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

[Posted: 9:30 AM EDT]

Today’s positive market action comes as state governments and countries around the globe continue to ease their coronavirus restrictions.  Besides that, it’s also VE Day, and the beginning of National Nurses Week!  We review all the virus news below, along with a discussion of new developments in U.S.-U.K. trade, Brazilian politics, and last week’s attack on Venezuela.

COVID-19:  Official data show confirmed cases have risen to 3,685,129 worldwide, with 258,051 deaths and 1,208,139 recoveries.  In the United States, confirmed cases rose to 1,204,175, with 71,078 deaths and 189,791 recoveries.  Here is the chart of infections from the Financial Times:

Virology

• Gilead Sciences (GILD, 79.14) said it will provide licenses to other drug firms to manufacture and sell its COVID-19 treatment, remdesivir, outside of the U.S., farming out production to ensure supply meets global demand.
• Highlighting how vulnerable the aged are to the disease, New York State said it has recorded at least 4,968 confirmed and presumed deaths at nursing homes and adult care facilities.  New Jersey said it has had 4,151 deaths at such facilities, as it and Pennsylvania have now become prime U.S. hotspots for COVID-19 fatalities.
• Russia reported its fourth straight day of at least 10,000 new coronavirus cases, making it an important hotspot for infections along with countries like Brazil, Mexico, and India.

Real Economy

• President Trump and Vice President Pence said Tuesday afternoon that the administration is considering disbanding its coronavirus task force, shifting its responsibilities to individual departments like FEMA, and perhaps setting up a new group focused on “safety and opening.”  A firm date for the transition hasn’t been decided, but Pence said it could be in late May or early June.
• Just as various states here are easing lockdowns in uncoordinated fashion, several of Germany’s federal states have started to move at their own pace, drawing complaints from Chancellor Merkel and the federal government.
• In a positive sign that travel and tourism could rebound well when virus lockdowns are eased, the CEO of short-term rental company Airbnb said domestic bookings in Denmark and the Netherlands are already at 80% to 90% of their levels at the same time last year.  However, he wasn’t sure how long the rebound would last, prompting the firm to lay off one-quarter of its employees.
  • A travel rebound can’t come fast enough for hotel owners.  A new JP Morgan analysis shows 23.7% of hotel properties in CMBS deals were behind on their mortgage payments in April, up from 4.2% in March.
  • More broadly, one lasting impact of the crisis could be that fixed, long-term rental agreements in commercial real estate will be replaced with shorter, more flexible payment plans.

Political Fallout

• The U.S. and Australian governments continue to push for an international inquiry into the origins of the new coronavirus and how China handled the initial outbreak, including putting pressure on the EU to support such an investigation.
  • However, top EU officials are pushing back in favor of a multilateral study of the epidemiology of the virus that wouldn’t place blame on any particular country.
  • Blaming China for poorly handling the initial stages of the outbreak is also complicated by increasing evidence that the virus may have been spreading to the U.S. and Europe, including France, as early as December, well before it was recognized as a major problem in much of China.
• With Russian virus cases surging and the government response widely panned as inconsistent and miserly, Russian President Putin’s approval ratings fell to just 59% in April, marking his lowest polling since taking office in January 2000.

United States-United Kingdom:  To accelerate a comprehensive U.S.-U.K. trade deal, U.S. Trade Representative Lighthizer and British International Trade Secretary Truss announced that almost 30 bilateral working groups will hold virtual discussions on key trade issues over the next two weeks.  It’s positive that the administration is now able to shift its attention to other issues beyond the coronavirus, but, as we’ve said before, it will be difficult to quickly reach a deal, and when push comes to shove, the Brits may not find U.S. demands to be very palatable.

Brazil:  Testimony made public yesterday indicates President Bolsonaro is being investigated for trying to control Rio de Janeiro police who are investigating his sons there for corruption.  The testimony from former Justice Minister Moro suggests the scandal could “have legs.”  If so, it would likely be an ongoing drag on Brazilian stocks.

Venezuela:  New details have emerged about last week’s mysterious paramilitary attack in Venezuela.  Reports say a group of about two dozen soldiers, consisting of Venezuelan military defectors and foreign mercenaries (including two U.S. veterans), planned a sea attack to arrest the country’s authoritarian government and free political prisoners.  However, the group was apparently infiltrated by Cuban or Venezuelan operatives, and the attackers were intercepted by Venezuelan forces before they could land.  Reports say eight attackers were killed and 13 were captured.  Both President Trump and Venezuelan opposition leader Guaidó claim they had no knowledge of the operation.  Nevertheless, the Bay of Pigs-like fiasco probably gives President Maduro a bit of help as he continues to resist efforts to topple him.

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

[Posted: 9:30 AM EDT]

The risk-on tenor in the markets today reflects continued scientific progress against the coronavirus and further lockdown easing across the globe, although there are also worries that the easing might come too fast and spark a second wave of infections.  Below, we review all the key virus news and related developments.

