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

[Posted: 9:30 AM EDT] | PDF

Global financial markets are facing some headwinds today from new U.S.-China tensions and signs that the negotiations over the next U.S. coronavirus relief bill may be tougher than previously expected.  We review all the key news below.

United States-China:  Following the Justice Department’s indictment yesterday of two Chinese hackers for attempting to steal sensitive information from U.S. firms (see below), the State Department said it has ordered the Chinese government to close its consulate in Houston within 72 hours “to protect American intellectual property and Americans’ private information.”  The Chinese government said it would retaliate if the move isn’t reversed.  It also complained that the U.S. has been opening its confidential diplomatic pouches in recent months, and in a sign that it fears more intrusive moves by the U.S., media reports from Houston this morning said firefighters were called to the consulate after neighbors noticed people burning paper in trashcans within the consulate courtyard—evidence of emergency document destruction to protect secret information.  The U.S. order to close the consulate represents a further escalation of tensions on top of the two countries’ trade war, disagreements over technology, and concerns about China’s aggressive geopolitical maneuvering.  As Western countries wake up to the challenge of a rising China, they are adopting more and more measures to counter and contain it.  Moves like the closure of the Chinese consulate in Houston provide evidence that those measures continue to be taken, and even more are likely in the pipeline as President Trump seeks to bolster his anti-China credentials for the November election and many foreign governments show signs of coalescing into a coordinated, allied approach to China.  Further efforts to isolate China could be disruptive economically and geopolitically, so the U.S. move today has taken wind out of risk markets and pushed down the renminbi.

Chinese hackers:  As mentioned above, the Department of Justice yesterday unsealed indictments against two Chinese hackers for trying to steal sensitive information worth hundreds of millions of dollars from U.S. defense contractors, research institutions, and healthcare companies, including at least two working on coronavirus vaccines and testing.  The hackers, who sometimes worked privately but at other times worked under the direction of the Chinese Ministry of State Security, are evidently still in China and therefore out of the reach of U.S. law enforcement.  Nevertheless, the indictment is likely a way to put pressure on China for its cyber warfare against the U.S. and to encourage U.S. firms to boost their cyber defenses.

COVID-19:  Official data show confirmed cases have risen to 14,976,453 worldwide, with 617,297 deaths and 8,499,299 recoveries.  In the United States, confirmed cases rose to 3,902,377, with 142,080 deaths and 1,182,018 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• As President Trump resumed coronavirus briefings at the White House yesterday, he warned the crisis will “get worse before it gets better.”  However, when questioned whether he would be held responsible for any worsening, he reverted back to his previous position that the virus will simply “disappear.”  He also encouraged people to wear facemasks to combat the disease, though he didn’t wear one himself.
• Meanwhile, even as the rate of newly identified infections appears to be stabilizing at a high level in the U.S., the rate of daily coronavirus deaths is now on a clear uptrend as experts have long predicted would happen.  Over 1,000 coronavirus deaths were recorded in the U.S. yesterday.
• The U.S. government has signed a commitment to spend $1.95 billion for 100 million doses of a potential vaccine being developed by Germany’s BioNTech (BNTX, 91.60) and U.S. pharmaceutical giant Pfizer (PFE, 36.69).  The deal also includes an option to purchase a further 500 million doses, if needed.  Once the vaccine receives regulatory approval and enters into mass production, the doses would be distributed free of charge to American citizens.
• Japanese Economy Minister Yasutoshi Nishimura said the government will postpone relaxing attendance limits for major events until end of August in a bid to help curb the country’s recent rebound in coronavirus infections.  Separately, reports today indicate Osaka has become the first prefecture outside of Tokyo to report more than 100 new infections in a single day.

