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

[Posted: 9:30 AM EDT]

Today’s uptick in the markets appears to stem in large part from chatter about COVID-19 lockdown restrictions being eased in the coming weeks.  Of course, other data shows that in some countries new virus cases and deaths are still rising strongly, so it’s still too early to call the “all clear.”  We review all the virus developments and other news below.

COVID-19:  Official data show confirmed cases have risen to 1,934,583 worldwide, with 120,863 deaths and 464,398 recoveries.  In the United States, confirmed cases rose to 582,594, with 23,649 deaths and 44,308 recoveries.  Here is the chart of infections now being published by the Financial Times:

Virology

• In the week ended April 3, the 16,387 deaths registered in England and Wales were more than 50% higher than the average weekly death total over the last five years.  In fact, the total was the highest since comparable records began in 2005.
• In Japan, experts from a government-appointed panel said that in 40% of confirmed COVID-19 cases they were unable to verify where or when patients had contracted the virus.  That suggests the virus is spreading widely in the country.
• On a more positive note, as spring takes hold across the Northern Hemisphere, debate is intensifying over the possibility that warmer temperatures and higher humidity could slow the pandemic.
  • Some scientists point to data showing a slower trajectory of new cases in warmer countries.
  • Other scientists say that may just reflect the fact that many warmer countries are testing more aggressively.

Real Economy

• While even hard-hit European countries like Spain and Italy are starting to modestly relax some restrictions, other countries are announcing that their lockdowns will be extended:
  • French President Macron announced a month-long extension of his country’s lockdown, prolonging measures to fight the new coronavirus into mid-May.
  • Indian Prime Minister Modi said he would extend his country’s lockdown into at least early May.
  • British Foreign Secretary Raab, standing in for Prime Minister Johnson as he recovers from the virus, will reportedly announce later this week that the U.K. lockdown is being extended into early May.
• On a much more positive note, two groups of states – in the Northeast and on the West Coast – have established working groups of government, public health, and business leaders to begin planning for phased reopening of the economy in their regions.  Separately, President Trump today plans to announce a new working group that will focus on the economic effects of the coronavirus and analyze options for reopening parts of the country.
• As some governments begin planning for an economic reopening, one thing that could accelerate the process is growing evidence that food supply chains are under stress in various places all around the world.  A key problem is finding healthy workers in Europe, for example.
• According to the Mortgage Bankers Association, 3.74% of homeowners were not making their monthly mortgage payments last week, up from 2.73% in the previous week.
  • That equates to more than two million homeowners in forbearance, with the number expected to keep climbing rapidly.
  • Since mortgage-servicing companies are still on the hook to pay investors in the mortgages, the burgeoning forbearance numbers are raising pressure for yet another new Fed program to support the mortgage servicers.

U.S. Policy Response

• Congressional Republicans and Democrats are reportedly having trouble agreeing on a $250 billion increase in the new Payroll Protection Program of small business loans, which is expected to run out of funds by Friday.  While the White House and legislators from both parties continue to sound optimistic, the sticking point is the scope of the bill:
  • Republican leaders prefer to simply top up the PPP funding.
  • Democratic leaders prefer a broader bill that would increase access to the program, provide additional funds for state and local governments, and add new funding for hospitals.
• The Fed’s new, $500 billion program to buy bonds directly from states and cities is also coming under fire for being too short-term and for favoring larger localities.  Given how readily programs have been expanded to date, the criticisms suggest this one could soon be extended or broadened as well.
• Citing improved money-market conditions, the New York FRB said yesterday that it will soon ease back on its emergency repo operations designed to add short-term liquidity to financial markets.

Foreign Policy Response

• The IMF said it will write off an estimated $214 million in debt relief for 25 of the world’s poorest countries by cancelling repayments owed to the Fund for the next six months, allowing them to use the money to fight COVID-19 instead.  The move comes ahead of a multi-billion-dollar program of debt relief expected to be announced by the IMF and the World Bank later this week.

Markets

• In an opinion piece in the Financial Times yesterday, Allianz Chief Economic Advisor Mohamed El-Erian wrote that P/E ratios are still too high and credit spreads are still too low compared with the likely slow and choppy recovery from the crisis.
  • In El-Erian’s opinion, investors should take advantage of the Fed-driven rebound in the markets to rotate into higher quality companies and issuers with stronger balance sheets, better cash flow, shorter supply chains, and less dependency on physical facilities.
  • El-Erian’s focus on higher quality companies is consistent with moves that the Confluence Asset Allocation Committee has made in recent months.

