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

[Posted: 9:30 AM EDT]

Today’s U.S. market strength stems in part from earnings reports showing many companies have been able to adjust relatively well to the coronavirus challenges, albeit with higher costs.  Adding to the positive vibe is news that all 50 states have now relaxed their coronavirus lockdowns, although remaining restrictions vary widely.  Overseas, officials also continue to loosen their lockdowns, or contemplate doing so, including several large developing countries where infections are still rising.  As always, we review all the key pandemic and related news below.

Additionally, our latest podcast episode, “The Lessons of History,” is available, which examines the economic, market and social effects of earlier pandemics.

COVID-19:  Official data show confirmed cases have risen to 4,922,137 worldwide, with 323,855 deaths and 1,706,539 recoveries.  In the United States, confirmed cases rose to 1,528,661, with 91,938 deaths and 289,322 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• Despite Monday’s good news of a small study pointing to the possible effectiveness of a coronavirus vaccine being developed by Moderna (MRNA, 71.67), a report late Tuesday on the closely followed medical news website Stat called into question the rigor of the study and prompted fresh doubt over the speed at which a vaccine can be developed.  The news sparked a late-day selloff in the stock market, but it’s important to remember that it’s still early days in the crisis, when the news and confidence can be volatile.  Looking farther out into the future and keeping in mind the amount of brainpower and money being thrown at the problem, there is probably still reasonable hope that a vaccine and/or treatment will be developed and deployed in the coming months, quarters or years.
• As Sweden’s coronavirus death rate per capita ticked higher and surpassed that of the U.K., Italy, and Belgium in recent days, officials in Denmark, Finland and Norway are debating whether to maintain travel restrictions on Sweden even as they ease them for other countries.
• In Brazil, the number of new COVID-19 deaths on Tuesday rose to a record 1,179, compared with the previous high of 881 set last week. Brazil now trails only the U.S. in daily deaths as well as the U.S. and Russia in confirmed cases.
• In Mexico, a report by an anti-corruption think tank accused the Mexico City municipal government of vastly underreporting COVID-19 deaths.  The report claimed actual deaths from the disease in recent weeks were about four times higher than in the city’s official data, prompting a rebuttal from Mayor Claudia Sheinbaum.
• Some scientists looking for ways to prevent a return to exponential growth in infections after lockdowns are lifted are focusing on a new approach: avoiding “superspreading” events such as concerts and other groupings where people gather in close proximity to each other for extended periods.

Real Economy

• The nonpartisan Congressional Budget Office yesterday released updated economic forecasts reflecting only a “gradual and incomplete pattern of recovery” from the virus crisis over the next year and a half.
  • The forecasts call for the economy to grow faster in 2021 than projected last month, but GDP at the end of next year would still be 1.6% smaller than in 2019.
  • The forecasts call for the unemployment rate to remain above 9% through the end of 2021.  The CBO’s reasons for a slow recovery in labor demand are also a handy summary of the key risks for investors:
    • The eventual expiration of the Payroll Protection Program, which could prompt renewed layoffs by smaller businesses.
    • Plummeting tax revenues, which could force state and local governments to lay off large numbers of workers.
    • The possibility that generous unemployment benefits and fear of getting sick could encourage many jobless people to put off looking for work.
• Some big U.S. retailers are ending the extra “hazard pay” they gave to front-line workers as coronavirus-related costs pile up and the ranks of jobless Americans surge, tipping the labor market in employers’ favor.
• In Britain, aircraft engine maker Rolls-Royce (RYCEY, 3.24) said it will cut nearly a fifth of its workforce in a bid to survive the collapse in global aircraft demand caused by the pandemic, which is expected to last for several years.
• In Canada, the state-owned mortgage insurer said the average house price in Canada will fall 9% to 18% in the coming year and won’t fully rebound to pre-crisis levels until 2022.  According to Evan Siddall, chief of the Canada Mortgage and Housing Corp., “The resulting combination of higher mortgage debt, declining house prices and increased unemployment is cause for concern for Canada’s longer-term financial stability.”

Financial Markets

• The U.K. has sold bonds with a negative yield for the first time, reflecting growing investor expectations that the Bank of England may need to cut its benchmark short-term interest rate below zero to support the economy, and push inflation back to its 2.0% target. The development came as Britain reported that its April consumer price index was up just 0.8% year-over-year, half the 1.5% increase in the year to March.
• The Turkish central bank said Qatar has agreed to triple its swap agreement with Turkey, under which Turkey can exchange its lira for Qatari riyal, which are pegged to the U.S. dollar.  The effect of the move is to bolster Turkey’s depleted foreign currency reserves by as much as $10 billion, so it should be a positive for the lira and Turkish assets.

