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

[Posted: 9:30 AM EDT]

The uptick in the markets today comes as coronavirus lockdowns continue to be softened around the world and several drug groups say they could have a COVID-19 vaccine within months.  The Fed ends its latest policy meeting today.  Overseas, it’s still a mystery where Kim Jong Un is, while Russia has apparently sent yet another hit squad to kill an enemy overseas.

COVID-19:  Official data show confirmed cases have risen to 3,132,363 worldwide, with 217,947 deaths and 938,037 recoveries.  In the United States, confirmed cases rose to 1,012,583, with 58,355 deaths and 115,936 recoveries.  Here is the chart of infections now being published by the Financial Times:

Virology

• Multiple U.S. and foreign pharmaceutical companies working on a COVID-19 vaccine say they have moved up their timetable for testing and could have a product available for emergency use as early as this fall.  Several organizations have already started safety and efficacy tests on human subjects.  The news should be a significant positive for a wide range of risk assets.
• On a less positive note, many commercial and academic laboratories in the U.S. say a lack of high-level coordination has left them processing far fewer coronavirus tests than they could.  Lab executives and public health officials blame barriers including fragmented supply chains, relatively strict test guidelines, incompatible electronic systems and a lack of centralized data on where capacity exists.

Real Economy

• President Trump invoked the Defense Production Act to declare meatpacking plants as critical infrastructure that must keep operating, in spite of some local governments and unions preferring to close them to slow the spread of the virus.  The move will require new measures to protect workers from infection, but it will not compel employees to return to work if they don’t want to.  Nevertheless, the news should be positive for major meat company stocks.
  • As much as 25% of U.S. pork production capacity is currently idle as is about 10% of beef production.  Administration officials said they feared 80% of all U.S. meat production capacity could be shut down without any action.
  • Large packing plants have become a target for virus shutdowns because they often represent a large, concentrated share of the total workforce in the small or rural communities where they are typically located.
• The American Petroleum Institute released data showing U.S. oil inventories expanded less than anticipated last week.  The news is boosting oil prices sharply higher so far today, although it will be important to see whether the more benign picture is confirmed by the Energy Information Agency’s data later this morning.
• As European countries gradually ease their coronavirus restrictions, high-frequency alternative data on economic activity, such as electricity use and travel, are already starting to show a revival.
• Unfortunately, new analysis shows that emerging market countries trying to support their plunging currencies last month depleted their foreign exchange reserves at the fastest pace since the global financial crisis of 2008-2009.  The drawdown of reserves leaves some nations vulnerable to further shocks, so the news is likely to be negative for emerging market bonds and stocks.

Financial Markets

• As a reminder that Italy’s economy has been left in tatters even as it gets control of the pandemic, Fitch has cut its rating of Italian sovereign bonds to BBB-.
  • With the downgrade, Fitch joins Moody in assessing Italy’s debt at just one notch above junk.  S&P last week rated it two notches above.
  • In its announcement, Fitch suggested it had been prepared to cut the rating even further, but the Italian government provided additional information that allowed for the investment-grade assessment.

U.S. Policy Responses

• Treasury Secretary Mnuchin said Payment Protection Program loans of $2 million or more would face an audit before being forgiven, with spot checks for smaller loans.  The audits will check whether the funds were really used to keep or rehire workers or meet other allowed expenses.
  • Some observers question whether the SBA will really be able to conduct effective audits, which it normally entrusts to banks.
  • All the same, the announcement reflects concern about the political ramifications if the emergency lending leads to widespread fraud.
• In another setback for the PPP, many restaurant owners are expected to forego or return the loans on concerns that they can’t meet the requirement to spend the funds within eight weeks, especially when lockdown orders are still in place and many of their employees have more income from unemployment benefits than they get from working.
• Senate Majority Leader Mitch McConnell told Republican lawmakers he doesn’t want to include infrastructure funding in the next coronavirus relief bill, but he does want a provision shielding companies from liability in pandemic-related lawsuits.

International Policy Responses

• Expectations are building that the ECB, as early as this week, could significantly expand its relatively modest €750 billion coronavirus bond-buying program toward something more similar to the Fed’s aggressive programs.
• The leftist economist Thomas Piketty, who is famous for his recent books linking capitalism to inequality, said in an interview that the EU’s need for a strong fiscal response to the coronavirus crisis was being undermined by the policy of making unanimous decisions.  To solve the crisis, he called for “a small group of countries” to start making decisions on their own based on majority voting.  The idea is yet another reflection of the growing potential for a breakup of the bloc.

Political Fallout

• Australian Prime Minister Morrison has called for an independent international inquiry into the origins of the COVID-19 crisis.  The call has drawn a furious response from Chinese officials, who have accused Morrison of being a U.S. pawn and threatened a boycott of Australian goods.

United States:  The FOMC will wrap up its latest policy meeting today.  While no change is expected in the Fed’s basic policy stance, the policymakers will release updated economic forecasts and Chairman Powell could provide additional color on policy going forward during his post-meeting news conference.

North Korea:  There is still no solid news on Kim Jong Un’s whereabouts, but media reports say North Korean consumers have been panic-buying staples.  If even domestic residents of the Hermit Kingdom are sensing a potential crisis, it provides further evidence that an important development may be happening.