Odds & Ends:  Top negotiators from the EU and the U.K. will hold a call tomorrow in an effort to restart negotiations on the U.K.’s post-Brexit relationship with the EU, after talks were curtailed by the virus crisis last month . . . North Korea has carried out what appears to be its fifth short-range missile test of the year . . . Israeli President Rivlin said he would give Benny Gantz and incumbent Prime Minister Netanyahu two more days to form a government, after they informed him they were struggling to agree on a new unity government but still making progress.

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

[Posted: 9:30 AM EDT]

Good morning!  Equities are modestly lower this morning; oil is steady.  We update the COVID-19 news.  OPEC+ has a deal.  Some comments on the Fed.  Here are the details:

COVID-19:  The official number of global cases is 1,860,011 with 114,983 fatalities and 438,516 recoveries.  Here is the FT chart:

For those looking for more intensive monitoring, here is the IHME site.  You can not only check out the U.S. data but also look at it by state.  The good news is that, according to these models, we are at the peak of fatalities now and should see slow improvement.  However, a caveat…the confidence bands are extremely wide.  The forecasts from these models are important but also carry a remarkable degree of uncertainty.

The virus news:

• PM Johnson has left the hospital. He has not returned to work quite yet.
• The virus has hit the Saudi royal family. The governor of Riyadh is said to be in intensive care and several dozen members have been infected as well.
• Spain is starting to ease restrictions, while India is in the early stages of the pandemic. Nations around the world are in various phases of dealing with the virus.
• Early on, COVID-19 was compared to the seasonal flu; we did that as well. As our experience has developed, important differences have emerged.  Those hospitalized with COVID-19 are there much longer and 10x more are hospitalized with it.  The fatality rate appears to be much higher.  There is also a mystery about why some people are not only asymptomatic but also virus “super-spreaders.”
• New York is struggling with the grim task of burying the indigent dead.
• Morgan Stanley (MS, $41.08) has generated a likely path for the recovery from COVID-19.

Their analysis, like our work, is an estimate, but it is a reasonable path of the disease.  By early summer, they estimate we will be seeing widescale testing, both for the virus and for immunity.  Workers will start returning by June with another wave by mid-summer, based on the idea that we will (a) have a much better idea of who has immunity, and (b) testing will allow for rapid isolation of those who catch it later.  Schools will reopen in the fall.  By Q4, we will be testing a potential vaccine; by late Q1 2021, a vaccine will become broadly available.  This schematic suggests that it will take about a year for conditions to return to normal but there will be steady improvement over time.  For those with sensitive conditions, returning to work may not occur for a year.  But, for those under 50 without complicating conditions, or with immunity, the sheltering-in-place orders will start to ease up.

The policy news:

• The firestorm of Fed programs is making it hard to keep up; Fed independence is clearly at risk. But, one of the nice things about a three-day weekend is that it gives one time to reflect and analyze.  The Fed’s decision to expand support for state and local debt is potentially a game changer.  One of the key points to Federal debt is that it is issued in a currency that the debt issuer can print.  In other words, default can only occur by decision because money can always be provided to service the debt.  That doesn’t mean that the Federal government can’t get into trouble by expanding debt, but it isn’t the same trouble that an issuer lacking currency sovereignty can find itself.  In other words, inflation is the problem for debt issuers with currency sovereignty; default is the problem for debt issuers that lack currency sovereignty.
  • The lack of currency sovereignty is one of the key differences between Federal debt and state and local debt. The latter cannot print the currency in which it issues its debt and thus can default.
  • But, the Fed is now backstopping state and local debt which means, in reality, these issuers now have currency sovereignty. Or, put another way, by putting this debt on the Fed’s balance sheet, state and local governments can, in theory, run persistent deficits.
  • In the short run, what the Fed is doing is justifiable. One of the problems of the Great Financial Crisis was that state and local governments, facing a collapse in tax revenue, were forced to cut spending.  In fact, spending was cut enough to mostly offset what the Federal government was spending.

Note that by Q3 2010, the Federal government was adding about 122 bps to GDP; state and local governments were subtracting 168 bps.  The government does not want a situation where the stimulus is being offset by falling state and local spending.

• • The trick is how this program ends. If it continues, state and local governments will have currency sovereignty and deficit spending could explode.
• The airline industry is not happy with the Treasury bailout proposal, objecting to the aid consisting of loans with conditions. Airline unions are warning of bankruptcies.

The economic news:

• The NY Fed has a paper that shows how COVID-19 is affecting the economic data in a pattern similar to a natural disaster, but for most of the nation. In other words, it’s not acting like a cyclical downturn, but a hurricane or earthquake.  Thus, our usual models for warning us of a recession didn’t work this time.
• We are starting to see reports of supply problems caused directly by COVID-19. The pork industry is facing capacity loss due to infections at plants.  Grocery workers are contracting the virus and at least 41 have perished.  Locally, we are seeing increasing restrictions on in-store shopping.  Meanwhile, tariffs are hampering the imports of products used for disinfecting.  Food crops are being lost due to the lack of workers for harvest or demand disruptions; even tea has been affected.  Other critical industries are struggling to cope with infections.  There are increasing concerns that the largest job displacement from COVID-19 will be with low-wage workers.
• The world economy is facing historic contraction; nothing in the postwar experience compares.