Foreign Policy Response

• New details on the €750 billion coronavirus relief program agreed upon by the EU yesterday provide some indication of how the funds will be allocated among the member countries.  Since the funds will be disbursed to countries based on the damage they’ve suffered from the crisis, the allotted amounts will be a more significant share of GDP for the relatively smaller, harder-hit southern countries like Spain and Italy.  Preliminary figures suggest those two countries would each receive almost 20% of the funds, while France would receive around 10% and Poland would receive about 8%.
  • If the final allotment is anything close to the preliminary figures, the funding for Spain and Italy would equal around 10% of their GDP in 2019.  That could be a significant boost to those economies, although it’s important to remember that the funding would be spread over three years.
  • For most of the other EU countries, the allotments would amount to a much less significant share of economic activity.
• As we’ve mentioned before, a key innovation in the new EU coronavirus relief program is the issuance of common EU bonds to finance it.  Those bonds will be backed by the full faith and credit of the EU, rather than just individual countries.  For a useful primer on these upcoming bonds, click here.
• Despite the EU leaders’ approval of the coronavirus program, it’s becoming clear that at least one major political fault line remains.  Some officials, led by European Commission President Ursula von der Leyen, insist that EU budget funding for countries will depend on their adherence to the EU’s rule-of-law standards, which would punish countries like Poland and Hungary.  Other officials insist Brussels has backed down from those demands.

U.S. Policy Response

• President Trump’s desire for a payroll tax cut is turning into a sticking point as the administration and congressional leaders work to hash out the next coronavirus relief bill.  While the tax cut would help encourage hiring, many economists and lawmakers see it as inefficient because it would primarily benefit those who haven’t lost their jobs during the crisis.
• Separately, a Senate Republican proposal for the next coronavirus bill will reportedly include $70 billion for K-12 schools, with half that amount reserved for schools that reopen fully for in-person instruction.

United States:  The Senate Banking Committee yesterday approved President Trump’s latest nominees to the Federal Reserve’s Board of Governors and sent their nominations to the full Senate for a final confirmation vote.  The vote was 18-7 for Christopher Waller, a mainstream economist and current director of research at the St. Louis Fed.  It was a much closer 13-12 vote for Judy Shelton, an unorthodox gold bug with a reputation for more politicized policy positions.  Shelton’s nomination has generated pushback from multiple observers, but it is important to remember that as only one of seven Fed governors, her influence on Fed policy would be limited.  For example, emergency lending programs of the sort implemented during the coronavirus pandemic require the votes of at least five Fed governors, so Shelton alone couldn’t sway Fed policy into new directions unless two current governors depart.

United States-United Kingdom:  Senior British officials have reportedly given up on their goal of reaching a comprehensive post-Brexit trade deal with the U.S. this summer.  On top of the delays arising from the coronavirus crisis, the two sides are still struggling to deal with contentious issues such as the amount of U.S. agricultural products to be allowed into Britain.  Perhaps more importantly, British officials see little hope of significant compromise on those issues ahead of the U.S. presidential election in November.

Russia:  President Putin’s bid to snuff out protests in the far eastern region of Khabarovsk by naming an opposition politician as governor appears to be falling short.  Hundreds of protestors continue to demonstrate today, marking the 11^th straight day of unrest.

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

[Posted: 9:30 AM EDT] | PDF

A new Confluence of Ideas podcast episode is available, titled “The 2020 Election: Part 3.”  This is the final episode looking at the 2020 election.  In this episode, we handicap the election based on the tools of prediction, polling and decision markets.  We examine the geopolitics of the election, focusing on what countries are likely to intervene in our election, their capabilities and their goals.  We also touch on what we expect to see in terms of policy if we get a new president or if the incumbent wins, and likely market reaction in either scenario.

Today’s upswing in risk assets comes in large part from yesterday’s good news regarding potential coronavirus vaccines and a massive new virus recovery program in Europe.  We discuss each of those developments in detail below, in addition to discussing today’s other major news developments.