Russia-Czech Republic:  A Prague district mayor says he is under police protection after authorities informed him that he and two other Prague officials, including the city’s mayor, were the targets of a Russian intelligence agent sent to the Czech capital to “liquidate” them.  The officials were apparently targeted for their role in removing a statue of a Soviet war hero from a public square in Prague.

Brazil:  The supreme court has authorized a police investigation into President Bolsonaro, days after Justice Minister Celso de Mello resigned and accused the president of crimes ranging from influence-peddling to obstruction of justice for trying to replace police officials investigating his family members.  The threat of a massive new political scandal and potential impeachment will likely be negative for Brazilian assets.

Lebanon:  As Lebanon’s government begins lifting its coronavirus lockdown, protesters demanding economic and political reforms are already back in the streets staging violent demonstrations.

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

[Posted: 9:30 AM EDT]

Market sentiment continues to get a boost from the fact that many foreign governments and various U.S. states are easing their coronavirus restrictions.  As always, we review all the latest virus news below.  We also provide an update on the continued mystery of North Korean leader Kim Jong Un’s whereabouts.

COVID-19:  Official data show confirmed cases have risen to 3,060,152 worldwide, with 212,056 deaths and 905,662 recoveries.  In the United States, confirmed cases rose to 988,469, with 56,253 deaths and 111,583 recoveries.  Here is the chart of infections now being published by the Financial Times:

Virology

• A placebo-controlled study of the arthritis drug Kevzara was stopped early when it became clear that it wasn’t likely to help patients with a severe form of COVID-19.
  • Highlighting the importance of using placebo controls to avoid wrongly judging a drug as being effective, patients taking the placebo and those taking the drug both did better than expected, but those taking the placebo did best.
  • A separate placebo-controlled study of Kevzara on patients with an even more severe form of the disease is continuing.
  • Studies are also continuing on dozens of other drugs, but the fast-developing science and changing dynamics of the pandemic are posing challenges for scientists.
• The Trump administration said it is prepared to send all 50 states enough tests to screen at least 2% of their residents for COVID-19, asserting that is the minimum level needed to help control the pandemic.
• The CDC announced it will start serum antibody testing in parts of Georgia where community spread of the disease is accelerating.
• The State of New York announced just 337 new deaths from the virus yesterday, marking its lowest daily tally since March 31.

Real Economy

• New analysis shows more than 30 million workers in Europe’s five biggest economies have applied to participate in short-term leave plans because of the crisis.
  • That beats the 26 million or so U.S. workers who have applied for unemployment benefits in the crisis to date.
  • Designed to limit outright unemployment, the European plans provide funds to companies to cover part of participating workers’ wages on condition that they be kept officially on the payroll.
• Because of the huge contribution that tourism makes to the overall European economy, observers are becoming increasingly worried about the impact if the virus extends or prevents traveling during the summer holiday.
• Though investors are focused on plunging crude oil prices as the world starts running out of places to store it, there is also a developing shortage of places to store refined product.

Financial Markets

• As companies scramble to preserve cash as the pandemic saps revenue, data from S&P shows more companies have suspended or canceled their dividends so far this year than in the previous 10 years combined.

U.S. Policy Responses

• Expanding support to states remains politically contentious.  For example, President Trump said he was skeptical about providing any state funding in the next fiscal support bill.  Senate Majority leader McConnell will likely end up supporting an aid package, but with restrictions on how and where the money will be spent.
• The SBA yesterday reopened its electronic portal for Payroll Protection Program loan applications, known as E-Tran.  However, the overwhelmed system was plagued by instability, crashes, and long wait times, severely limiting the number of loans processed.
• New analysis shows roughly half of all U.S. workers stand to earn more in unemployment benefits than they did at their jobs before the coronavirus pandemic shut down the U.S. economy.
  • Adding the federal government’s emergency weekly payment of $600 to the average state payment of about $378 will give workers a total income of $978, compared with the median weekly wage of $957 in the first quarter.
  • Until the federal payment expires at the end of July, the high level of unemployment aid could make it harder to entice some workers back to their jobs, especially if they are skittish about being exposed to the virus.
• State governments from California to South Carolina continue to gradually ease lockdown restrictions.

International Policy Responses

• The European Commission has proposed a temporary easing of bank capital standards in order to boost lending.  If approved by the European Parliament and national governments, the relief aims to increase lending by as much as €450 billion this year.
• New Zealand and Australia are the latest major developed countries to start easing social distancing restrictions, with both nations reporting dramatic decreases in new infections over recent weeks.
• In the U.K., the government is expected to approve and announce a plan to ease its lockdown measures later this week.
• As China continues to lift its restrictions, heavy equipment makers are boosting prices to take advantage of a sharp rebound in construction and infrastructure investment.

United States:  The FOMC begins its latest policy meeting today.  The policymakers are widely expected to leave the interest-rate policy unchanged when they announce their decision tomorrow.  However, given the wide range of support programs the Fed has undertaken to help cushion the economy from the COVID-19 crisis, all eyes will be on any potential new moves that might be announced in the accompanying statement.

North Korea:  Paramount leader Kim Jong Un remains out of sight, leaving foreign governments unsure about whether he is still alive and in control of the country.  South Korean officials insist Kim is well, but South Korea and the U.S. scrambled six reconnaissance planes to spy on North Korea yesterday amid rumors he is dangerously ill.  The North Korean government uses a highly refined system of secrecy and diversion to keep the outside world from knowing what’s going on with its leader.