The market news:

• OPEC+ has a deal, although details are rather scant. Oil prices are mostly steady on the news; given the rally we saw on early reports, an agreement was mostly discounted.  The headlines show a nearly 10.0 mbpd reduction agreement.  U.S. pressure was instrumental in getting this deal together.  Unfortunately, the cut pales in comparison to demand loss.

 

As we noted last week, history tends to show that the larger the cartel, the harder it is to avoid the free-rider problem.  The good news is that the arrangement likely prevents a sudden collapse.  However, it doesn’t mean that a bottom is in place either.  Meanwhile, we are starting to see well shut-ins; it is highly unlikely that many of these wells will ever restart in the absence of much higher prices.  Studies by regional Fed banks, including Dallas and Kansas City, warn of massive bankruptcies if prices remain below $30 per barrel.

• Given the sharp recovery seen in equities, we have been getting questions about whether this pace of improvement will continue. History would suggest it won’t.

We have weekly data for the S&P 500 Friday closes going back to 1928.  We reviewed every recession (except 1945, which had very odd behavior) and indexed each market to the pre-recession high.  The red line shows the average of all recessions, along with the three highest correlating periods.  We overshot both the average and the other correlating years.  We have rallied back to the average, but note that the average and 1968/1980 cycles remained rather flat until after week 15.  We are currently on week eight.  If history is any guide, we will likely see equities churn for another couple of months, at best.  At worst, we will stay sideways for more than a year.  Each recession is different and this one we are now experiencing is clearly unusual.  However, it would be a bit of a stretch to expect that what we have seen recently will continue.

The foreign policy news:

• Argentina is spiraling to its ninth debt default just as the G-20 is working on a broad set of debt relief measures for poor nations.
• Fires in the forests surrounding the Chernobyl plant are spewing radiation imbedded in the trees; so far, radiation levels have not reached dangerous levels.
• Daniel Ortega, the president of Nicaragua, has been missing for a month.  His country has not ordered any sort of social distancing.  There is increasing concern that Ortega is (a) incapacitated, perhaps by COVID-19, or (b) is worried about catching it and is engaged in social distancing, while not recommending it for anyone else.

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

[Posted: 9:30 AM EDT]

It’s Holy Thursday in the time of COVID-19.  With financial markets closed tomorrow for Good Friday, our next report will be published on Monday, April 13.  From all of us at Confluence Investment Management, we wish you a Happy Easter and Passover.  Equity markets are taking a breather today after the recent rally (although the breaking announcement by the Fed to boost lending has reversed the downtrend—see below), while oil is up on hopes of an output reduction agreement.  Our Weekly Energy Update is available.  Claims remain historically elevated.  We update the COVID-19 news.  Here are the details:

COVID-19:  The official number of global cases is 1,496,055 with 89,435 fatalities and 336,780 recoveries.  Here is the FT chart:

Clearly, Spain and Italy are bending the curve.  The U.S. is accelerating at a slower pace.

The virus news:

• One of the persistent questions we are getting is, “when is this done?” A recent NYT report offers four benchmarks that need to be met for the current measures to be reduced:
  • Hospitals need to be able to safely treat all patients without resorting to crisis standards of care. This wouldn’t mean COVID-19 cases would not continue but that treating them would become routine.
  • The government at all levels must be able to treat everyone with symptoms.
  • The government at all levels must have the ability to monitor confirmed cases and perform contact tracing. This may require some relaxation of privacy rules.
  • A state or region must have a sustained reduction in cases for 14 days.
  • In addition to these four conditions, we will need to see serological testing to see who has immunity.
  • And, it isn’t really under control until there is a vaccine.

Once the four benchmarks are reached, we should see gradual relaxation of social distancing measures.  Still, until herd immunity develops, we will likely see some continued modified social distancing measures, e.g., fewer restaurant tables, masks for those over 60 or with compromised immune systems, temperature testing at airports, etc.

