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

[Posted: 9:30 AM EDT]

Happy Friday!  It’s employment Friday, although this may be one of the most irrelevant reports ever.  Since the survey is conducted around the 10^th of the month, much of the jump in claims won’t be reflected in this report.  But, our quick take is that the weakness was profound as payrolls plunged 701k and the unemployment rate jumped to 4.4%; we have the details below.  We update the COVID-19 news.  Global stocks are under pressure, while oil makes a historic rally.  Here are the details:

COVID-19:  The official number of global cases is 1,030,628, with 54,137 fatalities and 218,771 recoveries.

The virus news:

• As the data above show, there are now over 1.0 million reported cases of the virus. We believe this is a deep undercount.  A new concern has emerged: the tests for the virus may be much less reliable than we thought and could be generating false negatives.  In one sense, if a person is sick and getting tested, a false negative probably won’t change their behavior.  They don’t feel well in the first place, which is why they wanted to be tested.  However, false negatives bring an undercount and will make the virus appear more deadly than it actually is.
• The real fix is a vaccine; although there is hope that one might emerge by autumn, more likely we will see one by H1 2021.
• NYC is looking increasingly grim. The city now has 45 mobile morgues in operation as the city’s death toll is now over 1,500.
• Critical drugs necessary to treat patients of COVID-19 are in short supply, exacerbating difficulties. Having a ventilator but lacking the drugs to sedate a user makes the device less effective.

The policy news:

• The special lending and cash distribution programs are starting to operate and the early read is not encouraging. The details of the small business loan program have not been fully determined.  Community banks complained about the interest rate on the loans, so the administration lifted it to 1% instead of 0.5%.  Meanwhile, distribution of virus checks may not be fully realized until September.  Passing the laws to stimulate the economy was a major win, but execution is the next step and, given the scale of the programs, it will not be seamless.  And, the administration has apparently eased regulations on paid leave, which could reduce its effectiveness.
• One of the problems in managing a crisis is that it is hard to determine how intertwined an area of the market is to the entire system. If Bush administration officials had realized how important Lehman debt was to the money market sector, we doubt they would have let the firm fail.  At the same time, there is always a worry that if you bail out everyone, you create moral hazard; in other words, policymakers reward bad behavior.
  • We are seeing a dramatic spike in credit downgrades, leading to a cascade of fallen angels.[1]

The chart shows that for the month ending March 20, $32 billion has left investment grade.  The past two weeks have been far worse.  A net $560 billion of corporate debt has been downgraded, with $97 billion now officially fallen angels.

• The Fed’s various support programs purposely exclude high yield. Bill Dudley, the former NY FRB president, recently argued that the Fed should not include such bonds on the basis of moral hazard.  We understand the sentiment but would argue that now is not the time to enforce market discipline because it is very difficult to know which debtor will trigger systemic problems and which won’t.
• We have been generally optimistic, all things considered, because of the aggressive policy response. Although we remain so, we are worried that the combination of the lack of execution and short-sighted reluctance to support all borrowers will trigger unanticipated negative outcomes.  To quote the recently departed Kenny Rogers, “…there will be time enough for countin’ when the dealin’s done.”
• Another area to watch is mortgages; defaults are almost certain to spike, and we doubt the nation would tolerate another response like we saw after the Great Financial Crisis.
• Members of the FOMC are pressing for more fiscal stimulus.

