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

[Posted: 9:30 AM EST]

Global equity markets continue under pressure this morning, despite rumors that some Asian “national teams” are trying to support the market.  U.S. equity futures are trying to stabilize.  We update the COVID-19 news, along with an update on Brexit.  Here are the details:

COVID-19:  The number of reported cases is now 81,191 with 2,768 fatalities.  South Korea now has 1,261 confirmed cases and Italy is up to 322.  Iran has 139, including its deputy health minister.  The U.S. has 57.  Brazil is likely to confirm its first case today.  A U.S. soldier stationed in South Korea has contracted the disease.  The WHO is still not declaring a pandemic, risking comparisons to debt-rating agencies.  Japan is expressing concern that the summer Olympics may be at risk.  Hong Kong is moving to “helicopter money” to deal with the crisis, handing out money to every Hong Kong citizen.  As the virus spreads across Europe, Italy is pressing for budget relief in light of the crisis.

However, the big news came yesterday when the CDC issued a warning that the COVID-19 will come to the U.S.  It warns that the U.S. should prepare for disruptions.  Since the middle of last week, evidence has grown that the virus has jumped China and is now becoming a global problem.  The CDC’s warning seemed to give a clear indication that comparisons to SARS no longer work and that we should be treating this more like a major influenza outbreak.  The next focus will probably be on Iran.  The country is suffering from sanctions and thus its health system is compromised.  Therefore, Iran is probably unprepared and under-resourced for COVID-19.  In addition, it is in the crossroads of the Middle East and it sponsors groups that infiltrate the rest of the region.  Thus, it could become a new vector for COVID-19.  It is becoming clear that COVID-19 will have a negative global impact.  The key questions are, “how deep” and “how long”?  We continue to believe that the economic impact will be deep but mostly outside the U.S. and last a duration of three to four months.  We also continue to watch for evidence that our central case is wrong.  It is worth noting that the IMF is warning against overreaction.

In China, there are increasing worries that agriculture continues to be disrupted which could create food shortages later this year.  Of course, this also may make it easier for China to achieve its Phase One purchase agreements.  One of our China sources suggests there are two items to watch that will signal that the CPC thinks it has COVID-19 under control: (a) Xi personally visits Wuhan, and (b) dates for the National Party Congress are announced.

Some observations on markets—first, Treasuries are proving to be the best hedge against risk.  Second, bitcoin has failed to do the same, showing it isn’t exactly like gold, which has performed rather well in this event.  In terms of the S&P 500, the decline so far has been 8.1%.

Although we are still focusing on the short-term effects of COVID-19, a potential longer term impact is that it could weaken the case for globalization.  Elements within the administration are said to be pressing the case for separation.

Brexit:  Next week, EU and U.K. negotiators open formal talks on a trade deal.  Comments from both sides suggest that talks will be difficult.  This news may be behind today’s weakness in the GBP.

Germany:  Candidates for CDU leadership are throwing their names in the hat.  The three named candidates so far are Arrmin Laschet, Friedrich Merz and Norbert Röttgen.  Here are their profiles.

Odds and ends:  There will be new local elections in Catalonia to try to break the separatist movement.  Khalid al-Falih, the former energy minister who was fired last September and stripped of his chairmanship of Saudi Aramco (2222, Tadawul, SAR 33.45), has been tapped to rejoin the government as investment minister, a newly created cabinet position.  It is generally believed that al-Falih was fired for slow walking the Aramco IPO; bringing him back could mean a number of things.  One is that the crown prince believes he will be better in this role.  The other could be that the king realizes his son made a mistake in firing al-Falih and wants an older hand in the government.  Axios reports that small business growth has mostly been centered in cities and suburbs and rural America has been losing small businesses.  In repo, one of the problems for this market is that banks have the desire to hold much more reserves than the Fed expected.  At the same time, there is a facility available for immediate liquidity needs, the discount window.  Unfortunately, borrowing through the discount window carries a negative stigma, suggesting a bank is in trouble.  And so, instead of risk being seen in a bad light, banks refused to lend at 10% overnight rates last September.  A recommended solution would be a standing repo facility, which would be like the discount window but with a different name.  This may or may not solve the problem because analysts may view the standing repo facility as equal to the discount window and view borrowing there as a sign that a bank is in trouble.  In an interesting development, JP Morgan (JPM, 126.26) has indicated it will begin tapping the discount window on occasion; since the bank is considered the gold standard for U.S. banking, its borrowing at the window won’t carry a stigma.  The belief is that if JP Morgan borrows there, other banks can too and the discount window can become the resolution for the repo problem and allow the Fed to reduce its balance sheet.

