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

[Posted: 9:30 AM EDT]

The general rise in today’s markets comes as multiple countries and states continue to ease their coronavirus restrictions and Democrats in the House released their proposal for another round of fiscal relief, but optimism remains tempered by health officials’ warnings against easing too quickly and signs of increasing tensions between the U.S. and China.  As always, we review the key pandemic and related news below.

COVID-19:  Official data show confirmed cases have risen to 4,283,885 worldwide, with 292,619 deaths and 1,504,429 recoveries.  In the United States, confirmed cases rose to 1,370,016, with 82,389 deaths and 230,087 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• Even as multiple states move to further loosen their coronavirus restrictions, NIAID Director Fauci and other top health officials testifying before a Senate committee yesterday warned that prematurely easing the lockdowns could lead to a resurgence in infections and a need to reimpose restrictions.  Leading the pushback against them, Kentucky Senator Rand Paul suggested the officials were being alarmist, but the testimony has still taken additional wind out of the recent rally in stocks.
• Now that researchers are gaining a better understanding of the benefits and limitations of the anti-viral drug remdesivir to treat COVID-19, they are starting to launch trials of the drug in combination with other therapies to see if its safety and effectiveness can be improved.
• A century-old tuberculosis vaccine known as BCG is now being tested as a stopgap shield against the new coronavirus.
• U.S. officials said Chinese and Iranian hackers are aggressively targeting American universities, pharmaceutical and other health care firms in a way that could be hampering their efforts to find a vaccine to counter the coronavirus pandemic.

Real Economy

• IMF Director Georgieva warned that since COVID-19 is spreading farther and the economic damage is proving worse than previously expected, this year’s global economic contraction will be even deeper than the 3% the institution forecast last month.  Revised forecasts won’t be released until next month, but the news is likely to further dampen the recent rebound in risk assets.
• Some farmers are shifting their planting plans from corn to soybeans as prices for the former plunge faster in response to weakened demand for energy and ethanol.

U.S. Policy Response

• The Democratic majority in the House of Representatives released their proposal for a fifth pandemic relief bill worth approximately $3 trillion, including $1 trillion for state and local governments.  House members are expected to vote on the bill this Friday, but negotiations with the Republican-controlled Senate aren’t expected to start until late May.
  • Republicans panned the Democratic proposal and insisted they would plan to take a wait-and-see approach to any new bill.
  • Concerns about ballooning deficits continue to build, raising the risk that fiscal policy could be tightened before the economy is back on its feet, as happened under the “sequester” after the Great Financial Crisis.
• Although much of the discussion of previous epidemic relief spending has focused on the Payroll Protection Program loans for small businesses, larger companies are now reporting significant cash flow benefits from tax cuts and deferrals in the relief bills.
• The Fed has started to implement its new purchases of corporate bond ETFs, giving a boost to the major funds yesterday.  The major corporate bond ETFs continue to have a tailwind so far this morning.

Foreign Policy Response

• In Japan, Prime Minister Abe signaled he would be open to compiling a second supplementary budget to cushion the blow of the country’s virus lockdowns as he was forced to defend his administration’s response to the crisis under pressure from opposition party lawmakers.
• In India, Prime Minister Modi proposed spending $266 billion to offset the economic impact of the country’s pandemic restrictions.  The program would amount to about 10% of Indian GDP and would include broad economic reforms in addition to emergency budget funds.  Details on the proposal won’t be released until later this week, but from the tenor of the announcement it could be a significant positive for Indian stocks.