COVID-19:  Official data show confirmed cases have risen to 14,729,037 worldwide, with 610,587 deaths and 8,323,901 recoveries.  In the United States, confirmed cases rose to 3,831,430, with 140,909 deaths and 1,160,087 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology:

• Echoing the good Phase II trial results announced for the Moderna (MRNA, 82.68) coronavirus vaccine last week, three other leading competitors yesterday posted trial results showing their vaccines successfully produced an immune response with little or no serious side effects.
  • Besides the four leading prospects, more than a dozen other vaccine candidates have entered human testing.  In total, about 160 potential vaccines are now in development.
  • With the rapid success of multiple vaccine candidates so far, and with the numerous alternatives in development in case the top four candidates falter, investors will now have greater confidence that a protective shot could be ready later this year.  Of course, unforeseen scientific issues with the vaccines could still arise.  In addition, there could be challenges in ramping up production, distributing the vaccine worldwide, and making sure enough people get it.  All the same, the news suggests humanity could well get control over the coronavirus in fairly short order and start to rebuild the global economy.  The news is therefore bullish for stocks, as shown by the positive reaction in the markets yesterday and today.
• Despite the good news on a potential vaccine, current infections and deaths continue to rise across the globe, with an especially heavy impact on Latin America.  The economic strains there are raising concerns about a potential new Latin American debt crisis.
• In the U.S., new infections rose by approximately 61,800 yesterday, although that was the lowest figure in a week.  The mayor of Chicago announced tighter restrictions on restaurants, bars, and gyms, but the mayor of New York said his city would generally proceed to its Phase Four of reopening.
• With the success that most major European nations have had in bringing the pandemic under control, some European sports organizations are opening for business again, in contrast to the continued shutdowns in the U.S.
• Now that researchers have had more than six months to study the coronavirus, they’re finally getting a hand on just how deadly it is.  Researchers now believe the disease kills from 0.3% to 1.5% of people infected, with most studies putting the death rate between 0.5% and 1.0%.  That means that for every 1,000 people who get infected, five to 10 would die on average.
  • The estimates suggest the new coronavirus is deadlier than the seasonal flu, though not as lethal as Ebola and other infectious diseases that have emerged in recent years.
  • The coronavirus is killing more people than the deadlier diseases, in part because it is more infectious.

Foreign Policy Response:

• On the policy front, the EU’s member states finally reached agreement this morning on a massive €750 billion coronavirus relief program that will not only channel funds to hard-hit countries like Spain and Italy to help them recover from the crisis, but will also involve the first large-scale issuance of common, mutualized EU debt.  Key points of the “Next Generation EU” deal are as follows:
• The approved financial assistance will include €390 billion in grants to hard-hit countries, supplemented by €360 billion in loans.  That spending would be partially paid for by spending cuts in the EU’s budget of €1.074 trillion for the next seven years, which the leaders also approved.
  • The grants will consist mostly of a “Recovery and Resilience Facility” totaling €312.5 billion.  To access these funds, member states will need to prepare national recovery plans pledging to reform their economies.  The funds will be distributed from 2021 to 2023.
    • Allocations of recovery money will be linked to the economic harm done by the pandemic, rather than relying on pre-crisis data regarding growth and unemployment.
    • To enforce some discipline on member states receiving the coronavirus aid, each EU member state has been given the right to raise concerns that another member is not honoring its economic reform commitments. In such cases, assistance funds can be halted for a period that “as a rule” should not last more than three months.  The final decision is formally left in the hands of the commission.
  • The remaining €77.5 billion of grants will be used to top up normal EU budgetary programs.
• To fund the €750 billion coronavirus program, the European Commission will be granted new powers to borrow on capital markets.
  • While most of the borrowed money will go to the new recovery fund, the remainder will be channeled through the EU’s normal budgetary programs in areas such as scientific research, rural development, and environmental protection.
  • The funds available for debt service were left vague, but EU leaders have suggested new sources of funds for the EU bonds might include taxes on digital services or carbon emissions.
• To overcome resistance from the Netherlands, Denmark, Sweden, and Austria, the leaders agreed that the “Frugal Four” nations will get more of their annual contributions to the EU budget rebated back to them.
• As we’ve been arguing, the provision of assistance to the EU’s poorest countries should help buttress the European economy, while the issuance of hundreds of billions of euros of common EU debt should help make the euro a much more viable reserve currency to compete with the dollar.  As reflected in today’s market action so far, the deal is therefore bullish for European equities, lower-rated European sovereign debt, and the euro.