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

[Posted: 9:30 AM EST]

After a deep selloff yesterday, equity markets around the world are mixed.  We are seeing some retreat in the flight-to-safety assets after a massive rally yesterday in gold and Treasuries.  As usual, we update news on the COVID-19.  The president wraps up his India trip.  Germany is preparing for a new leader for the CDU.  Here are the details:

COVID-19:  The number of reported cases is 80,289 with 2,704 fatalities.  South Korea is now reporting 977 cases.  As an undergrad, I took a course on organizational behavior.[1]  In that course, we discussed conditions that tended to undermine organizations.  The three most common were dissonant objectives, information overload and information depravation.  To some extent, we are seeing all three exhibited in the reaction to the COVID-19.  In terms of dissonant objectives, nations are trying to prevent the spread of the disease and avoid recession.  These objectives are mostly exclusive—ensuring that the virus doesn’t spread requires actions that will undoubtably lead to an economic downturn.  The second method is being seen in the West.  The media is putting so much information out there that it is difficult to ascertain what people should do.  Outside the developed world, we are seeing just the opposite; propaganda and the lack of information is leading to unfounded rumors being spread, some of which work against containing the virus.[2]

Here is the problem for policymakers.  If the virus is really the “big one” then taking aggressive steps to enforce quarantines is necessary and an economic downturn is a reasonable price to pay.  But, if the virus is mild, these aggressive steps are unnecessary and the cost of a recession is excessive.  So, where does COVID-19 fall?  Early evidence leans toward this being a mild virus.  A report from China’s CDC did a study on the virus using data through February 11.  It looked at 72,314 cases and it found a fatality rate of 2.3% for the confirmed cases and 1.4% for confirmed and suspected cases.  The fatalities were concentrated among the elderly (>60 years old,[3] 829 of the 1,023) and most of those who died also had chronic conditions (heart disease, diabetes).  Mild cases were reported in 81% of the cases.  Overall, the data likely confirms that this respiratory virus is similar to influenza; it does kill, but most who are infected survive and older people are at greatest risk due to other health complications.

So, where do we go from here?  Financial markets are clearly taking a second look at COVID-19.  If this event turns out to be a mild pandemic (as the data seems to suggest now), there will be a temporary hit to the global economy.  By summer, it will probably be past us.  It is going to spread further.  The rise in Italy and South Korea is worrisome; in fact, it may affect Korean politics.  The situation in Iran is also unsettling.  The country is claiming 61 cases and 12 fatalities, which would make this virus especially deadly.  In reality, the number of cases is probably far larger.  Unfortunately, Iran lies at the crossroads of the Middle East and the region is in such turmoil that if the virus spreads to refugee camps then it will become almost impossible to control.  At the same time, if the data can be trusted, it appears the number of new cases in China may have peaked.

In general, fear of this being a bigger deal will probably have a greater impact than the virus itself.  Of course, that assumes it remains mild.  In the history of the Spanish influenza of 1918, the virus seemed to mutate at least once into a much more virulent form, so the world isn’t out of the woods yet.  Nevertheless, our base case remains that this will be a three- to four-month event.

India:  Although there were hopes that a trade agreement might be part of this visit, it doesn’t appear that one was made.  The trip does seem to be a popular success for both Trump and Modi.

Germany:  The CDU will hold a special congress on April 25 to select a new party leader.  We are in the twilight of Chancellor Merkel’s reign; depending on who replaces AKK, that ending may come before her term ends in 2021.

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[1] This is Bill speaking here.

[2] A good source for readers wanting reliable information on the virus can be found here.

[3] Bill resents this characterization.