Political Impact

• New reports show Chinese health officials were conducting detailed investigations into the origins of the pandemic as early as December, but are now stalling any release of their findings and blocking joint studies with foreign researchers.  The reports help buttress a growing sense around the world that China is not being transparent about the virus or any possible missteps it may have made at the beginning of the crisis.
• Citing “the Chinese government’s concealment of critical information concerning the novel coronavirus,” President Trump ordered the federal government’s 401(k)-style Thrift Savings Plan to cancel a project that would allow federal workers to invest their contributions in Chinese stocks.  The order is a clear example of how the crisis plays into the administration’s policy of deglobalization and decoupling from China.
• In another black eye for President Putin and his handling of the crisis, the Russian government has suspended the use of a domestic-made ventilator used to treat patients infected with coronavirus after two of the machines reportedly caught fire, resulting in the deaths of six people.
• In an important development for the future of the EU, the judge who authored last week’s German constitutional court decision against the ECB’s bond-buying program and the European Court of Justice’s approval of the program warned that an EU infringement proceeding against Germany over the decision would trigger a constitutional crisis that could endanger the bloc.  We would agree that a standoff between the EU and Germany over which one has primacy is a further fracture in the bloc on top of those we discussed in our recent WGRs from March 30 and April 6.  The risk of an eventual breakup of the EU continues to grow, which could turn into a serious headwind for European stocks and bonds going forward.
• The crisis is also shifting political fortunes and boosting new potential leaders in key countries:
  • In Japan, Osaka Governor Hirofumi Yoshimura has gone from being a locally liked politician known as a team player to a national media darling now being discussed as a possible prime minister in the future.  Yoshimura’s rise stems largely from his strong individual leadership and communication skills in dealing with the coronavirus crisis.
  • In Germany, new polling shows 53% of voters think Markus Söder, the prime minister of Bavaria, should be the ruling Christian Democrats’ candidate to succeed Chancellor Merkel in next year’s election.  Söder’s reputation has been boosted by his willingness to take tough measures against the pandemic.  Support for the previous frontrunner, Armin Laschet, has fallen to just 27%.

Israel-China-United States:  Responding to U.S. concern about China’s growing influence over the Israeli economy, Israeli Prime Minister Netanyahu will force additional checks on whether a Hong Kong-based company should be allowed to bid for the construction of a $1.5 billion desalination plant in the country.

China:  Ahead of two major policy meetings in Beijing next week, Communist Party hardliners are reportedly planting criticisms in state media of January’s “Phase I” trade deal between the U.S. and China.  The criticisms likely signal an effort to push back against any further concessions to the U.S. in trade and other bilateral issues.

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

[Posted: 9:30 AM EDT]

Investors today continue to focus on pandemic lockdowns being eased around the world, including the reopening of schools in much of Europe, but a bit of caution is rising as some countries and localities are seeing a rebound in cases.  As always, we review the key pandemic and related news below.

COVID-19:  Official data show confirmed cases have risen to 4,201,921 worldwide with 286,835 deaths and 1,467,412 recoveries.  In the United States, confirmed cases rose to 1,347,936 with 80,634 deaths and 232,733 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 Wuhan, China, where the coronavirus first began to spread, the municipal government has launched a 10-day push to test all residents for the virus, following the discovery of a cluster of infections a full month after its lockdown ended.  The discovery ended a 35-day stretch of zero new locally transmitted cases in the city.
  • The new infections in Wuhan come as other places around the world, including South Korea and India, have also seen a rebound in cases after easing their lockdowns.
  • The rebound in cases highlights the risk of asymptomatic carriers sparking a resurgence of infections after lockdowns are eased.  That danger has taken some of the air out of risk assets in recent days.  However, it remains a question whether that risk will outweigh the impatience for easing felt by many individuals and businesses around the world.
• Russia reported its tenth straight day of more than 10,000 new coronavirus cases and a record number of daily deaths from the virus, making it the world’s second-most affected country after the U.S.  Even as President Putin announced federal lockdown orders would be eased, Moscow and many local authorities tightened their quarantine rules yesterday, including making face masks and gloves mandatory on public transport and in shops.
• Comparing actual total deaths to normal rates in March through May, a study by the CDC estimated the virus has killed thousands more people in New York City than the number officially listed as confirmed or probable.  The study’s methodology would likely capture not just those who died directly from the virus, but also those who died of health problems that were exacerbated by it or the epidemic, including those who died because they couldn’t get admitted to an overwhelmed hospital.
• Japan has become the second country to grant emergency approval of the antiviral drug remdesivir to treat critically ill patients with COVID-19.  Prime Minister Abe also said a drug known as avigan, from Fujifilm Holdings (FUJIY, 48.68), is in line for clearance by the end of the month.

