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

[Posted: 9:30 AM EDT]

Good morning.  Global equities are higher as Chinese markets continue on a tear.  News on China leads our commentary this morning.  Our usual update of the pandemic follows, along with foreign news, an update on policy, market action and the economy.  The updated Weekly Energy Update is available.  Off to work:

China news:

• China’s foreign minister, Wang Yi, gave a speech this morning suggesting that current relations are at their lowest point since normalization in 1979.
• Since taking power in 2012, Chairman Xi has aggressively consolidated control through a number of measures, including jettisoning informal term limits and purges of enemies. We noted a recent event where leaders close to Xi appeared to be instituting an aggressive crackdown on the legal system through a program of re-education (a long standing favorite tool of communists everywhere).  We are a bit surprised by the ferocity of this response; after all, there has been scant evidence of an independent judiciary for some time in China.  The fact that Xi seems to think these measures are necessary suggests a leader that is still unsure of his position, despite overwhelming evidence he has quelled opposition.  Either (a) Xi is becoming increasingly insecure, or (b) like Mao, he sees these sorts of measures as the way China is to be governed, a situation of constant “revolutionary” turmoil.
• There are reports that the U.S. is considering steps to undermine the Hong Kong dollar’s peg to the U.S. dollar. Hong Kong uses a currency board and issues its own currency based on U.S. dollars held in reserve.  If the U.S. were to deny the Hong Kong currency board access to U.S. dollars, the board could only issue new Hong Kong dollars by allowing the currency to depreciate.  It doesn’t appear that this action is imminent, although the very fact that it is under consideration suggests a deep deterioration of relations between China and the U.S.  Interestingly enough, Hong Kong has been experiencing inflows from abroad, which has required the currency board to intervene to prevent the Hong Kong currency from appreciating.
• The U.S. has put visa restrictions on Chinese officials involved in setting Beijing’s Tibet policy. China has retaliated.
• China is criticizing U.S. fiscal stimulus, fearing a drop in the dollar and calling for a new reserve arrangement. We note the CNY rallied this morning and this market action might be raising concerns in Beijing. This call for another reserve currency isn’t new, but there is a lack of attractive alternatives to the dollar.  We do note, in a recent WGR, we discussed that the potential for a Eurobond might be an attractive vehicle for reserve purposes.
• FBI Director Wray gave a speech at the Hudson Institute where he indicated the Chinese government and the CPC are a threat to U.S. economic and national security.
• It appears that if the U.S. wants to prevent the use of Huawei (002502, CNY 2.86) equipment, it is going to require the building of alternatives. In other words, the U.S. government may need to fund the creation of 5G equipment from firms other than Huawei. Meanwhile, the company is asking the K. to slow its decision on using Huawei’s 5G equipment, fearing it will be ejected from the British market.
• Despite the end of the “one-child policy” and steps to encourage additional births, Chinese couples apparently didn’t get the memo, as births hit a new low in 2019.
• Over the past couple of weeks, we have been reporting on massive flooding in south-central China along the Yangtze River. The sluice gates have been opened at the Three Gorges Dam which will exacerbate flooding downstream.  The current death/missing toll is 119.
• The Institute of International Finance (IFF) estimates that China’s total debt is 317% of GDP at the end of Q1 2020. That is up from 300% in Q4 2019 and the largest quarterly rise in history.  Consumer debt is the fastest growing segment.  Foreign investment in China’s bonds is only 2% of the total; the vast majority of China’s bonds and debt are held internally.  The rise in debt is likely tied to stimulus efforts tied to the economic recovery from the pandemic.  In related news, we note that a Chinese developer has not paid its bondholders.
• Chancellor Merkel has come under criticism for her government’s tepid opposition to China’s actions in Hong Kong. Germany is trying to maintain economic relations with China in a period where Beijing’s actions are making it difficult to keep such ties.
• The new national security law for Hong Kong makes it illegal for anyone to promote democratic reforms or criticize the government. This includes people living outside of China or Hong Kong.  The extensive reach of this law is remarkable; it begs for a global response.
  • Meanwhile, China’s secret police have officially taken up residence in Hong Kong.
  • S. tech firms are trying to decide if they can safely continue to operate in Hong Kong.
• There have been worries that the new security law will undermine Hong Kong’s financial firms. At the same time, Beijing needs Hong Kong’s expertise in this area and we suspect that Chairman Xi will take steps to support the financial firms in Hong Kong while he cracks down on security.  Although we are early in the process, recent listings by Chinese tech firms in Hong Kong suggest that the former colony’s financial prowess will likely be preserved, at least for now.

COVID-19:  The number of reported cases is 12,062,863 with 549,900 deaths and 6,609,462 recoveries.  In the U.S., there are 3,055,144 confirmed cases with 132,309 deaths and 953,420 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.  Axios has updated its state cases chart.

Virology:

• In the race for a vaccine, the U.S. has committed $2.0 billion to two companies, Novavax (NVAX, 101.44) and Regeneron Pharmaceuticals (REGN, 654.42) who are working on vaccine candidates as part of Operation Warp Speed.
• Testing is being conducted on a drug derived from the blood plasma of former COVID-19 patients. The drug may work for both treatment and as a prophylactic for the disease.
• As testing increases, wait times for test results have increased as well. This development is a problem because a tested person doesn’t know if they should continue their normal activities, assuming a negative test result, or self-quarantine, fearing a positive one.
• Although mask wearing remains controversial, we note a natural experiment that occurred in Germany suggests mask use does reduce the spread of infections.  In March and April, some German states required masks, others did not.  Researchers were able to measure infection differences and conclude that mask wearing reduced inflection spread by 40% compared to areas that didn’t have similar rules.
• Another area of controversy is the debate over airborne transmission. The fact that infections appear tied to events held indoors in close quarters suggests that the virus is probably airborne and can stay in that state for long periods of time.  However, WHO continues to say that the evidence is inconclusive.   If it is established that a prime transmission factor is indoor crowded events, mitigation measures could be adopted, e.g., more outdoor events, crowd spacing, masks, improved ventilation, etc.  But as long as the messaging is inconclusive, mitigation measures will likely not be adopted.
• As hospitalizations rise, the health care system is reporting growing shortages of personal protection equipment.