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

[Posted: 9:30 AM EST]

It’s “red Monday” – global equities are taking a hit as the COVID-19 virus is starting to look like a global pandemic.  Risk assets are down around the world while most risk-off assets, gold and Treasuries, are rallying.  We cover three elections – Iran, Germany and Nevada.  The president is in India.  Here are the details:

COVID-19:  Worldwide cases are now 79,524 with 2,626 fatalities.  Up to this weekend, the virus was mostly a Chinese problem.  That has now changed.  South Korea has seen its cases rise to 833, Italy is up to 215 and Iran has reported 61.  South Korea is facing a crisis as cases rise and quarantines go into effect.  Italy has seen a jump in cases as well.  The famous Carnival in Venice closed early due to the virus.  Italian authorities are putting towns under quarantine; EU nations are considering border blockades.  In China, it appears that victims of the COVID-19 who have recovered can still spread the disease, leading authorities to put recovered patients back into quarantine.  If this characteristic is confirmed, it would be most disturbing as it would become almost impossible to stop its spread because carriers would be asymptomatic.  Iran is seeing a rise in cases and is shutting down schools in response.  Neighboring nations are closing borders with Iran.  There is a dispute over the number of fatalities in Iran.   Chinese leaders confirmed that the National People’s Congress will be postponed due to COVID-19.

We would have to say that the perception of the virus has changed.  Financial markets have been looking through the initial wave of infections and expecting conditions to improve by the end of March.  If the virus prompted policy stimulus, risk-on assets would do even better.  That attitude appears to have changed over the weekend, although signs of caution were emerging last week.  As the virus spreads, it does appear that the global economic impact will be larger than first thought.  Clearly, China will be hurt but it does have policy space to react to the problem.  Unfortunately, most policy measures boost demand, but if the problem is supply, the impact of lowering interest rates or distributing cash will merely bring higher prices.  Reports suggest that Chinese firms are facing severe liquidity constraints and supplying credit will raise already elevated debt levels.  Low levels of global inventories are intensifying the impact of outages.  Further disruptions of global supply chains appear inevitable.  The G-20 warns that COVID-19 will threaten global growth.  At the same time, U.S. officials continue to believe that the virus will not be an impediment to China’s purchases as mandated by the Phase One agreement.  We suspect that position will change.

Our overall view of the virus remains the same; we expect it to be mostly a three-month event and look for the virus to dissipate.  However, this is a probabilistic statement; there is a chance that COVID-19 becomes a global pandemic that becomes impossible to control and has an impact similar to influenza pandemics of the past.  We continue to think the odds of this outcome are rather low but the spread we are observing is a concern.  But, for now, we still see this problem mostly over by spring.

Elections:  There were three elections of note over the weekend.  In Hamburg, Germany, local elections gave the beleaguered SDP a rare win.  The state will likely be governed by a Green/SDP coalition.  In Iran, as we noted last week, the leadership had restricted candidates that could run, ensuring that conservatives would triumph.  They did, but the turnout was so low that the mandate from the election was certainly weakened.   In Nevada, Sen Sanders (I-VT) won easily, putting together a surprisingly broad coalition.  As the schedule of primaries intensifies, Sanders has a chance to create an insurmountable lead.  Although we would put most of the blame for equity market weakness on the COVID-19, the rise of Sanders is likely contributing to market pressure as well.   The Left-Wing Establishment is in a tizzy over Sanders.  The complaints sound remarkably similar to 2016 among the Right-Wing Establishment.

Passage to India:  President Trump is in India for a two-day tour.  So far, things appear to be going well, although there are noteworthy policy differences between the two nations.

Odds and ends:  A rising CHF versus the EUR is causing problems for the Swiss National Bank.  In the past, the SNB has aggressively intervened to fix the CHF/EUR rate.  However, intervention to prevent the rise of the CHF would likely anger the U.S. and is complicating policy.  The booming tech sector in northern California is starting to look like a bust.  The impact on the broader economy might be next.