The economic news:

• As we continue to digest the incoming U.S. economic data and how it’s starting to reflect COVID-19, we think it’s important to emphasize that the March ISM Manufacturing Index released this week probably overstated the health of the factory sector.  The overall index fell to 49.1 in March, only modestly below the 50 level that indicates expansion, and not dramatically weaker than the readings of 50.1 in February and 50.9 in January. The figure for March was actually above every reading from August through December 2019.  The problem is that the overall figure is the average of five subindexes (new orders, production, employment, supplier deliveries, and inventories), and the subindex on supplier deliveries has been distorting the overall number for several months running.  That subindex measures how long it takes for manufacturers to get their supplies delivered once they’ve placed their orders, with the idea that delayed deliveries are a sign of high demand and strong factory activity.  When the subindex is higher, it means more manufacturers are experiencing delayed deliveries.  The problem is that the recent high numbers for the subindex are more a reflection of supply chain disruptions from last year’s trade war and this year’s virus shutdowns rather than high demand or strong manufacturing activity.  Excluding the distorted supplier delivery subindex from the calculation, the overall ISM Manufacturing Index for March would have been just 45.2, its lowest reading since May 2009.  That’s additional evidence that the economy has now slipped into a deep contraction.  Since the virus shutdowns are sure to keep the subindex on supplier deliveries high over at least the next couple of months, we’ll continue to focus on our adjusted measure of the ISM index to get a better sense of how the factory sector is faring.

• The chart above shows how the ISM Manufacturing Index, if computed excluding the subindex on supplier deliveries, is now at its lowest level since late in the Great Recession of 2008-2009.
• We are seeing a steady stream of reports of layoffs, buyouts, and furloughs. We are also seeing reports of wage cuts to maintain employment.

The market news:

• The key market news is oil. Prices leaped yesterday on reports that President Trump had engineered a meeting of OPEC and Russia with tentative promises of production cuts.  Prices are higher this morning on reports that OPEC+ will hold a virtual meeting on Monday to discuss output reductions.
• It appears the KSA is trying to get as broad of a group as possible to agree to reductions. This makes sense.  The wider the agreement, the better the chances of success…with one caveat.  Cartels always suffer from free riders.  Although all participants benefit from output constraints, an individual member has a great incentive to cheat.  We do expect some sort of deal on Monday, with promises of 10.0 mbpd of production cuts.  We do not expect cuts of this magnitude to be achieved.  At best, 3.0 to 5.0 mbpd is about all that can be expected, and we seriously doubt Russia will actually cut anything.  Failing to make any sort of deal at this meeting would be a disaster but it would be naïve to expect that compliance will be anywhere near what is promised.  This doesn’t mean a deal won’t have an impact; if the KSA doesn’t raise output to 12.0 mbpd, we probably avoid single-digit oil prices.  But, even with a deal, demand destruction is still a reality and prices in the $20s will be with us for a while.
• Add this industry to others that have found fortune in the era of COVID-19.

Foreign policy:

• Russia has extended its stay-at-home order, while Brazil continues to shun such measures.
• It appears the U.S. and China have engineered a truce of sorts in their recent rhetoric battle.
• The IMF is poised to support the EM markets with a $1.0 trillion loan package.

View the complete PDF

---

[1] A fallen angel is an investment-grade bond that has been downgraded to junk status and can no longer be held in an investment-grade bond portfolio.

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

[Posted: 9:30 AM EDT]

Good morning!  After a drubbing yesterday, we are seeing a rebound in global markets this morning.  One of the factors helping sentiment is a 10% jump in crude oil prices.  The White House is continuing to talk to Russia and the KSA, and the president is meeting with energy executives.  However, Moscow has indicated it won’t change its policy anytime soon.  China announced it is buying oil for its strategic reserves.  Linked here is our updated Weekly Energy Update.  We update all the COVID-19 news, including some charts on what is happening in the economy.  Here are the details:

COVID-19:  The official number of global cases is 951,901 with 48,284 fatalities and 202,342 recoveries.  The FT did not issue an infection chart; we will try to find one for tomorrow.

