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

[Posted: 9:30 AM EDT] Good morning; it’s the 75^th anniversary of Germany’s surrender in WWII.  Despite expectations of dreadful labor market data tomorrow, equity futures continue to move higher.   The BOE maintains current policy.  We update the COVID-19 news.  Our Weekly Energy Update can be found here.  Here are the details:

COVID-19:  The number of reported cases is 3,769,150 with 264,111 deaths and 1,250,579 recoveries.  In the U.S., there are 1,228,609 confirmed cases with 73,431 deaths and 189,910 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:
  • Epidemiologists and health economists are working to discern which social distancing measures are worth the cost. This exercise is an important next step in establishing how society should operate in the absence of established therapies for COVID-19.  In this current stage, epidemiologists dominated the conversation and were focused mostly on reducing infections.  The next phase will be figuring out which mitigation measures save the most lives compared to the costs entailed in implementing them.  This process will be difficult because we know so little about the virus.  And, it may lead to governments permitting activities only to find that this was a bad idea.  Still, this is progress because it is the process of learning to cope with the virus being with us for the foreseeable future.
  • There may be more UV light in our future; UV light disinfects the air and surfaces but tends to burn skin and eyes, reducing its usage as a safety measure. Scientists at Columbia have created a version of UV lighting that doesn’t burn skin or eyes that could be used as a continual disinfectant in public areas.  If this works, it would reduce the odds of transmission in public places and speed the return of opening businesses and restaurants.  We could see businesses, arenas and airports have visitors pass through such light to reduce transmission of viruses.
  • Mass testing has been something of a problem for many countries. Without testing, it is difficult to know the extent of the virus’s spread.  Researchers are investigating if they can trace the degree of infection in a community in sewage.  It is known that the virus does leave the digestive tract.  Measuring the “back end” may tell mayors and governors that a problem is developing before it becomes evident in hospitalizations.
  • Here’s another drug to watch—EIDD-2801, an antiviral that is currently under trial in the U.K. and will begin phase 1 in the U.S. later this month. It is designed to work similarly to remdesivir but can be taken as a pill; remdesivir must be administered intravenously.
  • There is some promising work being done with llamas to create a potential therapy for COVID-19. Their blood can generate unique antibodies to the virus.  The good news is that it would give a person immediate immunity to COVID-19; the bad news is that the immunity wanes rather quickly, in one to two months.  However, it could be used to protect health care workers until a vaccine is developed.
  • Germany, Europe’s largest economy, is beginning to reopen.  Its reported cases are in clear decline. The secret of Germany’s success was widespread testing and general compliance with social distancing.  Germany’s recovery would help the EU economy, which, as we note below, is in very bad shape overall.

• The bad news:
  • Coronaviruses are known to mutate. There are reports that the current virus is a version that began to emerge in mid-March and is different than what originally came from China.  The new version isn’t necessarily more virulent, but it may replicate faster, making those infected sicker than what was seen in the initial version.
  • One debate governments are having is when to reopen schools. There is evidence to suggest that children are less susceptible to the worst of COVID-19 and thus probably face less danger in reducing social distancing (assuming, of course, no preexisting conditions exist).  However, there is a potential problem with reopening schools—children may become vectors for COVID-19 by harboring asymptomatic infections and putting their families at risk.  We should note these studies conflict with others suggesting children are not necessarily a risk.
  • As noted yesterday, nursing homes remain an area of great risk for COVID-19.
  • There are reports that France may have had a fatality from COVID-19 as early as December. If true, it means the virus was circulating around Europe well before February.
  • Over the past few weeks, we have noted the various ways COVID-19 attacks the human body. This report is a recap of what is currently known.
  • There has been a rise in apparent suicides among Russian medical staff. It is believed that stress related to COVID-19 is to blame.

The policy news:

• One of the issues we have been watching for is a policy mistake. The biggest is when central banks or fiscal authorities inadvertently cause systemic risk because they didn’t backstop a certain area of the financial market.  The ECB may be introducing this risk because it has refused, so far, to offer support to the European high yield market.
• In the U.S., there were provisions in the stimulus package to aid student loan borrowers. Unfortunately, some borrowers, many of whom took out loans prior to 2010, find that the provisions don’t include their loans.  It doesn’t appear there was a rationale for the exclusion and seems to be a simple oversight.
• There has been massive fiscal and monetary support to the economy. However, one area that has been repeatedly rebuffed in getting support is private equity.  The lack of support shows how politically toxic this sector has become.
• There is also a political standoff brewing between the White House, which is pushing for additional stimulus, and the right-wing establishment in Congress, which is becoming uncomfortable with the level of spending. This is more of an intra-party conflict within the GOP.
• Part of the stimulus package was a boost to unemployment insurance. In addition to the usual state payments, the federal government is kicking in an additional $600 per week.  This measure was pushed by the representatives from large urban areas with high living expenses.  However, outside major cities, unemployment benefits exceed what many workers were making before the shutdown.  Needless to say, there is an incentive to simply exhaust the unemployment insurance before returning to work.  We are seeing reports that some businesses, which have been given permission to reopen after lockdown, are struggling to find workers, in part due to the generous benefits given for not working.