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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!  It’s central bank week; the BOJ has spoken, while the Fed and ECB meet later this week.  Equity futures are pointing to another higher opening and there are widespread reports of nations easing social distancing measures.  Oil prices are falling.  We update the COVID-19 news.  Here are the details:

COVID-19:  The number of reported cases is 2,982,933 with 206,8111 deaths and 881,635 recoveries.  In the U.S., there are 965,933 confirmed cases with 54,877 deaths and 107,045 recoveries.  Here is the FT chart:

The virus news:

• The WHO announced over the weekend that there is currently “no evidence” that people who have been infected by COVID-19 have developed antibodies that protect them from reinfection. There has been speculation that once a person is infected by the virus that a degree of immunity would be conferred.   That would allow governments to use serological tests to determine the degree of immunity and maybe issue “passports” that would allow those with immunity to return to normal activities.  However, that assumes that once infected, a person would be protected.  There has been evidence of those who were previously infected having caught the virus again.  In that regard, COVID-19 may behave like the common cold or influenza.
• Despite these concerns, there has been a rush to develop tests to determine who has been infected. Sadly, their reliability remains suspect.
• The FT has published a report that argues the death toll from COVID-19 could be 60% higher than reported. The study compares average death rates across 14 countries to normal and assumes increased death rates are likely from the virus.  The statistical counts we report each day should be treated as estimates; as an example, the spread between estimated fatality rates from the 1918 Spanish influenza varies widely even more than a century after the event.  This article’s methodology clearly has flaws (not all of the deaths above average have come from the virus), but it does act as a check on the official data.
• Although global mortality continues to show that age is a risk factor, doctors in the U.S. are reporting that young people who have been infected with COVID-19 are facing blood clotting issues and are suffering from strokes. Although the number of cases isn’t large, it is occurring with enough frequency that researchers are documenting the phenomena.  In what may be a related story, the autopsy of the Santa Clara County woman, who was the earliest confirmed fatality from the virus, concluded that she died of a massive heart attack that led the sack around her heart to fill with blood and “rupture.”
• Another twist to COVID-19 is that it seems to undermine lung capacity well before those infected discover it. Patients infected with the virus will have oxygen saturation readings well below the normal 94% to 100%.  Some are reported to have saturation as low as 50% with only mild symptoms.  The reaction, known as “silent hypoxia,” means that those infected are quite sick but don’t have the classic symptoms such as shortness of breath.  By the time they have noticeable trouble breathing, their oxygen saturation is at dangerously low levels and can progress to critical status quickly.
• Boris Johnson is back to work.
• Nursing homes continue to be an area of concern everywhere; France has been especially hard hit.

The policy news:

• The Fed meets this week. We do not expect any policy action to be announced given the huge actions already taken.  So, don’t expect much in the statement.  The press conference, on the other hand, could be interesting.  We are watching for two things—first, how does the chair handle the negative interest rate question, and second, what about expanding the municipal bond backstop?  On the first, expect the Fed to demur; on the second, expect promises to help if necessary.
• The Small Business Administration has moved to not allowing hedge funds or private equity firms to acquire small business rescue loans. It is also limiting the ability of firms owned by private equity to borrow on the payroll protection program.  Hospitals purchased by private equity firms are demanding bailouts or they are threatening to close in the midst of a pandemic.  Meanwhile, there is a “shaming” underway for larger firms that are taking bailout funds.  The popular view is that the bailout money is helping the local bar and grill; in reality, anytime the government offers money, all sorts of people will line up to take it.  And, helping larger firms can reduce the impact on unemployment.  But this isn’t how the public frames the debate, so larger firms are caught; do they take needed funds and risk the public relations backlash, or forego the money and hurt their companies?
• Another twist is that bankrupt companies can’t get stimulus money. This decision might actually be very bad for energy companies.
• States are starting to reopen, but slowly. To a great extent, governors and mayors are trying to balance public safety with the need for economic growth.  Complicating matters, as we noted in the virus news, is that we don’t really know everything about COVID-19.  Thus, what may seem like a reasonable decision could look like a terrible mistake in the eyes of historians years from now.  The news of reopening is helping equities this morning.

The economic news:

• In our memory, we can’t ever remember government-related entities issuing dire forecasts for the economy. Whether it be the IMF, OECD, World Bank or the Congressional Budget office, we rarely see a forecast of bad news.  However, recently, we have seen the IMF and the World Bank issue bearish forecasts.  The CBO has just forecast a deep decline in GDP for Q2.

The snapback in Q3 is mostly a function of annualization.  The key point to focus on is the level of GDP.  Note that the level of GDP remains below the recent peak of $21.7 billion reported in Q4 2019.  According to this forecast, nominal GDP won’t reach the peak this year.

• Chinese households have been increasing their debt in recent years. Although the level remains below that of the U.S., which is around 75% of GDP, the slowdown caused by COVID-19 is increasing pressure on China’s households.