The virus news:

• One of the characteristics of COVID-19 is a high number of asymptomatic cases. Sampling in Iceland suggests 50% of those who tested positive had no symptoms.  It may turn out that the disease is much more widespread than we think and we may achieve herd immunity quicker.  However, until testing becomes widespread and, perhaps even more importantly, serological testing is developed to determine who has immunity, nations are stuck with implementing difficult quarantine measures.  At the same time, those who are asymptomatic, during their infectious phase, become innocent carriers of the disease.
• Viruses mutate; China is warning that some patients seem to have a form that has very mild symptoms but shed the virus for long periods of time. If this mutation is real and spreads, the only hope is a vaccine.
• U.S. intelligence agencies are claiming that China concealed the extent of the outbreak; the fact that the U.S. has more cases with one-third of the population supports this theory.
• Latin America is becoming the next hotspot for infections. Brazil has been adamant about not implementing social distancing measures.  Although this policy runs counter to how most of the rest of the world is dealing with the crisis, poor nations with high levels of informal workers may not have much choice.  There are really two methods of dealing with a pandemic—one is to try to “flatten the curve” via social distancing measures so that the health care system can cope with the influx of infections.  This approach reduces infections but tends to extend the impact of the pandemic because herd immunity is slower to develop.  The other method is to simply accept that mortality will be really high but the impact will be short.  In developed nation democracies, the political impact of doing nothing is probably not feasible.  But, in the emerging world, allowing the disease to run its course may be a possible option.  Brazil appears to be a test case, although Mexico is operating similar policies.
• Italy is probably undercounting its death toll.
• As we learn more about the impact of the virus, it appears to have greater impact on men.
• Wimbledon has been canceled.
• Most U.S. states have now issued stay-at-home orders.
• Although China has been getting back to work, we are hearing reports of renewed quarantine efforts as new infections appear.

The policy news:

• While the White House is discussing an infrastructure package and House Democrats are preparing a fourth stimulus package, it doesn’t appear the Senate is ready to do anything further. We suspect another fiscal injection will be required.
• As we noted in the last WGR (which will be wrapped up in next week’s report), the EU is under tremendous strain. Italy desperately needs Germany to act as a benevolent regional hegemon.  Meanwhile, France is making aggressive efforts to maintain employment by giving aid to companies who are, in turn, required to keep workers on the payroll.
• The Fed continues to aggressively address liquidity issues; its last action is to ease reserve calculations by excluding Treasuries up to a year and central bank deposits when establishing leverage ratios. As we noted yesterday, the Fed is also showing itself as the world’s central bank.  This role was generally unspoken before; now it is explicit.

The economic news:

• Initial claims jumped to 6.65 million, a new record. We cover the data below.  There has been a surge in layoffs reported recently and the data confirm it.
• We are seeing a surge in worker revolt. Production workers, delivery drivers, health care workers, warehouse employees, and grocery clerks are starting to push back against what they see are unsafe working conditions.  They have high leverage at this moment.

The market news:

• China is expecting a surge of bad loans due to the COVID-19 downturn; in response, it is setting up a distressed debt market to manage this problem. The numbers are staggering, perhaps $1.5 trillion.
• Increasing oil shipments and storage is boosting tanker rates.

Foreign policy:

• Mask diplomacy is becoming a big deal. China is sending masks around the world and using this action to project soft power.  Russia is engaging in similar activities. Meanwhile, Congress is pushing to collapse medical supply chains away from China.
• The machinery of U.S. bureaucracy grinds slowly; as U.S. states and cities scramble for medical protective gear, the U.S. is sending such goods overseas. This is simply a case of the bureaucracy acting as it normally does and the executive branch not keeping up.  It does appear the White House is getting in front of these shipments and halting them.

Iran:  There are reports that Iran is planning attacks on U.S. military bases in Iraq.  The U.S. is warning Tehran against such actions.

View the complete PDF

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

[Posted: 9:30 AM EDT]

Happy April Fool’s Day!  But please don’t expect any foolishness here!  As always, we soberly review the latest U.S. projections on the course of the COVID-19 pandemic, which have rattled the markets so far this morning.  We also note the Fed has come out of the closet as the world’s central bank (see detailed discussion below), while Europe continues to struggle with a way to support its economy.

