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.

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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.

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

[Posted: 9:30 AM EDT] | PDF

Happy St. Ignatius[1] Day!  It’s Friday and the “dog days” of August await.  Equity markets are mostly higher this morning after the major tech firms revealed impressive earnings.  This may be one of the rare times where such earnings are a problem given the firms’ recent testimony to Congress.  Policy news, or the lack thereof, leads today’s coverage.  China and COVID-19 are next.  The new Asset Allocation Weekly is posted below (and published as a separate report on our website) and the related podcast and chart book are also available.  Here are the details:

Policy news: 

• As a number of recovery measures are set to expire, congressional leaders remain far apart on a deal for another stimulus package. The GOP has offered a series of individual bills that would address unemployment insurance and evictions.  Democrats were not impressed, fearing that once these measures pass, other goals would languish.  We do expect a bill to be passed, because the lack of additional support would be a serious problem.  As yesterday’s GDP data revealed, the economy is in a difficult spot.
• On the topic of yesterday’s GDP data, the headline numbers were so historically bad that much of the detail was lost in the coverage. This is the fourth recession since 1982, meaning that the U.S. economy has suffered a recession roughly every 9.5 years since then.  From 1946 through the 1982 recession, the economy had a recession, on average, every four years.  One reason that recessions became less frequent was due to a structural change in the economy.  As services became more important, downturns were less frequent.  This is because services are less prone to inventory cycles.  Goods production is hard to get exactly right; if overproduction occurs, and stockpiles rise, activity declines and recessions occur.  But, in services, the “inventory” is actually made up of workers.  Firms will adjust tasks when business slows and only reluctantly reduce headcount.[2]  In general, there is less volatility in services relative to goods.  From 1947 until Q1 2020, the average contribution to GDP from services consumption was 1.1% per quarter with a standard deviation of 0.6%.  For goods over the same time frame, the average was +0.9% with a standard deviation of 1.7%.  However, last quarter, goods consumption subtracted 2.2% from GDP, while services consumption pulled a whopping -22.9%.

This chart highlights the problem of boosting growth.  Consumption dominates GDP and services dominate consumption.  Goods represent 33% of consumption and services 67%.  Services are dependent on contact; 16% of service consumption is restaurant and recreation.  Add health care, another service that usually requires contact, and the percentage rises to 40%.  Without a reliable way to control the spread of the virus, getting services back will be very difficult.  A vaccine with widespread adoption is the best path to this goal, so, as Chair Powell indicated, the economic recovery is dependent on the virus.

• Environmental groups are pressing the Fed to stop buying bonds of energy companies. The recent decision by the Fed to venture beyond buying Treasuries and mortgages exposes the institution to political pressures for which it isn’t accustomed.

China news:

• The CPC announced it will hold its central committee meeting in October. Meanwhile, Chairman Xi is holding Politburo meetings about the economy where he is recommending a focus on fostering domestic demand for future growth.  This “pivot” to domestic consumption and away from the dependence on exports and investment has been recommended by economists for years.  The economics of the move are well understood, but the politics are another matter.  There are two problems with this shift politically; first, those who have benefited from the export/investment policy tend to be powerful members of the CPC.  Xi has deliberately purged most opposition but the blowback from harming this powerful group’s economic fortunes is risky.  Second, the transition won’t be easy; households would need to have assets and income moved in their direction and one would expect a lag between receiving that income and assets and increasing consumption.[3]  That would mean slower growth, at least for a while.  And, the CPC has made its mark on delivering growth, so the party’s political image would be harmed by a drop in GDP.
  • With regard to growth, China has returned to its old playbook of investment to lift output. It is pressing state and local governments to borrow.  This may be a short-term fix, but it does highlight how hard it is to break old habits.  It also explains this quarter’s lift in industrial metals prices.
  • Although this reform is likely necessary for China’s development, the proximate cause appears to be due to the deterioration of U.S./China relations.
  • It is also important to remember that China has a long history of cycling between openness and inwardness. The former tends to occur when the government wants faster growth and the latter when it wants political stability.  We may be heading into an “inward” phase.
• China’s economy does seem to be doing ok. PMI data indicates the expansion continues.
• Hong Kong legislative elections have been delayed, with leaders blaming COVID-19. A number of pro-democracy candidates have been banned from running.
• As we have been saying for a while, China continues to lag in its Phase One commitments. At the same time, we are seeing a surge in corn orders, a welcome sign for American farmers.
• At a hearing before the Senate Foreign Relations Committee, SoS Pompeo indicated that additional measures against China are planned.
• Lee Teng-hui, Taiwan’s first elected president, died yesterday at age 97.