Policy news:

• Nearly 60% of Americans have nothing saved for retirement. States are now moving to address this problem by creating programs to strongly encourage companies and individuals to start IRA contributions.
• Recently, Washington issued rules that required foreign college students to take classes in person. This action will either mean that colleges will need to take on campus students to retain and attract foreign students, or continue online classes and lose this source of tuition revenue.  This trend comes along with an anticipated decline in Chinese students due to deteriorating relations.
• Last September (seems so long ago, doesn’t it?) the financial markets were roiled by problems in the repo markets. Although Fed officials still seem to struggle to explain what exactly happened, the response was to flood the non-bank financial system with liquidity.  The balance sheet contraction ended and has expanded with abandon with the onset of the pandemic.  One sign of good news is that the Fed has withdrawn specific repo support due to the lack of demand.  Of course, when one sends the balance sheet to historic highs, one shouldn’t see problems in the short-term funding markets.
• One of the areas of risk to the economy are state and local governments. Unlike the Federal government, the state and local governments don’t issue debt in a currency they control and so their spending is pro-cyclical; it rises and falls with the business cycle.  Due to the downturn in the economy, state and local government spending is showing signs of falling, and if the Federal government fails to intervene, it could undermine Federal stimulus efforts.
• The entire housing payments chain is at risk as well. Renters and homeowners pay rent or mortgages respectively.  These payments flow to landlords or mortgage servicers and these flows eventually end up in mortgage backed securities.  There are government programs that offer protection to bondholders, but little support is available downstream.  Congress continues to discuss another stimulus package; some of the last one did support the housing payments chain.  If additional support isn’t forthcoming, the housing payments chain is at risk.  Interestingly enough, this problem is also a threat to state and local governments, because if this payment chain is broken, property tax payments will likely fall as well.

Foreign news:

• Yesterday, Mexican President Andrés Manuel López Obrador, commonly known as AMLO, made a rare foreign trip to Washington to mark the implementation of USMCA.  Although the relationship between Presidents Trump and AMLO was rocky at first, they have gotten along rather well over time.  Relations between Mexico and the U.S. have improved over the past two years.
• The U.K. Johnson government unveiled a massive fiscal support package to help the economy’s recovery. Much of it is based on funding to subsidize returning workers.
  • Scotland is rejecting Westminster’s food and environmental standards, showing continued divergences within the United Kingdom. Separatism in Scotland has been rising, in part due to disagreements over Brexit.
• Saudi Arabia is planning a summit meeting with Chinese officials. As the U.S. loses interest in the Middle East, the high revenue/low population nations in the Middle East will look for new patrons.
• It appears some European banks inadvertently purchased bonds issued by front companies for organized crime.
• Argentina has improved its offer for restructuring its defaulted bonds, taking the offer to 53.5 cents on the dollar, from 40 cents. The response from creditors was positive.

Market and Economy news:

• Although equity indices continue their impressive run, the equity market internals show that the industry’s most sensitive to reopening—travel, leisure and entertainment—are lagging. The so-called “reopening” trade has been stalling.   High frequency data in states hit by surging cases tends to confirm what is happening in the equity market.
• S. companies are cutting dividends aggressively, the fastest pace since 2009.
• While equities have rallied, precious metals have as well. We also note that industrial metals prices have improved too.  In the China section, we note that debt levels are surging, evidence that monetary stimulus is in place.  Aggressive monetary stimulus globally is a support for precious metals while Chinese stimulus is a boost for industrial metals prices.  Inflows into gold ETFs have been rising lately as investors add the yellow metal to portfolios in light of these factors.
• The Atlanta FRB’s CFO survey suggests that employment will remain below pre-pandemic levels through all of next year. Fed presidents from Atlanta, Boston and Richmond all suggest that the economy may be stalling, which would suggest that policy support from the Fed will likely remain in place.

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

[Posted: 9:30 AM EDT]

Despite rising stock markets overseas, sentiment in the U.S. markets today seems finely balanced between optimism about post-virus economic reopenings and accommodative policies on the one hand and the reality of resurgent infections and renewed lockdowns in some locales on the other hand.  We review all the key news below.

COVID-19:  Official data show confirmed cases have risen to 11,856,991 worldwide, with 544,871 deaths and 6,473,170 recoveries.  In the United States, confirmed cases rose to 2,996,333, with 131,481 deaths and 936,476 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• The U.S. reported about 60,000 new infections yesterday, setting a new single-day record as cases continue to surge in the South and West.  Texas alone reported more than 10,000 new cases, setting a new record for that state.  Hospitalizations and deaths are also rising in many of the states with surging cases, even though the national death rate is falling.
• Consistent with the resurgence in cases, high-frequency economic data such as restaurant seatings and retail store visits have begun to stall or decline, especially in the hard-hit states of California, Arizona, Texas, and Florida.  Importantly, the decline in consumer activity is often happening ahead of renewed government restrictions, suggesting people are isolating again voluntarily in order to avoid catching the virus.
• The Trump administration formally notified the WHO that the U.S. would pull out of the organization next July because the administration believes the WHO is under China’s sway and has failed to respond adequately to the pandemic.  Public health officials, legal scholars and members of Congress from both parties condemned the move, arguing that it would cost lives, hinder U.S. access to the global system for sharing outbreak data and vaccine research, and give China more sway over the U.N.
• Brazilian President Jair Bolsonaro, one of the most prominent world leaders to play down the severity of the coronavirus pandemic, said he has tested positive for the virus.  He was tested after having developed a fever of 100.4 degrees and other symptoms related to the disease, though he said his temperature had since gone down. Despite his infection, he echoed his earlier calls for Brazilians to accept the virus and get back to work.