• Banks are preparing for U.S. households to stop paying on credit cards due to the economic slowdown.
• Global trade fell again in February. Growth has been slow since late 2018.
• The shutdown has wreaked havoc for perishable food supply chains. There were lots of stories over the weekend about farmers ploughing under crops, while food bank demand remains elevated.  The problem is mostly logistical.  The food service system is designed to supply various groups—some retail, some commercial.  The latter has mostly been shut-down restaurants.  And, in related news, all that beer sent to stadiums for Opening Day and to bars for St. Patrick’s Day is now languishing and at risk of going stale.
• Although COVID-19 continues to dominate the news, companies are rethinking supply chains for the world after the virus. Deglobalization is the likely trend and firms are looking to adjust.  This action will also bring government involvement; the Pentagon has invested in the only U.S. rare earths mine in California.  Deglobalization will likely have a large impact on the profitability of technology hardware firms, which depend on China for their supply chains.
• There is baseball! But, only in Taiwan.  This report shows what baseball in the time of coronavirus looks like.

The market news:

• As fear recedes, investors are returning to the markets in search of yield. Asset-backed securities and structured notes are making a comeback.  Emerging market bonds are also finding flows.
• S&P has declined to downgrade Italian sovereign debt. There were fears the credit rating agency would reduce Italy to below-investment grade, which would have made it difficult for the ECB to buy Italian bonds.

The foreign policy news:

• Under pressure from Beijing, the EU has apparently made deep revisions to a report critical of China’s disinformation surrounding COVID-19. It appears European countries were worried the criticism would lead Beijing to punish European companies operating in China.  According to reports, China warned the EU three times to soften its criticism of China’s handling of COVID-19.
• The BOJ left rates unchanged but has removed caps on buying JGBs and is also planning to buy corporate debt. Thus, the bank is relying on QE rather than rate cuts for stimulus.  The JPY didn’t budge, so the actions were likely anticipated.  Meanwhile, the ECB is expected to start buying bonds below investment grade.  And, the PBOC promises to support the Chinese economy, although its actions thus far have been modest, at best.  As an aside, China’s major macroeconomic problem is the lack of demand caused by income and wealth inequality.  The long-term solution is to rebalance the economy toward domestic household consumption and away from exports and investment.
• It’s not just U.S. states and cities that are reopening; Europe is, too. Italy is allowing some activities to return but is also planning methods to encourage citizens to stay within the bounds of the new rules.

North Korea:  As promised, we continue to monitor developments tied to the disappearance of Kim Jong Un.  South Korean Defense Minister Jeong Kyeong-doo indicated that North Korea has increased inspections of its artillery’s readiness and has been increasing air force operations.  The most threatening part of North Korea’s military is its artillery.  Massed along the border, it could cause serious damage to Seoul and would take a major air campaign to suppress.  The fact that it is holding inspections and increasing combat readiness could be indicating preparations.  We also note that China has suspended some rail traffic in Dalian.  Although this move is probably in response to COVID-19 infections, Dalian is close enough to North Korea that if the PLA needed to move troops to the border, it would probably use trains from this major port city.

The site 38^o North is reporting that a train known to be used by the Kim family has been at the Wonsan compound since April 21.  This merely shows that the train is in place but doesn’t indicate anything about Kim’s condition.  Media accounts continue to conflict.  Sources in Hong Kong and Japan have reported that he is in a vegetative state.  South Korean media continues to report that Kim is “alive and well.”  Reuters reported that China has sent a team of doctors to advise on Kim’s condition; if this story is accurate, it lends credence to the idea that the “young general” is suffering a serious medical problem.  So, what do we think?  First, it is really hard to know what is going on in North Korea; it isn’t called the Hermit Kingdom for nothing.  Second, we find it a bit odd that a young man could have such terrible heart disease.  It’s not unprecedented, but unusual.  Third, it is quite possible that COVID-19 is running rampant through North Korea and Kim has decided to evade the public in order to avoid infection.  Kim has disappeared before, sparking rumors, only to return later.  Simply put, we don’t know and neither does anyone else outside of the Kim family.

As we reported last week, if Kim is indeed dead or incapacitated, it isn’t clear who would be next in line to the “throne.”  North Korea is a dynastic kingdom acting as if it is Marxist.  Although Kim has a sister who plays a prominent role in the government, we have doubts that the Korean people are ready for a “queen” to rule.  Both China and South Korea fear a breakdown of the regime, worried that it might trigger a refugee crisis.

Turkey:  Ankara riled the U.S. and NATO when it purchased the S-400 missile system from Moscow.  The system has been delivered but President Erdogan has decided to “leave it in the box” for now.  The U.S. is prepared to invoke the Countering America’s Adversaries Through Sanctions Act (CAATSA) against Turkey for buying the S-400.  Turkey’s collapsing economy is likely leading Ankara to avoid deploying the missile system and triggering the CAATSA sanctions.  Turkey has also approached the Fed about a currency swap line.  Given the turmoil in the region, Erdogan has apparently concluded that angering the U.S. is a bad idea and decided that the benefits of the missile system do not outweigh maintaining relations with Washington.

China:  The U.S. has pulled its heavy bombers from Guam.  The Air Force has had nuclear weapons-capable bombers on Guam since 2004.  The DoD argues that both North Korea and China have missiles that can reach Guam, putting the bombers at risk.  In addition, they can still attack both targets from North Dakota and Missouri and not be at risk from the same type of missile attack.  At the same time, the symbolism of the U.S. removing these assets will not be lost on U.S. allies in the region.