COVID-19:  The number of reported cases is 17,322,041 with 673,833 deaths and 10,156,580 recoveries.  In the U.S., there are 4,495,224 confirmed cases with 152,075 deaths and 1,414,155 recoveries.  For those who like to keep score at home, the Financial Times 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 is showing some improvement.  Forty percent of the states have a reading under 1, which would indicate the virus spread should diminish.  On a local note, Missouri has the highest reading in the union, at 1.2.

Virology:

• Chinese hackers have reportedly targeted Moderna (MRNA, 77.63), one of the leading firms in vaccine research.
• Sanofi (SNY, 52.50) and GlaxoSmithKline (GSK, 40.25) have made an agreement with the U.S. to provide the vaccine to the U.S.
• Survivors of COVID-19 are being warned that their infection may not have provided lasting immunity and thus they should exercise care.
• Former presidential candidate Herman Cain has died from COVID-19.
• We are seeing the first lawsuits against companies over COVID-19 infections. The GOP has been pressing for protection against such suits, correctly fearing that if companies face legal liability they will simply not reopen.  At the same time, if companies are given blanket protection, they will have no incentive to protect workers.  Finding a midpoint between applying complete immunity and full legal responsibility is an obvious necessity.  One way to thread this needle would be to rely on insurance standards—companies have to engage in various precautionary standards and, if those are met, they are protected from lawsuits.
• Testing remains a serious problem. As the country has ramped up testing, it has overwhelmed the test processing industry, leading to delays so long as to render the tests nearly useless.  But, to improve the turnaround, we would need to reduce the number of tests.  Without adequate and widespread testing with quick responses, we are mostly “flying blind” regarding the virus.
• We often hear commentators and political figures speak reverently about science. However, any reading about the history of science will show that science is a method of inquiry.  And it’s a good one.  Following the rules of science will tend to overcome human bias and reach favorable conclusions.  Nevertheless, the process of science isn’t always straightforward and it’s not sacred.  The history of science is littered with positions that were considered “facts” until disputed with new information.[4]  Often, it takes generational change to adjust theoretical understanding.[5]
  • One of the problems with COVID-19 is that we aren’t really sure how it spreads. Initially, it was thought to be spread on surfaces.  Thus, hand washing and mass sanitizing was implemented; this was probably best described as “hygiene theater.”  We all saw the shortages on hand sanitizers and bleach.  But further research indicated that it also probably spreads by droplets.
    • However, even this discovery complicated things. If the dispersion comes from large droplets, they fall to earth by gravity.  This led to the recommendation of being “six feet apart,” or social distancing.
    • At the same time, there is evidence to suggest that much smaller droplets, or “aerosols,” may be the primary spreading vector, meaning that being six feet apart is completely inadequate. These aerosols can be suspended in air for some degree of time and thus being further apart would be necessary.  Instead, the guidance would call for avoiding closed areas and close contact and crowds, especially indoor crowds.  Instead of bleach, we should be considering HEPA filters.
    • It isn’t all bad news. Aerosols don’t last very long outside.  Sunlight can weaken them, and they dissipate in moving air.  There is probably less risk in outdoor activities.  Being indoors, on the other hand, is quite risky.  Mass events and optional mask wearing indoors would present a problem, while walking the dog without a mask is much less risky.
  • The point is, there is much we really don’t know. And that is to be expected.  This is a new virus.  It will take time and research to develop certainty surrounding COVID-19.  Unfortunately, the media does a poor job of reporting on science news, projecting an air of certainty when it isn’t warranted or indicating skepticism when it shouldn’t.
  • So, what should be done? It is important to realize the situation is fluid and that recommendations will change over time.  In finance, we make decisions under conditions of uncertainty all the time.  In the end, all of us have to make probability judgements for which a certain degree of humility is required.