• Although there is increasing optimism that the U.S. is “bending the curve” for new infections, this news needs to be tempered with the fact that the virus is starting to affect rural America. Sadly, the medical system outside of urban areas is less robust and thus the spread into less populated areas could bring an uptick in fatalities.  Meanwhile, in the cities, medical systems are reaching the point of triage, meaning that scarce medical resources are starting to be rationed.
• There are reports that the Defense Intelligence Agency warned the U.S. government about a unique coronavirus developing in China as early as November. There does appear to be some open source confirmation that this report is true.
• We continue to see what we know about COVID-19 evolve. For instance, in China, it looked like it was a scourge for the elderly, but not a big deal for younger people.  In the West, it has been surprisingly lethal to younger citizens.  One thought?  China may have underreported young fatalities.  Genome analysis is suggesting that most of the virus cases in New York came from Europe.  Thus, the China travel ban probably helped the West Coast but may not have done much for the East Coast.  The research also suggests it was circulating in New York as early as mid-February.  German researchers are finding that a large pool of cases are going undetected.  This is both good and bad news.  The good news is that a large number of cases could mean that herd immunity may be closer than we think.  The bad news is that there are asymptomatic carriers among us, meaning that easing social distancing measures may be fraught with risk.  AEI has a study trying to frame the actual infection rates in China; think 2.9 million.  Additional studies suggest the virus may spread 2x faster than earlier thought.  Finally, all this information suggests that (a) we don’t know all that much about COVID-19, and (b) it remains a mystery as to why there is such a wide variation in symptoms.  For many, COVID-19 is a mild cold; for others, it’s deadly.  It is hard to imagine a more effective virus.
• PM Johnson is reportedly “feeling much better.”
• As the curve bends in Europe, some countries are taking tentative steps to reopen their economies. These nations could offer guidance to U.S. officials as Washington prepares to ease social distancing measures in the coming weeks.  Reopening is tricky; open too fast and risk a return of infections.  But, open too slow and the economy suffers further.
• The U.S. National Stockpile of personal protective equipment (PPE) is nearly exhausted. The states are considering a consortium to buy medical equipment.  This development bears watching; if states band together for this issue it is not inconceivable that this could be done for other things…think health insurance.  As the Federal government steps back in certain areas, the potential for the vacuum to be filled by multiple states raises concerns about the regionalization of governance.
• Germany is sourcing PPE from China directly. The U.S. is restricting the export of PPE.

The policy news:

• BREAKING: The Fed announced it will purchase $2.3 trillion in new debt purchases which includes the government’s small business loans, municipals, mortgages, and, maybe, non-investment grade (yes, junk) bonds. Details are still sketchy, but the initial look is that this is yet another dramatic expansion of funding.  Apparently, the Fed is not planning on buying junk directly but the ETFs; this is a bit of a distinction without a difference.  We will be watching this going forward BUT THIS IS A BIG DEAL.  The Fed is getting deeper into the “weeds” of credit, increasing the odds that the bank will eventually take credit losses.  We have been watching the Fed’s balance sheet expansion with great interest; it is looking increasingly like it is trying to resolve the large private debt overhang (defined as household and non-financial corporate debt) by taking it on the public balance sheet.  The last time we witnessed this sort of public/private debt swap was WWII.  The alternative to dealing with this overhang is debt/deflation, which has become politically impossible.  The last 12 years of very low rates allowed the overhang to persist without triggering a downturn but also led to weak growth.  This debt swap may be the only way out, but there will be strings attached.
• The Fed minutes held no real surprises, but did clearly show a high level of concern.
• Europe continues to struggle to develop a response to the economic problems caused by the virus. It appears that the European Stability Mechanism (ESM), a body created during the 2010-11 Eurocrisis, will be the lending arm; Eurobonds look like a dead letter.  Apparently, northern European nations are open to lending out of the ESM but want “memorandums of understanding” that would put restrictions on borrowers.  This demand is toxic for southern Europe, a holdover of what Greece was required to accept during the Eurocrisis.  Thus, not much has been accomplished.
• Congressional bickering over additional fiscal support is making headlines; the GOP wants a quick add to small business lending, while the Democrats want to add more money and other funding. Although much ink (or electrons) is spilt over this wrangling, this is rather normal.  We expect something to be passed in the next week or so.
• The firehose of policy stimulus has a couple of caveats. First, using the banking system as a conduit has proven to be rather clunky.  Second, there is a surprising lack of oversight on both fiscal and monetary policy.  The lack of oversight at this stage opens up the potential for retroactive supervision years from now; you could see borrowers being questioned before Congress at some point.
• A warning: the CFTC is reporting a surge in new scams involving complex derivatives. The common feature is high fees.

The economic news:

• There are increasing reports that tenants are not paying their rent due to rising joblessness. As these payment flows stop, it is reasonable to expect that some sort of backstop will be necessary.  Meanwhile, similar concerns are developing for the mortgage market as well.  The leadership of the FHFA is indicating that aid to mortgage servicers isn’t likely, which probably means the Fed will need to eventually backstop that industry, too.
• State and local governments are increasingly vulnerable to rising demand for social services and falling revenue. It’s looking increasingly likely that the Fed will need to expand its support for this level of government borrowing.  Unlike the Federal government, state and local governments lack monetary sovereignty and thus can’t issue debt without tax revenue.
• All eyes remain on China as it emerges from lockdown. What is being seen is that restarting an economy on lockdown is difficult.  We are also seeing scattered reports of bank runs in China.
• Retailers are being severely hurt by the shutdown; it appears a wave of bankruptcies is coming.