COVID-19:  Official data show confirmed cases have risen to 3,603,217 worldwide, with 252,102 deaths and 1,174,006 recoveries.  In the United States, confirmed cases rose to 1,180,634, with 68,934 deaths and 187,180 recoveries.  Here is the chart of infections from the Financial Times:

Virology

• Hong Kong passed a crucial milestone of two weeks, or one full quarantine period, without recording any new, locally transmitted coronavirus infections, encouraging local leaders to continue loosening its relatively limited epidemic control restrictions.
• Under criticism for allowing inaccurate coronavirus antibody tests onto the market, the FDA will now require test companies to submit an application for emergency use authorization and show that the tests meet stringent precision standards.
  • Currently, 13 tests on the market have received FDA emergency use authorizations, meaning they meet the agency’s standards.
  • However, it’s important to remember that scientists still don’t know for sure whether or to what extent antibodies confer immunity from COVID-19.
• An online G20-backed pledging conference led by European Commission President Ursula von der Leyen raised more than €7.4 billion for coronavirus testing, treatment, and vaccine research by the time it closed on Monday, even though major powers such as the United States and China declined to participate.
• Researchers have begun injecting healthy volunteers in the U.S. with four experimental coronavirus vaccine candidates in an effort to accelerate the identification of vaccines that work against the virus.
• Despite the apparent progress on getting control of the virus, continued lockdown easing in many countries and states have alarmed some medical and policy professionals, who warn that easing the restrictions too rapidly could spark a second wave of infections in the coming months.  In an interview with National Geographic, top coronavirus official Dr. Anthony Fauci also called for great caution in reopening, warning that if given the opportunity, the virus will resurge.

Real Economy

• Even as Germany, France, Spain, and other countries in Europe continue to ease their virus lockdowns, the pace and method of easing the restrictions continue to generate controversy.
  • Union leaders, politicians, and the wider public are often urging governments not to move too quickly.
  • Pablo Casado, the leader of Spain’s center-right People’s Party, said he would not support Socialist Prime Minister Sanchez’s call for a two-week extension of the country’s lockdown, even though the lockdown is gradually being eased.  Instead, Casado is demanding any extension in the state of emergency should be approved in legislation.
• Japanese Prime Minister Abe yesterday also extended his country’s lockdown for an additional two weeks.
• Rather belatedly, Saudi Arabia is finally ramping up efforts to support its domestic economy from the impact of the virus and the associated plunge in oil prices.
• In the U.S., even though the self-induced economic coma imposed to fight the virus has driven down all manner of asset prices and undermined activity, home prices have actually been rising.  The reason: many sellers have taken their homes off the market during the crisis, crimping supply.

U.S. Policy Responses

• The Treasury Department said it expects to borrow at least $4.5 trillion this fiscal year, up from $1.3 trillion last year, on account of the decline in tax revenues and increased spending related to the virus crisis.
  • The department said it plans to issue $2.99 trillion in marketable securities in the second quarter alone, approximately five times the peak quarterly bond issuance during the Great Financial Crisis of 2008-2009.
  • As we’ve noted in previous analyses, burgeoning budget deficits tend to be associated with rising gold prices.

International Policy Responses

• Threatening the ECB’s massive bond-buying program, Germany’s constitutional court asked the institution to justify its purchases of public sector debt in recent years and warned it could block any new purchases of German debt if the ECB doesn’t respond within three months.  The court also opened the door to fresh legal challenges against the ECB’s new €750 billion pandemic emergency purchase program, saying the earlier bond purchases were only acceptable because of various limits that have subsequently been eased under the new program.
  • In its ruling, the court said the ECB needed to explain how it decided that the economic and fiscal effects of its bond-buying were proportionate to its mandated monetary policy goals.
  • The European Court of Justice had approved the ECB’s quantitative easing program in 2018, sending the case back to the German court, but in today’s ruling the German court explicitly rejected the ECJ ruling as “inadequate from a methodological perspective.”  That makes this another example of the EU’s faltering unity.  If the case continues in its current direction, it could be a significant negative for European fixed income and equities.
• EU Internal Market Commissioner Thierry Breton said the virus crisis shows the need for Europe to bolster the resilience of critical industrial supply chains in sectors ranging from pharmaceutical ingredients to raw materials used in advanced batteries, adding to the evolving policy momentum toward deglobalization.

Political Fallout

• Just days after President Trump threatened to impose new tariffs on China in retaliation for sparking the virus crisis, and after U.S. Secretary of State Pompeo claimed he has evidence that the coronavirus escaped from the Wuhan Institute of Virology, Treasury Secretary Mnuchin and Deputy National Security Advisor Pottinger on Monday offered assurances that there is no plan for punitive action against China.
  • Although there has still been no official Chinese reaction to Pompeo’s accusation, Chinese state media angrily accused him of “spitting poison” and lying.
  • U.S.-China recriminations over the virus are a negative for the financial markets because they could complicate the effort to get the global economy working normally again after the crisis subsides.
• As evidence that the Japanese may also be looking to blame China for the coronavirus, graffiti calling for all Wuhan residents to be killed was found on the wall of a restroom at the Yasukuni Shrine in Tokyo.

