• In an interview with the Financial Times, Tokyo Olympic Games Chief Toshiro Muto insisted Japan will hold the event next summer as currently planned, even if the coronavirus isn’t yet under control.

U.S. Policy Response

• Treasury Secretary Mnuchin said the White House and congressional Democrats are aiming for a deal on the next coronavirus relief bill by the end of this week.  However, he also warned that the two sides are not yet “at the point of being close to a deal.”  Given the way massive monetary and fiscal stimulus have been so instrumental in buoying the U.S. economy and financial markets through the crisis to date, continued negotiations and optimistic statements like Mnuchin’s are a positive for risk assets.  All the same, if brinksmanship rears its ugly head again or the resulting package is deemed disappointing, the markets could become volatile late in the week.

Lebanon:  After a massive explosion at a warehouse in central Beirut killed dozens of people yesterday, Lebanese officials offered assurances that the blast occurred because of a fire and was not on purpose.  Press reports say the explosive was 2,700 tons of ammonium nitrate seized from a Russian ship in 2014 and stored in a waterfront warehouse pending legal proceedings.  However, President Trump called the explosion a “terrible attack” and said U.S. military leaders believe the tragedy was caused by “a bomb of some kind.”  Even though Israel exchanged fire with Hezbollah militants on its border with Lebanon last week, an Israeli government official said Israel had no involvement in the explosion.

United States-China:  U.S. and Chinese officials have agreed to meet via videoconference on August 15 to assess Beijing’s compliance with the Phase I trade deal signed in January.  The meeting will reportedly include both U.S. Trade Representative Robert Lighthizer and Chinese Vice Premier Liu He, President Xi Jinping’s point man on economic policies.

United States-China:  In a move China will likely see as provocative ahead of the trade deal meeting, U.S. Health and Human Services Secretary Azar will lead a delegation to Taiwan to discuss the coronavirus pandemic.  Azar’s trip would be the first visit by a U.S. cabinet official to Taiwan in six years.  In a statement, Mr. Azar said his trip is intended to show President Trump’s support for Taiwan, its democratic government and the leadership it displayed in handling the coronavirus outbreak.

Saudi Arabia-China:  Based on information from Western officials, the Wall Street Journal yesterday said Saudi Arabia has secretly built a facility to extract yellowcake from uranium ore, advancing its drive to master nuclear technology and keeping open an option to develop nuclear weapons.  The Saudi government categorically denied the report, but the news is still bound to generate concern in the U.S. Congress, where a bipartisan group of lawmakers has expressed worries about Crown Prince Mohammed bin Salman’s vow to develop a nuclear bomb if Iran does so.  Given Saudi-Iranian enmity, possession of nuclear capability by both sides would seriously increase potential devastation in the event of war.  Besides that, the report said the facility was built with Chinese help, which will raise concerns that China might try to woo U.S. allies into its orbit with promises of nuclear technology.  Finally, the news will likely be concerning to Israel due to its past military confrontations with Saudi Arabia.

India:  Prime Minister Modi has presided over a ceremony to kickstart the construction of a Hindu temple on the site of a 16^th century mosque, whose destruction in 1992 sparked deadly riots across India.  The ceremony underlines Modi’s commitment to Hindu nationalism one year after he revoked the semiautonomous status of India’s only Muslim-dominated region, Jammu and Kashmir (see our WGR from September 9, 2019).

North Korea:  After a period of relatively good behavior, satellite imagery shows North Korea has ramped up its sanctions-busting coal exports again.  The new activity is being taken mostly as a sign of increased economic pressure on North Korea.

View PDF

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

[Posted: 9:30 AM EDT] | PDF

Despite the mixed performance for equities so far today, reports are showing a moderation in new U.S. coronavirus infections, as well as hints of progress in the negotiations for a new virus relief bill in Congress.  As always, we review all the key news items below.

COVID-19:  Official data show confirmed cases have risen to 18,317,520 worldwide, with 694,715 deaths and 10,935,280 recoveries.  In the United States, confirmed cases rose to 4,718,249, with 155,478 deaths and 1,513,446 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• Several large states in the South and West that had recently seen a surge of new infections continued to report moderating caseloads, though part of the decline in recent days may reflect the shutdown of some testing sites in Florida ahead of Tropical Storm Isaias.  Unfortunately, public health officials also continue to report signs of rebounding caseloads in the Midwest and some areas of the Northeast.
• Despite the improving overall trend in the U.S., researchers in the U.K. and France warned that without adequate procedures to test and trace positive cases, there will likely be a large, new outbreak of the disease this autumn.
• Scientists are noticing that as many as 10% of those who become sick with COVID-19, including young adults, suffer from a long, drawn-out form of the disease that some refer to as “long-haul COVID,” “LONGCOVID,” or “post-COVID syndrome.”  The condition is evidently similar to chronic fatigue syndrome, or myalgic encephalomyelitis.  The news is a reminder that even if the statistics show large numbers of people recovering from the disease, some of them may actually be saddled with lingering symptoms that could weigh on their ability to work.
• As the horserace among several leading vaccine candidates continues into Phase III tests, investors remain optimistic that a shot will be ready by the end of the year.  However, investors are also starting to pay more attention to the already high valuations for some of the vaccine companies’ stocks.