Economic Impact

• As we’ve been warning, state and local governments across the U.S. have begun to slash their payrolls and other spending to deal with the decline in tax revenues resulting from the crisis.  We continue to believe that a major risk to the economic recovery is the possibility that state and local governments will have to tighten their fiscal policy so much that they offset the looser policy at the federal level.
• Since mid-June, Chinese customs officials have suspended meat imports from at least 14 foreign processing plants, citing fears that the products could carry the coronavirus.  The affected plants are located in the U.S., Canada, Brazil, Germany and other countries.  The restrictions are already boosting Chinese food prices and raising more doubts about China’s implementation of its Phase I trade deal with the U.S.

European Union:  ECB President Lagarde said her ongoing review of the central bank’s operations will examine how they can be made “greener.” This includes potentially shifting its massive asset purchases to sell off obligations issued by carbon-intensive companies and buying more obligations issued by less carbon-intensive firms.  Separately, she also tried to tamp down expectations that the EU’s proposed €750-billion coronavirus recovery, including common debt issuance, would be approved at a summit to be held on July 18.  According to Lagarde, approval of the plan will probably come closer to the end of July.

EU-Germany:  The German central bank will reportedly accept the positive findings of a finance ministry and parliamentary review of the ECB’s massive bond-buying program. This suggests the program won’t be tripped up by the German constitutional court’s ruling in May, stating that government officials must review the economic and financial costs of the bond purchases.

United States-China:  The U.S. is imposing visa restrictions on Chinese officials involved in Tibet policy.  This is the latest rise in tension with Beijing, as the Trump administration increasingly uses immigration measures as a tool to target China.

Mexico:  The Jalisco New Generation Cartel, which dominates the trade in fentanyl and methamphetamines, has become Mexico’s most powerful criminal organization, eclipsing the more famous Sinaloa Cartel. Perhaps most worrying, the Jalisco Cartel has made it a hallmark to attack Mexican security forces and public servants directly, making it the biggest danger to the country’s, at times, fragile stability and further complicating the country’s investment environment.

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

[Posted: 9:30 AM EDT]

Risk assets are under pressure this morning in part because of multiple reports pointing to the reimposition of coronavirus lockdowns in some locales and the risk of halting, prolonged economic recovery.  On top of that, geopolitical tensions between the Western democracies and China and Russia remain high.  We outline all the key news below.

COVID-19:  Official data show confirmed cases have risen to 11,648,268 worldwide, with 538,828 deaths and 6,328,930 recoveries.  In the United States, confirmed cases rose to 2,938,750, with 130,310 deaths and 924,128 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• S. medical centers have reported more than 5,000 cases of patients likely catching the coronavirus once admitted for other conditions between May 14 and June 21 alone, on top of any staff members who may have caught the disease while working in the facilities. The spread of the disease within health facilities illustrates how health workers have struggled to learn the best way to deal with the novel virus.  The continuing spread of the disease to staff members is particularly concerning as it effectively reduces the facility’s capacity to treat victims and could hasten the point when the facility becomes overwhelmed.
• New York City entered its third phase of reopening its economy yesterday, allowing some personal care services such as nail salons and tattoo parlors to open at limited capacity. Indoor dining at restaurants was also supposed to be part of phase three, but city and state officials have indefinitely postponed those plans because of rising cases of the new coronavirus in other states and a lack of social distancing in the city.
• Illustrating how some localities have been forced to backtrack on their reopening while others loosen restrictions, Miami-Dade County Mayor Giménez rolled back his area’s reopening and ordered gyms to close and restaurants to limit service to takeout and delivery, although office buildings, retailers and grooming services will remain open.
• In Australia, which had been seen as a leader in managing the pandemic, a rebound in infections in the Melbourne area has prompted authorities to reimpose a lockdown in that area. For the next six weeks, people will be allowed to leave their homes only for essential shopping, exercise, medical care or work. Restaurants and cafés, which had begun to reopen with social distancing measures in place, will now only be allowed to service takeaway food and drinks.
• In Brazil, President Bolsonaro said he has been tested for the virus after showing symptoms consistent with the disease, including fever. Bolsonaro said his test results will be made public Tuesday.
• Regeneron Pharmaceuticals (REGN, 627.25) said the small Phase I safety study of its experimental coronavirus drug received a positive review from the company’s independent data-monitoring committee, so it now plans to launch a much larger, combined Phase II and III study to delve deeper into the drug’s safety and effectiveness. The drug, REGN-COV2, is among the most advanced in a class of medicines known as monoclonal antibodies being developed to treat the disease.

Economic Impact

• The OECD issued a new employment outlook calling for the overall jobless rate in advanced countries to decline to 9.4% at the end of 2020 and 7.7% at the end of 2021, assuming there is no major second wave of the pandemic. That would leave the unemployment rate at the end of this year at its highest level since the 1930s.  As if that isn’t bad enough, the organization said unemployment in the advanced countries will rise to 12.6% at the end of 2020 and only fall to 8.6% in 2021, if there is a second wave and countries reimpose some of their lockdown measures.
  • For the U.S. alone, the OECD forecasts unemployment of 11.3% at year-end 2020 and 8.5% in 2021, if there is no sustained second wave.
  • The organization sees U.S. unemployment at 12.9% at year-end 2020 and 11.5% in 2021 in a scenario where it does experience a second wave.
• Separately, the European Commission issued an updated economic forecast showing the EU’s gross domestic product will shrink a record 8.3% this year, even worse than its earlier forecast for a drop of 7.4%.
  • The officials ascribed the downgrade mostly to a slower-than-expected economic reopening after virus resurgences led to lockdowns being tightened again in some localities.
  • The commission also lowered its forecast for a potential economic rebound in 2021, estimating a growth of 5.8%, compared with their previous forecast of 6.1%.
• In an interview with the Financial Times, Atlanta FRB President Bostic warned that the rebound in U.S. economic activity is in danger of stalling as a result of the recent spike in coronavirus infections in the South and West. Bostic said he was most concerned by high-frequency data showing a “levelling off” of business openings and mobility.  Echoing Fed Chair Powell, he also called on Congress to pass another significant round of fiscal support for the economy to help prevent permanent business closures and job losses.
• In China, an upmarket Chinese real estate developer failed to repay yuan bonds worth about $214 million that were due Monday, saying it had been hit by a property downturn that was worsened by the coronavirus pandemic, which exacerbated its large debts, high financing costs and the concentrated maturity of its debts. The news highlights the risks inherent in China’s heavy debt ratios.
• Despite the U.S. economic rebound to date and the associated rise in commodity demand, there’s still too much natural gas for the market to absorb.