Iran:  The Iranian parliament has approved currency reform that will slash four zeros from the country’s currency to help ease the psychological impact of soaring inflation.  Under the reform, every 10,000 rials will be swapped for one unit of a new currency known as the “toman.”

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

[Posted: 9:30 AM EDT]

Good morning!  It’s employment week; we are expecting a very weak report for April, with the unemployment rate in the 16% area.  Equity futures are lower.  We update the COVID-19 news.    Here are the details:

COVID-19:  The number of reported cases is 3,523,121 with 247,752 deaths and 1,130,996 recoveries.  In the U.S., there are 1,158,341 confirmed cases with 67,686 deaths and 180,152 recoveries.  Here is the FT chart:

The virus news:

• The good news:
  • Roche (RHHBY, 42.84) has received clearance for emergency use of an antibody test from the FDA. The company claims an impressive accuracy—100% in detecting COVID-19 antibodies and a 0.2% false positive result.
  • There are currently 254 therapies being tested for COVID-19 and 95 vaccines. That is good because many of these will fail.  Meanwhile, there is also something of a geopolitical race for a vaccine; the soft power a nation would get by being the first to bring a vaccine would be large.  So far, the U.S. has shown little interest in global participation to find a vaccine.  One would assume that if the U.S. does develop it first, we would protect Americans first and the rest of the world later.
  • Here’s another oddity of COVID-19—habitual smokers are underrepresented among those hospitalized. In France, this news has led to a run on smoking-cessation products on the idea that nicotine may act on the lungs in such a way that it slows the invasion of the virus in the body.
  • There is increasing investigation of blood plasma to treat COVID-19. Some studies are looking at introducing antibodies from those who have recovered from the virus, while others are looking at regulating the immune response.
• The bad news:
  • Meanwhile, in comparison to the Roche test, others have been far less impressive in (a) determining if a patient has been infected, or (b) suggesting they have been infected when they haven’t. We hope the Roche test is as good as they say it is, but, compared to the others, we will go with Reagan’s “trust but verify.”
  • There are widespread reports that imported PPE, especially masks, are substandard. The N95 mask, named because it filters out 95% of small particles and gives the standard of protection, is being imported but tests show that about 60% fail.  News such as this will undermine confidence in global medical supply chains and bring production back to the U.S.
  • There are lingering concerns that if the virus is in the air, HVAC systems could spread it through the ventilation system.
  • Although herd immunity can be achieved without a vaccine, the cost is really high.
  • Russia is seeing a surge in cases of the virus. The official case count jumped 10k on Sunday.

The policy news:

• The economic data released this month and next will look awful; this is no surprise. However, even though the downturn is well anticipated, the data will likely drive another round of fiscal action.  Already, political camps are laying out their goals.  Democrats want more aid for state and local governments.  Congressional GOP leaders are pushing for liability protection.  The White House is flirting with tax cuts and maybe a further delay in filing taxes this year.  With divisions this wide, bridging them means that another round of fiscal stimulus will take a while.  For now, the official line from the administration is that we should have a “pause” to see how approved spending affects the economy.
• Hurricane season is less than a month away. Forecasts suggest it will be an active season.  On average, the Atlantic hurricane season generates 12 named storms of which three become major (category 3+) hurricanes.  Most university projections are expecting mid-to-high teens for this year’s season.  FEMA is preparing for an elevated season with the added complication of COVID-19; one can imagine hurricane shelters, which often put lots of unrelated people in close quarters, as potential vectors for spreading the virus.
• The EU will begin debating a €1.0 trillion stimulus package to address COVID-19. This comes in the aftermath of a program half this size for the Eurozone.  So far, we are seeing widening credits spreads between sovereign yields of the southern nations compared to the northern ones.  This spending is, in part, designed to narrow that gap.

The economic news:

• Last Friday’s manufacturing ISM data came in better than expected. Don’t be fooled.  It was much worse than expected.  Why?  The supply deliveries component has distorted the report.  Under normal circumstances, slower deliveries usually coincide with a robust economy.  Therefore, the ISM is constructed to treat slow deliveries as positive.  However, in the current environment, slower deliveries are an artifact of shutdown orders; in other words, in a really strong economy, bottlenecks in deliveries occur due to tightening supplies.  In the current situation, bottlenecks simply reflect the shelter-in-place orders.  Here are a couple of charts:

Note that it is unprecedented to see a supplier delivery reading above 70 with an ISM less than 60.  In this chart, we adjust the ISM by excluding supplier delivery.  This leads to a reading of 33, which is more in line with a deep downturn in the economy.

• Bees are critically important to America’s food crops. Lockdown measures have reduced the ability of beekeepers to move their hives to fruit and nut orchards.  However, another threat has emerged in the northwest—the Asian giant hornet.  This insect, native to Asia, has recently been found in the U.S.
• Around the globe, various levels of government are starting to ease social distancing restrictions. In the U.S., three-fifths of the states are allowing some businesses to reopen.  It is unknown how this will go.  We don’t know how the virus will behave in the summer months.  There is some speculation it could act like influenza and spread less quickly.  However, opening businesses is one thing; getting customers is something else.  Early evidence suggests that business activity will recover slowly, at best.  The other risk, of course, is a return of the virus and the need to reimplement lockdowns.
• Construction firms in the U.S. report slow activity. Although stalled projects have resumed as lockdowns ease, order pipelines show little future activity once current jobs are completed.