Political Impact

• Now that Spain’s coronavirus infection rates and daily death toll are falling, the country’s polarized political tribes are fighting over the lockdown, its loosening and the aftermath, including nightly protests in Madrid’s wealthiest districts, where protesters have been accompanied by members of the hard-right Vox party.
• An airliner from the United Arab Emirates made the first publicly acknowledged direct flight from Abu Dhabi to Israel yesterday to deliver pandemic supplies for Palestinians.  The flight was a milestone in relations between the two nations, which have no formal diplomatic ties.

China-Taiwan:  In her second inaugural address today, Taiwanese President Tsai Ing-wen reiterated her rejection of China’s efforts to assimilate the island, but she also offered to work with Chinese leader Xi Jinping to stabilize relations in ways that respect Taiwan’s democracy and sovereignty—conditions that China has previously rejected.  To bolster Taiwan’s ability to resist Chinese coercion, she also pledged to further revamp the economy, strengthen the military and deepen ties with friendly countries.  After U.S. Secretary of State Pompeo offered his congratulations to Tsai, the Chinese ministries of foreign affairs, defense, and Taiwan relations lashed out at him for interfering in China’s internal affairs, highlighting today’s increased friction in U.S.-China relations.

United States-China:  More broadly, the increased U.S.-China bickering over trade, the coronavirus and Taiwan are signs that the two countries continue to struggle with the “Thucydides Trap,” or the tension caused when an incumbent power seeking to preserve its position is challenged by a rising power seeking to gain what it perceives to be its rightful place in the world.  As we’ve discussed in the past, this type of situation can eventually lead to military conflict if not managed well.  Reflecting the current defense-oriented stance of the U.S., Senator Josh Hawley (R-Mo.) will lambaste China on the Senate floor today, arguing that the international order must be ripped up to avoid America taking “second place to the imperialists in Beijing.”  Separately, the U.S. Air Force has ramped up flyovers of B-1B Lancer bombers over waters near China, complementing increased military operations by both the U.S. Navy and Air Force in the South China Sea, East China Sea, the Taiwan Strait and the Yellow Sea.

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

[Posted: 9:30 AM EDT]

The generally positive trend in risk markets today comes as coronavirus restrictions continue to be lifted around the world and scientists continue to make progress in understanding the virus, coming up with treatments and developing vaccines.  We review all the key news below.

Additionally, our next podcast episode, “The Lessons of History,” is now available. This episode examines the economic, market and social effects of earlier pandemics.  Although the Black Death is mentioned, we focus on relatively recent events, including the Spanish influenza.  One of our themes has been an impending reversal in the equality/efficiency cycle; in this podcast we discuss the potential that the pandemic could accelerate the shift to an equality phase.

COVID-19: Official data show confirmed cases have risen to 4,829,232 worldwide, with 319,031 deaths and 1,801,461 recoveries.  In the United States, confirmed cases rose to 1,508,957, with 90,369 deaths and 283,178 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 the aircraft carrier USS Theodore Roosevelt prepares to depart Guam following a two-week layover because of a COVID-19 outbreak, reports indicate some crew members have come down with the disease for a second time.  Defense officials didn’t know whether some of the tests had produced false negative readings, or whether the sailors had contracted the virus after spending two weeks in quarantine in Guam.  Either way, the news serves as a reminder that scientists still don’t know for sure whether being infected by the virus leads to future immunity.
• On the other hand, South Korean health officials found that a group of patients who tested positive a second time for the coronavirus hadn’t passed the disease on to others, lending credence to the possibility that the suspected relapses were a fluke of testing rather than the re-emergence of an active infection.