Real Economy

• Elon Musk, CEO of Tesla (TSLA, 811.29), yesterday said his company is resuming car production at its sole U.S. plant in California in defiance of a county order that the facility be limited to “minimum basic operations” until it gets approval of an operating plan that would protect its workers from the coronavirus.
  • In spite of Musk’s bravura in announcing the production start, it may not be quite the act of defiance it seems.  Over the weekend, Tesla filed suit in federal court to be allowed to resume operations, and that court could potentially block the county order at any time.  Besides, the company was reportedly planning to submit its plan for review as early as Monday, and it could be approved quickly.  Finally, California Governor Newsome noted that Tesla would likely be allowed to restart production next week anyway.
  • All the same, Tesla’s production restart escalates the pushback against state lockdown measures, which until now had been largely confined to relatively limited groups of individuals and small businesses rather than publicly traded companies.  It could therefore help accelerate the ongoing moves to gradually lift restrictions, although it could also open Tesla to expensive lawsuits, especially if workers feel forced back to the assembly line or if an employee becomes sick and dies.
• Touching on the emerging debate about whether the pandemic will lead to higher or lower inflation, China’s April producer price index was down 3.1% year-over-year compared with a decline of just 1.5% in the year to March (see tables below in Foreign Economic News).  The April CPI was up 3.3% on year compared with 4.3% in the previous month.  The cooldown in inflation came mostly from a collapse in commodity prices and weakening demand.  In the U.S., the latest CPI data also show weakening inflation.  However, the question is whether inflation in the longer term will remain lower, or whether problems like supply restrictions will lead to less efficiency and higher prices.  The long-term outlook for inflation will have a significant impact on monetary policy and bond prices going forward.
• Bernard Looney, the new CEO of British oil giant BP (BP, 23.50), warned that the hit to crude oil consumption was likely to endure beyond the pandemic, and that the world therefore may have already passed “peak oil” demand.

Financial Market Impact

• Data from the Wilshire Trust Universe Comparison Service shows public pension plans in the U.S. lost a median 13.2% in the three months ended March 31, slightly worse than the previous record decline in the fourth quarter of 2008.  Despite a partial rebound in performance since the beginning of April, the loss will likely make pension costs even more burdensome for states, counties, and cities going forward, which will probably impact their creditworthiness for years.

U.S. Policy Response

• The next round of federal fiscal support for the economy, which Democrats in Congress hope to introduce as early as this week, may allow local news outlets to participate in the Payroll Protection Program of small business loans being run by the SBA.
• According to a survey conducted by the Global Business Alliance, which represents U.S. subsidiaries of groups including BMW, Nestlé, and HSBC in Washington, 77% of its members said they thought the U.S. would become more protectionist on trade, cross-border mergers and acquisitions, and government procurement because of the pandemic.

Foreign Policy Response

• Germany’s main business organization has signed on to a call for more “fiscal solidarity” in Europe, in a sign of widening support in Berlin for a bigger German contribution to the EU’s post-coronavirus recovery.
  • Germany, like several other high-saving countries in Europe, fear that grants or other aid to debtor countries in southern Europe will be squandered, but they are probably also beginning to fear a prolonged loss of markets if the southern countries can’t recover soon.
  • That trade-off was brought into stark relief last week, when Germany’s constitutional court challenged the European Court of Justice over its approval of the ECB’s massive bond-buying program.  Even many conservative Germans have said the German court’s move went too far in challenging the Euro system and the primacy of EU law over member states’ law.

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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!  Given the news flow of recent weeks, it was rather quiet overnight.  Risk markets are lower this morning.  We update the COVID-19 news.  Here are the details:

COVID-19:  The number of reported cases is 4,122,173 with 283,001 deaths and 1,418,656 recoveries.  In the U.S., there are 1,329,799 confirmed cases with 79,528 deaths and 216,169 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:
  • One of the early concerns as hospitalizations rose was a shortage of ventilators. There were measures taken to repurpose assembly lines to make the medical device.  As we have noted in earlier reports, there have been cases of silent hypoxia, where patients have blood/oxygen levels that are critically low yet seem to exhibit little distress.  The usual protocol in such cases is to deploy a ventilator.  However, due to the lack of distress, doctors are now using less invasive measures to raise oxygen levels, instead deploying CPAP machines, laying patients in a prone position or giving oxygen.
• The bad news:
  • We are seeing countries around the world scale back their social distancing measures. Results so far suggest that opening up is leading to rising case counts.
    • In Iran, the number of confirmed cases has increased by 50% since early May following the decision to ease social distancing measures. Despite this rise, Tehran has scheduled a phased reopening over the next two weeks.
    • South Korea has been given high marks for its handling of the virus. The country used aggressive testing, contact tracing and quarantine to keep infections at bay.  However, as the country has eased restrictions, it too is seeing new increases and has ordered nightclubs and bars closed.
    • Northeastern China is reporting a rise in infections. Shulan, a city in Jilin province, has been put on elevated alert.  What is worrying about this news is that Jilin borders North Korea; Pyongyang claims it has no infections, which is highly improbable.  Although the border has been closed for weeks, there are worries that North Koreans may be moving across the border and bringing new cases into China.  Meanwhile, Wuhan has reported its first new COVID-19 cases since the lockdown.
  • One of the characteristics of this virus is that children seem to either be asymptomatic or suffer mild cases. However, there are reports that three children in New York have perished from a virus-related condition.  Although the number is clearly small, we watch for such changes as indications of mutation.
  • Domestic counterintelligence agencies are warning that China is making a concerted effort to hack U.S. research on vaccine development and antiviral therapies. China isn’t the only one.  Allies such as South Korea and Vietnam, and enemies such as Iran, have been reportedly active as well.