The market news:

• In the Great Financial Crisis, investors with cash were able to make investments in stricken firms at favorable rates. Interestingly enough, this time around, the Fed has moved so fast to offer support that these same investors are finding themselves shut out of these opportunities.
• As the first week of May is upon us, landlords and mortgage lenders are bracing for another round of missed payments. This is a classic case of “who bears the cost of adjustment.”  Lenders and landlords clearly can’t get money from renters and borrowers who have no income but there has been varying responses on how these missed payments will be handled.  Some of the lenders or landlords want a lump sum for the lost payments, which doesn’t appear likely.  There have also been calls for organized rent strikes.  Although eviction and foreclosure are options, neither is all that attractive for mortgage holders or landlords; there is no guarantee that the unit can be re-rented, and if home prices fall foreclosure can mean a drop in mortgage values.  We will be watching to see if the Fed comes to the rescue here as well.  As we noted above, we doubt there will be fiscal action to resolve this situation anytime soon.

The foreign policy news:

• As we detailed last week, relations with China continue to deteriorate, and it’s not just the U.S. Punishing China looks to be a major campaign point this November.  The U.S. is building alliances in the South China Sea with those who are increasingly worried about China’s aggressive actions in the area.  SoS Pompeo continues to argue there is a “significant amount of evidence” that COVID-19 came from a Chinese bio lab.  China is also accused of hiding the virus’s lethality in order to hoard medical supplies.  The administration is accelerating plans to remove China from the U.S. supply chain.

Turkey:  Sensing that President Erdogan is in trouble, the U.S. is increasing sanctions threats to forestall the activation of Russia’s S-400 missile defense system.  The Fed has widened swap lines to foreign central banks and created a Treasury repo market for central banks that are not given swap lines so these excluded central banks can access dollars without having to sell their bonds in reserves.  It appears that Ankara, facing a dollar supply crunch, will not get help from either source.  The Fed won’t give a swap line to such a dodgy borrower and Turkey doesn’t have enough reserves to repo.

Iran:  Iran’s new parliament is chock-full of hardliners and the election authorities restricted more liberal candidates.  However, just because there is a large majority of a certain political leaning doesn’t mean factions can be avoided.  There is an apparent battle for who will replace Ali Larijani for speaker of the parliament.

North Korea:  Well, to paraphrase the early Weekend Updates, Kim Jong Un is still not dead.  He was seen at a fertilizer factory over the weekend.  We do note there was an exchange of gunfire on the DMZ; no casualties were reported.

Venezuela:  Although details remain scant, there was apparently some sort of mercenary incursion into Venezuela last month.  There is no evidence that the U.S. government was directly involved in the action, but it is possible the U.S. was aware of the event.  Apparently, it went badly.

Argentina:  Buenos Aries is almost certainly going to default (again!) and require some sort of bailout.  However, the economic minister of the country, Martin Guzman, suggests in an FT op-ed that much of the emerging world will require similar support.  He seems to be suggesting we may see a broad debtors’ strike which would roil the global financial system.  In related news, growing financial stress is leading to trade tensions in South America and may threaten the Mercosur, the free-trade zone on that continent.

Germany:  The Social Democrats are arguing that Germany would be better off without U.S. nuclear weapons on its soil.  The presence of these warheads has been a sore point for the German left for decades.  However, maintaining the alliance has always led Germany to allow the U.S. to deploy these weapons despite the misgivings.  As the alliances fray, we may see these nukes go.  If they do, Germany will need to dramatically boost its conventional defenses or develop nukes of its own in the face of the potential threat from Russia.  Or, Germany could take the route favored by the SDP for ages, which is to improve relations with Moscow.  As long as Chancellor Merkel is in power, the nukes will likely stay.  But, if the SDP can break free from the current coalition, and perhaps join the Greens, this issue may return.

U.K./U.S. trade:  The two nations will launch talks for a free-trade agreement tomorrow.  If Brexit comes at the end of the year, it is clear Westminster wants to have a deal with the U.S. prepared.

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

[Posted: 9:30 AM EDT]

Good morning, happy Friday and happy May Day, the international celebration of Labor Day.  Most European financial markets will be closed, although Denmark and the U.K. remain open.  Equity futures are lower as tensions with China rise, while oil is rallying again.  We update the COVID-19 news.  Relations with China are deteriorating; we report on the latest.  Here are the details:

COVID-19:  The number of reported cases is 3,274,747 with 233,792 deaths and 1,022,331 recoveries.  In the U.S., there are 1,070,032 confirmed cases with 63,109 deaths and 153,947 recoveries.  Here is the FT chart:

Here is an updated map of all the state-level social distancing measures.

