If you ever find yourself in Volgograd, Russia, you will visit Rodina Mat’ Zovyot. It’s unavoidable. The statue, depicting Mother Russia calling her sons to battle against her invaders, is one of the tallest in the world. Standing almost 280 feet high, she is nearly twice as tall as the Statue of Liberty. Her colossal height is accentuated by her position at the summit of Mamayev Kurgan, the high ground overlooking Volgograd, whose great, grassy green slopes were fertilized by the blood of a quarter-million Soviet soldiers who died defending it from the invading Nazis during World War II, when the city was still known as Stalingrad.
You never know when you’re about to have an experience that will stay in your memory, and haunt you, for the rest of your life. Such was the moment when I first entered the glittering round chamber below the statue, where an eternal flame keeps alive the memory of the 20 million or so Russians who died in the war. I entered just at the beginning of the ceremony marking the changing of the guard. Young Russian soldiers in ill-fitting uniforms and black jack boots marched in painfully slow goose steps up the ramp around the perimeter of the chamber to relieve the previous sentries of their duty. It was impressive in the extreme. But, more than anything, I remember the haunting, plaintive choral music playing in the background (see this video). It perfectly expressed the quiet calm and peace that all who suffer in war must yearn for, if only in death. But when I asked my guide what the song was, I was flabbergasted by her reply: “Daydreams, by Schumann.”
What?! A Russian World War II memorial playing the music of a German composer? How could it be?
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.
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.
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.
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.
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 14th 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.
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.
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.
The U.S. economy has been hit with shelter-in-place orders that have depressed consumption and reduced production. The economic readings on Q2 will be historically bad, perhaps even worse than the Great Depression. However, based on the assumptions that (a) aggressive policy support will continue, and (b) the pandemic will wane over time, either due to natural herd immunity or medical intervention, financial markets are assuming the impact of COVID-19 will be severe in impact but short in duration. Although we mostly agree with that assessment, the rebound has much to do with how GDP is reported. The common way is to annualize the quarterly change. Thus, if we get a large decline in Q2, a very modest rise in GDP in Q3 will tend to look quite large. This is not the only way to measure the change in GDP. The year-on-year change will look less onerous in Q2 but won’t look as impressive in Q3.
Another way we like to look at the GDP data is against its long-term trend. To forecast Q2 GDP, we are taking advantage of a new high-frequency index created by the New York FRB. The index is designed to measure the yearly change in GDP—how much GDP has changed compared to Q2 2019. It is currently forecasting about a 12% yearly change.[1] We can then take that number and calculate what the level of GDP looks like compared to its long-term trend.
To generate this chart, we log-transform real annual GDP and regress a time trend through the data. The important line is the lower deviation line. There are two periods when GDP was well below trend; the Great Depression and the post-Great Financial Crisis to the present. The Great Depression showed a massive drop in the level of GDP that took until 1942 to return to trend. Although fiscal and monetary policy were expanding after 1932, it took war spending to finally bring the economy back to trend. What has been disconcerting about the past expansion is that it was much slower than the long-term trend. And so, the level of GDP continued to fall compared to trend; our estimate for GDP in the COVID-19 recession shows a downleg in growth that is rivaling levels seen in 1935.
The point of this analysis is that the trend should represent some degree of capacity. It is possible the trajectory for GDP that held from 1901 to 2008 is no longer possible. But, if that trendline does represent a normal level for GDP, it would suggest the economy can absorb aggressive fiscal and monetary policy expansion before inflation becomes a problem. If inflation starts to rise before the trendline is achieved, it would confirm that the trendline is no longer valid; however, for the political class, it would seem natural to find out if the long-term trend line remains a measure of capacity. In other words, we would expect even more deficit spending and easy monetary policy until inflation returns. Given how far GDP remains below trend, the return of inflation may take a rather long time.
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.
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.
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)
(Data: Lucy Dadayan/The Urban Institute. Chart: Andrew Witherspoon/Axios)
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.
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.
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.
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.
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.
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EDT] Good morning; it’s the 75th 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.
(Source: FT)
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.
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.
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.
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.
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.
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.
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.
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.
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
Here is an updated crude oil price chart. The oil market is showing signs of recovery.
(Source: Barchart.com)
Crude oil inventories rose 4.6 mb compared to the forecast rise of 8.0 mb.
In the details, U.S. crude oil production fell 0.2 mbpd to 11.9 mbpd. Exports rose 0.4 mbpd, while imports rose 0.2 mbpd. Refining activity rose 0.9%, a bit more than the 0.8% rise forecast. The inventory build was mostly due to continued elevated U.S. production, although the pace of the rise is starting to slow.
(Sources: DOE, CIM)
The above chart shows the annual seasonal pattern for crude oil inventories. The last six weeks have pushed stockpiles almost “off the charts,” although there is evidence to suggest the pace of inventory injections is starting to peak.
Based on our oil inventory/price model, fair value is $29.18; using the euro/price model, fair value is $44.58. The combined model, a broader analysis of the oil price, generates a fair value of $36.58. As we noted recently, the model output is less relevant as there is a non-linearity tied to the loss of storage capacity that cannot be fully captured with these models. At the same time, if storage remains available, the models would suggest upside for oil prices. We also note that the Eurozone could be roiled by German court decisions which could limit the flexibility of the ECB to support the Eurozone economy. This outcome would be bearish for the euro and may weaken it further, which would be bearish for oil prices.
Although consumption remains depressed, gasoline data does show that a bottoming may be underway.
The weekly reporting is showing a steady decline in oil production. Media reporting is confirming this trend as well. The Fed has expanded its loan program to offer help to energy companies but there is little chance that it will be enough to protect smaller firms. Longer term, there is growing concern among oil companies that oil demand may never return to pre-COVID-19 levels. If that is the case, it will have profound effects on the energy industry. Between the slow recovery and climate change legislation, oil consumption may have already peaked. If so, higher cost reserves may not be recoverable. It isn’t just oil that is affected; coal is also affected because weak prices for oil and natural gas will further weaken demand for coal as well.
In international news, Iran’s OPEC governor suffered a severe brain hemorrhage. It is unlikely he will return to his post, but we doubt this will change Iran’s oil policy. Israeli sources suggest that Iran may be reducing its support for Syria. Recent bombing attacks by the IDF have brought little response from Tehran. Consequently, Israel has stepped up its attacks. We suspect two events have led to Iran’s pullback. The first is that the assassination of Qasem Soleimani has reduced Iran’s ability to manage the relationship with Hezbollah in Syria. Soleimani was a strong leader and his death may have created a leadership vacuum outside of Iran. Second, low oil prices and U.S. sanctions have damaged Iran’s economy to the point where it can no longer spend the funds necessary to maintain influence in Syria. If this trend continues, Russia and Turkey will vie for domination of Damascus. The Iraqi government has stopped payments to the Kurdistan Regional Government. Between the loss of these funds and lower oil prices, the Kurdistan government is near collapse. If it fails, we would not be surprised to see Turkey try to expand its influence. Most of the Gulf Cooperation Council states peg their currencies. This action brings stability and allows these nations, which often import nearly all their consumer goods, to maintain low prices. However, the decline in oil prices has raised fears that devaluations may be in the offing. If so, it could raise internal tensions in these countries.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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