U.S. Policy Response:

• With the U.S. Congress now back in session and starting to work on a new economic support bill to repair the damage from the virus crisis, President Trump and Republican leaders met yesterday to hash out their initial negotiating position.  Treasury Secretary Mnuchin said the White House favors a new package of $1 trillion in supplemental aid. However, he said the administration does not want to see enhanced unemployment benefits continue at their current level of $600 per week.  Senate Republicans are expected to formally release their proposed bill later this week.

Financial Market Response:

• Despite the good news on a potential vaccine and a slowing in U.S. infections, which might be assumed to take the wind out of safe-haven precious metals, gold and silver prices continue to trend upward, with silver hitting a multi-year high yesterday.  Our research shows precious metals tend to move along with the gross size of the federal budget deficit, so today’s loose monetary and fiscal policy are likely to keep pushing gold and silver higher for the foreseeable future.

United Kingdom-Russia:  A long-awaited parliamentary report into Russian interference in British politics has concluded that Moscow’s influence is “the new normal,” with senior figures linked to the Kremlin enjoying access to top business and political leaders.

Russia:  To diffuse the massive anti-government protests that have broken out in Russia’s far eastern region of Khabarovsk after the arrest of its popular governor, President Putin has chosen a politician from Russia’s tightly controlled “systemic opposition” to take over the position.  The new governor will be Mikhail Degtyarev, a 39-year-old lawmaker from the nationalist Liberal Democratic Party.

Egypt-Turkey:  The Egyptian parliament has approved deploying troops to Libya in order to prevent the UN-recognized Government of National Accord from advancing eastward and capturing the strategic port of Sirte, a gateway to Libya’s oil installations.  Such a deployment would raise the stakes in Libya’s proxy civil war by increasing the potential for direct clashes between Egypt and Turkey.

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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday!  Equity markets are mixed; the U.S. is modestly lower, while Chinese markets jumped on reports that insurance companies will be able to hold more stocks.  Foreign news leads today’s report as the EU was unable to make an agreement this weekend, but marathon talks continue; the EUR is modestly higher.  Congress is back and negotiations on a fourth stimulus bill are front and center.  We update the pandemic news and close with the economy and markets.  And, as promised, the Asset Allocation Weekly podcast and chart book are updated.  Here are the details:

Foreign news:

• EU leaders continue to talk. France and Germany are pressing for the package, with the Netherlands and Austria acting as spoilers.  This budget summit is critical.  In a situation where the U.S. is no longer guaranteeing the security of Europe, if the EU fails it is hard to see how Europe will be able to have much of a global impact.  A couple of reflections on the EU and Britain: if the U.K. were still in the EU, the idea of a Eurobond would have been a non-starter. And, if the EU can’t act in unity over the pandemic, the U.K. will look prescient, being the first in line to leave a failing project.  If the EU fails, it is hard to see why Italy would remain in the Eurozone.  You can follow the latest on talks here.  The fact that the EUR has held up and Italian borrowing costs have declined despite no deal over the weekend suggests financial markets do expect an agreement.
• Although the EU recently lost its tax disagreement with Ireland, the push to regulate global tech remains in place. A budding trade war over digital taxes is looking increasingly likely.
• Saudi King Salman has been admitted to the hospital in Riyadh over gallbladder inflammation. If he were in serious trouble, we would expect him to be moved to a European or U.S. hospital, although the pandemic may have affected where his treatment would be conducted.  Although his son, CP Salman, appears to have solidified his rule, we would not be shocked to see a power struggle once King Salman dies.  The crown prince would be the first king of his generation, the grandchildren of Ibn Saud.  Given the large number of claimants to the throne and the heavy-handed way King Salman promoted his son, a challenge is possible.
• Bulgaria is facing widespread unrest as protests rise against the center-right government over accusations of corruption.
• Russia is seeing continued protests in the Russian Far East due to Putin’s decision to remove a controversial governor.
• Lebanon, facing a serious debt crisis, is nearing economic collapse. Electricity has become so sporadic that nighttime aircraft landings have become challenging.  International aid is available but only if the country accepts austerity.  Given the political divisions in Lebanon, austerity is problematic because every group wants to shift the burden of adjustment to the other.
• Argentina is negotiating with its creditors but is essentially saying that it can offer no further concessions. It is difficult to have much sympathy for the creditors.  Argentina is a serial defaulter and anyone lending money to it should have expected a fairly high chance of default.