Foreign news:

• European regulators are looking to apply new regulations on tech firms that would undermine their ability to provide “house brands” that undercut prices on competitors.
• For the first time, the EU is applying sanctions on Russia, North Korea and China over hacking.

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[1] The founder of the Society of Jesus (Jesuits).

[2] This is why the advent of gig work is so interesting.  It allows firms more flexibility in their “inventory.”

[3] The economic theory is called the permanent income hypothesis.  It postulates that households spend based on their income and wealth history.  Thus, if incomes fall but the decline is seen as temporary, spending continues.  If the opposite occurs, wherein a windfall happens, spending doesn’t immediately adjust.

[4] Until 1956, it was generally believed that humans had 48 chromosomes; turns out, we have 46.

[5] “Science progresses one funeral at a time.” — Max Plank

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

[Posted: 9:30 AM EDT] | PDF

It’s GDP day!  It has been well forecast for months that Q2 GDP would be an epic negative.  It turned out to be bad, but not as bad as expected.  GDP fell 32.9% on an annualized basis compared to expectations of a 34.5% decline.  See below for the details.  It’s a risk-off day so far.  We have a plethora of policy news as the Fed held its meeting, the tech giants met with Congress, and the stimulus bill is a mess.  News on China is extensive as well.  We discuss pandemic updates.  The Weekly Energy Update is available.  There is a lot to cover so let’s get to it:

Policy news: 

• There were no major surprises from the Fed. Rates remain unchanged and QE will continue at $120 billion per month, with $80 billion to Treasuries and $40 billion to mortgages.  As we noted yesterday, the Fed has extended its backstop programs; forex swap lines were also extended.  Overall, the statement was somewhat downbeat, with comments suggesting the pandemic is continuing to weigh on economic activity.  Hence, the FOMC decided to continue its extraordinary support for the economy and financial markets.  There were no dissents to the decision.
• CEOs of Apple (APPL, 380.16), Google (GOOGL, 1523.51), Facebook (FB, 233.29), and Amazon (AMZN, 3,033.53) all testified remotely in front of the House Antitrust Subcommittee. It would be difficult to describe the testimony as friendly.  Anger at the large tech companies is bipartisan, although the reasons for the displeasure are not.  Democrats were upset with the monopolistic behaviors of the firms and their fostering of misinformation; Republicans were angered by censorship of right-wing views.  Social media firms try to hide behind algorithms to suggest their software is unbiased; in reality, the goal is eyeballs on screens, so there is a documented manipulation.
  • It would be difficult to argue that at least three of these firms (GOOGL, FB, AMZN) are not engaging in blatant anti-competitive behavior. They have purchased rivals and duplicated and engaged in predatory pricing actions of products on platforms.  Their ability to generate profits and revenues in any season is probably not possible without market dominance.  Their actions would have already been curtailed under legal standards prior to the mid-1980s.  That hasn’t happened under current standards because it is hard to argue that consumers have been hurt.  However, labor has; we offered a framework in our WGR series last year, “The Economic Triangle: Parts I and II.”  Using that framework, antitrust policy over the past 35 years has aligned the interests of capital and consumers against labor.  The well-documented rise of populism suggests that alignment is probably near an end and new (or a return to pre-1985) antitrust policy is part of that realignment.
  • At the same time, although anger is universal, complaints are not. Democrats are attacking the firms mostly on size and behavior grounds, but the GOP is divided.  The GOP establishment mostly wants social media to not censor right-wing views, while GOP populists are more aligned with Democrats over the market power of these firms.  Look for the tech firms to try to exploit this difference.  Although we do expect these firms will eventually face antitrust actions, it will probably be a while.
• It is looking increasingly unlikely that a stimulus package will be ready before August 1, when the current measures expire. The GOP is deeply divided.  The White House mostly wants spending and lots of it (although the Chief of Staff may have misgivings), whereas GOP populists want spending too but the establishment wants to slow the rise of the deficit.  If the Senate majority leader wants a bill, he can cobble together a majority with Democrats, but that will hurt his own caucus.  Democrats have already rejected a patch measure.  Some Republicans are offering new programs, meaning consensus is not occurring.  The lack of a plan is likely weighing on market sentiment this morning.