Real Economy

• In an important sign that people are becoming less fearful of social interaction, a new Axios/Ipsos poll showed only 64% of Americans now see a risk to their health, or wellbeing from in-person gatherings of friends and family outside their immediate household.  That’s down from more than 80% in early April.  Since the poll suggests consumers may be more willing to go out and spend than they were previously, the news should be positive for stocks going forward.
• In another positive note for the economy, the University of Notre Dame said it will not only bring its students back to campus for the fall semester, but it will also try to limit their travel exposure by starting the semester early on August 10^th, ending it before Thanksgiving, and not starting the spring semester until January.  Sadly, the university offered no indication that the move would help the football team finally win a national championship again, as alumni like me (Patrick) have been waiting for.  GO IRISH!
• Federal health regulators released revised guidelines for reopening U.S. nursing homes, offering additional details and more stringent testing requirements than in an earlier draft.
• On a less positive note, New York said it is delaying payment of some $1.5 billion in grants and aid to the state’s counties, cities, colleges and schools because of the massive revenue decline caused by the coronavirus crisis.  According to Governor Cuomo and State Budget Director Mujica, the state would ultimately have to cut spending by $10 billion unless federal financial aid is provided to help make up for the shortfall soon.
• Many commercial property owners are complaining that many national restaurant and cafe operators are asking to renegotiate their leases or extend their rent deferrals on grounds that social-distancing guidelines restricting them to 25% to 50% capacity have forced them to cut expenses to stay in business.
• In a survey of the chief executives and chairmen making up the European Round Table for Industry, more than 80% of respondents said the global economic recovery from the crisis will take between one and three years.  The respondents said the top cost-cutting measures they’re taking to get through the crisis include postponing planned investments, cutting travel and freezing recruitment.

U.S. Policy Response

• Federal Reserve Chairman Jerome Powell and Treasury Secretary Steven Mnuchin will appear by videoconference before the Senate Banking Committee on Tuesday to testify on how they are handling $500 billion in emergency lending programs.  The testimony could potentially include the announcement of new initiatives, or tweaks to the fiscal responses already put into place.

Foreign Policy Response

• German Chancellor Merkel and French President Macron proposed a new, €500-billion coronavirus recovery fund for the EU, boosting hopes for a coordinated European fiscal response to the pandemic.  The funds would be raised by the European Commission borrowing on capital markets — which to date has only been done on a relatively modest scale — and would be used to provide grants funneled through the EU budget rather than loans to national governments.  To be implemented, the plan would need to be approved by all 27 member states at an upcoming EU summit.
  • The plan would move the EU farther toward common debt obligations than it has ever gone before, but it still falls short of the massive grant program funded by joint “coronabonds” that some hard-hit countries in the south have demanded.
  • At the same time, the plan has already met resistance by some creditor nations north of the EU – including the Netherlands, Denmark and Sweden – who oppose any mutualization of debt and any reliance on grants instead of loans.
  • Despite the plan’s uncertain future, it should be a positive for European stocks and bonds.  Indeed, bonds issued by hard-hit, highly indebted countries such as Italy and Spain are rallying on the news so far today.

Political Impact

• U.S.-China tensions continue to worsen against the backdrop of the coronavirus crisis, highlighting the risk of renewed trade disruptions, political tensions, and further deglobalization like we’ve described many times in the past.
  • At the WHO’s online annual meeting yesterday, more than 100 countries, including China, agreed to support an independent inquiry into the source of the pandemic and the early response to it.  However, the resolution was far short of the intense scrutiny on China demanded by the Trump administration, as it omitted any reference to China and allowed for the inquiry to come only after the pandemic has been brought under control.
  • Responding to the U.S. demand for a China-focused inquiry and its threat to leave the WHO unless the organization shows it is independent of China, the Chinese foreign ministry accused the Trump administration of a “smear” campaign designed to shift blame for its own handling of the crisis.  In an effort to bolster its image, China also announced it would contribute an additional $1 billion to the WHO to support its work.
  • All the same, many U.S. firms continue to ramp up their exposure to the Chinese market in spite of the risk of further U.S.-China “decoupling.”
• In Hungary, Prime Minister Orban is coming under fire for his response to the virus crisis.  A key issue is his government’s April requirement that hospitals free up 36,000 of their publicly funded beds for potential COVID-19 cases, forcing the early discharge of many gravely ill people.  Some of those people died, even as the total infections in Hungary has only reached about 3,500.

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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!  Equity markets are on a tear this morning, and oil is also higher.  Reports that vaccine trials are going well are boosting stocks.  There wasn’t much news on China overnight, which probably accounts for some of the lift.  We update the COVID-19 news.  Here is what we are watching:

COVID-19: The number of reported cases is 4,730,968 with 315,488 deaths and 1,739,890 recoveries.  In the U.S., there are 1,417,889 confirmed cases with 89,564 deaths and 246,414 recoveries.

For those who like to keep score at home, the FT has created a nifty interactive chart that allows one to compare cases and fatalities between nations, scaled by population.  It also has a chart showing global lockdowns.