The virus news:

• The good news:
  • We have been reporting of evidence that some of those who have recovered from COVID-19 have tested positive again, suggesting there isn’t much of an immune response from contracting the virus. Reports out of South Korea suggest that the tests actually reveal flaws in the test; those who reportedly were re-infected did not become ill.  Instead, the test was picking up virus fragments.  Thus, there is a good chance that those who have recovered do have some degree of immunity.
  • Although remdesivir is getting a lot of press, there are other drugs being tested against the virus. This “repurposing” process is actually what led researchers to remdesivir; it was originally created to combat Ebola.  Interestingly enough, it failed against that disease.  The benefit of a repurposed drug is that it has likely already passed safety tests.  This testing is positive because usually one drug alone doesn’t work forever with infectious diseases because the virus mutates against it.
  • As we have been reporting, the administration is preparing to bring a vaccine to the country by January.
• The bad news:
  • Researchers at the Center for Infectious Disease Research and Policy (CIDRAP) at the University of Minnesota published a report suggesting that (a) COVID-19 will likely be spreading for another 18 months to two years until herd immunity is achieved, and (b) there is a chance that, similar to the Spanish influenza pandemic, a strong return in autumn could occur.
  • It appears the Veterans Administration is preparing for continued fatalities; it ordered $300k of body bags.
  • COVID-19 is spreading rapidly in Brazil. To some extent, this was a deliberate policy of the Bolsonaro government, which concluded that the Brazilian economy could not tolerate aggressive social distancing.  Officially, the country has 87,187 confirmed cases and just over 6k fatalities; these numbers are likely a serious undercount.  There are anecdotal reports suggesting the health care system is being overwhelmed.  The situation is deteriorating enough to where Brazil’s neighbors are either considering or implementing steps to manage the border to limit the spread into their countries.  These measures will almost certainly reduce trade.
  • Russia’s prime minister has tested positive for COVID-19.
  • Although the Senate has returned to Washington, the Capitol physician, Dr. Brian Monahan, warned that he does not have access to unlimited testing and that he will only test senators and staffers who exhibit symptoms. The average age of a senator is 61.8 years old and 28% are 70 or older.  If the Senate is infected, we could see significant problems develop.
  • China is reporting that 60% of new COVID-19 new cases are asymptomatic. This scenario facilitates the spread of the disease in the absence of widespread testing.

The policy news:

• For the past several years, a number of states have created impediments to applying for unemployment insurance. The goal was to eliminate potential abuse of the system.  When the economy had unemployment below 4%, these changes didn’t matter all that much.  But, now that millions of Americans are filing for unemployment insurance, the rules are becoming an obstacle to households getting aid.
• The Fed is widening potential participation in its $600 billion Main Street lending program by expanding the eligibility criteria. The Fed will now support lending to larger firms (15k employees from 10k) and the size of the loans will be lowered to $500k from $1.0 million.  Restrictions on firms held by larger companies will remain in place.
• The Paycheck Protection Program is being panned by a larger number of businesses who find that the requirements of using 75% of the loan proceeds to pay employees is too restrictive. Many businesses, especially in large cities with high rental costs, are finding that they need more funding for rent and less for payrolls.

The economic news:

• In a recent WGR, we examined the issue of optimization, arguing that efficiency can introduce fragility into a situation. The meatpacking crisis looks like an example of this underlying issue.
• Colleges and universities are facing a major crisis due to COVID-19. It isn’t obvious if they can safely reopen next fall and it hardly makes sense to pay tens of thousands of dollars for online education when it can be found much cheaper.  State public colleges are being hit with budget cuts as states struggle to balance budgets, and private schools, especially small ones with limited endowments, may not survive.  International students, who had represented a source of full-tuition paying attendees, may not be able to return from abroad.
• Rent strikes are widening which may put some mortgage-backed securities at risk.

The market news:

• The FDA is limiting the use of ethanol-based hand sanitizers, fearing the product may have carcinogenic impurities. This is yet another blow to the farm belt and the ethanol industry.

The foreign policy news:

• The COVID-19 pandemic is straining Western relations with China. We have been documenting conflicts with the U.S. and the EU.  Now, Australia can be added to the list.
  • Australia’s PM Scott Morrison is calling for an international inquiry into the origins of COVID-19. Although Morrison has suggested that China wasn’t necessarily the target of the proposed investigation, the Chinese government is viewing his call as a threat.
  • One of the industries at risk with deteriorating relations between Australia and China would be mining. Recently, an Australian mining executive invited a Chinese diplomat to an official event held by Australia’s health minister, a violation of protocol.
  • Australia’s intelligence agencies, consistent with findings by similar organizations in the U.S., have not found definitive proof that COVID-19 originated in a Chinese biology lab. However, that isn’t to say there isn’t circumstantial evidence to support this theory.  President Trump suggested that he is “confident” COVID-19 came from a Wuhan laboratory.
  • The U.K. and Sweden are also supporting an inquiry.
• Officially, the U.S. intelligence community has indicated that COVID-19 was not a bioweapon. There has been some conjecture that the naturally occurring virus (likely originating in bats) may have leaked out of a Chinese lab due to poor biosecurity.  U.S. intelligence agencies have confirmed they are investigating this possibility.
• If it turns out that China is responsible for introducing the virus to the world, what is to be done? The administration is making plans to punish China; actions may include tariffs, a repudiation of some of the Treasuries China holds in its foreign reserves, stripping China’s sovereign immunity (which would subject China to the tender mercies of the U.S. tort bar), demanding reparations, blocking Chinese assets in government pension funds and other measures.  Any of these would dramatically increase tensions between the U.S. and China.  The one we would be most concerned about is the repudiation action.  We could write a whole report on that (perhaps a future WGR) but suffice it to say that such a move would effectively end U.S. hegemony.  One of the two roles of a global hegemon is to provide a reserve currency which, outside of a gold standard, implies also providing the reserve asset, which is currently the Treasury.  If reserve managers suddenly believe that the U.S. would selectively default on Treasuries, we would be in a world where there would be limited assets available to reserve managers.  This is a bit like crossing the streams.
• As we noted earlier this week, China pressed the EU to temper comments about the origin of the virus. Apparently, the pressure is becoming strident.
• Taiwan is an extremely sensitive issue for China. The U.S. and China have engaged in strategic ambiguity[1] over the island since the 1970s.  However, maintaining that ambiguity requires the world to avoid suggesting that Taiwan has the status of a state; once that bridge is crossed, Taiwan is no longer a runaway province of the mainland but a renegade.
  • The Netherlands has run afoul of Beijing by changing the name of the foreign mission in Taiwan to “Netherlands Office Taipei,” which is clearly less than calling it an embassy but enough to trigger a response from China. The announcement came on April 27, the day when the Dutch named Taiwan a colony in the 17^th  China is considering trade retaliation against the Netherlands.
  • Australia is backing Taiwan’s return to the WHO, which will certainly infuriate Beijing.
• Meanwhile, tensions between Secretary of State Pompeo and China are rising rather strongly. He is continuing to press for access to Wuhan labs, something that China likely sees as an infringement on sovereignty, and he is calling for China to stop arresting Hong Kong protestors.  It appears it is starting to get personal as these screenshots from Chinese television show.

• Beijing has tried to use sales of medical equipment to nations reeling from COVID-19 as a form of soft power. However, there have been persistent reports of substandard equipment; the state of Missouri received counterfeit KN95 masks from China and Illinois may have as well.  Now, Britain is reporting it has received ventilators from China that may be deadly.  The combination of potential negligence at the Wuhan labs and the faulty medical equipment is raising the odds of retaliation against China.
  • At the same time, the White House itself is divided over this issue. Peter Navarro, a China hawk, has been pressing for the U.S. to produce more medical equipment domestically.  Other members of the administration oppose this action for fears that it will (a) harm relations with China, (b) raise costs, and (c) lead to shortages of such equipment at this important time.
  • The GOP as a party is becoming increasingly hostile toward China.
  • In addition, the White House wants Phase 1 of the trade deal with China to be executed. China is “committed” to the agreement, but further escalation of tensions could bring the arrangement into doubt.
• China claims it forced the U.S.S. Barry, an Arleigh-Burke class guided missile destroyer, out of the South China Sea. The U.S. has not confirmed the Chinese report.  A second U.S. ship has reportedly made a freedom of navigation operation in the South China Sea.
• Finally, China is finding itself under pressure from frontier market borrowers who are facing difficulties in servicing their debt. China has been a major lender to many of these nations through its “one belt, one road” project and is now facing calls to offer debt relief.  We suspect Beijing is reluctant to offer significant support, viewing itself as a developing nation.  The U.S. behaved similarly after WWI; Europe asked for debt relief to which President Coolidge allegedly responded with, “they hired the money, didn’t they?”

Saudi Arabia:  Reuters is reporting that the U.S. threatened to withdraw American military support from Saudi Arabia if the kingdom didn’t agree to cut output.  The Saudis, as one would expect, have not responded to this report.  We will be watching to see if MBS allows this statement to stand; if it does, it would make him look weak.  And, as we have stated all along, promising to cut is one thing, but reducing supplies is another.

Hezbollah:  Germany has banned Hezbollah from any activity in its country and is pressing the rest of Europe to adopt its measures.  The actions will weaken relations with Iran, which views Hezbollah as a client.

Iran:  Iran’s recent launch of a satellite suggests that it is mastering intercontinental ballistic missile technology.  Although it cannot reach the U.S. yet, Iran is clearly heading in a direction where it will be able to achieve that goal in a few years.  Already, Europe is at risk.  If Iran acquires a nuclear weapon, the ability to deliver a bomb would make Iran impossible to invade and overthrow.

North Korea:  The latest in the unending game of “where is Kim?” is that luxury boats are now at the Wonsan compound.  Although the appearance of these vessels doesn’t tell us much about the health of the young general, it may suggest he isn’t dead quite yet.