Foreign Policy Response

• British chancellor of the Exchequer Rishi Sunak will face MPs in the Commons this morning as he prepares to announce a long list of coronavirus-fueled spending items in tomorrow’s “Summer Economic Update.” The expected measures include bringing forward an immediate stamp duty holiday and providing £3 billion to make homes and public buildings more energy efficient, with homeowners to receive cash grants of up to £5,000 each to fund insulation and heating systems.

China-India-Bhutan:  Chinese and Indian troops started to withdraw from disputed areas along the two countries’ Himalayan border, following talks between senior diplomats and military commanders to calm tensions.  The moves should help end the fistfights between the two sides, which caused at least 20 deaths among Indian troops last month.  However, Indian media reports say China has now begun designating part of the border with Bhutan as disputed.  The new pressure may be a way to keep pressure on New Delhi, which is a key Bhutanese ally.  In any case, Chinese territorial aggressiveness appears alive and well, which will keep up geopolitical tensions in the region.

China-Germany:  Chancellor Merkel is facing criticism in Germany for failing to take a tough line on China over the new national security law it has imposed on Hong Kong, with politicians from both opposition and government parties accusing her of being too soft on Beijing.

China-United States:  The U.S. Chamber of Commerce, the Business Roundtable and other business groups issued a public letter urging the U.S. and China to fully implement their January “Phase I” trade deal.  The letter reflects growing concern that Chinese purchases of U.S. goods are running far short of the pace required under the deal.  China has made decent progress with its ramp-up of U.S. agricultural goods, but that probably just reflects President Xi’s belief that President Trump would be so satisfied with increased farm exports that he would overlook China’s failure to implement other parts of the deal.  That could be a miscalculation, as China’s failure to meet its obligations could generate enough anger among U.S. conservatives that Trump would walk away from the deal.  A formal breakdown of the deal would signal even worse U.S.-China tensions and more trade conflict, which would likely be very negative for global risk assets.

United Kingdom-Russia:  Britain has imposed sanctions on more than two dozen Russian individuals in connection with the 2009 death of lawyer Sergei Magnitsky, signaling it may become more active in imposing U.S.-style economic sanctions against authoritarian regimes for their destabilizing acts.  The Kremlin said it would hit the U.K. with “reciprocal measures” in response.

Russia:  An adviser to the chief of Russia’s Roskosmos state space agency, Ivan Safronov Jr., has been detained on a charge of high treason for passing classified military information to an unspecified NATO country.

France:  As part of his cabinet reshuffle, President Macron has promoted a young lieutenant, Gérald Darmanin, to replace Interior Minister Christopher Castaner, who was criticized for his handling of the anti-government gilets jaunes protests last year.  More recently, the police also lost faith in Castaner for not doing enough to protect them from criticism by Black Lives Matters protesters.  In other aspects of the reshuffle, Finance Minister Le Maire kept his job, as did the foreign, defense and health ministers.  However, with the post-coronavirus economic recovery central to Macron’s re-election hopes, the president named new labor and environment chiefs.

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

[Posted: 9:30 AM EDT]

Good morning, and happy Monday!  U.S. equity futures and global equity markets are moving higher this morning led by China after comments in the state media suggested it’s good to buy stocks.  We update the pandemic news.  China has several news items of note.  Overseas, we have a new PM in France and elections in Croatia.  Here are the details:

COVID-19: The number of reported cases is 11,470,637 with 534,784 deaths and 6,193,538 recoveries.  In the U.S., there are 2,888,729 confirmed cases with 129,947 deaths and 906,763 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 latest R₀ data suggest the majority of states are seeing a rise in the pace of infections.  Additionally, this link gives a single source for the testing progress of treatments and vaccines.

Virology:

• Temperature checks are the most common way that companies screen customers or employees. However, smell checks, where the person is asked to determine a scent may be more effective.  The most common symptom of COVID-19 is a loss of the sense of smell.
• Although studies are in the early stages, vitamin D may prove to offer at least some protection against COVID-19.
• Hospital systems are approaching capacity in some southern and southwestern states.
• One of the more frustrating elements in monitoring this pandemic has been a surfeit of research papers published, many of dubious value. The media tends to report on the most sensational headlines but almost never touches on the retractions.  China has been publishing a great deal of research; a recent analysis suggests that researchers there are reusing data, which allows for the fast publication of reports that probably don’t add much to the pool of knowledge.
• Apple and cherry farms usually hire seasonal workers to pick their crops. Reports indicate these workers have been hit by the pandemic, putting the harvest at risk.