The policy news:

• We have been reporting for some time our concerns about the non-bank mortgage servicers. As more mortgage holders need forbearance, the servicers are caught between needing to provide payment on mortgages to meet the obligations of mortgage bond holders and the lack of payments from homeowners.  Most of these firms lack the financial backstops that banks have.  We continue to expect the Fed to eventually provide support for this part of the mortgage industry, but, to date, it has not.
• As we noted last week, the financial markets were signaling growing odds that the Fed may consider negative interest rates. Fed officials downplayed the likelihood and we tend to agree.  The Fed is more likely to engage in balance sheet expansion and forward guidance but seems to hold that the benefits of negative rates are more than offset by the costs.
• The next round of stimulus is under debate. House Democrats are pressing for another trillion in stimulus spending; so far, the Senate is cool to the idea and the White House appears noncommittal.  An interesting element of the proposals is a temporary form of universal basic income, a key part of Andrew Yang’s presidential bid.
• We have seen a strong rally in corporate debt since the Fed announced its support program. However, so far, the Fed actually hasn’t bought anything, a clear indication of the impact of announcement effects.  The actual buying is just about to start.

The economic news:

• Last week’s jobs data was mostly bad; there are scattered reports that companies are planning further job cuts as economic growth slows. Employment data tends to be a coincident to lagging numbers.  This lagging characteristic will likely continue as we are seeing widespread reports of new layoffs being announced.
• Surveys of corporate leaders indicate growing worries about rising protectionism. This isn’t news, as globalization likely peaked in 2006, but the idea of deglobalization has moved from being a fringe idea to mainstream.  We note that in 2019, Chinese investment into the U.S. fell to its lowest level since the Great Financial Crisis, likely a reflection of growing tensions between the two nations.  In Q1, FDI rose $200 mm, down from last year’s quarterly average of $2.0 bn.  Of course, much of this decline can probably be attributed to COVID-19-related disruptions.

The market news:

• One of the downsides of low interest rates is that it makes some financial products very difficult to create. There are reports that life insurance companies are refusing to underwrite policies due to low interest rates.

The foreign policy news:

• For years, economists have argued that China’s economy was overly dependent on investment and exports. In fact, China’s policy mix deliberately disadvantaged households, forcing them to oversave.  This saving provided funds for investment but as household saving continued to rise, it swamped the needs of domestic investment, leading to large trade surpluses.  As China prepares its 14^th five-year plan, policymakers are anticipating a more hostile foreign environment that will require more domestic-driven demand.  Perhaps deglobalization will finally prompt a policy mix that boosts domestic consumption and reduces the trade surplus.
  • China’s credit growth in Q1 rose CNY 1.7 bn, a yearly change of 13.1%. The PBOC is vowing more aggressive growth policies but has refused to offer details.
• The U.K. has outlined its reopening process. Although most stay-at-home orders remain in place, relaxation starts in earnest on June 1, when primary schools reopen.  Additional openings are expected in early July.  The U.K. will impose a quarantine on air travelers.
• In response to the drop in oil revenues due to lower oil prices, Saudi Arabia announced a series of measures designed to reduce the impending fiscal deficit. Spending will be cut and its VAT rate will be tripled.  Austerity is rarely popular, so we will be watching the reaction to these measures from Saudi citizens.  We note that the kingdom has announced a unilateral 1.0 mbpd cut in production, likely in a bid to lift prices and oil revenues; oil prices jumped on the news.