Venezuela:  The Maduro government is reportedly selling gold reserves (around nine tons) to Iran and the latter is using its aircraft to ferry the bars back to Tehran.  Venezuela is reportedly paying Iran for its assistance in operating PDVSA’s moribund refineries.  Iran has been using gold for some time to conduct trade and skirt U.S. sanctions.  We have no reports of how much Iran paid Maduro for the gold, but we would not be surprised if Tehran paid a premium.

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[1] Where two parties say the same thing but mean something entirely different.  This is a very effective strategy in diplomacy and marriage.

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

[Posted: 9:30 AM EDT]

Good morning as another month, that feels like a year, comes to a close.  Just a reminder—tomorrow is May Day, the international celebration of Labor Day.  Most European financial markets will be closed, although Denmark and the U.K. will remain open.  The ECB meets today; initial market reaction to the statement was negative as the moves taken appear modest.  Equity futures are mixed, and oil continues to recover; our Weekly Energy Update is available.  We update the COVID-19 news.  Here are the details:

COVID-19:  The number of reported cases is 3,207,248 with 227,971 deaths and 984,161 recoveries.  In the U.S., there are 1,040,488 confirmed cases with 60,999 deaths and 124,023 recoveries.  Here is the FT chart:

Here is another interesting graphic—it shows the spread of COVID-19 over time.  What is shown is that the only parts of the world that have not reported the virus are some islands in the Pacific.  According to rt.live, there are only seven states with R₀ higher than one and six are in the Midwest.

The virus news:

• Equity markets rose yesterday on reports that Dr. Fauci, the head of the National Institute of Allergy and Infection Diseases, had positive comments related to Remdesivir, an anti-viral medicine produced by Gilead Sciences (GILD, 84.09). There are generally two different paths to dealing with COVID-19.  The first is developing a vaccine.  A vaccine, widely distributed, would establish herd immunity.  A vaccine will be difficult to create; making vaccines has a host of problems, one of which is the mutation of viruses into a less virulent form, reducing the incentive to create one.  A successful vaccine for any coronavirus has never been developed and research on coronaviruses suggest that natural immunity doesn’t last very long.  Additionally, if the virus mutates, COVID-19 may require a new vaccine each year, similar to influenza.  Despite these hurdles, the efforts to make a vaccine are impressive.  There are joint projects with drug makers and academia, and the U.S. is planning a crash effort to make and distribute a vaccine.  The other path is to create treatments for those who have the virus.  A successful antiviral would mean that catching the bug would likely be less dangerous; this was the path taken for HIV.  In addition to Remdesivir, other drugs are being investigated as well.  As noted above, Dr. Fauci’s comments were very well received yesterday.  However, there are conflicting studies on Remdesivir, some suggesting the drug isn’t all that successful in helping patients. As a result, having other drugs to combat the virus may be necessary.  Having both types might be needed to successfully corral COVID-19, especially if the virus regularly mutates.  We do note that despite mixed results for Remdesivir, the U.S. may greenlight the drug for emergency use.  Our take?  We suspect that Remdesivir has some value, but we may find that it is more effective for certain degrees of infection, or that timing is critical.  We note that Tamiflu works best when taken early against influenza; waiting until the symptoms have become obvious tends to reduce its effectiveness.  Something similar may emerge with Remdesivir.
• In our daily coverage of COVID-19, we have seen a broad spectrum of reports. At first, the virus looked like a typical respiratory malady.  Although it was clearly deadly to some parts of the population (aged, with co-morbidity factors), a large number of those infected appeared to be asymptomatic, or with very mild symptoms.  However, as the virus spread around the world, new symptoms emerged.  There were cases of blood clotting apparently caused by the disease, and younger patients were suffering strokes after being infected.  Patients who appeared mildly ill would have blood oxygen levels so low doctors tended to immediately ventilate.  Renal failure was reported.  Certain cancers are now a co-morbidity factor.  Even dermatologists are reporting very odd symptoms from COVID-19. There is also a tendency for patients to be afflicted and appear to recover, only to become suddenly deathly ill.  It sort of seems like there is a “second-week syndrome” with COVID-19.  Simply put, whatever we are dealing with is affecting the human body much more broadly than it looked initially.  It is unclear what we are dealing with here.  However, one possibility is that the virus is mutating much more rapidly than expected.  It is possible that the U.S. is being hit with different strains of the virus.  This may account for the wide differences in fatalities.  One possibility is that the West Coast was infected by a less virulent Asian strain, while the East Coast was infected by a stronger variant from Europe.
  • The CDC now has offered six symptoms that COVID-19 tends to cause.
  • Although the virus continues to surprise, there is a consensus that children are less at risk from COVID-19. It may be that they are not vectors for transmission either.
• Every government that has faced this disease has taken a number of policy steps to try to cope with the outbreak, while also reducing the impact on the economy as much as possible. Social distancing reduces the spread of the disease and saves capacity in the medical system.  However, social distancing cannot exist indefinitely because of the harm done to the economy.  Essentially, policymakers are being asked to manage two conflicting goals; keeping people safe and maintaining some semblance of an economy.  This puts leaders in a very difficult spot, because either goal could be considered absolute and there will always be a pundit somewhere who can castigate a leader for putting a focus on either.
  • Due to the broad spectrum of responses, there have been a number of natural experiments that we have been tracking. Sweden has been an important test case for COVID-19 social distancing policy.  The country has had a “light touch,” putting fairly modest restrictions that are not aggressively enforced.  Its death rates are elevated, but not widely different than other nations.  A NYT study showed its fatality rates are about 18% above normal, which is low relative to other countries.