China news:

• Taiwan has become a flashpoint in U.S./China relations. Beijing is imposing sanctions on Lockheed Martin (LMT, 386.66) over arms sales to Taipei.  Analysts suggest the sanctions are not terribly damaging for the company, but more of a warning shot.  However, the Global Times, a CPC mouthpiece, warned that rare earths could be affected.  China has used its dominance in rare earths before, against Japan over the Senkaku Islands (also referred to as the Diaoyu Islands by China).  The warning by the Global Times suggests that Beijing may return to constraining the supply of rare earths again if tensions escalate.  Rare earths, although not all that rare, are critical to numerous high tech and defense applications.  We are seeing some production outside China, but a cutoff of supply would be a problem.
• Unemployed graduates are a risk to stability. China is making a particular effort to expand state jobs to absorb new graduates.
• The recent decision by the U.S. to close China’s consulate in Houston appears to be a signal to China. The U.S. has become aware of how China uses consulates not only for espionage but also for monitoring Chinese nationals and other former citizens.
• This week’s WGR, along with Part II next week, discusses recent Chinese policy. In next week’s report, we will examine China’s policy from Beijing’s perspective.  We continue to monitor China’s position for insights into future behavior.  We note that Xi’s policy of aggressive confrontation is facing some criticism within the CPC.  In addition, two hawkish generals, Dai Xu[1] and Qiao Liang, have cautioned that the PLA is no match for the U.S. military at this juncture and prompting a war could be catastrophic.  The generals note that:
  • The U.S. has developed a profound hatred for China, which is a new development.
  • The U.S. government’s negotiating stance has changed, becoming aggressive and well beyond what China expected.
    • Although not part of the general’s comments, we note that China hawks within the administration are reported to have made contacts with members of the Biden camp. This would suggest these members of the administration are preparing for the possibility of a change in office and are attempting to establish a policy that will extend beyond 2020.
  • No nation has come to China’s defense, suggesting that either the U.S. is still powerful enough to coerce compliance or, more likely, the rest of the world sees China as a threat and supports U.S. policy.
  • A united front is developing around U.S. policy, not China’s.
  • The U.S. isn’t a paper tiger; it’s a potent one that can inflict damage.
  • The U.S. has remarkable ability to course correct and adjust (democracies are actually pretty good at this).
  • The U.S. is less interested in ideology and values and is more driven by economic interests.
  • It was bad policy to say out loud that China was going to surpass the U.S. (in Xi’s defense, Khrushchev made the same mistake in the 1960s).
  • The U.S. really doesn’t care if it offends other nations; it has lots of allies and doesn’t sacrifice its own interests.
  • China needs to understand it is not the world’s superpower; the U.S. is, and Beijing needs to admit that fact.
  • Don’t talk about “sharing information” with the U.S. Americans see that as intellectual property theft.
  • Elections don’t matter all that much as national strategy lasts beyond whomever is in the White House.
  • You don’t fight the U.S. alone.

These admissions are remarkable.  We doubt these two generals will survive these comments; as we noted, one has already tried to deny them.  But this does show that the triumphalism of President Xi is not universally held.