China has arrested five former employees of Huawei (002502, CNY 3.31) who claimed on social media that the company did, indeed, sell products to Iran, violating U.S. sanctions.  This news comes at a time when public opinion of China is falling rapidly.

Iran:  In a twist, the U.S. is arguing that it remains a participant in the Iran nuclear deal.  This is being done to press the U.N. Security Council to extend the arms embargo or increase sanctions.  The current ban expires in October and Washington is likely worried that trade with Tehran will rise after the expiration.  The U.S. is using this ploy to trigger the “snapback” provisions of the agreement.  This situation will become more important as summer ends.  Stay tuned…

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

[Posted: 9:30 AM EDT]

Good morning!  Equity futures are pointing to a modestly higher opening; oil prices are also higher.  We update the COVID-19 news.  Here are the details:

COVID-19:  The number of reported cases is 2,721,354 with 191,231 deaths and 745,605 recoveries.  In the U.S., there are 869,172 confirmed cases with 49,963 deaths and 80,934 recoveries.  Here is the FT chart:

Here is another website to add to your COVID-19 monitor.  It attempts to measure the R₀ (pronounced “R-naught”) by state.  That number tells you how many new cases are generated by each infection.  A R₀ greater than one would mean that each infection generates more than one new infection.  Thus, one should be careful about relaxing social distancing standards if the reading is greater than one.  Although this is an interesting site, the output is only as good as the data input.  In other words, the actual count of infections is necessary to generate the R₀.  But, even with that caveat, watching the history of the data does show that social distancing has had a positive impact on reducing new cases.

Although we have seen some impressive data analysis on the virus, the data collection itself remains a problem.  Nations have reasons to manipulate the data for political reasons; perhaps the nation with the most serious undercount is Brazil.  Its leader, Jair Bolsonaro, had downplayed the impact of COVID-19; in his defense, Brazil may not have much of a choice.  Its economy can’t afford to engage in social distancing, so Brazil needs to acquire herd immunity through widespread infection.  It is a risky strategy, but one we may see repeated elsewhere.  We note that Africa may become the next hot spot for COVID-19.

The virus news:

• There were mixed headlines on the virus over the past 24 hours. Here is the good news:
  • An antibody survey in New York State showed wide exposure to COVID-19. The survey of 3,000 people showed that 14% were carrying antibodies and 21% of those from New York City were carrying antibodies.  The caveats:
    • The sample is small and not random. Participants volunteered at shopping centers, meaning they were healthy enough to be circulating.
    • Although 14% and 22% is a start, herd immunity requires at least 70% of the population to be carrying the antibody. Achieving herd immunity through infections isn’t really possible (that’s why parents used to have “chickenpox parties” because it was better to get a child exposed early; however, the fact that these parties were held showed that the virus still circulated and herd immunity was not achieved).  On the other hand, rising numbers of those who are likely immune would allow those who survived an infection to go back to regular activities.
  • The bad news:
    • An accidentally leaked WHO report indicated disappointing results that a study of remdesivir was ineffective in addressing COVID-19. However, Gilead Sciences (GILD, 77.60, -3.71), the company that made the drug, noted that the leaked study lacked enough participants to make statistically meaningful conclusions.  The jury remains out on remdesivir, which is the subject of several ongoing studies.  Equities did retreat on the news.
    • One of the characteristics of COVID-19 is that it has elevated mortality for patients with hypertension. It is unclear if it is high blood pressure that is the risk factor or the drugs that treat the condition.  If it is the latter, patients are left with a dilemma—continue taking the medicine and be at higher risk of dying if they contract COVID-19, or stop taking their medication and risk renal failure, heart attack or stroke.
    • Lebanon has its first confirmed case of COVID-19 in a Palestinian refugee camp. Although Lebanon has managed to control the spread of the virus rather effectively due to aggressive social distancing measures, refugee camps tend to be crowded with substandard hygiene.  If the virus begins to spread in the camp, it may be difficult to control.
    • Highlighting the vulnerability of aging and COVID-19, in Europe, nursing homes account for about half of the fatalities from the virus.
    • As the West gets to the “right-hand side” of the distribution curve, we are starting to see signs of the legal response. In Italy, it appears that lawyers are preparing to act against officials who may have made errors resulting in fatalities.  We would be surprised if this trend doesn’t start to emerge elsewhere.
  • And the interesting news:
    • There has been a strong call for ventilators in the COVID-19 crisis. However, there is increasing nuance in deciding when to use the machines.  More doctors are concluding they should be used as a last resort.  In some cases, it appears the lung damage from intubation and ventilation is so great that the use of the machines may need to be curtailed.
    • A study of transmission in China shows that, by far, the most dangerous place one can be for the virus is indoors. The study suggested that the most common transmission came in homes (probably from an infected family member), followed by transportation.  The safest place to be was outdoors.  It’s not that there were no reports of outdoor transmission but there was only one out of 7,324 that was identified as suffering from outdoor transmission.  Here is the paper.  If other research confirms this study, we could see parks reopen, and concerts and religious services being held outdoors.