The virus news:

• The good news:
  • We are seeing a global reopening of economies, although, as one would expect, some new clusters of infections are being reported. In the media, the reopening debate is often pitted as health vs. the economy.  However, this binary position lacks necessary nuance.  A recent paper on the Nordic response concludes that mandated shutdowns had less of an impact on the economy compared to the virus itself.  In other words, just because lockdowns are lifted doesn’t mean that recovery follows rapidly.  People remain selective on what activities they will engage in based on perceptions of risk.
  • Vaccine research continues at a rapid pace. A reliable vaccine is the fastest way the world will return to any semblance of normal.
  • Italy has reopened its borders and suspended quarantines for visitors.
• The bad news:
  • As we have been documenting for some time, the range of effects from COVID-19 infection varies widely. Large numbers appear to have either very mild cases or are completely asymptomatic.  Others are struck with a variety of maladies, including blood clotting, organ failure, etc.  Even months after recovery, some victims continue to report effects from the disease.
  • In the U.S., COVID-19 cases are now rising in rural areas as the crisis starts to dissipate in the urban centers. Unfortunately, the medical systems often lack resource depth and thus may have higher risk of fatalities.  A larger elderly population increases that risk.

The policy news:

• Chair Powell was on 60 Minutes last night and warned that the downturn could be quite lengthy. At the same time, he noted the central bank has unlimited financial firepower and could continue to respond to potential problems.
  • Although we don’t disagree that the Fed has virtually unlimited ability to create money, allocation is another matter. The Fed’s Main Street Lending Program continues to struggle to fill a gap in policy.
  • Late last week, the Fed warned that financial stress could return for banks. We have noted that the stress indices we monitor have been falling recently in response to Fed action.  However, financial stability suggests the Fed’s aggressive “dike plugging” exercise still may not be enough.
• Political haggling has the next round of stimulus on hold. Although more help is critical, it is also important that spending be targeted to supporting the recovery.
• Firms are returning Paycheck Protection Program funds, deeming the threat of audit is greater than the need for the funds. Although there have been some high-profile cases of misuse, there is a risk that the desire for accountability may end up reducing the effectiveness of the program.  The government is attempting to adjust the balance of stimulus and accountability by easing some of the restrictions.
• The creaky state unemployment claims bureaucracy has been overwhelmed by the sheer number of claimants. This conduit has become a serious problem in delivering aid to unemployed workers.
• Under current conditions, we expect a surge of bankruptcies. Unfortunately, the American bankruptcy court system, considered a model for the world, is too becoming stalled as the number of companies surge.  Firms are in limbo as courts fail to handle the rising caseloads.

The finance news:

• The credit union is a fixture of U.S. consumer finance. Created as an alternative to banks and finance companies, these entities are designed to serve a narrow audience, often employees working for a single firm or industry.  The COVID-19 recession has increased the risk of this business model for industries that have faced serious downturns.  By design, the customer scope of these financial firms is limited, so when an industry is especially hard hit the credit union that serves the employees is suddenly at risk.
• The dollar continues to rally but, for now, the White House appears OK with that. Part of this acquiescence to dollar strength could be that reversing it might be close to impossible.  Despite Fed efforts to ease pressure through swaps and other measures, many nations are still scrambling for greenback and thus demand remains elevated.  On the other hand, as the recovery gains strength, we could see the dollar ease later this year.

The economic news:

• As part of his aforementioned interview, Chair Powell warned that the economy may not recover until 2021. A bit of explanation is in order.  In business cycle parlance, the recovery phase begins when the economy stops falling; recovery lasts until the economy exceeds its previous peak, whereby the expansion phase begins.  Powell also warned that the unemployment rate could reach Depression-era levels of 25%.
• Automakers are reopening, but the restart will likely be halting as workers learn how to build cars while wearing protective gear. One major worry is that Mexican parts manufacturers remain on lockdown, which may delay parts shipments and slow the U.S. restart.
• Industries are trying to figure out what the post-COVID-19 world will look like. As we work from home and use video conferencing, it is quite possible that firms will shrink or eliminate home offices.  One of the issues facing the U.S. is that workers have been flocking to cities in recent years, reducing the population in suburban and rural areas.  However, if we can work from anywhere, maybe it might make sense for workers to return to the lower cost parts of the country, which would reverse the recent decades of social and economic problems plaguing rural areas.
• It’s no secret that airlines are struggling. But, as is often the case, some parts of the economy benefit.  Repossession firms for airplanes are seeing a surge in demand for their services.
• NASCAR is back.

The foreign news:

• Although the news about China was overall rather light compared to previous weekends, new restrictions on Huawei (002502, CNY 3.06) have raised fears on the viability of the company. At the same time, there is evidence the company is figuring out how to use fewer U.S. parts in its phones.
  • The EU wants to ensure that China won’t use the crisis to acquire European firms hurt by the recession.
• Brazil’s health minister resigned; this is the second resignation in a month.
• Nicaragua has generally shunned lockdown measures, most likely because its economy would be unable to cope with the economic ramifications. There is evidence the country is taking steps to undercount the COVID-19 death toll.