China news:

• For the first time in six years, the U.S. has sent two carrier groups into the South China Sea. China is in the midst of a five day drill around the Paracel Islands; Vietnam and the Philippines have protested against the military exercise.  The U.S. has also expressed concern.  This region has been under stress for some time, as China asserts its right to an area of control that is not recognized by any other power.
• S. security policy has been steadily shifting toward Asia, especially China. The U.K. is formulating its security policy and a similar pivot toward Asia is likely in the offing.  At the same time, the U.K. has clearly cooled on using Chinese 5G technology for its next generation of telecommunications.
• As Beijing implements the crackdown on Hong Kong, Taiwan is deciding how open it will be in allowing Hong Kongers to emigrate. The more open Taipei is to allowing dissidents to flee, the angrier the PRC will be and the greater the threat to the island.  Meanwhile, Australia is planning to become much more welcoming to Hong Kongers looking to exit.
• Zhou Li, a former deputy director of the CPC’s International Liaison department, warned Chinese leaders that they should decouple from the dollar system in anticipation that the U.S. will use the dollar’s reserve status to harm China’s economy. If China were to make this shift, it would no longer need, in fact it should avoid, trade with the U.S.  This is because trade will generate dollar balances it wants to avoid.
• Flooding is raising worries about the stability of the Three Gorges Dam. Taiwan media reports earthquakes have occurred in the region around the dam, triggering landslides.  So far, nothing official has come from Beijing, but a problem at this dam could be a catastrophe for the areas downstream.
• We have noted that China has relaxed its “one-child” policy for Han Chinese. According to reports, it is implementing aggressive tactics to reduce the birth rate of its Uighur population, including forced abortions, sterilizations and IUD’s.

Policy news:

• One of the issues we are watching carefully is state and local government spending. Unlike Federal government spending, which can be countercyclical, state and local governments are pro-cyclical.  When economic activity slows, state and local governments usually see a decline in revenue with leads to falling spending.  If the Federal government or the Fed refuse to take action to counter this issue, the impact of fiscal and monetary stimulus will be blunted due to a drop in state and local government spending.
• Sen Hawley (R-MO) proposed a bill to force the U.S. to exit the WTO. Reports indicate that parliamentary maneuvering will prevent the bill from coming to a vote before the elections, sparing incumbents a potentially problematic vote.

Foreign news:

• July is the critical month for Brexit. The Johnson government has indicated that it will not ask for an extension, so negotiators will need to have a deal done by July 31 or it will not give enough time for the EU to sign off on an agreement.  Meanwhile, negotiators have failed to meet a deadline of June 30 for finishing an assessment of the financial system regulatory regimes, meaning that U.K. banks and asset managers may lose access to the EU’s financial markets.
• The Johnson government is proposing to exempt most home purchases from taxes in a bid to boost homebuilding.
• President Macron of France is implementing a cabinet shakeup, naming a new prime minister, Jean Castex. Other new members of his government are expected to be named throughout the day.
• A couple of months ago, the German Constitutional Court threatened the ECB’s unconventional monetary policy. The Merkel government and the Bundesbank, through their actions, appear to be deciding for the court that the ECB’s policy is legal.
• Last week’s WGR explored the notion of a true Eurobond and the potential for the euro to become a much more significant reserve competitor to the dollar. For that threat to emerge, Chancellor Merkel must negotiate the difficult differences of opinion between the northern and southern European nations.  Greece’s PM warns that his country won’t agree to the plan if it faces conditions on the funding.
• Elections were held over the weekend in Croatia. The incumbent center-right Croatian Democratic Union won a plurality of seats but will need to create a coalition to form a majority government.  PM Andrej Plenkovic called early elections and the gamble worked.
• In the wake of the USMCA, Japanese car manufacturers have opted to triple the pay of Mexican workers, rather than move production to the U.S.
• The Swedish ruling coalition is fracturing over the issue of immigration and asylum. The current government is already a minority as the Swedish political landscape is so divided that forming a majority government proved impossible.  Thus, if we see a member of the current coalition exit, it may not trigger elections.
• Sharp declines in worker remittances are having a negative impact on numerous frontiers and emerging economies.
• We may see a rare snap election in Malaysia as PM Yassin attempts to solidify support.

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

[Posted: 9:30 AM EDT]

Good morning, and happy Thursday!  This is the last trading day of the week before the Independence Day holiday, so there will be no Daily Comment tomorrow; enjoy the holiday!  Global equity markets are higher this morning on improving global economic data.  Due to the holiday, the BLS has put out the employment report.  We cover it in detail below but in short, it was much stronger than forecast.  We recap the Fed minutes and other policy news.  We also look at the pandemic news.  Concerning China, we take a look at the initial response to the new security law in Hong Kong.  In foreign news, Putin “won” his referendum (the outcome was as certain as the Chiefs playing the Raiders).  Here are the details:

Policy news:

• The Fed released the minutes from the last meeting. Although there were no policy actions taken, there was interest to see what the members were thinking.  There appeared to be a great deal of discussion about forward guidance; this was evident in the dots plot, which showed there would be no change in rates for at least two years.  The members did consider yield curve control; it seems to be in the context of forward guidance, although it was also noted that if the markets were convinced that the Fed would cap rates, it may not need to actually buy a lot of bonds.  Overall, the message was accommodative policy would be in place for a long time.
  • In separate comments, Louis FRB President Bullard warned that the pandemic could still trigger financial problems and thus supported continued broad actions to prop up capital markets.
• In a surprise move, Congress extended the Paycheck Protection Program to August 8. The program still has unused funds, but the deadline of the original bill was set to expire.  President Trump still needs to sign the extension.
• So far, the Fed’s Main Street lending program has not attracted much borrowing. Critics suggest the terms are such that distressed borrowers can’t qualify and qualified borrowers are looking elsewhere.  However, its existence will act as a backstop if the financial markets seize up again, and we would not be surprised to see lending terms ease.

COVID-19:  The number of reported cases is 10,716,063 with 516,726 deaths and 5,499,628 recoveries.  In the U.S., there are 2,686,587 confirmed cases with 128,062 deaths and 729,994 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 Axios map has been updated; cases are rising across the country.