• U.S. spy aircraft have been stepping up their flights around mainland China.
• There are reports that President Trump is “willing to accept more risk” with regard to China. It is not clear what exactly this means but it appears to be related to building a coalition of nations around China.
  • The FBI is warning that China is trying to interfere with our elections. We discussed this issue in our recent WGR on the elections.
• This is a big one. Chinese banks are being warned to prepare to lose access to the S.W.I.F.T. network.  We have not heard anything official out of the U.S. on this threat, but if it were implemented, it would clearly divide the world.  Given the high number of comments from U.S. officials recently, one would think this would have been mentioned if such a move is imminent.  If adopted, this policy would remove China from the global financial system; alternatives are not really workable.  Again, there hasn’t been anything out of Washington on this, but this would be a major hostile act if implemented.
• The Pentagon is warning that China is becoming a more potent nuclear threat.
• For background, Miles Maochun Yu is emerging as an influencer of the SoS.
• We are seeing pushback from the establishment against the administration’s China policy. Richard Haass, the president of the Council on Foreign Relations, opined recently that the recent hawkish turn is a mistake and a misreading of history.  This is no surprise; the establishment has done quite well by integrating China’s economy into the world economy.  Haass notes that the Trans-Pacific Partnership would have been a great tool to force China into adopting the U.S. trade system.  Haass is correct…except those sorts of trade agreements are no longer politically possible in the U.S.  Populists on both sides contend that such deals harm their interests and passing them is probably not possible.
  • On a related note, Australia, which has been a target of Beijing’s ire recently, is negotiating with great care with the U.S. on trade, clearly wanting to overtly take sides. According to reports, the U.S. and Australia are quietly building a defense plan as well.
  • The EU and China held talks on trade and economics this week. Surprisingly, not a peep was heard about how talks went.  That usually means they did not go well at all.
• The U.S. is warning Brazil about using Chinese telecom technology.
• Serious flooding continues on the Yangtze River.
• The Phase One tracker shows that China is woefully behind its obligations and it is highly unlikely it will be able to achieve its targets. However, rising corn prices in China could lead to a lift in buying of U.S. grain.
• China hacked the Vatican.

COVID-19:  The number of reported cases is 17,054,819 with 667,707 deaths and 9,984,590 recoveries.  In the U.S., there are 4,427,493 confirmed cases with 150,716 deaths and 1,389,425 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 weekly Axios map shows an improving situation, with case growth slowing, although here in Missouri things are looking rather ugly.

Virology: 

• One of the puzzles of COVID-19 has been the wide dispersion of the effects on patients. Many are completely asymptomatic.  As professional sports return and consistent testing of this population ensues, it has been interesting to note how many players test positive without symptoms or conditions so mild they mistake it for a cold.  At the same time, others are severely impaired or fail to survive in infection.  One development vexing doctors are cases where patients appear to have long-term symptoms of the disease but fail to test positive for it.
• The Sandinista-led government in Nicaragua has been dismissive of COVID-19 and is now persecuting doctors who are calling for measures to reduce the spread of the virus.
• China is reporting an outbreak of cases in the northeastern regions. Nine cities have reported new cases.
• Vietnam, which appeared to have completely eradicated the virus, is seeing a return of cases.
• Johnson & Johnson (JNJ, 146.54) began human trials for a vaccine that protected monkeys.
• The FDA is expected to rule on convalescent plasma as a treatment.
• The FBI is investigating claims that China attempted to steal COVID-19 research from the University of Texas.
• One of the areas of failure has been the inability of policymakers to craft a policy mix that reduces the risk of the virus while protecting the economy. This has been a breakdown along many fronts.  Medical advice has been contradictory at times; face masks were downplayed then recommended.  Initially, there was great worry about the virus on surfaces; now we know most of the spreading is in the air.  At its heart, managing the virus is about probabilities.  What activities are high risk?  Who bears the most risk from contracting the virus?  Humans are not very good at measuring probabilities.  We often fear things that have a low probability of harming us and blithely engage in actions that are rather dangerous (the classic example is the fear of flying when the most dangerous part of the trip is getting to the airport).  Eventually, we will learn to live with this virus and it will likely require some changes in behavior until a vaccine is developed and widely adopted.

Market and Economy news:

• Although it’s not a huge surprise, high frequency reports suggest that loan default rates are rising. Hospitality is showing the greatest weakness.  Risky bond issuance has increased in Europe as well.
• As we have touched on before, one of the great debates is whether the $600 per week boost for unemployment is weakening employment growth. The level, for much of the country, represents more than their normal pay.  The University of Chicago found that 68% of workers received more from unemployment than what they earned from working.  Anecdotal reports suggest that some businesses were struggling to find workers due to the supplemental benefits.  However, a study from Yale did not find that the higher benefits had an appreciable effect on employment.  That is probably because there were much fewer jobs to return to.  Policymakers are debating this issue; the House stimulus package would keep the benefit, while the Senate version would reduce it to $200 per week.  This looks like a structure for bargaining.  We expect a supplement between these two figures.
  • The risk to the economy in the short run is that cuts will probably slow spending, which appears to be softening due to the resurgence of COVID-19 cases.
  • There is probably a bigger risk that extending the supplement could adversely impact employment later this year. The recovery is continuing, and, at some point, labor demand is going to accelerate.  The trick is to keep the supplement in place long enough to support consumption but not so long as to crimp output.
• The Chicago Board of Options exchange is considering an order batching system that would reduce the ability of high-speed traders to gain advantage in trading.
• All the major retailers will close on Thanksgiving. Perhaps this is one good outcome from the pandemic.