The market news:

• We have been noting that globalization is retreating during the COVID-19 crisis. Food hoarding by countries is starting to become a problem.  If this accelerates, it could create instability in nations that are net food importers.
• Sanders (I-VT) has suspended his campaign.

The foreign policy news:

• China is coming nowhere close to its Phase 1 requirements. It remains to be seen how the U.S. will respond.
• Stimulus in China has been steady, but slow, especially in contrast to the aggressive actions of the Fed.

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

[Posted: 9:30 AM EDT]

Yesterday’s optimism about a potential peak in the coronavirus crisis is being undermined a bit today by reports of re-tightened lockdowns in some countries and the failure of EU finance ministers to agree on an aid program for hard-hit European countries.  We review all the key virus news along with other odds and ends below.

COVID-19:  Official data show confirmed cases have risen to 1,446,242 worldwide, with 83,424 deaths and 308,146 recoveries.  In the United States, confirmed cases rose to 399,929, with 12,911 deaths and 22,539 recoveries.  Here is the chart of infections now being published by the Financial Times:

Virology

• After declaring victory over the coronavirus and easing some travel and other restrictions in Wuhan city, Chinese authorities have quietly re-tightened some lockdown rules after dozens of citizens tested positive for the virus but were asymptomatic.  In fact, in the last eight days, more than two-thirds of those testing positive for the virus showed no symptoms.
  • The reports suggest there is still chance of a renewed outbreak that could force Beijing to reimpose its earlier draconian lockdowns.
  • Such a quick second wave could also force other countries to delay easing their restrictions until well after they get control of their new infections.
• Singapore, which had been praised for its early response and initial success in getting control over the virus, is now seeing a second wave that has forced the government to impose a near-total lockdown on the city-state.
• In Spain, now one of the key epicenters of the crisis in Europe, as many as 757 have died from the virus in the last day, marking the second consecutive rise in deaths after four straight days of declines.  However, the figure is still much lower than the peak of 950 less than a week ago.
• In England, another emerging hot spot in Europe, reports say actual deaths from the coronavirus through March 27 were almost double the official count, largely because of lagging counts and the failure to catch people who died but hadn’t been tested.

Real Economy

• The National Multifamily Housing Council has released a survey showing that as of April 5, just 69% of U.S. apartment renters had made their monthly payment compared with 81% in the same period during March and 82% in the same period as of April 2019.  The news is likely to weigh on REITs today.
• All the same, as signs emerge that at least the first wave of infections is peaking, government officials and corporate leaders are starting to develop plans for easing restrictions and reopening the economy.
  • Officials stress that reopening the economy will be a gradual process.
  • Key preconditions will be having a testing and surveillance system set up to detect a possible new outbreak, as well as plans to reintroduce restrictions if a new outbreak occurs.
• Glimmers of light are becoming even more visible in European countries that were quick to take steps against the virus.  Austria, the Czech Republic and Denmark have all announced that they will begin to loosen restrictions in the coming weeks.
  • Denmark has made the most far-reaching changes, saying this week that kindergartens and primary schools will reopen April 15.
  • The Czech Republic announced that shops selling some non-essential goods would be able to reopen on Thursday.
  • Austria said that small shops, DIY stores and garden centers would be able to open April 14.
• In contrast, evidence is building that poor, late-hit developing countries are facing increasing challenges from the virus, with India starting to suffer shortages of basic foods as workers get sidelined by the virus or social distancing rules.  In Thailand, rice prices have risen to a seven-year high.

U.S. Fiscal Policy Response

• President Trump and top lawmakers in Congress said they hope to approve hundreds of billions of dollars in additional funding for the newly created Payment Protection Program of small business loans, perhaps as early as Friday.  Demand for the loans has been higher than expected, raising concerns that the initial appropriation of $350 billion might run out.
• Along with the potential for PPP funding to run out and perceived difficulties in applying for the loans, the Small Business Administration is under fire for failing to meet a congressional directive to provide grants of up to $10,000 to businesses within three days of their application to its Economic Injury Disaster Loan program.  As we’ve noted before, it’s one thing for Congress to fund emergency virus programs, but how much they help the economy will depend largely on how well they’re implemented.