The economic news:

• Tomorrow, the BLS will release April’s employment report. As yesterday’s ADP report showed, job losses are going to be historic.  The current forecast is for a drop in nonfarm payrolls of 21.0 mm.  The largest previous drop in history, starting in 1939, was 1.959 mm in September 1945, due in part to war demobilization.  The unemployment rate for April is forecast at 16.0%.  Although there are great hopes that the economy will rebound quickly and workers will only face temporary layoffs, some businesses won’t recover from this drop in business, turning temporary layoffs into permanent ones.  At the same time, some real time data does suggest there is an element of stabilization in the economy; it’s not recovering fast but it isn’t getting worse.
• The economic situation in Europe is terrible. The EU warns that the virus has affected nations differently and the uneven nature of the shock requires a unified response.  The BOE warned that the K. economy could contract by 25% in Q2.
• An idea that is emerging is the concept of the flexible lease. Currently, lease payments are fixed; under normal circumstances, that makes sense.  The building owner doesn’t see his sunk capital costs drop in a recession.  But, in the wake of the current downturn, some landlords are showing openness to the idea of setting rent based on business revenue.  This could create some rather interesting situations; for example, a REIT may be valued based on the business growth of tenants, not how well leased a building is.  If this practice were to become widespread, it would tend to turn real estate investments into more of an equity product and less of a fixed income product.
• We have been documenting the growing problems in the protein supply chain. Stores are beginning to put limits on meat purchases and prices are rising.  Until we see processors reopen, supplies will likely remain constrained.

 

• One of the arguments used to end restrictions on interstate banking was that larger banks would have economies of scale that would improve their efficiency and reduce costs. This was more of a faith-based idea; there wasn’t much evidence at the onset that it was true.  In some aspects of banking, scale turned out to be important.  The handling of transactions has improved with concentration, for example.  And, there is no doubt that scale helps with creating and building technology.  However, for relationship banking, there is scant evidence that scale improves service, especially for smaller firms.  Community banks have proven this in the COVID-19 situation, being much more effective in tapping the government programs to provide loans to small businesses.
• As we detail in the data table below, China’s April exports bounced unexpectedly, although much of this may be clearing up the backlog from Q1. We also note that Chinese car sales are starting to recover.

The market news:

• The battle for the USPS is underway. The postal service has been losing money most years, in part due to its mandate to deliver letters.  In general, delivery services make their money on parcels, while regular mail is a loss leader.  Delivery companies have reduced the USPS hold on parcels and electronic mail has made letter carrying even less attractive.  In addition, the unionized workforce of the USPS makes it difficult for the service to adapt to changes in the marketplace.  The White House has appointed a new postmaster and is pressing to renegotiate labor contracts and delivery arrangements that are unfavorable to the USPS.  We note that online retailers who tend to benefit from these delivery arrangements are lobbying hard to maintain the current status and are asking Congress for a bailout of the postal system.
• Years ago, we participated in a conference call with a client and her advisor. The client wondered if she should buy one-ounce gold coins or quarter-ounce coins.  We responded by noting that four of the latter equal the former, to which the client said, “If I need to bribe the border guards, am I better off with smaller coins?”  We responded, “If we get to that degree of societal breakdown, you will be better off with booze, bullets and tobacco.”  Much to the chagrin of the advisor, the client agreed with us.[1]  Recent market performance appears, at least to some extent, to support this notion.