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

[Posted: 9:30 AM EST]

It’s Friday!  Virus worries lead to mixed equity markets but a distinct element of worry—gold—continues to move higher despite dollar strength.  Treasury yields continue to fall.  However, the other flight-to-safety asset, the JPY, has failed to rally this time on fears of recession in Japan.  We update the virus news.  There are reports of a peace deal with the Taliban.  Iranians go to the polls today.  The EU is struggling with budget negotiations. Japan restricts foreign investment.  We recap the DOE report.  Here are the details:

COVID-19:  The total number of reported cases is 76,778 with 2,247 fatalities.  China is continuing to adjust its reporting parameters, raising concerns about an undercount.  There has been a surge in cases in South Korea, with many tied to a church in Daegu.  The country also recorded its first fatality.  We note that U.S. equity markets slumped at mid-morning yesterday, likely on reports of a large rise in reported cases in Beijing.  Up until now, the vast majority of cases (62,662 out of 76, 778) were in Hubei province, where the city of Wuhan sits.  If case reports begin to show a rapid rise in infections beyond Hubei, it would suggest that the trajectory of the disease may not be lessening over time.  There is evidence to suggest COVID-19 has a similar physiological effect as SARS.

Meanwhile, the economic impact of the virus is becoming clear.  Airlines have been hurt.  Energy demand has declined.  There are increasing reports of manufacturing disruptions.  Although today’s PMI data shows improvement, the virus may be distorting the reports.  One element of the report, supply deliveries, may be giving a false reading.  In the construction of PMIs, slower deliveries are considered bullish because they signal rising demand.  However, in this case, slower deliveries caused by COVID-19 are actually a reflection of weakness.  It appears that equity markets are taking a more cautious reading on the impact of the virus.

A deal with the Taliban?  There are early reports from the SoS that a plan to reduce violence in Afghanistan may be in the offing.  If true, it would be a signal that plans for a peace accord, set to be signed on February 29, may be closer to reality.

Iranian elections:  Iranians go to the polls today to vote on a reduced slate of parliamentary candidates.  The choice in most districts is either a hardliner or an extreme hardliner.  The Council of Guardians, who decides which candidates can run, has severely restricted choices.  The vote will generate a conservative parliament; however, the legitimacy of the vote is clearly weakened.  In other Iranian news, the Financial Action Task Force, a Paris-based organization that monitors terrorist financing, is planning to put Iran on its blacklist.  This action will further isolate Iran and undermine relations with Europe.

The EU budget:  The EU is in the process of creating a seven-year budget.  One of the major parts of this process is the transfer payments that move from the wealthy EU nations to the poorer ones.  The latter want a bigger budget with high transfers; the former want less spending.   A rebellion of sorts from Germany and the “frugal four,” trying to contain spending, is making it very difficult for negotiators to make a deal.  Overhanging the problem is Brexit.  The U.K. leaving the EU has left a €60 to €75 billion “hole” in available funds; the northern European nations are loath to fill that gap.  In effect, the southern nations want the northern nations to offset the loss of Britain, while the northern nations want to offset the loss by reducing available funds.

Japan:  The government is finalizing a plan to tighten scrutiny of foreign investment in 12 economic sectors, including defense, nuclear power, aerospace, telecom, utilities and others.  Signaling a further rollback of globalization, the plan says any foreign investor buying 1% or more of certain firms in those sectors would be subject to prescreening, up from 10% currently.

Odds and ends:  Despite the Phase One trade deal, financial conditions in the farm belt continue to deteriorate.  Farm bankruptcies are forecast to remain high this year.  The poor financial situation for farmers may be behind a shift in recommendations by Agriculture Secretary Perdue.  He has come out in favor of a carbon tax, a significant break from the stance of the administration.  It appears he is angling for farmers to receive payments for carbon sequestering.  When farmers plant corn or soybeans, carbon is pulled from the atmosphere into the soil.  After harvest, if the silage rots, some of this carbon is released back into the atmosphere.  However, various techniques may prevent this from occurring and, if so, we suspect Perdue would push for farmers to receive payments for containing the carbon that was captured in the growing process.

Energy update:  Crude oil inventories rose 0.4 mb compared to the forecast rise of 3.2 mb.