U.S. Policy Response

• After an hours-long negotiating session yesterday, Democratic leaders and White House officials sounded cautiously optimistic that they were making progress on the next coronavirus relief bill.
  • Nevertheless, the two sides remain at odds over whether to cut the supplemental federal unemployment benefit of $600 per week, whether to provide more assistance to financially strapped state and local governments, and other issues.
  • One complicating factor is that the competing Democratic and Republican proposals are riddled with pork barrel spending unrelated to the virus crisis.
  • To raise pressure on the Democrats, reports say the White House may attempt to implement some relief measures by executive order (a kind of decree), including a cut in the payroll tax and a further moratorium on evictions.
  • According to officials, the negotiations will resume on Tuesday.
• Of course, the Federal Reserve also continues to provide extremely loose monetary policy in support of the U.S. and global economies.  For a useful review of its actions as global lender of last resort, see this WSJ article.
  • The article highlights how the Fed’s agile and powerful action to support the dollar financial system around the world has helped burnish the greenback’s status as the world’s key reserve currency.
  • However, the article also highlights how the resulting status of the dollar as the predominant safe currency has raised concerns that it is too dominant.  That sentiment is a key reason why we place so much importance on the EU’s new coronavirus relief program, which will include the issuance of common EU debt on a scale that should make the euro a more viable reserve currency and a more viable competitor for the dollar.

Financial Market Response

• Double-digit stock gains boosted public pension systems’ median return to 11.1% for the second quarter, marking their best quarterly performance since 1998.  However, even with their rebound from the first quarter, median annual returns for the public pensions, whose fiscal years ended June 30, were just 3.2%, far short of the funds’ long-term target of around 7%.
• As investors begin to note the current upward momentum for precious metals and the positive impetus they’re getting from factors like safe-haven buying, the falling dollar, and the rising federal budget deficit (all of which we’ve described repeatedly), gold and silver continue to rise.  Here is a handy WSJ article on the mechanics of the gold market.

World Trade Organization:  In interviews with the Financial Times, the two main candidates to become the next leader of the WTO said the U.S. has valid concerns over judicial overreach by the organization’s dispute settlement system.  Kenya’s Amina Mohamed and Nigeria’s Ngozi Okonjo-Iweala both said they would support reining in the system, though it’s not clear when or if that would convince the Trump administration to lift its freeze on naming new judges to the WTO’s appellate body, which has prevented it from operating.

United States-China:  President Trump said he is ready to approve the purchase of the U.S. operations of the Chinese video-sharing app TikTok by Microsoft (MSFT, 216.54), but only if the government receives “a lot of money” in exchange.  The move has drawn bipartisan pushback, especially as it would appear to constitute a kind of arbitrary, one-off tax on a private corporate transaction.  Just as important, the demand also exacerbated tensions with Chinese officials, who are chafing at Trump’s earlier threat to ban TikTok from the U.S. over concerns that the company could share sensitive user data with the Chinese government.

United States-Poland:  A week after announcing the pullout of 12,000 troops from Germany and only partially redeploying them elsewhere in Europe, the Trump administration said it will send 1,000 additional soldiers to Poland.  The increased U.S. presence there will include intelligence, surveillance and reconnaissance capabilities, as well as infrastructure to support an armored brigade combat team and combat aviation brigade.  However, the small move in Poland is seen as insufficient to offset the loss of forward defense capabilities associated with the large troop drawdown in Germany.

Argentina:  The Argentine government reached a deal with its biggest creditors on restructuring $65 billion of its foreign bonds after it agreed to make some debt payments earlier than it wanted.  If the country’s bondholders approve the deal, the country will avoid years of exclusion from the global credit markets and a potentially acrimonious, drawn-out legal battle like the one that followed its 2001 default.