• The above chart from the FT shows Sweden’s death rate compared to other nations. Here is the entire array.
• On the other hand, the disease has been starkly more deadly for the elderly in Sweden; 86% of the 2,194 confirmed deaths have come from those over 70. Sweden’s experience seems to suggest that less restrictive measures may not be as risky for the entire population, but may be a problem for the elderly.  On the other hand, it is important to draw the right lessons from an analog; Sweden’s population density is 64 people per square mile, 194 out of 235 nations.  The U.S. ranks 177, with 94 people per square mile.  The U.S. experience shows that highly populated areas tend to be more at risk.  What this may mean for the U.S. is that restrictive measures may be appropriate for urban areas, while less restrictive measures may work in rural and more suburban settings.
• Meanwhile, India is struggling to reopen; workers are reluctant to return to work, fearing another outbreak of the virus. Meanwhile in China, manufacturing is starting to recover but the consumers of Chinese goods, both home and abroad, are slower to restart buying.

The policy news:

• The Fed met; as expected, it didn’t do anything but clearly indicated that if more was necessary, it would act. Here is a report that compares the changes in the last two statements.  The statement does show that this was a continuation meeting.  Nothing new was revealed, and what is in place will likely remain so for a while.  Chair Powell signaled that fiscal policy should remain expansionary.  On a side note, it appears the KC FRB will not be able to hold its annual monetary policy meeting in Jackson Hole this year, for the first time since 1982.
• The ECB is planning on expanding its balance sheet further, but left rates unchanged. It did ease conditions for banks to borrow, which has been characterized as “helicopter money for banks.”  For the most part, financial markets were a bit disappointed in the statement.  In the press conference, Chair Legarde appears to be following the Greenspan playbook, which is to answer each question with a long response resulting in fewer questions and the answers are hard to follow.  The ECB simply can’t move as much in some areas, like yield curve control, compared to the Fed.  That lack of power is reflected in Eurozone financial assets.
• What to do about food? President Trump has used the Defense Production Act to force meatpackers to reopen slaughterhouses, in some cases overruling state regulations.  However, it isn’t clear if this action will lead to a return of meat processing.  It’s one thing to open facilities, but it’s another to get workers to return to their jobs.  COVID-19 have ravaged these facilities where workers process carcasses in close quarters.  Unions representing these workers have criticized the executive action.  It is clear that if meat processers don’t open soon, shortages will start to develop; chicken will probably be first and beef last.  At the same time, these workers have more leverage than one would think.  These jobs are very difficult and don’t pay all that well.  If the workers don’t show up, the firms could fire them, but replacing them won’t be easy.
  • One of the underlying problems for the food service industry is that there has been a huge shift in demand. Sales to restaurants have collapsed, while grocery store demand has soared.  This situation has created a logistical nightmare; the packaging and distribution appropriate for commercial firms is completely wrong for households.  Quantities are too large and are not in packaging that households can manage.  So far, shortages in grocery stores have mostly been sporadic, but the food service industry doesn’t necessarily want to retool itself for households only to see restaurants roar back later this year.  So, for now, we are limping along with reports of some food being lost.

The economic news:

• The Eurozone economy fell at its fastest pace on record in Q1; that record will almost certainly be broken in Q2.
• Chinese PMI data held up rather well in April, although exporters remain depressed.

The market news:

• Firms are increasingly turning to convertibles to raise money (not this convertible!).  Nearly 60% of equity capital raised this month has come from these bonds, which can convert to equity if the stock price recovers.  In 2008, we saw a similar pattern.

The foreign policy news:

• An important indicator has been announced that China is feeling more confident about having the virus under control. It has scheduled a date for its National People’s Congress for May 22.  It will be held in Beijing, meaning it will be held in person.
• Because of the closure of stores, some countries are struggling to update their inflation indices.
• The battle of the virus narrative between the U.S. and China continues. China has embarked on an aggressive campaign to hold itself blameless for COVID-19.  At the same time, the U.S. is engaging its intelligence agencies to determine if China, or the WHO, withheld data on the pandemic.

Brexit:  Although the focus recently has been on COVID-19, Brexit negotiations have been held.  The conventional wisdom is that PM Johnson will ask for an extension.  However, what we have seen thus far suggests that the U.K. fully intends to leave at the end of the year and if that intention leads to a hard break with the EU, so be it.  Although there hasn’t been much attention paid to Brexit recently, a hard break would likely be taken as negative for U.K. financial assets.  A side note:  PM Johnson is a new father.

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