Virology: 

• A recent study out of China suggests that being infected by COVID-19 does not bring long lasting immunity. Antibodies, according to the study, offer immunity for only around eight weeks.  If this study is confirmed (and we note it hasn’t been peer reviewed) it would suggest that immunity passports after contracting the disease would not be a good idea and vaccines may only offer limited immunity.  It may be that COVID-19 vaccines would need to be offered on an annual basis, like influenza.  At the same time, it suggests that a more fruitful approach may be antiviral therapies.
• At the same time, the BBC reports that a Swedish study showed widespread evidence of T-cells associated with COVID-19. Although this evidence may indicate that a much larger number of people have been exposed to the virus, it isn’t clear if they have gained any immunity from the exposure.
• COVID-19 may have been with us longer than we thought; some tested in New York had antibodies in February.
• As we get to know more about the transmission of the disease, the primary vector is extended close contact with an infected person. It is less likely to get it from surfaces and incidental contact.  Large, enclosed gatherings are the primary way that people are catching the disease.
• As we see an uptick in cases, states and cities are starting closures and restrictions on various businesses.
• Initially, COVID-19 looked about as problematic as influenza. Although it was novel and humans had little natural immunity, it seemed possible that simply allowing the virus to infect the population and build herd immunity might be a viable plan.  To some extent, this was Sweden’s initial program.  However, as we have watched the disease progress, it appears that the infection is widespread through the body and some of the impact is lasting.  We are starting to see autopsy reports.  These take a while to process but there a now enough to where some patterns can be observed.  First, micro-clotting is being widely seen (of course, in fatalities).  Small clots are being observed in numerous organs, including the brain.  Second, although brains are not showing signs of inflammation (good news, as it suggests the blood/brain barrier is working) the virus does reduce blood oxygen and if it lasts long enough, it can irreparably damage brain cells and is leading to reports of dementia type symptoms in some patients.  This finding may mean patients may need oxygen therapy even if they remain at home.
• Researchers are monitoring cases of the virus where the victims are facing long recoveries, with some exhibiting signs of permanent impairment. Although articles didn’t discuss this issue, the chance that an infection could lead to permanent impairment is a particular risk to athletes.  Sports teams will need to weigh the potential loss of a star to the disease, or the risk to a prospect.  It is possible that this summer’s limited MLB season could be populated with AAA players.  It will be interesting to see how college sports handles this problem; at least professional players are paid directly whereas college players who become infected could see their careers end before they get the chance to “cash in.”  As we have noted before, college athletics are heavily dependent on football; if the season is lost, it may undermine a myriad of college sports.
• As we and others have noted, the recent wave of infections is skewing to the younger population. Although they are more likely to survive, albeit with the above section caveats, there are worries that they could become vectors for vulnerable populations.
• An experimental vaccine that uses a novel gene-based technology has shown some initial promise.
• After the U.S. announced it was purchasing a large amount of remdesivir, the EU is in talks to secure supplies for Europe.
• And, finally, on fears of COVID-19, North Korea took aggressive steps to seal its borders. This action has led to a sharp decline in defections.

China news:

• Although it will be a while before we can know the full impact of the new Hong Kong security law, the initial response has been widespread arrests. Both Britain and the U.S. are taking steps to allow Hong Kongers to move to their respective nations.  The U.K. is offering residency rights and a path to citizenship.  Congress has proposed a bill offering refugee status to Hong Kong citizens under persecution.  It does appear that there could be a meaningful exodus from Hong Kong.   Rubio (R-FL) is preparing a bill to ban Chinese firms from U.S. capital markets.

Economic news:

• There is a cottage industry in economics about what the shape of the recovery will be. Our take is that the recession will end soon (it may be already) but the recovery will be slow.  One new shape that has been suggested is a square root; a sharp bounce followed by flat growth.
• For the past few years, we have noted that the U.S. coastal real estate markets have benefited greatly from foreign buyers. We could see another wave due to the exodus from Hong Kong.  However, in recent months, it does appear that the buying from overseas is slowing.
• One industry that has been booming on pandemic fears, and supported by recent presidential polling, is firearms.

Technology news:

• Tech CEO’s are scheduled to testify before Congress next month. The topic will likely be antitrust.

Foreign news:

• As noted above, the referendum on extending Putin’s rule won easily. Although the Duma had already approved the measure to extend Putin’s rule to 2036, the vote does offer a patina of legitimacy.  There were reports of voting irregularities, but it doesn’t appear they would have been enough to change the outcome.
• The Hagia Sophia in Turkey is a historic religious facility that was both a Greek Orthodox cathedral and a mosque that has been a museum since Ataturk created the modern secular Turkish state. President Erdogan is asking a Turkish court to return the building to religious status, returning to a mosque.  If he does, it will be a notable cultural signal that Turkey is moving from being a secular state to an Islamic one.
• The U.S. is seeking to seize gasoline tankers from Iran on a destination for Venezuela. Both nations are under sanction; seizing the cargos would be sanctions enforcement.

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

[Posted: 9:30 AM EDT]

A slew of purchasing managers’ indexes from around the world today show manufacturing activity is either growing again, or declining at a much milder pace than at the initial peak of the coronavirus crisis (see tables below).  However, renewed infection outbreaks and lockdowns are taking the wind out of investors’ sails, as are renewed tensions with China after its imposition of a new national security law on Hong Kong.  We present all the key news below.

COVID-19:  Official data show confirmed cases have risen to 10,501,482 worldwide, with 511,909 deaths and 5,378,800 recoveries.  In the United States, confirmed cases rose to 2,636,538, with 127,425 deaths and 720,631 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• In his testimony before a Senate committee, top infectious disease official Dr. Anthony Fauci warned yesterday that new U.S. infections could surge from their current rate of about 40,000 per day to more than 100,000 per day if people continue to ignore advice on social distancing and using face masks.
• Highlighting the disparate response of some state governments as they face rebounding infections, Florida Gov. Ron DeSantis said his state was “not going back” after reopening because its increase in cases was caused by young people out socializing rather than people visiting businesses.  Massachusetts Gov. Charlie Baker relaxed his state’s 14-day self-quarantine mandate for visitors by exempting those from seven nearby states, including New York and New Jersey, but New York Gov. Andrew Cuomo extended quarantine requirements enacted last week to include people coming from California, Georgia, Iowa, Idaho, Louisiana, Mississippi, Nevada and Tennessee.
• Even after months of experience with the virus, emergency room physicians also disagree on the best way to treat victims and are taking a wide variety of approaches.  The disparity in approaches even extends to the proper settings to use on ventilators.