COVID-19:  Official data show confirmed cases have risen to 874,081 worldwide, with 43,537 deaths and 185,194 recoveries.  In the United States, confirmed cases rose to 189,633, with 4,081 deaths and 7,136 recoveries (though the recovery data is lagging).  Here is the main chart of infections now being published by the Financial Times:

• Virology.  In its daily news conference yesterday, the Trump administration laid out the projections that prompted the president to back down from his goal to end the nation’s lockdowns as early as April 12.  If strict social distancing is maintained, the projections call for a total U.S. death toll of 100,000 to 240,000, versus as many as 2.2 million if social distancing is abandoned.  The projected number of serious cases is many times greater, so the key issue will be how badly local health systems are overwhelmed.  The statements appear to be a major factor in pushing U.S. equities sharply lower so far today.

• • Highlighting the political danger from mismanaging the pressure on a health system, British Prime Minister Johnson is being criticized for insufficiently testing NHS doctors and other workers in self-quarantine. The few tests done to date indicate only some are actually infected, suggesting they’ve been pulled from the front lines for no good reason.
  • Several European countries have adopted the Asian strategy of urging everyone to wear masks in public, based on growing evidence that people experiencing no symptoms can spread the disease more widely than previously thought. In the U.S., CDC Director Dr. Robert Redfield said his agency is reviewing its recommendation that healthy people who aren’t hospital workers should refrain from using masks.
  • About 70 crew members on the U.S.S. Theodore Roosevelt have now tested positive for COVID-19, prompting the aircraft carrier’s commander to order the remaining 5,000 or so sailors into quarantine in vacant hotels on Guam.
  • Now that China has gotten egg on its face from the faulty masks and test kits some Chinese firms have sold abroad, the government has banned firms from exporting medical supplies if they’re not licensed to sell them domestically.

• Real Economy.  IHS Markit said its final March PMI for the Eurozone manufacturing sector came in at a seasonally adjusted 44.5, modestly lower than the flash estimate of 44.8 and the final February reading of 49.2 (see data tables below).  In the U.K., the IHS Markit/CIPS manufacturing PMI fell to a three-month low of 47.8 in March versus 51.7 in February.  As with all major PMIs, readings under 50 point to falling activity.
• Financial System.  In a welcome sign that the junk bond market may be stabilizing after seizing up in early March, junk bond prices have improved a bit this week.  At least two major firms have also been able to float riskier debt.  Below-investment grade obligations are still trading at elevated spreads over U.S. Treasuries, but the improved market dynamics suggest that aggressive fiscal and monetary policy may have turned the tide.  All the same:

• • Reports note a massive shriveling in the market for unconventional mortgages, which aren’t backed by the government and therefore aren’t being bought by the Fed. Multiple firms have stopped offering the mortgages, denying financing for many irregular or self-employed people who find it difficult to qualify for a conventional mortgage.
  • Under pressure from the Bank of England, most of the U.K.’s major banks have agreed to suspend their dividends and stock buybacks in order to preserve capital during the crisis. The regulators also expect them to refrain from paying bonuses.  As might be expected, the news has driven British bank shares sharply lower so far today.

• U.S. Fiscal Policy Response.  President Trump has called for $2 trillion in new spending on infrastructure to help rekindle economic growth after the coronavirus crisis passes.  The new spending, which would follow the three major economic support bills already passed into law, would be paid for by borrowing at today’s super low interest rates.  House Speaker Pelosi has also been calling for a “Phase 4” economic bill that includes infrastructure investment, but Senate Majority Leader McConnell hasn’t been supportive.  Separately:

• • Major private-equity funds are lobbying hard for their portfolio companies to be deemed eligible for the $350 billion in small-business rescue loans included in last month’s economic support package.
  • Flight attendant unions are urging Treasury Secretary Mnuchin not to make airline rescue grants contingent on transferring an equity stake to the government, as allowed in the Phase 3 package. The flight attendants fear the stake provision amounts to a “poison pill” that would discourage airline executives from accepting the money and result in mass layoffs.