Brexit: Last week, we reported that trade talks between the EU and Britain were not going well.  It would appear the most logical outcome is an extension to give negotiators more time to develop a trade agreement.  However, PM Johnson has expressly ruled out asking for one.  This situation raises worries that a hard Brexit may be coming.  One possibility to avoid such an outcome would be a conditional extension, allowing both sides to continue talking without asking for a formal extension.  This is exactly the kind of “fudge” or “can-kicking” action that the EU does best.  The financial markets, especially the GBP, have been worried about a hard break, and the potential for a conditional extension reduces that likelihood.

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

[Posted: 9:30 AM EDT]

Good morning and happy Friday!  Equity markets are weaker after a rather robust recovery yesterday.  Trade worries appear to be a problem.  We update the COVID-19 news.  Retail sales are out this morning—details below.  Here is what we are watching:

COVID-19: The number of reported cases is 4,444,670 with 302,493 deaths and 1,588,858 recoveries.  In the U.S., there are 1,417,889 confirmed cases with 85,906 deaths and 246,414 recoveries.  For those who like to keep score at home, the FT has created a nifty interactive chart that allows one to compare cases and fatalities between nations, scaled by population.

The virus news:

• The good news:
  • Japan has lifted its state of emergency in 39 of the nation’s 47 prefectures. The major cities, Osaka and Tokyo, remain under emergency orders, but the government is planning on ending those orders by May 21.
  • A large-scale study on the use of plasma from infected patients to others was found to be safe, passing Phase 1 of the process. The next step is to see if the process reduces symptoms in those infected.
  • The CDC has released guidelines for reopening.
• The bad news:
  • Health care workers in Russia are dying at an alarming rate from COVID-19. PPE is generally lacking in Russia and the health care system suffers from underinvestment.
  • We have been worried that the race for a vaccine would become so politicized that it would hamper research and production. The head of Sanofi (SNY, $47.67), a French company, caused a stir when he indicated he would give preference to the U.S. for vaccine supplies because America has provided more money for research and development.  Needless to say, the Europeans were not pleased.  However, this comment raises the problem of free riding; why shouldn’t the U.S. get preferential treatment?  At the same time, there is a moral argument that suggests there should be equal access.  However, in reality, what would that mean?  Equal by what standard?  This row suggests that even when a vaccine is ready, factors for distribution will be difficult to create without triggering a political backlash.

The policy news:

• The House will vote today on a $3.0 trillion fiscal package. Although the Democrat-sponsored bill should pass, it is meeting some resistance within the party.  The bill appears to have lots of unrelated spending and the GOP-controlled Senate has already declared it won’t pass in its current form.
  • The package includes aid for states. This is a problem for the GOP as there are some states that have created a problem for themselves by creating pension programs they can’t fund.  Thus, the GOP does not want to reward such behavior.  At the same time, in the last recovery, falling state fiscal spending more than offset federal stimulus.  States usually do their budgeting now for a June deadline.  It is almost certain that without some form of aid, state-level spending will decline precipitously due to the lack of revenue.  Because states don’t print the money they borrow in, they must balance their budgets.  If lawmakers are not careful, we could have a situation where fiscal spending is much less than advertised because states are cutting back as the federal government spends.
• The Fed published a report on consumer finances; no surprise, lower income households have been severely hurt by the pandemic. Nearly 40% of workers earning <$40k per year have lost their jobs.
• Seventy-five percent of small businesses have applied for government aid. So far, just under 40% have received help.  It is likely the number of those receiving aid will rise in the coming weeks, but the fear is that some may not survive long enough to get support.
• Chair Powell and other members of the FOMC have made it abundantly clear they will not take policy rates below zero. And yet, futures markets continue to signal that such an outcome is possible.  Why is that?  One factor driving this outcome is a peculiarity of interest rate swaps.  Let’s say I have a fixed rate loan and I think rates are going to fall.  I could go to my bank and repaper the loan to a floating rate.  Or, we could do a swap.  Instead of paying my fixed rate, the bank and I make a deal where I pay the difference on some short-term interest rate compared to the current rate.  So, if rates, fall, I pay less.  However, once rates fall below zero, as the borrower, I would be required to pay the bank.  Borrowers don’t want that risk, so banks offer a downside cap that keeps the rate at zero.  To make that cap, banks go to the futures market and short the instrument so it would pay them if the rate goes negative. Thus, the rate signaling may be less about expectations and more about the mechanics of swaps.