Policy news: 

• Congress is back in session and the leadership is scrambling to negotiate a fourth pandemic stimulus package. There are two areas we are closely watching.  The first is unemployment insurance.  The $600 per week additional support is, in many cases, more than many workers made on their job, giving them a disincentive to return to work.  At the same time, many of these workers have no job to return to.  If you just end the program, the risk is that those without job prospects will dramatically curtail their spending, weakening an already weak economy.  We would expect (hope?) for a bit of creativity from lawmakers, perhaps a bounty for returning to work along with a reduction in the support package.  A second and perhaps even more intractable problem is daycare.  Getting people back to work if their kids can’t go to school or daycare will be a challenge.  But, as anyone who had kids in daycare knows, they are places where infections spread easily.  If the bill doesn’t address funding for PPE in schools, there is a risk that the rebound in employment could be at risk.
• The Senate banking committee is expected to approve Judy Shelton to an open Fed governor position. Shelton may be the most politically oriented governor appointed in my lifetime; we would expect her to support easy policy under a GOP White House but be hawkish if a Democrat is in the Oval Office.  If she does get approved by the banking committee, we do expect her to be approved by the broader Senate.  (An aside…it will be fun to see her interactions with the rest of the FOMC when the full transcripts of the FOMC meetings are released in 2025.)

China news:

• The U.K. has pulled its extradition treaty with Hong Kong.
• Hawley (R-MO) is planning on introducing legislation that will require firms importing goods from foreign sources to certify that the supply chains are free of forced labor. The proposed legislative target is China.

COVID-19:  The number of reported cases is 14,508,892 with 606,206 deaths and 8,134,747 recoveries.   In the U.S., there are 3,773,260 confirmed cases with 135,205 deaths and 1,131,121 recoveries.  For those who like to keep score at home, the FT has a nifty interactive chart that allows one to compare cases across nations using similar scaling metrics.

Virology: 

• The first clinical trial results from the Oxford vaccine will be released later today. This is a Phase One trial.  The NY Times ran a feature article in the Sunday edition raising concerns that acceptance of a vaccine could be slow.  There is an established anti-vaccine movement in the U.S., but beyond this group there are concerns that the rush to deliver a vaccine may increase the odds of unexpected side effects.  It is quite possible that many Americans may take a “wait and see” approach to the vaccine before taking the shots.  If so, even the production of a vaccine may not lead to economic recovery.
• Epidemiologists are noticing that rapid increases in COVID-19 infections appear to be tied to “super-spreader” events, where a few asymptomatic carriers can trigger an exponential increase in cases. This information suggests that (a) widespread regular testing might catch these carriers, and (b) mass gatherings should be greeted with great caution.
• Venezuela is facing a rapid rise in new cases. President Maduro is blaming returning refugees. The collapse of the Venezuelan economy led to a mass migration out of Venezuela in recent years.  However, as surrounding countries shut down due to the pandemic, these refugees are returning to Venezuela.  Although the government is attempting to secure the border, reports of harsh treatment of returnees has led many to illegally return.  If these returnees are infected, they could be boosting infections.
• Hong Kong is seeing a rise in new cases.
• Mask wearing remains controversial. It was controversial in the Spanish Influenza pandemic too.

Market and economy news:

• Back-to-school shopping is the second most important season for retailers, exceeded only by Christmas. Given the degree of uncertainty surrounding the autumn school session, retailers are struggling to determine their response.
• Reflecting on bank earnings, it is clear that the banking industry is expecting a rapid rise in bad loans. Although some of this may be an excess of prudence, it does suggest banks don’t expect a rapid recovery in the economy.  We would concur.
• There is growing evidence that corporate America is adopting the same stance as banks.  If so, we could see a stall in rehiring.