View PDF

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

[Posted: 9:30 AM EDT] | PDF

Happy Monday!  U.S. equity futures are ticking higher this morning and the dollar is stronger.   There was lots of policy news, which will be our lead.  The virus news is next; mask controversy isn’t just a U.S. issue.  An update on China follows, and we close with foreign news.  Here are the details:

Policy news: 

• The U.S. is poised to close TikTok, the video app, but Microsoft (MSFT, 205.01) is interested in buying the U.S. operations of the company. This subsidiary of the Chinese tech company ByteDance claims the U.S. TikTok operations are isolated from China.  The U.S. fears the company gathers data on American users that is accessed by Chinese intelligence.  And, it’s not just the U.S.  Australia shares similar concerns.  Although TikTok is catching most of the attention, the U.S. is moving beyond this particular company to Chinese tech firms, in general.
• The Fed has been considering changes to how it manages inflation targeting. Since Volcker, the Fed moved rates in anticipation of rising inflation.  This policy was enacted to manage inflation expectations.  One of the oft-forgotten elements of inflation is the role of expectations.  When economic actors anticipate higher prices, they make balance sheet decisions accordingly.  Businesses will hold more inventory to preclude higher prices and households will tend to spend faster and make bulk purchases.  In the 1970s, inflation expectations became elevated; Volcker’s shock treatment made it clear to economic actors that the Fed was serious about containing inflation.  In the ensuing decades, that trust meant increases in inflation didn’t gain momentum.  That was due, in part, to the policy of preemptive rate hikes.  It could be argued that the policy has worked so well that despite aggressive attempts to lift inflation by expanding bank reserves, the Fed has been unable to reach its 2% core PCE target.
  • This looks to us to be a classic case of “intergenerational forgetfulness.” Policymakers introduce a policy under conditions, often extreme, that is an appropriate response to the problem at hand.  The Fed adopted preemptive policy rate hikes because the pain of 19% fed funds rates in the early 1980s was emblazoned on the minds of the FOMC.  However, that pain is now 40 years old and we have a different problem now—inflation that is persistently so low that the Fed can lower real interest rates.
  • For those of us old enough to remember, abandoning preemption looks like a really bad idea. However, the succeeding generations of Americans who have benefited from low inflation disregard its value, in part, because they don’t know how corrosive inflation can be.

• • The experience of high inflation is steadily becoming a generational artifact. We are seeing the groundwork of the next great reflation.  The end of preemption, MMT, high deficits, etc. will all eventually end in higher inflation.  That is certain.  What is not certain is the timing.  It could take more than a decade before inflation expectations reverse.  After all, the Depression children, who came of age in the 1950s, did not engage in behaviors consistent with inflation fears even though financial repression was rife.  It wasn’t until the mid-1960s that the policies designed to lift prices gained momentum.  Once inflation expectations turned, it got ugly.
• The Fed’s Main Street lending program has been a disappointment thus far. The question is an age old one for lenders—is the borrower facing a liquidity problem or a solvency problem?  If it’s the former, lending will support the company until conditions improve.  If it’s the latter, lending will only delay the inevitable.  The borderline cases are the problem; it can be exceedingly difficult to determine whether a troubled company really isn’t going to make it or, with help, if it can survive.  For generations, banks trained loan officers for this task.  However, banks noted this was a labor-intensive exercise and decided that lending to larger companies carrying credit ratings was a more efficient way to lend.  We doubt the Fed has the wherewithal to make these judgements and is likely erring toward caution, meaning not a lot of money is being lent.
• Meanwhile, congressional and White House leaders met over the weekend. Nothing was accomplished and the support measures passed in March are expiring.  There are a number of sticking points, but perhaps the most troublesome is the $600 per week employment insurance supplement.  We do expect an agreement to be reached, but the fact that we are seeing a disruption will likely lead households to try to save as much as they can for fear of future disruptions.
• British trade officials are coming to Washington for face-to-face meetings. Westminster was hoping for a quick trade agreement with the U.S. to give the U.K. leverage with the EU over their trade talks.  However, the British found that, after Brexit, the U.K. has little bargaining power.  The U.S. is demanding concessions (agriculture is a big sticking point) and if the U.K. doesn’t concede, Washington has little need to make a deal.

COVID-19:  The number of reported cases is 18,093,891 with 689,625 deaths and 10,700,077 recoveries.  In the U.S., there are 4,667,957 confirmed cases with 154,860 deaths and 1,468,869 recoveries.  For those who like to keep score at home, the FT has created a nifty 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: 