In the details, U.S. crude oil production was unchanged at 13.0 mbpd.  Exports rose 0.4 mbpd, while imports fell 0.2 mbpd.  The inventory build was less than forecast due to rising exports, falling imports and a rise in refining activity.

This chart shows the annual seasonal pattern for crude oil inventories.  This week’s report was consistent with seasonal patterns and the gap remains narrow between the normal pace of inventory accumulation and the actual.  Seasonally, next week should be steady too, but further builds would be expected into May.

Based on our oil inventory/price model, fair value is $59.59; using the euro/price model, fair value is $46.28.  The combined model, a broader analysis of the oil price, generates a fair value of $50.13.  The wide deviation in model forecasts is due to the weakness in the dollar.  Although we have seen a rebound in oil prices on hopes that the COVID-19 virus will be contained soon, dollar strength remains a bearish risk factor for oil prices.

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

[Posted: 9:30 AM EST]

Global equities are mixed this morning with U.S. equity futures taking a breather.  We update the COVID-19 news.  The Fed is warming up to the economy.  U.K. changes immigration rules.  A new DNI.  The president is off to India.  Trouble in Argentina.  Here are the details:

COVID-19:  The number of reported cases are 75,776 with 2,130 fatalities.  On its face, this appears to be good news as the daily increase in cases is clearly declining.

However, it is not clear whether the decline is anything more than another change in reporting standards.  One of the problems with analyzing China is that there is clear manipulation of data in normal circumstances.  Thus, the temptation is strong to jigger the numbers to make it appear that the virus is under control.  We aren’t saying the data is necessarily tainted but simply unreliable.  However, that doesn’t stop researchers from trying to capture what is really happening.

China cut its lending rate by another 10 bps.  There are reports that Chinese bond investors are getting hit again on bonds from state-owned enterprises.  Meanwhile, overall yields have declined in China, falling to four-year lows on expectations of slower growth.  China’s credit growth slowed to 12.1% from last year, in line with expectations.

Overall, our stance remains the same; the COVID-19 virus will most likely be a one- to two-quarter event with a recovery fueled by global fiscal and monetary stimulus.

Fed minutes:  There were no surprises in the report (there seldom are).  Although the tone was a bit more upbeat on the economy than what we have seen previously, there was nothing in the content to suggest the FOMC is thinking about raising rates.  Worries about the fallout from COVID-19 are probably going to keep the Fed on hold; recent dollar strength should also give policymakers pause.

Westminster goes Canberra:  Australian immigration policy is based on a “points” system that tends to screen immigrants for desired skills.  The U.K. unveiled a similar system yesterday that is designed to reduce the number of unskilled immigrants, while increasing the openings for skilled labor.  This move has raised fears of labor shortages for firms that employ low-skilled workers; it appears the government wants to reduce labor competition for low-skilled Brits in a bid to raise their wages.

Off to India:  President Trump will visit India next week and there are hopes that a mini-trade deal might be in the offing.  India tends to be protectionist and this has caught the ire of U.S. trade negotiators.  However, India has strategic value as a foil for China, so we may see an attempt by the president to improve relations.

Japan:  Environment Minister Koizumi, a rising star of the ruling Liberal Democratic Party and the son of a former prime minister, has been forced to apologize for skipping a government meeting on the COVID-19 epidemic in favor of attending a party thrown by his supporters.  The incident shows the epidemic is now able to impact political fortunes even outside China.

A new DNI:  German Ambassador Richard Grenell has been named acting Director of National Intelligence.  There is concern over Grenell’s lack of experience.  In general, the longer a president is in office, the more they tend to prize loyalty more than other values.  This is because as a president gains experience he usually wants someone who will do what he is asked rather than offer guidance.

Germany:  A right-wing extremist killed nearly a dozen people near Frankfurt before apparently killing himself.  Many of the victims were ethnic Kurds, and the killer left behind a letter calling for the extermination of “certain peoples” that could no longer be expelled from Germany.  The killings highlight the ongoing ethnic tensions and right-wing pushback against immigrants at the center of Europe.

Argentina:  The IMF said Argentina’s public debt position has become so precarious that a restructuring is necessary, including a “meaningful contribution” from private creditors.  With Argentina continuing to struggle with ballooning debt, falling international reserves, and a weakening peso, the outlook for the country’s stocks and bonds is deteriorating rapidly.