Foreign news:

• In our five-part WGR series on the upcoming elections, we discussed the potential for foreign nations to affect the outcome. In the report, we noted that Russia’s primary goal was probably less about electing a certain candidate and more about sowing chaos.  Recent reports accuse Moscow of spreading pandemic misinformation to undermine the public health response.  Whether or not this is true, the fact that the discussion is even occurring indicates Russia’s success.
  • It’s not just U.S. elections that are subject to Russian action; Belarus is accusing Moscow of direct interference.
• The Pentagon has confirmed that nearly 12K troops will be leaving Germany soon. About 5,600 will be dispersed throughout other NATO countries and the remainder will return to the U.S.  The WSJ editorial page pans the move.
• Iran has constructed a wooden aircraft carrier to practice small vessel attacks. S. bases in the region increased their alert status.

Odds and ends:  Coming to a safe near you…a new metal said to be harder than diamonds.

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[1] For the record, Dai Xu disavowed his comments on a social media post yesterday.  It’s not clear why, and doesn’t necessarily mean the comments are not a reflection of some within the PLA.

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

[Posted: 9:30 AM EDT] | PDF

Investors today are hoping for more clarity on future monetary policy after the Federal Reserve finishes its latest policy meeting.  Also in Washington, top tech firm executives are being grilled remotely by a House antitrust committee regarding the market dominance of their online platforms.  Finally, we note signs that both the EU and Japan may be swinging toward the U.S. administration’s “Tough on China” policy, which could have a significant impact on global stock markets in the coming years.  After reviewing the latest coronavirus news, we examine these developments and others below.

COVID-19:  Official data show confirmed cases have risen to 16,762,605 worldwide, with 661,012 deaths and 9,771,236 recoveries.  In the United States, confirmed cases rose to 4,352,304, with 149,260 deaths and 1,355,363 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• Pfizer, Inc. (PFE, 39.02) said it expects global demand for coronavirus vaccines, including the one it’s developing, to last at least into 2022, while booster shots may be needed annually or every few years if the new virus becomes a seasonal or long-term health concern.  Although the multiple vaccines under development have helped convince many investors that the disease is likely to be brought under control eventually, the long time frame mentioned by Pfizer is a reminder that getting the world’s population vaccinated will likely be a long, drawn-out affair.
• Echoing the likely need for future booster shots, the chairwoman of the British government’s vaccine task force has warned that scientists are unlikely to develop a “silver bullet” vaccine that provides lifetime immunity against COVID-19.  According to the chairwoman, it’s more likely that scientists will only be able to develop a vaccine that provides one year of immunity or one that only mitigates the symptoms of the virus.
• Tech companies and medical researchers are reportedly investigating whether wearable devices can spot COVID-19 and function as a personal early-detection system to contain the virus.  The systems under investigation would collect wearable sensor data from both healthy people and those afflicted by the disease, compare and look for patterns in the data, and then create artificial intelligence that could alert others whose data patterns point to a possible infection.
• Meanwhile, against a plateauing of total new confirmed cases in the U.S., many states and some other foreign countries continue to see a resurgence in infections after recently easing their lockdowns and as people tire of mask wearing and social distancing.  In Europe, public health officials are sounding the alarm over rebounding cases in Spain, Germany, eastern Europe, and the Balkans.
  • The U.K. has imposed quarantine on people returning from Spain, while Germany and France have ordered mandatory testing for travelers from high-risk areas.
  • Belgium moved on Monday to toughen social distancing and urge teleworking after a spike around the city of Antwerp, where a curfew has been imposed.
• Illustrating the extensive spread of the coronavirus in many large, resource-poor developing countries, a study has found that more than half of residents in several of Mumbai’s slums may have been infected.  The study suggests the spread of the virus in India could be far greater than previously thought.
• Separately, after Maltese officials succumbed to outside political pressure and rescued almost 100 immigrants adrift in the Mediterranean Sea, tests showed 65 of the migrants were infected with the coronavirus.  Not only will that number raise the risk of a significant epidemic within Malta’s small population, but it threatens to rekindle the European migration crisis and again empower right-wing populists throughout the EU.
• Illustrating the threat of disinformation regarding the pandemic, U.S. officials have identified three English-language websites that they say Russian intelligence services are using to spread disinformation about the coronavirus and complicate the U.S. struggle to contain the outbreak.