• U.S. Monetary Policy Response.  Launching yet another new rescue program, the Fed said it will temporarily allow approximately 170 foreign central banks and international monetary authorities to borrow dollars by pledging the U.S. Treasuries they hold at the New York FRB.  The new “FIMA Repo Facility” will supplement the currency swap facilities already in place with more than a dozen major central banks.  Amid the global scramble for dollars touched off by the coronavirus crisis, the Fed said a key aim of the facility is to give foreign central banks access to the dollars they need without forcing them into disruptive sales of their Treasury holdings.  The facility will likely be considered especially helpful for smaller emerging markets, though China was probably the key country under consideration.  In a broader sense, the facility may be one of the most radical, risky, and controversial of the Fed’s many moves to counter the crisis as it amounts to a full, unabashed embrace of being the world’s central bank or the global lender of last resort.  That role is clearly at odds with the broader U.S. trend toward deglobalization, and it is out of sync with the administration’s policy of withdrawing from the traditional U.S. role as global hegemon.
• Foreign Fiscal Policy Response.  The EU continues to struggle to come up with fiscal programs that can cushion the blow from the crisis without generating pushback from the northern creditor members.

• • European Commission President Ursula von der Leyen formally proposed the creation of a new EU unemployment reinsurance program to help national governments finance short-time wage subsidies, which are designed to discourage firms from laying off workers when orders dry up.
  • To help Europe recover from the coronavirus, French Finance Minister Le Maire proposed an EU-wide facility funded by common EU debt, but the program would be limited to five or 10 years and focused strictly on economic recovery to head off German and Dutch objections to mutualizing obligations.

View the complete PDF

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

[Posted: 9:30 AM EDT]

As March draws to a close today, we’re reminded of the old adage about the month: in like a lion, out like a lamb.  After what we’ve all gone through during the last month, we certainly hope for a day that’s as quiet and gentle as a lamb!  As always, we review all the key news on the coronavirus epidemic and related, market-relevant items.

COVID-19:  Official data show confirmed cases have risen to 801,400 worldwide, with 38,743 deaths and 172,657 recoveries.  In the United States, confirmed cases rose to 164,610, with 3,170 deaths and 5,945 recoveries (though the recovery data is lagging).  Here is the latest chart of infections from the Financial Times:

• Virology.  Two research groups affiliated with the Chinese insurance giant Ping An (2318.HK, 76.70) yesterday projected that new infections will peak no later than this weekend in key countries including the United States.  The projections seem rosy to us, especially since they show U.S. infections topping out at just 300,000.  Besides, a respected model from the University of Washington still projects the U.S. peak hospital usage will come later, on April 15.  All the same, we think the Ping An researchers’ model sensibly incorporates factors such as how late the countries started to enforce social distancing, their population density, the share of their population aged 60+, the number of intensive-care hospital beds they have available, and the level of public support for their officials’ lockdown orders.  Those markers are probably worth watching to gauge the future course of the pandemic.

• • As serious COVID-19 cases start to overwhelm the medical resources available in New York City, one of the nation’s top academic medical centers there told emergency room doctors that they have “sole discretion” to decide whether to place patients on ventilators or to “withhold futile intubations.” In other words, rationing.
  • China for the first time admitted that its official tally of cases excluded people who were infected but not showing symptoms. Officials said they will begin counting asymptomatic cases on Wednesday.
  • U.S. spy agencies have been tapped to try to figure out the true incidence and impact of the virus on China, Russia, North Korea, and Iran.
  • In a reminder that human folly, carelessness, or malintent could all be at play here, reports say U.S. customs officials in recent years have often intercepted Chinese scientists trying to transport undocumented and undeclared biological substances – including SARS and MERS samples – into the U.S.
  • While the crisis is opening up new opportunities for healthcare firms (especially in telemedicine), there are also new threats. The heads of the WHO and Unitaid, a UN-backed group funding global health innovation, are supporting a proposal that would force companies to pool their intellectual property related to coronavirus treatment, vaccines, and diagnostics and make them available at low cost to world governments.