The policy news:

• The House has passed the most recent support package; it goes off to the White House where President Trump is expected to sign it into law.
• The next round will be much more challenging. We see five brewing problems that will likely need federal attention and additional support.  All are fraught with political risk.
  • State and local governments are in deep trouble. High job losses have led to massive demand on unemployment insurance.  Although the weekly claims data has soared, the antiquated systems the states use to process claims have been balky; there has been a surge in demand for COBOL programmers, an indication of the age of these systems.  Funds for unemployment insurance are being drained.  Medical care costs have hit state coffers as well.  This need for support is running headlong into a deep political divide.  Some state governments over the years have made pension promises they probably can’t keep.  While the union movement has been languishing for years in the private sector, it continues to flourish in the public sector.  The GOP fired a broadside yesterday, suggesting these governments should avail themselves to the bankruptcy courts, which would likely force the reduction of pension payments and abrogate union contracts.  Democrats oppose this idea and want to give states aid.
  • The Energy sector continues to reel. Although the drop in oil prices has caught the attention of the media (nothing like a unique event like negative prices to generate interest), the bigger story is that the industry is struggling.  Treasury Secretary Mnuchin is considering a lending program for the oil industry.  This is where the politics flip; oil production tends to be centered on the red states and Democrats, especially left-wing populists, are strongly opposed to fossil fuels.  It is possible the administration could bypass Congress and prompt the Fed to lend directly to the industry or backstop bank loans.  But, much of this debt is very risky, which would expose the Fed to losses.  At the same time, a disorderly collapse of the Energy sector would be a risk to the broader economy.
  • The postal service is in financial trouble again. Although it has received some assistance, the administration appears to want to prompt significant changes to its business model in return for a bailout.  We would not just expect higher rates on package shipping but a renegotiation of union contracts for postal workers.
  • Policymakers face a dilemma with private equity. Often, firms that are bought by private equity firms have their assets leveraged to support the debt used to buy them.  As the downturn worsens, the firms purchased by private equity will likely fall into trouble; bailing them out could end up supporting the private equity firms that purposely weakened the target company’s balance sheet.  Preventing bailouts means innocent workers could lose their jobs and worsen the downturn, but bailouts increase the risk of privatizing the profits and socializing the risk.
  • The government has allowed homeowners forbearance with federally backed mortgages. However, the legislation apparently didn’t tell servicers how this would work.  According to reports, some servicers are offering only short breaks in payment and demanding a balloon payment once forbearance ends.  We have been saying for some time that mortgage servicers will need support; until they get it, their offers of forbearance will be so onerous that few borrowers will want it.  At the same time, many of the mortgage servicers are the largest banks.  As the smaller ones are not supported, further concentration in the industry is certain.
  • From our perspective, all five issues could cause disruptions that would have an adverse impact on financial markets. For example, muni bankruptcies won’t just force public workers to be the only party to bear the cost of adjustment; bondholders will almost certainly do so as well.  If bond obligations for state and local governments become a credit issue on a systemic basis, it would cause a serious jolt to the financial system in a time of great risk.  Allowing broad business failures in Energy could spill over into other areas of the financial system.  As 2008 showed, it is hard to know where systemic risk emerges.  The same is true with private equity.  And, in a period when home delivery is expanding, a postal strike would be a problem.  So far, policymakers have done a good job in preventing a widespread decline in the financial markets but the longer this goes on and the more contentions the political issues become, the greater the chances are that a mistake is made.
• The Fed will begin disclosing who it is lending to in a new report.
• So far, Japan has been the largest participant in the Fed’s forex swap program.

The economic news:

• As we noted yesterday, the expanding shutdowns of meat processing plants will start to lift prices and reduce supplies next month.
• There have been glitches in getting stimulus checks to households. These delays are not good news for the economy.
• There are increasing worries about a flood of business bankruptcies. One of the problems of years of low interest rates is that some companies who would not have survived under conditions of normal rate levels have struggled on over the last decade.  These so-called “zombies” may finally be facing their fate but probably wouldn’t have survived a normal recession either.  A bigger worry is that startups have slowed dramatically in this downturn, which will slow the recovery once it starts.

The foreign policy news:

• Chinese medical goods producers have been taking advantage of spiking demand by engaging in old fashioned price gouging. This action is occurring in the midst of rapidly deteriorating relations between the U.S. and China.
• Europe is struggling to formulate a response to the virus. Although there has been talk of a €2 trillion package, the actual level is about a quarter of that and details have not been worked out.  The southern nations are worried they won’t get enough support.
• As the virus spreads in Russia, anger over the government’s response is rising.  The combination of COVID-19 and collapsing oil prices is creating a problem for President Putin.

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

[Posted: 9:30 AM EDT]

Good morning!  Ramadan begins this evening.  Equities are steady this morning as financial markets digest historically weak economic data out of Europe.  Meanwhile, oil prices continue to recover; we update our views on oil in this week’s Weekly Energy Update.  We also update the COVID-19 news below, and, proving that geopolitics, like rust, never sleeps, we update geopolitical concerns over North Korea and China.  Here are the details:

COVID-19:  The number of reported cases is 2,647,512 with 184,372 deaths and 721,349 recoveries.  In the U.S., there are 842,624 confirmed cases with 46,785 deaths and 76,614 recoveries.  Here is the FT chart:

The virus news:

• The reopening after lockdown is the next phase of the virus. We are watching with great interest the steps that various governments are using to make this work.
  • South Korea is quarantining those with the virus and using wristbands to make sure that those who are ordered to stay home do so.
  • Chile is issuing “immunity passports” to those who have recovered from the virus. This will allow them to return to work.
  • In the U.S., because of our federal system, states and local governments are generally in charge of reopening. This is leading to a mixed response, with Georgia taking a rather aggressive stance compared to a more cautious one from New York.  However, reducing restrictions is one thing, but changing behaviors is another.  Even reducing restrictions may not lead companies and households to change their behavior.  Another lurking worry is fear of litigation.  Although the White House has argued that businesses should not be liable for infections that occur on their premises, it isn’t a stretch that some lawyer somewhere will bring a case against a restaurant or a grocery store for a patron that believes he contracted the disease while visiting that establishment.  That may keep businesses from aggressively reopening.
  • Another factor is that, for some workers, the combination of state unemployment plus the federal boost is high enough to discourage returning to work. That may slow reopening as well.
• New reports indicate that the first confirmed case of COVID-19 occurred in Santa Clara as early as February 6. This means COVID-19 got here earlier than previously thought.
• The most vulnerable to the virus appear to be residents of nursing homes.
• Meanwhile, there remains great uncertainty about the veracity of the infection and fatality data. This report sheds some light on the issue by comparing overall death rates to normal rates in numerous nations.  One interesting sidelight is that Sweden’s fatality rate is only running about 12% above normal compared to Spain at 66% or England and Wales at 33%.  Sweden has been doing “lockdown-lite” and this data would suggest it is working, at least so far.
• A new, and we must say, unsettling, development is being reported about COVID-19. Infections seem to be triggering difficult to control blood clotting in some patients.  Researchers are not sure but speculate that the clotting may be caused by the body’s reaction to the virus itself.  In other words, COVID-19 doesn’t directly lead to clotting but the body’s immune response triggers the reaction.  There were some reports of clotting overseas but the U.S., plagued by obesity and heart disease, is seeing more cases.  Apparently, it has become a risk factor for women immediately after childbirth.  This is the first time we have heard of this characteristic, but it might explain why age has become such a serious risk factor for the virus.
• In China, testing of patients who have had the disease, recovered and are asymptomatic are still showing the virus remains present. It is unclear whether (a) these patients continue to shed the virus and are thus able to spread it, or (b) the tests are generating false positives.  It is universally held by researchers that the key to reopening economies and easing social restrictions is testing.  However, we are increasingly concerned the testing may be flawed.  When one creates an indicator, there is always a tension between sensitivity and accuracy.  Constructing an indicator for sensitivity will tend to give lots of positive signals but risk false positives.  Making one that leans toward accuracy means the test confirms clear cases but will miss borderline ones or generate false negatives.  This is simply a fact of creating such instruments.  We suspect researchers have feared false negatives more than false positives, which makes sense.  And, we note there has been little evidence that those who have recovered have been transmitting the disease to others.  However, if we go “all in” on testing, we could create situations where we believe we are surrounded by “typhoid Mary’s” who we quarantine when they pose no threat at all.
• China is facing a new surge in cases in Heilongjiang province which borders Russia in the northeast. Local officials have imposed travel restrictions with Russia, fearing that the new cases are being imported from the north.
• SOS Pompeo has accused China of deliberately destroying coronavirus samples as part of a cover-up to prevent analysts from determining the origin of COVID-19. This allegation continues the pattern of deteriorating relations between the U.S. and China.

The policy news:

• There is a brewing battle between the Speaker of the House and the Majority leader in the Senate. State and local governments have increased their spending to respond to COVID-19.  Democrats wanted to boost support for state and local governments in the latest stimulus package but were rebuffed.  McConnell revealed his thoughts yesterday, suggesting state and local governments should probably avail themselves to the bankruptcy courts.
  • The position of state and local governments has been a brewing problem for some time. A number of states (our neighbors east, in particular) have difficult financial positions due to pension obligations.  Bankruptcy may be the only way to address the pension problem, forcing a resolution.
  • That might be a solution, but now is a potentially dangerous time to bring it up. Financial crises develop because asset holders fear a “run on the bank.”  If muni bond holders begin to believe their bonds could default on a widespread basis, it could trigger a mass selloff and lead to a broader financial crisis.
  • We will watch to see how the Fed and the White House react; our suspicion is that McConnell will get some sympathy for his position, but, in the end, there will be aid for state and local governments.
• Another area we are watching closely is the mortgage industry. There are growing concerns that Fed support isn’t broad enough and the fiscal side isn’t doing enough either.
• It appears the backlog for the Paycheck Protection Program is growing rapidly and may quickly exhaust the $320 billion new funding. Another item we discovered that we didn’t know before: there are moral clauses in SBA lending which are shutting out businesses for these loans.  We are starting to see talk of a stimulus idea that, in one form, which we noted over a month ago, would be a payroll tax holiday.  However, what is being considered now would put the plan on steroids; it would use the system in reverse to funnel money to firms that pay the payroll tax to subsidize keeping employees on the payroll.
• As we note below, European PMI data fell to historically low levels. The European Commission is mulling a €2.0 trillion support package that includes loans and grants.   However, there has still been no movement on a Eurobond.

The economic news:

• The preponderance of the data still points to a very weak economy. The NY FRB has issued a weekly estimate of GDP designed to show what the yearly change in GDP will be based on current data.  The index doesn’t have a long history, but it fits GDP rather well.  It is suggesting a nearly 11% yearly decline is on its way.  We will continue to monitor this data for insights into the path of the economy.