Economic Impact

• Even though a lot of global economic data points to an economic recovery as lockdowns ease, some figures suggest the recovery could already be hitting a plateau.  For example, data from the digital timecard firm Homebase show the number of small-business employees working in late June was lower than earlier in the month.
• European airliner giant Airbus (EADSY, 17.85) said it would cut 15,000 jobs across its commercial aircraft division, citing what it expects to be a years-long impact on the aviation sector from the pandemic.  The cuts will amount to about 11% of the company’s total workforce.
• German auto giant Volkswagen (VWAGY, 16.17) said it would cancel plans to build a new factory in Turkey because of the severe decline in auto demand caused by the virus crisis.  The plant was slated to start producing 300,000 cars per year in 2022.

 

U.S. Policy Response

• In their testimony before the House Financial Services Committee yesterday, Federal Reserve Chair Powell and Treasury Secretary Mnuchin said they would consider additional relief measures to prevent lasting damage to labor markets and businesses, as more states struggle to suppress a rebound in the coronavirus pandemic.  Despite the concerns generated by renewed outbreaks and lockdowns, the policymakers’ willingness to keep adding monetary and fiscal support should offer significant support for risk assets.

China-Hong Kong:  The Hong Kong municipal government officially published the text of the new national security law imposed on it by Beijing yesterday, putting the legislation into effect just one hour before today’s 23^rd anniversary of Britain’s handover of Hong Kong to China.  The full text of the law, which can be found here, is largely consistent with the hints and summaries provided by Chinese officials over the last few weeks.  In other words, the legislation seems as bad as feared, which will further tamp down anti-China political opposition in Hong Kong and exacerbate tensions with the U.S. and other Western democracies.  Police in Hong Kong today made their first arrests under the law when a group of protestors tried to hold a demonstration marking the 1997 handover of Hong Kong to China.  Under the law,

• Secessionist, subversive, and terrorist activities against China, or Hong Kong are criminalized beginning today, as are acts of collusion with foreign forces that endanger national security. The collusion offenses include espionage and efforts to impose sanctions against China, or Hong Kong, as well as inciting hatred against the central or local government.  Punishments include jail terms up to life in prison.
• Any person who commits offenses defined by the legislation are subject to the law’s provisions, even if they are outside Hong Kong and aren’t permanent residents of the territory. It wasn’t clear how this provision would be implemented.
• China’s central government is empowered to supervise the policing of subversive activities in Hong Kong and, in some cases, intervene directly. Its provisions would supersede Hong Kong legislation should there be inconsistencies between them.
• A special council formed by Hong Kong officials and led by the city’s chief executive has responsibility for enforcing the law. Their work will be confidential, with decisions not subject to judicial reviews.
• Within the municipal police force, a special unit will be set up to handle national security cases.  Beyond the police’s usual powers in criminal investigations, the law allows the special police unit to put suspects under secret surveillance with authorization from the city’s chief executive.
• Hong Kong’s government is also required to strengthen its scrutiny and management of schools, civic organizations, media and the Internet, and use these platforms to educate local residents on matters related to national security.
• A dedicated central-government office in Hong Kong will oversee national-security affairs, and its personnel are empowered to gather and analyze intelligence, as well as advise and supervise local authorities on security matters. Its personnel won’t be subjected to Hong Kong law when they are carrying out their duties.

China-Hong Kong-United States:  Just after the publication of the new Hong Kong security law, a bipartisan group of U.S. senators and representatives introduced legislation that would offer refugee status to Hong Kong residents at risk of persecution under it.  The legislation would require the State Department to give special status to Hong Kong residents and certain family members who suffered persecution, or have a well-founded fear of it, due to their expression of political opinions, or peaceful participation in political activities. The paperwork could be completed in Hong Kong or in a third country, and refugees would then be able to apply for permanent residency and citizenship. The opportunity, which wouldn’t be restricted by the current U.S. cap on refugees, would be valid for five years from the date of the bill’s passage.

Russia:  The country will finish voting today on a series of constitutional changes that would allow President Putin to run for two more terms in office and stay in power until 2036.  To sweeten the pot, the amendments also include a range of social and nationalist goodies such as guaranteeing social benefits and a ban on “belittling the significance” of Russia’s victory over Nazi Germany in World War II (though voters can only vote for or against the entire package).  And in case that’s not enough to drive participation, posters and mass text messages are promising Muscovites “a million prizes” through raffles in exchange for voting, officials are pressuring public employees to vote and large state companies are offering their own prizes for doing so via QR codes that could be used to track people at polling stations.  A positive outcome for Putin seems little in doubt.

Germany:  Defense Minister Annegret Kramp-Karrenbauer is dissolving a unit of the country’s special forces, known as the Kommando Spezialkräfte (KSK) after some of its members were found to have radical rightwing sympathies.  The KSK will also be restructured and stripped of control over its training.

United States-Mexico-Canada:  The new U.S.-Mexico-Canada (USMCA) trade agreement, which updated the previous NAFTA deal, officially went into effect today.

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

[Posted: 9:30 AM EDT]

U.S. risk assets are little changed today as encouraging economic data out of China is being largely offset by reports of renewed coronavirus outbreaks and lockdowns in many key U.S. states and some foreign localities.  At the same time, geopolitics are rising to the forefront again, with China passing its new national security law for Hong Kong and Australia boosting its cyber-defenses against Chinese aggression.  We present all the key news below.