The economic news:

• Thousands of stores are expected to close their facilities as consumers continue to embrace online buying. As these stores close, it will remake the look of commercial property in the U.S.

The foreign news:

• As usual, there was lots of China news:
  • Relations between the U.S. and China remain tense. In an interview yesterday, President Trump suggested that “we could cut off the whole relationship.”  The president proposed that Chinese firms may be required to meet U.S. accounting standards to acquire a U.S. exchange listing, although he did acknowledge this could simply mean Chinese firms may list elsewhere.  The president did seem to suggest that Phase 1 could be in trouble; China is stepping up farm purchases, indicating it doesn’t want to see this agreement fail.
  • Taiwan Semiconductor (TSM, 52.10) announced it will build a chip factory in Arizona. This is a significant act by the firm, which has always straddled the East and West.  By moving production to the U.S., it is signaling a greater reliance on the U.S.  This move will clearly get the attention of Beijing and may prompt greater chip self-sufficiency by China.
  • The Global Times, a tabloid in China, published an article suggesting that China should consider retaliatory measures in response to various COVID-19 lawsuits emanating from the U.S. One idea floated was to freeze U.S. assets in China.  Although this source is not considered an official mouthpiece for the Chinese leadership, it is a fount of nationalist trial balloons and may reflect a warning to Washington that Beijing is not without measures it can take.
  • The National People’s Congress (NPC) meeting starts today after a two-month delay due to the pandemic. We are watching to see:
    • What growth forecast, if any, China establishes. Even a 3% target for the year would require a robust recovery.  On the other hand, a number below that would look bad.  One of two outcomes is likely: either (a) they don’t offer a forecast, or (b) they make a 6% forecast for a two-year period.  In any case, China’s stimulus thus far has been modest and more will be needed if these sorts of numbers are going to be reached.  On the other hand, if there is no forecast, stimulus will likely remain modest.
    • We will be watching for any clues about an official response to cooling U.S. relations.
  • The U.S.S. McCampbell transited the Taiwan strait yesterday. This is a “freedom of navigation” maneuver that will clearly get the attention of Beijing.  It is also notable this occurred a week before the inauguration of Tsai Ing-wen to her second term.  China views the Taiwan leader as a separatist and thus the McCampbell sailing will be seen as a show of support for the incoming president.
  • As we noted yesterday, the head of the WTO has resigned a year before his term ended. It is apparently setting off a leadership struggle as both the U.S. and China vie to put “one of their own” in that role.
• One of the measures of statehood is that a state holds a monopoly on violence. A country that can’t control security is one that doesn’t fully fulfill the role of a nation.  The active drug cartels in Mexico have raised this problem.  We note the cartels are using the pandemic to burnish their reputations by providing aid to the localities.

Brexit: Brexit talks are not going well.  The latest round of talks ends today.  The EU accuses the U.K. of refusing to compromise on key areas, including fisheries and the legal framework that will exist between the two sides.  The U.K. is accusing the EU of being “ideological.”  It seems unlikely the two sides will have a full deal by year’s end.  This means one of three outcomes: (a) we see an extension, although PM Johnson opposes this outcome, (b) a “mini-deal” that allows the two sides to claim that a deal was struck and then details on a broader deal will be worked out in the coming years, or (c) a hard break.  The most likely outcome is (b), although the odds of (c) are probably increasing.

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

[Posted: 9:30 AM EDT]

Good morning!  Equity markets continue under pressure this morning.  We update the COVID-19 news.  The Weekly Energy Update is available.  Here are the details:

COVID-19:  The number of reported cases is 4,364,172 with 297,491 deaths and 1,418,656 recoveries.  In the U.S., there are 1,390,764 confirmed cases with 84,136 deaths and 243,430 recoveries.  For those who like to keep score at home, the FT has created a nifty interactive chart that allows one to compare cases and fatalities between nations, scaled by population.  Here is another map from Axios, showing the growth of new cases by state.