U.S. Policy Response

• The Federal Reserve will wrap up its latest policy meeting today, but there is little expectation that it will announce any significant change in monetary policy.  Rather, speculation centers on what clues may be offered in the post-meeting statement or Chair Powell’s press conference regarding additional monetary stimulus in the future.  We note that yesterday the Fed extended all seven of its emergency coronavirus lending programs that had been set to expire in September.  That brings to eight the programs that will last through December, while one is set to expire at the end of next March.
• As congressional leaders prepare to negotiate over the next round of virus relief spending, much of the debate is focusing on the supplemental federal unemployment benefit of $600 per week and the extent that it may be discouraging employees from going back to work.  Although many business owners say the benefit is making it unattractive for workers to go back to their jobs, some economists say the data shows that workers with more generous jobless benefits didn’t experience larger employment declines when the benefits took effect and that they have returned to their previous jobs at similar rates as others.
• In a sign of how the coronavirus crisis is playing into major economic trends that existed even before the pandemic hit, Eastman Kodak (KODK, 7.94) won a $765 million government loan under the Defense Production Act to help it develop U.S. production capacity for “active pharmaceutical ingredients” and other pharmaceutical chemicals.  The goal of the loan, which is meant to leverage Kodak’s century-old expertise in chemicals, is to reduce U.S. dependency on ingredients from China and other countries.  Similar moves to bring home pharmaceutical and medical equipment production are also being seen in Europe, especially in France.

European Union-China:  The EU announced it will impose sanctions on China over the new security law it has imposed on Hong Kong.  The sanctions include limiting exports of equipment that China could use for repression and reassessing extradition arrangements with Beijing.  The move is notable because EU governments have sometimes been reluctant to put their Chinese export markets at risk.  If EU governments are now becoming more convinced of China’s geopolitical, military, and economic threats, they may eventually adopt a “Tough on China” policy like the one developing in the U.S.  If such a conflict arises between the broader West and China, new anti-China capital regulations and other measures could be especially negative for Chinese assets.

Japan-China:  Adding to the evidence that the developed democracies could be coalescing around a “Tough on China” policy, China hawks in Japan also appear to be gaining influence and are pushing Prime Minister Abe to take a harder line on Beijing.

China-Hong Kong:  Prominent pro-democracy campaigner Benny Tai was fired from his job as an associate law professor at the University of Hong Kong based on his participation in a 2014 protest.  The move illustrates how academic freedoms in the city are becoming constricted as China asserts its authority.  Separately, Hong Kong officials drew a rebuke from the U.S., the U.K., and Australia after they said they may postpone their September legislative elections for up to one year due to the city’s recent rebound in coronavirus cases.

United States:  The chief executives of several major U.S. technology firms including Amazon.com (AMZN, 3,000.33), Apple (AAPL, 373.01), Facebook (FB, 230.12), and Google (GOOG, 1,500.34) are being hauled before the House Antitrust Subcommittee today to be grilled on the market dominance of their online platforms.  With politicians across the political spectrum signaling their displeasure with the companies, for various reasons, there is a risk that tough questioning of the CEOs could spook investors in the tech sector.

United States:  Presumptive Democratic nominee for president Joe Biden issued a plan to tackle racial inequality that would include pushing the Federal Reserve to monitor and target gaps in employment, wage rates, and wealth.  The proposal would “require the Fed to regularly report on current data and trends in racial economic gaps—and what actions the Fed is taking through its monetary and regulatory policies to close these gaps.”  However, the plan stops short of calling for the Fed to directly target the unemployment rates of Black and Hispanic communities, instead of the U.S. average, as has been backed by some economists (including Jared Bernstein, one of Biden’s economic advisers while he served as vice president).

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