• It’s not all bad, however. Daily consumer sentiment data from Morning Consult is suggesting that consumers remain glum, but conditions are not worsening.
• The move to cash by households and firms has led to a massive jump in M2. This measure of the money supply is up over 15% from last year.  Under normal circumstances, this available liquidity would be considered bullish for future growth.  However, uncertainty surrounding the futures will, at least for a while, lead to a drop in velocity.

• Quietly, China is admitting it won’t meet its 6% GDP target this year.

The market news:

• Another meatpacking plant has been forced to close due to COVID-19. Tyson Foods (TSN, 59.92, -1.99) announced it would close its Waterloo, IA, pork processing plant, the largest in the company.  This follows closures by other firms in South Dakota.  We would expect pork shortages to begin developing very soon.
• One of the consequences of working from home may be that households begin to realize that living in a big, expensive city may not be necessary for employment. That may lead to an exodus from these overcrowded areas into areas with lower costs of living.

The foreign policy news:

• We reported recently that Australia was taking measures to force news aggregators to pay more to content providers (news organizations). France has moved in a similar direction and the EU is considering action as well.  If this trend accelerates, it will affect Google (GOOGL, 1258.41, +46.25) and Facebook (FB, 182.28, +11.48).
• Declines in developed nation employment are hitting remittances from immigrant workers to their families in emerging economies.
• Iran’s Revolutionary Guard Corps is using the pandemic to increase its influence in the country. We have wondered for some time whether when Ayatollah Khamenei dies the Corps might end up seizing power and either dispensing with rule by clerics or installing a puppet to take full control.

China:  China has been taking increasingly aggressive actions in the South China Sea.  Malaysia is reporting that a Chinese survey vessel has been operating in its waters without asking for permission.  This same ship, the Hai Yan Di Zhi 8, operated in a disputed area near Vietnam.  This is just the latest in a series of actions China has taken recently.  To some extent, this is nothing new; China has claimed the entire South China Sea as its own, but does appear to be using the distraction triggered by the COVID-19 pandemic to continue these actions.  The U.S. has responded by sending U.S. warships into the area.  China has also been accused of using social media to send fake messages into the U.S. designed to spread disinformation.  These actions, along with others, have been increasing anger at China, which may have an adverse reaction in the future.

North Korea:  Although COVID-19 is clearly dominating the news and markets, there are other concerns we are monitoring.  The mystery of Kim Jong Un’s health is front and center.  As we have noted, the “young general” has been out of sight for much of April.  He missed his grandfather’s birthday remembrance celebration on April 15.  There are reports, still not actually confirmed, that he had heart surgery, perhaps of an emergency nature.  Kim is said to be a heavy smoker and may be sporting a BMI of 45.  On the one hand, those risk factors would point to a cardiac problem; at the same time, there are plenty of men in their early 30s with those factors who do just fine.  It’s when they get a bit older that problems emerge.  Thus, if Kim needed bypass surgery at this age, that would be a problem.

At the same time, we are not seeing the sort of behavior we usually see when an authoritarian leader is stricken.  Often, if the leadership is in doubt, the military is confined to barracks to prevent a coup and, if a praetorian guard is in place, it is put on high alert.  None of these situations have been reported.  It is not uncommon for those whose status is totally dependent on the sickened leader to head for the exits when it looks like a new person is going to take over.  After all, the new leader will have his own people and the previous leader’s sycophants are usually dispatched either to remote and hostile areas of the country or to regions beyond this earthly pale.  There is no evidence of high-level defections.  This isn’t the first time Kim has disappeared; he was missing for a month in September 2014, only to reappear using a cane.  It was suspected the young leader fell victim to a bout of gout.  So, we do have to take care in overreacting.

Here are two items to consider. First, if Kim is really in grave danger, watch China and South Korea.  China is always worried about a collapse in Pyongyang because it will trigger a refugee crisis.  If we see Beijing take steps to aggressively seal the border with North Korea, it would probably mean something is up.  South Korea has similar worries.  Seoul is terrified of the costs West Germany bore to integrate East Germany.  Given how militarized the 38^o parallel is, it would be suicidal for North Koreans to flee south unless the regime completely collapses.  But, if South Korea starts moving to protect the border, it may mean it knows the regime is in trouble.  Second, there are reports that Kim’s half-sister, Kim Yo Jong, would be the next in line for the “throne.”  We have serious reservations about this idea.  The Kim regime isn’t called the “Hermit Kingdom” for nothing; this is a dynastic system and it isn’t clear a woman would be accepted as leader.  She might, but it’s not guaranteed.  Kim Jong Un has an older brother, Kim Jong Chul.  The oldest brother, Kim Jong Nam, was assassinated in 2017.

The collapse of the North Korean regime would be a geopolitical mess.  There would be a scramble for power among the non-Kim leaders.  We could see a mass selloff of military hardware, and there is the aforementioned refugee crisis.  There are reports that the U.S. has contingency plans, which is good.  However, one must always remember Mike Tyson’s comment about plans.  If a breakdown occurs, equities in South Korea and Japan would be at highest risk.

Argentina:  The government missed a $503 million debt payment yesterday, starting the clock for default.  If an arrangement isn’t made in the 30-day grace period, there will be an official default on $65 billion of debt owed to private creditors.

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