• In mid-March, Tomas Pueyo, a tech entrepreneur, published an article in Medium titled “The Hammer and the Dance.” In the article, he outlined the challenges of managing the virus without a vaccine.  We reread the article every few weeks.  In March, most of the developed world was in lockdown.  He correctly predicted that lockdowns would work but were unsustainable.  The “dance” part was how much reopening could occur before infection rates returned and triggered partial restrictions.  His report showed that the “dance” would be difficult because it would be impossible to predict in advance what openings were possible and what were not.  Since lockdowns eased in May, we have seen a resurgence in cases in the developed world.  In a sense, we are learning what actions can be safely managed, and what can’t.
  • For example, we are learning that “bubble” sports, such as the NHL and NBA, seem to work rather well. MLB is stumbling because it is traveling.
  • There is a notion that the controversy over mask-wearing is an American issue. Not so; Germany had a massive protest over the weekend on this issue.
  • Lockdowns are especially difficult for younger people. The natural desire to socialize creates “lockdown fatigue” and eventually breaks down.  Europe is seeing a rise in cases as younger Europeans return to beaches and bars.
  • Australia is implementing regional lockdowns after a surge of cases.
• One of the persistent mysteries of COVID-19 has been the variability of symptoms. Generally speaking, a “mild” case of the flu is a real pain.  A bad one is never forgotten.  But, with COVID-19, there is ample evidence of completely asymptomatic cases.  At the same time, other cases have led to death or permanent damage to cardiovascular systems.  In other cases, patients can’t seem to shake the disease and bear severe symptoms for weeks.
  • A recent Nature article offers an interesting perspective. COVID-19 is a coronavirus, a broad family of viruses that include SARS, MERS and the common cold.  Studies were conducted to determine the immune response from those who had contracted the disease.  For comparison purposes, researches looked at blood samples from others who had not tested positive for COVID-19.   To their surprise, a large number of the unexposed showed similar immune responses to those who had been diagnosed.
    • Researchers speculate that earlier coronavirus infections may have created a degree of immunity, which would either lead to a mild or asymptomatic case of COVID-19.
    • However, they also noted that the wide dispersion of symptoms may be tied to existing immunity triggering a massive immune response once exposed to COVID-19, and it is this cytokine storm that leads to a severe case of the disease.
    • The existence of pre-immunity will complicate vaccine testing. For those with a high level of pre-immunity, the vaccine may very well lead to a robust immune response and suggest smaller doses of the vaccine will be effective.  At the same time, if the vaccine triggers an excessive immune response, it could lead researchers to conclude the vaccine has failed.
  • Additional research is necessary. If confirmed, a pre-test may be required to measure native antibodies in a patient and tailor the vaccine to the existing level of immunity.  That may make the vaccine much safer and effective, but it would likely slow the rollout.
• Eli Lilly (LLY, 150.29) is testing an experimental drug that could potentially protect the elderly and staff at nursing homes.
• Russia is planning a mass vaccination program in October with its vaccine. There are fears that the vaccine hasn’t been fully tested and there is a possibility that extensive vaccinations could lead to adverse outcomes.  This is a situation that will be closely watched.

China news:

• The U.S. has sanctioned a paramilitary group in Xinjiang. The Xinjiang Production and Construction Corps (XPCC) is a group that controls much of the economy of the province.  The U.S., deploying the Global Magnitsky Act, has sanctioned two CPC members tied to the XPCC.  This move will infuriate Beijing as it suggests the U.S. will take actions against individual members of the CPC for executing Chairman Xi’s policies.
• Although we maintain skepticism that the CNY will replace the USD as a global reserve currency (primarily because Beijing has a closed capital account), we do watch for evidence that our position may be wrong. We are seeing broadening use of CNY in Indonesia, suggesting in that country the CNY is being seen as an alternative store of value.  So far, we haven’t seen other nations take similar steps, but the actions China has taken to increase the use of CNY in Indonesia are notable.
  • On a related note, the PBOC is experimenting with a digital CNY in a few provinces. Digital central bank currency is a topic of interest and will likely be the focus of a WGR before year’s end.
• Germany has finally suspended its extradition treaty with Hong Kong. Berlin has been slow to sanction China over its behavior in Hong Kong due to Germany’s extensive direct investment in China.
• In a twist, a recent study found that somewhere between $192 million to $419 million of PPP loans went to small firms controlled by China.
• How have relations between the U.S. and China deteriorated? Here are a couple of charts:

Foreign news:

• In a move that will concern its neighbors, Japan is moving toward a “first use” policy. Since the end of WWII, Japan’s military has struck a defensive posture.  It would not initiate an attack against anyone.  It could maintain that policy because it had faith in the U.S. security guarantee.  It would appear that guarantee is less ironclad, so Tokyo is likely preparing for a world where it may need to defend itself.
• The UAE has a nuclear reactor, the first Arab nation to do so.
• Protests continue in Russia’s far east.

Markets and Economic news:

• Last week, we noted that savings rates remain very high. That would appear to be one of the consequences of the $600 per week unemployment insurance supplement.  Consumers have been curtailing their use of credit card debt in response.
• Just a reminder: it’s employment Friday this week.

Odds and ends:  There have been rising fears surrounding the November elections.  Here’s a new worry to add to the collection—ransomware could be used to take voter data hostage.

View PDF