The virus news:

• The good news:
  • One of the tools being developed in the fight against the virus is blood antibodies. These drugs are developed either from the blood of humans who have recovered from COVID-19 or from animals who have been immunized.  This report from the FT is a primer on the process.
  • We have been reporting on new UV light processes to disinfect public areas. A robot equipped with a UV light has been able to disinfect hospital rooms.
  • Researchers at Yale say they have found that saliva is superior to nasal swabs to test for COVID-19 infection. If true, this would make the testing process much easier.
  • Border controls and social distancing measures are being relaxed.
    • In a bid to save the tourism season, Europe is reopening its borders.
    • Mexico is easing distancing and border measures. One of the problems for some American businesses has been the disruption of trade flows with Mexico.  These measures should ease those concerns.
  • The bad news:
    • Wuhan has launched a mass testing drive after a series of new infections from COVID-19 were reported.
    • South America is seeing a surge in cases without the resources to cope with the economic fallout from the virus.
    • Although children usually have mild cases of COVID-19, there are reports from New York of 100 cases of an inflammatory syndrome that comes from the virus. It is unclear if this development represents yet another mutation of the virus.
    • The medical establishment is working feverishly to create a vaccine for COVID-19. However, there is the possibility that a vaccine may not be accepted by part of the public.  This would slow herd immunity if this outcome develops.   Meanwhile, data from Spain suggests only about 5% of the population has been infected with COVID-19 and thus herd immunity is much further off (70% is considered a minimum for herd immunity).
    • The WHO’s chief scientist, Soumya Swaminathan, told a group yesterday that it may take four to five years to get COVID-19 under control, depending on medical developments and virus mutations.
      • Although one would wish for something different, it is also likely that the virus will simply need to be accommodated. Broad lockdowns do blunt the initial rise of the disease but are not a permanent solution.  After all, economic disruption and social isolation carry their own dangers.  What Swaminathan is really getting at is that society will need to learn to cope with the virus, similar to how we accommodate influenza and other infectious diseases.
      • This may mean that vulnerable populations will take greater precautions than others.
      • One of the more disturbing, but not surprising, elements of the current situation is that COVID-19 has become politized. This leads to binary thinking—either you open the economy full bore and risk rising infections or stay locked down for good and have no growth.  But, in reality, this isn’t the only set of choices.  We can build safety into our economy without complete social distancing and have vulnerable populations take additional measures without having those who are less at risk carry the same burden.  Will things be different?    Airplanes may need to build different seating arrangements.  Some things may cost more.  A generation may learn to cook at home.  Hotels are figuring out how to sanitize so patrons will return.  But, people and societies are remarkably adaptable.  This will get figured out.

The policy news:

• Chair Powell warned yesterday that further stimulus measures will likely be necessary from both fiscal authorities and the Fed to offset the weakness in the economy. He backed further Congressional action to stimulate growth.  He expressed worry that a deep and long recession would have long-lasting negative effects on the economy which policymakers should make every effort to avoid.  The tone of his comments weakened investor demand and pushed stocks lower yesterday.
  • The Fed may curb bank dividends due to the pandemic.
  • The Fed is easing conditions on its Term Asset-Backed Loan Facility (TALF), which is designed to allow CLO managers to finish deals that were negotiated prior to the economic downturn.
• Although the Fed continues to downplay the likelihood of negative interest rates, President Trump remains a fan.
• Congress is considering a bill that would give states more leeway in how they spend their stimulus money. It would not be allowed for funding retirement programs, but it would give states some latitude to use the money for non-virus-related spending.  President Trump expressed support for the measure.
• Tax breaks and deferrals are helping companies bear the economic slump. This factor is one of the parts of the stimulus that has generally been less appreciated.
• On-the-fly changes to the payroll protection program is worrying some small businesses that have taken the loans, fearing they could run afoul of changes that occurred after they took the money. There is always a tension between oversight and speed.  The more oversight one has, usually the less fast money can get distributed.  The problem with post-hoc changes is that potential recipients will be leery of accepting such programs in the future.

The economic news:

• Colleges are facing a serious problem in the fall. Offer only online courses and students (and their parents) may wonder why they are paying a mountain of tuition when online should be much cheaper.  Open up campus, and there is the potential of virus outbreaks.  Some state schools have already decided that online is their best option.  At the same time, most college students would rather go back to campus.
• Advertisers are questioning whether they should continue ad campaigns when consumer spending is falling. Media outlets will almost certainly face less ad revenue as the year progresses.
• Borrowers are trying to get forbearance from their lenders. They are finding the lenders are overwhelmed with demand and are struggling to respond.
• About 3% of restaurants have closed for good and another 11% may close permanently in the next 30 days according to a recent survey. More than 3k retail stores have closed as well.  It is estimated that 100k small businesses have closed due to the downturn triggered by the pandemic.
• COVID-19 has caused significant disruptions to food distribution. We have noted the shutdowns to meat processors and are starting to see local news reports about much higher meat prices.  The disruption of food distribution is a global problem; in some areas, food goes to waste because processors are trying to shift from making restaurant sized packages to smaller ones for households.  In other parts of the world, food shortages are developing.  As lockdowns ease, some of this problem will subside.  But there will simply be some food lost due to this crisis.
• After the Great Financial Crisis, there was great fear that the expansion of the Fed’s balance sheet and the fiscal deficits would trigger an inflation problem. Those fears turned out to be baseless, in part because households engaged in austerity; they boosted saving and reduced their debt.  Companies are preparing for another round of household austerity in the wake of the COVID-19 crisis.  After all, the lessons since 2008 for households is that having savings is necessary and avoiding debt is not a bad thing either.
• The WSJ survey of economists had no big surprises; the majority expect a “swoosh” recovery and the levels of uncertainty are high. Nevertheless, growth is expected to recover as the year wears on.