Odds and ends:  Global car sales are expected to fall significantly this year.  EU leaders are trying to create policies to boost their tech industries after falling behind the U.S. and China.  There are rising fears of bankruptcies in the shale oil patch.  The drug lobby in the U.S. finds itself with few friends as attacking the industry is taking on a rare bipartisan tone.

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

[Posted: 9:30 AM EST]

World equity markets have mostly shrugged off yesterday’s weakness and continue to focus on the post COVID-19 world; doses of additional stimulus aren’t hurting either.  The Fed releases its minutes from the last meeting today.  Here are the details:

COVID-19:  The number of reported cases are 75,317 with 2,012 fatalities.  Although there is growing evidence of economic disruption, so far, this has been met with additional stimulus.  Due to expectations that the virus will be a one quarter event, the stimulus is enough to support risk markets.  On that note, we do find it interesting that gold prices are higher this morning despite the recovery in equity markets.  On the negative side of the ledger, there are reports of shortages and Chinese companies are warning that they are struggling to meet payrolls.  If the payroll problem spreads, the impact on the Chinese economy will be much more serious.  The Chinese real estate market is a special concern due to high leverage.  The drop in air traffic to China is also starting to have an impact.  On the positive side, Chinese policymakers are moving quickly to aid the economy.  To reiterate, the most likely outcome is a one to two quarter slump in growth that will be partly offset by stimulus and that same stimulus will set the stage for a stronger economy by H2.  That doesn’t mean that tail risks don’t exist and could make this event much worse.  But, for now, financial markets are assuming the worst won’t occur.

China:  There were a number of cross currents in the news.  First, President Trump personally took steps to cool trade tensions with China.  Hawks in Congress and the administration were pushing to prevent the sale of jet engines to China and have been pushing for other restrictions as well.  The president rebuked these officials, suggesting that he does not want to close off China but only wants them to change their behavior.  The president does not want to put U.S. businesses at a disadvantage and thus is trying to find a middle ground between no restrictions and isolation.  However, the U.S. has also designated five Chinese media firms as “foreign government functionaries” which will reduce the abilities of these firms’ reporters to operate in the U.S.  Meanwhile, China has expelled three journalists from the WSJ.  But China has also taken steps to reduce tariffs on U.S. products, preparing to meet its obligations in the Phase One part of the recent trade agreement.   We see these crosscurrents as evidence both nations are trying to figure out what relations are going to look like in the coming years.  What existed before, where China was given great latitude to exploit U.S. hegemonic public goods, is over.  What replaces it isn’t clear.

U.S. sanctions:  The U.S. is imposing sanctions on Rosneft (RNFTF, 7.15) for breaking restrictions on trading in Venezuelan crude oil.  The U.S. estimates that the company handles half of Venezuela’s oil exports.  The move will likely reduce Venezuela’s oil sales, or, at a minimum, reduce the price it can get to offset the costs of sanctions.

MMT rises:  In response to a February survey, global investors stated that fiscal policy was likely better positioned to solve the persistently low inflation than monetary policy.   The sentiment reflects growing clout of modern monetary theory in economic circles. That said, there are critics who believe that increased fiscal spending could be detrimental to price stability, which in turn could be harmful to equities.  Furthermore, it appears that the Federal Reserve may also welcome fiscal stimulus in the economy. In a testimony to Congress, Federal Reserve Chairman Jerome Powell hinted that the Federal Reserve may not have the tools needed to combat the next recession.

Odds and ends:  We reported yesterday that the Dutch were close to scuttling the EU/Canadian trade deal.  It was close but, in the end, the Dutch Parliament passed the measure by a mere three votes.  Britain is considering bringing in China to build its proposed high-speed rail project.  France is restricting foreign financing of mosques and a number of other measures to discourage Islamic teaching that is managed abroad.  As planned, the Fed is set to reduce the amount of liquidity it is offering the financial system.  Following the reelection of Ashraf Ghani a President of Afghanistan, the rival party has threatened to form its own government.

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