Iran:  At least 19 Iranian sailors died in what appears to be a friendly-fire accident during naval exercises.  Although details are sketchy, it looks like a vessel was mistakenly struck by a ship-to-ship missile.  The exercises were being held in the Gulf of Oman; there are no reports that any U.S. ship was in the vicinity.

India/China:  The border between the two nations has been in dispute for some time but, since it sits in the inhospitable Himalayan mountain range, military operations tend to be limited.  It appears that soldiers from both nations exchanged words and non-lethal blows over the weekend before officers on both sides ordered troops to disengage.

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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!  Global risk markets are rising at the same time Treasury yields are falling.  It’s employment Friday; we cover the data below but, suffice it to say, it’s historic and not in a good way.  We update the COVID-19 news.  This week’s Asset Allocation Weekly is published below.  And, podcasts are back!  Despite being unable to utilize our recording studio, our sound engineer, Dane Stole, has figured out how we can record remotely.  Check it out!  Here are the details:

COVID-19:  The number of reported cases is 3,862,174 with 269,881 deaths and 1,291,490 recoveries.  In the U.S., there are 1,256,972 confirmed cases with 75,670 deaths and 195,036 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:
  • The FDA has approved a vaccine for the second phase of clinical trials. Moderna (MRNA, 53.19) announced its vaccine will move on to Phase 2.  Phase 1 determines if the drug or vaccine is safe; Phase 2 determines if it is effective.  If it passes this phase, it will move on to Phase 3, which tests the vaccine for safety and effectiveness on a larger scale.  If it passes all three, it may be available for the general public early next year.
  • A new study confirms that anyone who has had COVID-19 does create antibodies to the disease. It isn’t clear how much immunity this gives a person, but it does suggest that it gives at least some protection for an unknown period of time.
• The bad news:
  • As we have noted before, COVID-19, like all viruses, tends to mutate. Often, they mutate into a less virulent form.  A recent study confirms earlier reports that the virus that hit Europe and the East Coast was different than the one that struck Wuhan.  The virus in China may have been more deadly but was less transmissible.  A mutating virus increases the challenge for vaccine manufacturers.
  • One of President Trump’s personal valets has tested positive for the virus. The president himself has not.
  • Given our general lack of knowledge about COVID-19, nations around the world are reopening their economies without knowing what risks they are undertaking. In a sense, we are seeing a series of real-time experiments that will be difficult to analyze on the fly.  There is no doubt that future historians will write about what worked and what didn’t, but it’s a lot harder actually living through the process.
    • Sweden has been one of the important “test cases” for the response to the virus. The government there implemented rather soft measures, allowing restaurants to remain open, for example.  Its fatality rates have been rather high but what surprised us is that the easier measures led to only modest economic improvements relative to others.  It’s early in the process, but that’s what we see so far. Some of this may be due to the fact that even without official lockdown orders, Swedes mostly followed them on an informal basis.  Another factor is that exports represent 46.7% of Sweden’s GDP, making it more susceptible to slowing global growth.
  • Although it is well documented that children generally avoid the worst of the virus, it isn’t exactly clear why this is true.
  • There is growing concern that the antibody tests are flawed and may be giving false comfort to some recipients.

The policy news:

• House Democrats are putting together a fourth coronavirus stimulus package. Early reports suggest a number around $2.0 trillion.  However, we would not be surprised to see this number go higher.  Lobbyists realize this will probably be the last one for a while so they are trying to get the “last shot” at their goals.  We do note negotiations with the GOP, both Senate and White House, have not started.  We expect a rather frosty response from the Senate, but perhaps a more positive one from the executive branch.
• One of the lingering concerns about the policy response to COVID-19 is that much of the funds come from the states, which mostly lack the ability to deficit spend. In the recovery from the 2007-09 recession, falling state spending mostly offset higher federal spending, blunting the policy response.  The decline in state tax revenues is widespread. A bill has been introduced to shore up state revenue.

(Data: Lucy Dadayan/The Urban Institute. Chart: Andrew Witherspoon/Axios)

• The Small Business Administration has reduced the loan size for the Economic Injury Disaster Loan Plan from $1.0 mm to $150k. Not to be confused with the new Paycheck Protection Program, the former plan is a long-standing program that has been overwhelmed with requests.  Thus, to cope with the demand, the SBA is tightening the eligibility criteria.
  • The SBA is reporting that demand for its loans has slowed rather dramatically. It appears there are several reasons for the slowdown, but one concerning issue is that firms are worried about the terms, fearing they will fall afoul of the rules and could find themselves in legal trouble.
• Although the Fed has continually panned implementing negative interest rates, financial markets are starting to discount the chances that the FOMC will be forced to take policy rates into negative territory. The two-year T-note hit a record low yesterday, and fed funds futures have started to price in a negative rate.