Foreign Fiscal Policy Response

• At yesterday’s virtual meeting to hammer out fiscal aid for Europe’s hard-hit countries, the EU’s finance ministers failed to reach an agreement.  The ministers will reconvene on Thursday in hopes of agreeing on recommendations they can make to EU leaders, but last night’s failure is still weighing on European stocks and Italian bonds so far today.
  • Press reports indicate the key holdouts were Italy and the Netherlands.
    • Italy, leading a group of mostly southern debtor countries that have been decimated by the virus crisis, is demanding the issuance of joint EU “coronabonds” to fund the aid, as well as the removal of any conditions on loans from the European Stability Mechanism.
    • The Netherlands, leading a group of northern creditor nations, is dead-set against mutual, EU-wide obligations and insists that any ESM loans be given on condition of economic reforms.
  • The dispute highlights how the crisis could potentially lead to a breakup of the EU as we discussed in our latest Weekly Geopolitical Report series on March 30 and April 6.
• The president of the European Research Council―the EU’s top scientist―has resigned after failing to persuade Brussels to fund a large-scale scientific program to fight the virus.
• A day after Japanese Prime Minister Abe announced an economic support program valued at ¥108 trillion, or about 20% of GDP, skeptical economists say the true value is much less because it takes into account multiple spending programs already in place.  Toshihiro Nagahama, chief economist at the Dai-ichi Life Research Institute, estimates the true amount of additional spending is only ¥16.8 trillion (about $160 billion).

Odds & Ends:  Afghan and Taliban negotiators have broken off talks on a prisoner swap meant to pave the way toward a peace agreement, just weeks after U.S. Secretary of State Pompeo rescued the talks from a similar near-failure.

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

[Posted: 9:30 AM EDT]

After yesterday’s strong market action, investors are again in risk-on mode based on optimism that the coronavirus pandemic may be peaking.  We report on all the key developments relating to the virus as well as building pressure for a cut in oil production and Chinese use of the pandemic as cover for more mischief in the South China Sea.

COVID-19:  Official data show confirmed cases have risen to 1,362,936 worldwide, with 76,373 deaths and 292,188 recoveries.  In the United States, confirmed cases rose to 368,449, with 10,993 deaths and 19,919 recoveries (though the recovery data is lagging).  Here is the chart of infections now being published by the Financial Times:

Virology

• For the first time since January 20, there were no reported deaths from the coronavirus in China (though it’s important to remember the country is suspected of seriously underreporting its experience with the virus).  Of the 32 new infections reported in the country, all were in patients arriving from overseas.  As shown in the chart above, multiple key countries are now showing the “bend in the curve” that suggests the rate of infection is slowing, even if the peak in deaths is probably still in the future.
• President Trump continues to press for widespread use of the antimalarial drug hydroxychloroquine to prevent coronavirus infections.
  • That suggests Trump is taking the advice of international trade advisor Peter Navarro rather than top pandemic advisor Dr. Anthony Fauci, who has asserted that the small studies to date on the drug’s effectiveness are “at best, suggestive.”
  • India said it is now willing to start exporting hydroxychloroquine again, but with restrictions.  According to the foreign ministry, it will focus its shipments on neighboring countries that have few alternatives to Indian supplies and countries where the virus outbreaks are the worst.
• Scientists are starting to investigate whether people’s genetic variations explain why some of the infected have only slight symptoms, while others get much more sick and die.

Real Economy

• In a new poll, 73% of Americans said the pandemic has reduced their family’s income, with 24% saying their income has been cut “very significantly.”  In the poll, conducted in late March, 71% of respondents said the pandemic had affected their personal or business activities, including travel and investments.  In a similar poll conducted in February, only 13% said the same.  The new poll also showed 62% were avoiding public places, 48% were changing or cancelling travel plans, and 35% were putting off a large purchase.
• Facing a continued rise in Japanese cases, Prime Minister Abe has declared a state of emergency that will give governors in seven prefectures the power to request business closures to increase social distancing.
• Philippine President Rodrigo Duterte has approved the extension of a community quarantine across the island of Luzon until April 30.

Financial Markets

• Goldman Sachs (GS, 158.23) has published a new analysis showing companies in the S&P 500 Index will cut their stock repurchases by half this year compared with last year, weakening a key prop for stock prices as they shore up their balance sheets.
• In the debt markets, continued downgrades by the major ratings firms have tripled the total value of “fallen angel” bonds (corporate obligations that previously were considered investment grade) to more than $120 billion in just the last few weeks.

U.S. Fiscal Policy Response

• In a reminder of how the crisis is affecting government power over the economy, President Trump said 3M Company (MMM, 140.70) has succumbed to his pressure to import more than 166 million N95 respirators from its factories in Asia to supplement the 35 million per month that the company produces in its U.S. facilities.  The deal will require the company to divert much of its foreign mask production from its Asian customers to the U.S., though it will still be allowed to export some respirators to Canada and Latin America.