COVID-19:  Official data show confirmed cases have risen to 10,417,063 worldwide, with 509,474 deaths and 5,255,829 recoveries.  In the United States, confirmed cases rose to 2,682,897, with 129,544 deaths and 705,203 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• Surging coronavirus cases in California, Arizona, Texas and Florida are reportedly straining hospital systems and maxing out the capacity of their intensive care units.  In Phoenix, where ICU units at several hospitals are already full, some are reportedly refusing to admit patients arriving by ambulance to the emergency room.  When a community’s health system is overwhelmed, it tends to prompt government officials to take action they otherwise wouldn’t take, and it can have a significant negative impact on people’s confidence.  The development could prompt renewed economic restrictions and undermine political support for current incumbents in key localities, so it’s an important risk for the equity markets.
• Just as Florida and Texas did last week, Arizona has responded to the surge in caseloads and stress on the hospital system by putting its economic reopening into reverse.  Governor Ducey said yesterday that the state would immediately close all bars, gyms and cinemas for at least one month.  Separately, New Jersey halted plans to allow indoor restaurant operations and New York’s governor said he is considering a similar move, while Tennessee’s government said its state of emergency would be extended.  Curiously, even as states continue to stretch their traditional health and welfare responsibilities into stringent economic lockdowns, few of the new announcements touched on the imperfect but much simpler and less costly measure of requiring people to wear facemasks in public.
• Meanwhile, in Britain, the city of Leicester and surrounding areas have been placed under renewed lockdown in response to a resurgence in COVID-19 cases.  Health Secretary Matt Hancock said non-essential shops had been told to close on Tuesday and schools asked to shut their doors to the majority of their pupils from Thursday.  Classes will remain open for vulnerable children and children of critical workers.
• In India, the government said schools would stay shut for another month and restrictions would be extended until the end of July on nonessential services and movement of persons in containment zones—coronavirus hot spots where lockdowns are still in effect. A nighttime curfew will also be kept in place across the country.
• The FDA today will outline its conditions for approving a COVID-19 vaccine, including a requirement that any vaccine be at least 50% more effective than a placebo in preventing the disease.  According to the Wall Street Journal, the agency will also say that a vaccine won’t be approved simply if it leads to antibodies in the bloodstream of patients, on grounds that it is not known what level of antibodies will confer protection.  The guidance will also reportedly say that no vaccine would be approved unless a vaccine company had “clearly demonstrated” proof of a vaccine’s safety and effectiveness through a clinical study.
• WHO Director General Ghebreyesus warned that the virus pandemic is far from over and the worst could yet come.  He also said the WHO would send a second team to China to investigate the source of the pathogen.

U.S. Policy Response

• Federal Reserve Chair Powell and Treasury Secretary Mnuchin will testify before the House Financial Services Committee today on the coronavirus crisis and the policies implemented to fight it, as required by economic support legislation passed in March.  According to his prepared remarks, Powell will say that even though the economy appears to have bounced back faster than previously expected, there is still significant uncertainty as to whether the virus will be kept in check and how the economy will grow from here.  If Powell sticks to that theme, it will probably be interpreted as confirmation that monetary policy will remain extraordinarily accommodative, which would be supportive of the markets.

Foreign Policy Response

• In an effort to build momentum for the European Commission’s proposed €750 billion post-coronavirus recovery fund, which would be financed with common EU debt, German Chancellor Merkel assured the “frugal four” nations opposed to the idea that all EU countries must also be willing to reform their economies and make them more “future-proof.”  Merkel expressed confidence that EU leaders would reach agreement on the fund and on the bloc’s new budget at a summit due to be held in July, although she admitted there is still a “long way to go.”  If Merkel’s gambit helps push the recovery fund forward, it will likely be positive for European assets and negative for the dollar, at least in part because the common EU debt would help create conditions for the euro to eventually become a true reserve currency to rival the greenback.

China-Hong Kong:  In an extraordinary meeting, China’s rubber-stamp legislature gave final approval to a new national security law for Hong Kong and President Xi immediately signed it, though full details are still to be released.  Demonstrating how swiftly the new law is affecting Hong Kong politics, anti-China activist Joshua Wong disbanded his Demosisto opposition party and urged pro-democracy leaders to use “more flexible” methods to resist Chinese influence on Hong Kong.

China-India:  New Delhi announced it would ban dozens of Chinese mobile apps from being downloaded or used in India, citing this month’s China-India border clashes in the Himalayas and the possibility that the apps could be used to monitor and profile Indian citizens.  According to a senior Indian official, “This is India’s first salvo to China after the border clashes, showing that India has a diverse range of retaliatory options.”  The move deprives some of China’s biggest and most important technology firms from accessing India’s large, fast-growing market.  It may therefore encourage similar moves by the U.S. or other countries that are concerned about China’s growing assertiveness.

China-Australia:  The Australian government is recruiting 500 additional cyber spies and making its largest-ever investment in digital security after a breakdown in diplomatic relations with China and mutual allegations of espionage activity.  The investment of almost $1 billion over a decade follows a warning from Prime Minister Morrison that the nation’s government, companies and educational institutions have been under sustained attack from a “sophisticated state actor.”

Russia-Libya:  The Russian government is sending additional fighters, weapons and cash to Libyan opposition leader Khalifa Haftar, who is on the defensive after a failed effort to topple the country’s UN-backed government.  In an effort to maintain influence in the country in case Haftar loses further support, the Russians are reportedly also building relationships with alternative opposition leaders, including Aguila Saleh.

United States:  A nonprofit higher education research organization said overall enrollment at U.S. colleges and universities this spring was down 1.7% from a year earlier, marking the seventh straight year of annual declines.  The drop was most severe for four-year, for-profit institutions and smaller, nonprofit schools.  Many large public and private nonprofit schools saw increased enrollment.

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