The economic news:

• As states reopen, companies are struggling to restart their businesses. Three major problems have emerged.  First, generous unemployment benefits are keeping workers at home.  Second, with schools closed as well as many day-care centers, workers who might be willing to return to their jobs can’t due to the lack of child care.  Third, many of these laid off workers may not have a job to return to as bankruptcies rise.  These factors may slow the recovery even as shutdown orders ease.
• There is growing labor unrest in the meatpacking industry. Union leaders strongly criticized the decision to use the Defense Procurement Act to force facilities to reopen that had been closed due to virus infections.
  • This isn’t just a U.S. problem. Concerns over the lack of safety measures have led to a walkout at an auto factory in Spain.

The market news:

• Fed forex swap data show that Asia has had the heaviest users of the credit lines. This development bears watching because it may signal underlying financial stress.

The foreign policy news:

• A few China notes:
  • It appears Secretary Pompeo is walking back some of his comments on the origins of COVID-19. One reason is that he isn’t getting much support from Australia, which has publicly questioned the theory that COVID-19 leaked from a Chinese biology lab.  The WSJ editorial page suggested that if the White House had evidence, it should release it.  And, the chair of the Joint Chiefs of Staff has indicated that evidence of the virus’s origin does not suggest it came from a lab or was manmade.  If we see officials back away from this story, it may ease tensions.
  • Beijing is pushing for the WHO to investigate the origin of the virus.
  • Meanwhile, the U.S. is making the case that Taiwan should be allowed to attend the WHO summit. This position will infuriate Beijing.
  • It is becoming noticeable that China’s fiscal and monetary response to this crisis has been rather modest. Yesterday, we noted the spat between the Finance Ministry and the PBOC, where the latter is balking at monetizing the former’s new debt issuance.  This modest effort contrasts with the massive stimulus China implemented after 2008.  Why the smaller action this time around?  The 2008 stimulus led to a massive rise in debt; it appears the Xi regime doesn’t feel comfortable with a similar rise in debt this time.  If this pattern continues, China’s only way to lift growth may be through exports, which will not be popular with its trading partners.
  • On the issue of trade, U.S. and Chinese trade negotiators discussed getting Phase One going. The talks came after President Trump threatened the deal.  China, in part due to the impact of the coronavirus, has been lagging in fulfilling its requirements for purchasing U.S. goods.
• The EU has failed to develop a Eurobond in response to the crisis and has been less than generous in assisting the southern nations hard-hit by the virus. But, it is allowing Italy to tap ESM funds with very little oversight, a small victory for the country.
  • Spain’s deputy PM, Pablo Iglesias, is calling for EU-wide minimum income guarantees, warning that the EU and the Eurozone may fall apart if such a program isn’t implemented.
• As Iran eases restrictions on religious worship, COVID-19 cases are rising again.

Argentina:  The country’s biggest bondholders are balking at the restructuring deal being offered by the government.  The Kirchner government wants a 62% reduction in interest payments and a 5.4% write-off.

China:  There are reports that a new computer virus, called Aria-body, was developed by a group with ties to the Chinese military.  The virus can take control of a computer and apparently cover its tracks.  It is passed invisibly through emails.  Its primary purpose appears to be information gathering.

Middle East:  The U.S. is pulling Patriot missile batteries out of Saudi Arabia.  These were initially put in the kingdom in response to the missile attack last year.  The decision to remove the missile defense system could reflect a number of factors.  First, it is possible that the kingdom has improved its own defenses and no longer needs the U.S. support.  Second, backchannel contacts with Iran may have reached some sort of agreement not to repeat the missile attack; as we noted yesterday, Israel noted that Iran appears to be pulling back from Syria.  It may be that Iran simply lacks the resources to threaten Saudi Arabia and the U.S. is reacting to that fact.  Finally, there is a clear move to reduce the American military footprint in the Middle East and this action reflects that.  We do note that Islamic State is stepping up its activities as the U.S. and Europe reduce troop strength in Iraq.

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