U.S. Monetary Policy Response

• Launching yet another new program, the Fed said it is working with the Treasury Department to create a facility offering term loans to banks and other lenders to finance their participation in the new Payroll Protection Program (PPP) being run through the Small Business Administration.  The financing, to be backed by the lenders’ PPP loans, aims to increase the amount of loans the banks can make.
  • The program is separate from the Fed’s new Main Street Lending Facility, which will help businesses that are too large to qualify for help from the SBA programs and too small to receive aid from lending facilities the Fed is creating for large, highly rated corporations.
  • Together with the half-dozen other new lending and debt-buying programs launched by the Fed to support the economy, the new PPP financing program marks an enormous socialization of U.S. debt.  In the short term, the programs offer an important cushion for private-sector obligations.  They’ve already helped stabilize debt markets, at least for favored sectors.  In the longer term, they could morph into the substitution of public-sector debt for private-sector debt, as during the Great Depression and World War II.  Therefore, the programs will likely have a significant impact on issues ranging from the federal debt burden to economic growth and income equality.

Foreign Fiscal Policy Response

• EU finance ministers are meeting later today to hammer out a financial aid program for Italy, Spain, and other bloc members that have been hard hit by the virus crisis.  EU Economy Commissioner Gentiloni is pleading with member states to forget their past fights and rally behind an ambitious plan, including joint debt to fund economic support and reconstruction.  Hard-hit members like Italy and Spain complain the proposals on the table are insufficient, while creditor countries in the north, such as Germany and the Netherlands, continue to resist mutual obligations.
• Along with the state-of-emergency declaration, Japanese Prime Minister Abe announced a new economic support package amounting to ¥39 trillion ($357 billion).

Political Fallout

• As Prime Minister Johnson continues to fight the virus in intensive care, Cabinet Office Minister Michael Gove today declined to say whether full executive authority has been given to Foreign Secretary Dominic Raab, who is the prime minister’s designated stand-in as first secretary of state.  That suggests the British political system is unsure about how much power Foreign Secretary Raab really has.
• Poland’s right-wing Law and Justice Party last night used the coronavirus crisis to ram through a series of major electoral system changes, just weeks ahead of the May 10 presidential vote.

Global Oil Market:  Ahead of Thursday’s virtual meeting between OPEC, Russia, and other major oil producers to address the Saudi-Russia price war, Saudi Arabia and its OPEC partners are warning that global storage capacity will soon be completely full and prices could fall further.  The warning aims to put pressure on Russia and other major producers, including the U.S. and Canada, to cut output on Saudi terms in order to support prices.

United States-China:  The U.S. State Department has issued a statement condemning China for using one of its coast guard ships to ram and sink a Vietnamese fishing boat in a disputed area of the South China Sea last week.  The incident suggests China is again trying to assert its sovereignty over the region while the world’s attention is diverted by the coronavirus pandemic.

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

[Posted: 9:30 AM EDT]

Happy Monday!  Global equities are rising on hopes that the pandemic is stabilizing.  We update the COVID-19 news.  Here are the details:

COVID-19:  The official number of global cases is 1,280,046, with 69,789 fatalities and 265,462 recoveries.  Here is the updated FT chart:

We have received requests for a chart weighted by population.  We found this one yesterday.

Note that Japan’s numbers are rising at a slow pace but showing no signs of “bending.”  We suspect the recent action to declare a limited state of emergency (see below) is due to worries that an exponential rise may be in the offing.

The virus news:

• PM Johnson, the first G-7 leader with a confirmed case of COVID-19, has been hospitalized. Foreign Secretary Raab is the designated successor if Johnson becomes incapacitated.  The PM’s office is suggesting his hospitalization is just for observation but there are reports that his condition has worsened.
• U.S. officials are warning that this will be a difficult week.
• Some European nations are preparing to ease movement restrictions. Italy is considering serological testing to determine who can return to normal life and who must remain in lockdown.  Essentially, the presence of antibodies will determine if one has been infected and is now immune.
• Ventilators have been a point of discussion with COVID-19; this report suggests that being put on the device is a grave situation that the majority don’t survive.
• Japan has declared a state of emergency for seven prefectures. The area includes Tokyo.  There has been a surge of new cases in Japan.
• A tiger at the Bronx Zoo has tested positive for COVID-19, an apparent case of humans infecting other mammals.
• There have been a series of cell tower fires in the U.K. after rumors that 5G causes COVID-19 spread.
• On a lighter note, a Finnish tradition appears to be catching on in the rest of the world.