• Real Economy.  As consumers continue to stock up on grocery staples, and as production and logistics systems continue to snarl, global grain prices have jumped 15% or more in recent weeks, in contrast with the steep price declines for many commodities facing reduced demand because of the pandemic.  However, grain stockpiles are actually relatively high, suggesting prices could quickly drop again as the crisis passes.

• • The All-England Lawn Tennis & Croquet Club meets on Wednesday to determine whether to hold this year’s Wimbledon Tennis Tournament. Observers expect the June 29 tournament to be canceled for the first time since World War II.
  • As China continues to restart its economy, its official purchasing managers’ index for manufacturing rebounded to 52.0 in March from its record low of 35.7 in February. That was a welcome surprise as the index had been expected to remain significantly below the 50 level that indicates expanding activity.  However, even the statistical agency warned not to interpret the rebound as a sign that China has had a “V-shaped” recovery and is now back to full health.
  • As if to underline that recovery from the pandemic will be a stop-and-go affair, some recent moves by Chinese local governments to reopen movie theatres, tourist attractions, and other venues have been reversed on fears of a rebound in infections.

• Financial System.  New reporting suggests U.S. and European banks are struggling with about 100 “warehouse” credit lines to collateralized loan obligation marketers.  The credit lines provide temporary funding to CLO managers as they build portfolios of lower-quality loans that are later marketed to investors.  Those assets have now plummeted in value, leaving the banks with an undisclosed amount of potentially problematic loans.
• U.S. Fiscal Policy Response.  The Treasury Department said the government will begin sending out stimulus payments to households in the next three weeks, with no action required for most people.  For people who don’t regularly file tax returns, the government will create a web portal for people to upload their direct-deposit information to the IRS.  Separately, Secretary of Labor Eugene Scalia said the federal government will release the recently approved funds to boost jobless benefits this week, but how quickly those payments reach laid-off workers depends on overburdened state unemployment systems.
• Foreign Fiscal Policy Response.  Just three weeks after the U.K. released a budget calling for £156 billion in bond sales in fiscal 2020-2021, the government issued a revised plan calling for a total of £46 billion in April alone.  Separately:

• • Klaus Regling, the managing director of the EU’s European Stability Mechanism, poured cold water on the idea of issuing EU-wide “coronabonds” to finance the bloc’s response to the pandemic. According to Regling, it would take between one and three years to set up a new European institution to issue such debt.  However, in an apparent olive branch to hard-hit Italy and Spain, he did suggest aid in the short term could be funded via existing bodies and instruments.
  • Similarly, Eurogroup President Centeno said in a letter to EU finance ministers that coronavirus aid could be raised using existing institutions and mechanisms, though “alternatives” could be considered. He also called a meeting of all 27 EU finance ministers to discuss aid next Tuesday.
  • As a reminder, our latest Weekly Geopolitical Report, published yesterday, examines how the disputes over coronavirus funding have the potential to cause a breakup of the EU.

• Political Implications.  Russia has sent military medical units to Italy in order to help it deal with the crisis, echoing China’s effort to burnish its image by sending aid abroad.  Separately, Hungary’s parliament gave Prime Minister Viktor Orbán the right to rule by decree until his government decides the coronavirus crisis has ended.

Global Oil Market:  Two major shale producers in the Permian Basin have asked Texas regulators to consider curtailing crude output in the state as the industry grapples with collapsing demand and plunging prices.  Meanwhile, poorer oil producers such as Iraq and Venezuela are being forced to consider steep budget cuts as low oil prices cut deeply into their revenues.