The market news:

• Two areas of the debt market are starting to raise concerns among investors:
  • Collateralized loan obligations (CLO) are structured loan products with various degrees of risk. The first cut of payments tends to be highly rated; the last cut tends to be near junk.  However, as we found during the 2008 financial crisis, no matter how one cuts up something, a bad loan is simply a bad loan.  There are worries that we may be facing another round of trouble in this complex market.
  • The slump in emerging markets is raising concerns about emerging debt.
• The U.S. is pressing chipmakers to move production out of China and into the U.S. Taiwan is under specific pressure in this arena.
• The IEA monthly report projects global demand fell 21.5 mbpd in May but did indicate market conditions are starting to improve.
• Fitch is warning that its downgrades of financial and corporate debt are on pace for a record.

The foreign news:

• News out of China has been coming fast and furious. Here is a rundown:
  • Increasing pressure on China from the U.S. has foreign exchange traders leaning toward a weaker CNY. Currency weakness would undermine the Phase 1 deal and weaken the impact of tariffs.
  • China, upset with Australia’s position on an investigation of the origins of the pandemic, has suspended some beef imports. Beijing is threatening other measures as well.
  • New Zealand is facing similar threats over its support of Taiwan.
  • As we noted yesterday, the U.S. is restricting federal retirement programs from buying Chinese equities. Beijing is worried that further measures may be forthcoming.
  • President Trump has indicated he has no interest in renegotiating the Phase 1 trade agreement, despite the pressure brought by the pandemic. Meanwhile, China has granted waivers on some tariffs of U.S. goods.  China is increasing its soybean purchases as well.  However, China’s imports of Brazilian soybeans hit a record in April, raising doubts that Beijing will meet its Phase 1 targets with the U.S.  The Phase 1 deal has a target of $36.5 bn of agricultural products in 2020; so far, about $3.0 bn have been purchased.  Why is China buying from Brazil?  The BRL has been making new record lows; in CNY, Brazilian beans cost about 20% less.
  • The S. has extended its ban on U.S. companies using equipment made by Huawei (002502, CNY 2.99).
  • Vietnam is encouraging its fishermen to defy China’s fishing ban in the South China Sea. China implements a seasonal ban to build fish stocks; however, if other nations comply, it is granting China sovereignty over these waters, which other nations dispute.  In related news, the U.S. Navy is boosting its presence in the seas off Malaysia to support that nation in its maritime disputes with Beijing.
• Conditions in Turkey continue to deteriorate. The lira has been weakening, foreign reserves are falling and COVID-19 is hitting the country.  President Erdogan is warning of a coup, although there isn’t much evidence to support this concern.
• There are elements of supports for Brazilian President Bolsonaro who are backing a military coup. Essentially, it appears they want to end the democracy and implement rule by decree.

WTO:  The head of the WTO has resigned a year before his term ended.  The WTO leadership has been under great strain due to rising trade tensions, and Roberto Azevedo has apparently decided to move on.

Islamic State:  Islamic State is becoming active again in the area on the Iraq/Syrian frontier.  This region is generally not controlled by either Damascus or Baghdad, and with the U.S. reducing its troop strength it appears the group is coming alive again.  One sign of activity is that Islamic State is being blamed for a series of crop fires in Iraq.

U.K.:  In anticipation of trade talks with the U.S., Westminster is planning to cut agricultural goods tariffs on U.S. farm exports.  As one would expect, there is opposition from British farmers to the news.

German courts:  Although Chancellor Merkel was (as expected) non-committal, the judges of Germany’s Constitutional Court are holding firm on their position in the fight over ECB QE.  If Germany continues on this path, the Eurozone will either (a) acquiesce to German hegemony over the Eurozone, or (b) likely accelerate the breakup of the single currency.  This is a very difficult dilemma.

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