The policy news:

• Our position has been that the COVID-19 recession would be historically deep in terms of magnitude but short in duration. That belief was based on the expectation that policymakers would move quickly to support the economy and virus suppression efforts would relax by autumn.  Like all our forecasts, they are always subject to re-evaluation.  We have three immediate concerns:
  • Although Congress moved with uncommon speed to pass a $2.0 trillion support package, passing is one thing…execution is another. On Friday, small businesses were able to apply for loans for the first time.  Reports suggest the program has not gone well.  First, the Treasury didn’t get rules to banks until late Thursday.  Second, banks put their own restrictions on the loans.  Borrowers went to banks to apply only to be turned away or faced with a myriad of rules.  Compare this mess with how Switzerland executed its program.  This stimulus will do little good if the process fails to deliver funding soon to small businesses.  We also note that large restaurant and hotel chains can tap this program, which probably means it will run out of capacity quickly.
  • While $2.0 trillion is a massive program, it probably isn’t enough. Here’s a way of thinking about it—nominal U.S. GDP is near $22.0 trillion.  That means the U.S. economy generates around $418 billion per week.  The stimulus will fund the U.S. economy for about five weeks.  Obviously, we haven’t lost the entire economy; some level of business is still being conducted.  At the same time, 80% of U.S. counties, representing 96% of GDP, are on lockdown.  If the economy remains stalled beyond five or six weeks, additional help will probably be necessary.  Congress needs to be working on this now, just in case.
  • That being said, we do give credit to the Fed for moving rapidly and, so far, effectively. We still think that at some point the central bank will need to dip into the junk bond market and support at least down to “B,” simply because too many large companies have fallen into the category.  Estimates now suggest the Fed’s balance sheet could end up at $9.0 trillion, well above its current $5.8 trillion, before things settle.
• Meanwhile, Germany continues to push back against a Eurobond, instead calling for more emergency lending. If this continues, the Eurozone will be in grave danger.
• The UN is warning that it is facing a budget crunch due to spending on COVID-19.

The economic news:

• One observation from Friday’s March employment report is that there was significant divergence between the payroll survey and the household survey with reference to employment.  As most of you are aware, the employment report consists of two different surveys, one gathered from employers and the other from households.  The employer survey is where the non-farm payrolls number is generated.  The household report is where the unemployment rate comes from.  The two numbers often diverge; the payroll report will capture those working at traditional businesses, while the household report is better at capturing sole proprietors and gig workers.  In March, payrolls fell 976k; employment from the household survey plunged 2.9 million.  The household survey is sobering, suggesting conditions are much worse than they look.

• Emerging market economies are reeling from COVID-19. Default risks are rising, reflected in recent dollar strength.
• Supply chains are payment chains in reverse. Goods and services flow one direction, money the other.  Supply chains work due to financing.  There are growing worries, again seen in recent dollar strength, that these supply chains are being threatened by funding issues.
• Texas is being especially hard hit from COVID-19.

• Shipping firms are facing an employee problem. Some sailors are stuck in port due to lockdowns.  This is leaving ship crews working extreme hours.  Simply put, those on ships are being stretched to the limit, while others can’t get to their vessels.
• Hoarding isn’t just for households. Countries are restricting food exports.

The market news:

• Oil prices plunged overnight on news that a spat between Russia and the Kingdom of Saudi Arabia (KSA) has delayed today’s scheduled meeting on output reduction. The meeting will be held on Thursday.  We have seen prices rally off the lows as the market is betting that a deal will be made at some point.  However, the fact that a “you started it; no, you started it” fight between adult leaders of Russia and the KSA has led to a delay is a clear indication that managing these egos will be a challenge.
• Meanwhile, President Trump has backed away from his threat to implement tariffs on oil. Although such ideas have been circulating for some time, it is important to note that a tariff might not be all that effective in propping up prices.  Assume the U.S. puts a $10 per barrel tariff on imported oil.  Foreign prices will likely fall in response, but perhaps even more importantly the dollar will soar.  The dollar strength will have unintended consequences for the global financial system.  If the government wants to support oil producers (after all, why should any government outside of OPEC want higher oil prices), a better tactic would be to do what we do for farmers.  Simply set a price for oil and pay oil companies the difference between the world price and the desired price.  Although this would require a massive “spend” of political capital, we could see it as part of a stimulus bill.
• So, will we get a deal or not? We suspect that a deal will be struck and will likely collapse in short order.  Both Russia and the KSA want a wide agreement with other producers to prevent the loss of market share.  However, any reading of cartel behavior shows that the larger the cartel, the less likely it is that it will avoid free riders.
• One interesting piece of evidence on how much oil demand has declined: air quality around the world is showing remarkable improvement.
• One fallout from the virus is that Chinese household borrowing is slowing rapidly, and bad debt is rising.

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