View the complete PDF

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

[Posted: 9:30 AM EDT]

Good morning and happy Monday!  Before we begin, we want to note a correction from our Friday comment; we erroneously reported the NHL had cancelled its season.[1]  That wasn’t true, and we apologize for any confusion.  Global equities are lower and oil prices are testing $20 per barrel.  However, U.S. equity futures are ticking higher.  We update all the COVID-19 news, including some charts on what is happening in the economy.  Here are the details:

COVID-19:  The official number of global cases is 735,560 with 34,830 fatalities and 156,380 recoveries.  There is growing skepticism over China’s numbers; this is especially pertinent given media reports that the U.S. now has more cases than China.  Here is the usual FT chart:

There is a recognizable “bend” developing in the U.S. infection rate.  That is potentially good news.

The virus news:

• President Trump has extended social distancing guidelines until the end of April. There had been rumblings of ending social distancing by mid-April, but the continued surge of cases has led the government to continue the current policy.
• There is growing speculation that China may have drastically undercounted fatalities from COVID-19. There are reports that the level of cremations is far exceeding the reported 2,500 deaths from the virus in Wuhan.  Although it may be possible that people died of something else, it is also possible that officials only reported those who were tested and died and did not perform autopsies on the others.
• Meanwhile, the world is watching China’s slow return to work to see how an economy recovers from lockdown.
• It appears that hospital workers in the Netherlands may have been asymptomatic carriers of the virus. If so, they may have been inadvertent vectors of the disease.
• Although China has tried to gain goodwill by sending medical devices to nations affected by COVID-19, it turns out much of what was sent was defective, blunting the soft-power effort. It seems that the crisis policy of retooling other factories for medical device production had flaws.
• One of the world’s largest producers of ventilators, Drägerwerk (DRWKR, $104.50), is warning of a global supply shortage even though it is rapidly increasing production. The FDA has approved the emergency use of hydroxychloroquine and chloroquine for treating COVID-19.  Virus transmission in Seattle appears to be slowing, giving hope that social distancing is working; however, without aggressive testing and serological following for immunity, we still don’t really know for sure.

The policy news:

• Congress and the White House are already preparing for “Phase 4” of the stimulus program. The general consensus is that the preceding measures will merely offer support to those affected by COVID-19 and act as a stopgap.  Restarting growth will be another matter.
• Congress is “rearming” the Fed, boosting its ability to begin lending directly to businesses and local governments. These new powers are significant; one of the problems that hampered the response in 2008 was that the Fed pushed liquidity into the banking system, where it sat idle.  That led to calls among left-wing politicians for direct central bank support; in Britain, Jeremy Corbyn called for “QE for people.”  These new powers are a step in that direction—the Fed would be simply bypassing the financial system and putting money directly into the economy, à la MMT.  This development comes in the face of a severe testing of the U.S. social safety net.
• The U.S. plans to suspend tariff collection for three months.
• The next battle brewing could be in insurance. The industry is claiming that policies it has written specifically exclude pandemics; governments beg to differ.
• Across the pond, there are a couple items of note. First, Italy’s widespread “off the books” labor market means that millions of workers will be excluded from government support measures.  And, there is a deep battle brewing in the Eurozone; a growing roster of nations, mostly in the south, are pressing for a Eurobond, a bond backed by the full faith and credit of the entire (read: Germany) Eurozone.  Needless to say, Germany and the Netherlands are opposed to such measures.  As we are reporting over the next two weeks in the WGR, the fracturing of the EU is becoming a geopolitical concern.

The economic news:

• Although the employment news is bad, we are seeing aggressive hiring in logistics, medical and large retail. This is a massive shift in the labor market.