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

[Posted: 9:30 AM EDT] | PDF

Good morning!  Equity markets are modestly higher after a choppy week.  The EU budget summit is underway.  Relations between the U.S. and China continue to deteriorate.  The new Asset Allocation Weekly is published below; the accompanying podcast and chartbook will be available on Monday.  Here are the details:

Foreign news:

• The EU budget summit is underway; here’s a way to follow along. The biggest issue at the meeting is the pandemic rescue plan that includes a mutualized Eurobond.  This meeting is historic; if the leaders agree to a mutualized debt scheme, it would make the EUR an attractive alternative reserve currency.  If the leaders fail completely, it may signal the end of the Eurozone.  We may not get a deal this weekend, but if the leaders agree to continue talks, all won’t be lost.  Given that Chancellor Merkel is endorsing the rescue plan, there is a good chance we see passage at some point.  As we discussed in a recent WGR, a mutualized bond issued by the EU would likely be bearish for the dollar.

China news:

• High ranking U.S. officials have been making speeches denouncing China. AG Barr is the most recent member to give a talk on this issue.  He accused Hollywood and Tech of collaborating with China in his remarks.  He also expressed concerns that businesses could be used by Beijing to undermine the U.S. policy crackdown.  This is a legitimate concern.  Chairman Xi will likely try to offer preferential treatment to U.S. firms in return for informal lobbying efforts to foster a more friendly policy regime.
• The U.S. is increasing pressure on China across a number of fronts. There have been notable trade actions and an increase in freedom of navigation operations in the South China Sea.  The administration is considering travel bans on CPC members.  This would be a significant action; there are over 90 MM members of the CPC.  The U.S. is considering banning TikTok (the owner, ByteDance, is not publicly traded) due to security concerns.
• Although China’s GDP showed a strong recovery, worries that the growth was driven by investment remain. Evidence that policy easing may be fostering yet another property boom could lead to a deterioration of credit quality.  China’s financial authorities have used financial repression for years, keeping deposit rates at low levels to create pools of cheap financing for investment.  Households are seeking higher returns on investment and there is an underlying belief that policymakers won’t allow residential property prices to fall (sound familiar?).  The key question that follows is “who will pay for the bailout, if it comes”?  The recent rise in foreign buying of Chinese sovereigns provides one potential clue.
• After a sharp rally, Chinese equities are taking a sudden hit.

COVID-19:   The number of reported cases is 13,830,933 with 590,608 deaths and 7,735,623 recoveries.   In the U.S., there are 3,576,430 confirmed cases with 135,205 deaths and 1,090,645 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.  Only seven states have a reproduction ratio under one, which means that the virus is expanding at an increasing rate.  However, there was some good news in the data; Arizona, which has been hard hit recently, saw its R₀ fall under 1.

Virology: 

• The S., U.K., and Canada report that Russians are attempting to hack vaccine and anti-viral researchers in an attempt to steal their research.  As expected, the Kremlin has denied the claims.
• “…some animals are more equal than others…”; this famous quote from Animal Farm seems to describe the current testing regime.
• It is looking less likely that school districts will be able to fully open this fall. Instead, a mix of online and in school regimes is more likely.  The long-term impact on education is uncertain, but the likely outcome is a slower pace of learning.
• A bit of good news, as doctors deal with more COVID-19 patients, they are learning more about the disease and are developing treatment protocols that are improving hospitalization outcomes. These include less use of ventilators and a greater deployment of high concentration oxygen, various treatments to reduce the symptoms of the disease and simple changes, like laying patients on their stomachs.

Market and Economy news:

• The 30-year mortgage rate has dipped under 3.00%, a record low.  Housing data has been strong recently and there is evidence of a move to the suburbs.  That could put urban housing at risk.
• Food banks have seen high demand during the pandemic. Now they are dealing with logistics challenges as food supplies are increasing after facing disruptions.

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