The foreign policy news:

• Tensions with China continue to escalate:
  • An internal report from the China Institutes of Contemporary International Relations (CICIR), a think tank in China, suggested that the Xi government’s handling of COVID-19 was becoming another Tiananmen Square in terms of international standing.
  • Op-ed columnists in Hong Kong warn that U.S. efforts to seek damages from China over COVID-19 might spark a hot war.
  • China is pressing the argument that its system was superior to that of the U.S., suggesting the virus has proven the U.S. is no longer the global hegemon. At the same time China is touting its prowess, it is demanding that nations receiving its aid “kowtow” and praise Beijing for its largess.  Germany has reported such actions recently.
  • The EU is embroiled in a scandal where Brussels succumbed to Chinese pressure to censor references to COVID-19 originating from China. However, a number of European nations apparently didn’t get the memo and released the original document.
  • The U.S. is moving missiles and other weapons to the Pacific, continuing the process of focusing on China and reducing America’s footprint in Europe and the Middle East.
  • The White House is continuing to encourage companies to reduce supply dependence on China.
  • The rise in tensions has, so far, not dramatically affected equities. But, if the Phase One trade deal is scuttled because of the increase in hostilities, we would expect a negative reaction.
• A surprising fight has emerged between China’s Finance Ministry and the PBOC. The Finance Ministry wants the Chinese central bank to monetize its spending.  In other words, the ministry wants the PBOC to directly purchase its debt.  It is unusual for such fights to occur in the open; we suspect the battle is underway because the government’s leadership doesn’t know how it wants to handle increased fiscal spending.  We have been noting evidence that China is reverting to its “tried and true” methods of boosting the economy via infrastructure spending.  Apparently, Chairman Xi hasn’t decided how he wants to fund that spending quite yet.  And so, the PBOC is pressing to maintain some semblance of independence.  There may be an element of entertaining a foreign audience as well.  It is becoming clear that the Fed is steadily seeing its independence erode.  If the PBOC appears to “win” this one, it might boost the status of the CNY relative to the USD.
• Recent oil losses have not just affected oil producers. Retail clients in China purchased products designed to follow the price of oil.  Apparently, they were structured a bit like futures contracts; you can lose more than your initial investment.  When oil prices fell into negative territory last month, these speculators took losses they didn’t expect.  Apparently, regulators are pressuring Chinese banks to absorb some of these losses to quell investor unrest.
• The impact of COVID-19 on Russia has been escalating recently. President Putin was planning on a referendum of sorts and expanding infrastructure spending this year; both have been disrupted by the virus.  Putin has tended to foster close relations with the Russian Orthodox Church, something a bit unusual for a former KGB agent.  However, social distancing rules have created divisions between the church and the government.  Although we don’t expect Putin to face any real threats to his position, he is clearly having a rough time.
• An issue we are watching with increasing interest is Germany’s Constitutional Court, which ruled that the ECB engaged in monetary practices outside of mandate and the approval of these measures by the Court of Justice of the European Union (CJEU) were in error. Germany’s court ruled that the ECB must give it adequate justification for its bond-buying or the Bundesbank will no longer be permitted to participate in the program.  This situation is a problem on various levels.  First, it violated the ECB’s independence for a German court to dictate policy.  Second, it clearly undermines the authority of the CJEU.  If Chancellor Merkel doesn’t thwart the German court, then she will be creating a situation where the ECB may not be able to continue to act in any way that defies Germany, and it will seriously weaken EU governing bodies.  In some respects, we have been expecting the EU and the Eurozone to eventually fall apart; without the Soviet Union to act as a threat to work in concert, and without the U.S. providing costless security, the EU and the Eurozone were in grave danger.  However, we didn’t expect a court ruling to be the event that triggers the potential breakup.  We would not be surprised to see Merkel try to resolve this problem; at the same time, it is hard to see any other German leader with the power and authority to buck the court’s ruling.  When she is gone, the chances that Germany goes its own way increase.  We are starting to see other European leaders criticize the German court, seeing it as a threat to stability.
• On the topic of the ECB, the European central bank has been offering loans to European commercial banks to maintain credit lines. However, the banks have been turning down the programs because they are already burdened with bad loans from the last downturn.  In addition, the recovery in the EU has been rather sluggish anyway, meaning that many companies were unable to grow out of their bad debt.  EU policymakers have limited capacity for fiscal spending and rely on banks for stimulus.  However, if the banks can’t be forced to lend, the support will fail to work.
• We have been keeping close watch on a number of GOP senators who have been crafting a right-wing populist agenda. Their policy mix is based on deglobalization and anti-trust.  Who is involved?  Hawley (R-MO), Sen. Cotton (R-AK), Sen. Rubio (R-FL) and Sen. Cruz (R-TX).  Hawley recently published an op-ed calling for the end of the WTO.  Three of the four sent letters to the White House calling for a suspension of temporary work permits granted to foreign workers due to the virus-driven job losses.  Anti-immigration is part of this policy mix.  Our position is that populism in the U.S. is on the ascendency; the only question is the variant, i.e., right- or left-wing.  So far, it appears the right wing is winning the most influence.

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[1] Again, this is Bill’s story and he is using the imperial “we.”