The market news:

• Banks and other lenders are tightening lending standards as borrowing demand rises. Historically, lenders are pro-cyclical; they tend to increase lending in good times and withdraw it in bad times.  Unfortunately, this sort of behavior makes the recession worse.  Hence the entry of the Fed into direct lending.
• There are three charts we want to note this morning. First, there has been a flight-to-government money market funds (IMMK) and away from prime funds.  During the 2008 Financial Crisis there was similar activity.  The second chart updates the retail MMK and S&P 500, while the third chart shows how foreign central banks are drawing the Fed’s swap lines.

In 2016, SEC regulations changed and allowed the NAV on MMK to deviate from $1.00 per share.  This change prompted a flight into government funds.  However, we did see a modest recovery in prime MMK until recently.  As financial stress has increased, so has the exodus from prime MMK.

Second, readers will be familiar with our retail MMK/S&P 500 chart, which is updated below.

When the trade war expanded in early 2018, retail investors began building cash positions.  This positioning accelerated despite the rally in stocks from Q2 2018 into February of this year.  But, as stocks have declined, MMK has risen sharply.

Third, the Fed’s forex swap lines are being drawn aggressively.

These swap lines are used by foreign central banks to provide dollars to their borrowers who have dollar-denominated debt.  As financial stress has increased, we have seen the dollar rally.  In 2008, the dollar weakened only after the draw on foreign currency swaps declined.

• Oil prices continue to spiral lower. A couple news items of note.  First, the recently passed stimulus bill failed to include funding to purchase oil for the SPR.  Second, gasoline crack spreads, which is a rough measure of refining margins, have dipped under zero recently.  The chart below shows that a barrel of gasoline is trading below the cost of a barrel of oil.  If this continues much longer, we will likely see refining activity decline which will put additional pressure on prices.

• Compounding problems for oil is that the calendar spread, the spread between spot and deferred futures, remains wide. This allows firms to buy oil in the spot and sell it in the future, pocketing the gain.  This activity will continue until storage reaches capacity; it is at that point that oil prices will collapse.  We are seeing shipping rates for oil tankers rise as firms are starting to use tankers for storage.
• The last time the U.S. shale industry was threatened, in 2016, once prices recovered production returned even stronger. That outcome is less certain this time around—the price decline will be deeper and longer and financing may be slower to return.  We expect the price weakness to last longer because Russia is better positioned than the usual OPEC nation to take on the KSA.  There are breaking reports that President Trump will be calling President Putin to talk about oil today; we will see how that goes but would not expect much help from Moscow.
• One area we are watching with increasing interest is real estate. We know that as households and businesses lose income their ability to service mortgages or maintain rent is coming into question.  One factor we are investigating are rules that limit the liability of a commercial lessee for breaking a lease.  Section 502(b)(6) is the part of the commercial code that deals with unpaid leases in bankruptcy.  The bottom line is that the landlords of commercial firms may find their remedies in bankruptcy are rather constrained and this may explain part of the recent weakness we are seeing in REITs.
• There are rising concerns about widespread EM defaults; the rise in the dollar is probably a symptom of this worry. At the beginning of the year, four EM nations’ dollar debt was at distressed levels; that number is up to 18.  Another complication is that China has become a larger lender into the EM space.  It isn’t clear how China will deal with bad loans, but we would expect behavior more akin to the 18^th
• LIBOR’s replacement, SOFR, is failing miserably as a new rate tool in the crisis. We wonder if one of the outcomes of COVID-19 will be the resurrection of LIBOR.
• Just when we need them most, there is an apparent shortage of jigsaw puzzles.

Foreign policy news:

• Russia and China are using the crisis to sow dissention through social media by releasing disinformation and spreading unfounded conspiracy theories. And, as has been the pattern, the social media firms are failing to police these actions.
• U.S. sanctions have exacerbated the impact of COVID-19 on Iran.  The U.S. is pulling troops out of the K1 base in northern Iraq, the third pullout this month.

View the complete PDF

---

[1] One of the dangers of working from home is overhearing members of the household making unsubstantiated claims.  Going forward, we will rely on Ronald Reagan’s dictum of “trust but verify.”