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

[Posted: 9:30 AM EST]

Welcome back!  Equities are under pressure due to Apple (APPL, 324.95) news.  The U.K. rejects the EU trade agreement proposals as it appears Britain is ramping up fiscal spending.  The Netherlands threatens the EU/Canada trade deal.  We’re seeing rising tensions over the U.S/China technology war.  Here are the details:

COVID-19:  Today’s big news on the virus came from Apple, which announced it would not meet its quarterly revenue targets due to production disruptions caused by the COVID-19.  Although the news of supply disruptions should not be a shocker, until this report, this expectation was merely generalized.  Now, it is real.  We expect other companies will start admitting similar problems in the wake of this announcement.  Companies are working on anti-viral drugs but are reporting snags in getting approvals for testing.  We are seeing the virus’s impact on global economic activity as trade has been weakening, Japan’s GDP slumped, and a combination of post-consumption tax blues and the loss of Chinese tourists.  Europe is missing Chinese tourism as well.

The latest data shows 73,345 confirmed cases with 1,874 fatalities.  Although the numbers are rising, the pace of the increase is showing signs of slowing.

Of course, we offer our usual caveats; we suspect the actual number of infections is much higher, but the lethality is much lower than the official data suggests.  Although nothing we have seen convinces us that our take on the disease is wrong (we expect one weak quarter from the event), we remain vigilant for the unexpected.  We do note that China’s equities have recovered their losses since the return from the New Year holiday, supported by fiscal and monetary stimulus from Beijing.

In other related news, the CPC has postponed the National People’s Congress meetings usually held in March due to COVID-19.  This is an important meeting and the fact that it is being postponed shows the degree of concern among CPC leadership.  President Moon called for “emergency steps” to prevent the COVID-19 virus from derailing the South Korean economy.  According to Finance Minister Hong Nam-ki, this month the government will offer emergency low-interest loans to a range of companies in the airline, shipping, travel and restaurant industries to cushion the blow

U.S./China tech:  The battle over Huawei (002502, CNY 2.85), in particular, and U.S. attempts to retard China’s technology development, in general, continues.  The U.S. has been pushing European nations to avoid using Huawei’s technology; Britain has already rejected U.S. overtures and Germany appears ready to follow the U.K. lead.  The U.S. has announced it is considering banning the export of U.S. microchip machine tools.  The world is rapidly heading toward a “one world, two systems” situation in technology.  Needless to say, such a world would operate at a lower level of efficiency.

Brexit:  The EU is offering a trade deal with the U.K. in exchange for a “level playing field” on rules and regulations.  Westminster is outright rejecting such an arrangement, which it should; there is no point to Brexit if the country leaves only to follow rules that it no longer has input in setting.  Meanwhile, PM Johnson appears to be ramping up a fiscal splurge.  If it occurs and the BOE turns more hawkish as a consequence, it should be bullish for the GBP.

EU:  There are two items of note.  The Netherlands, normally a supporter of free trade within the EU, may reject the recent free trade deal with Canada.  Under EU rules, all the members must approve a free trade arrangement, which explains why getting anything approved is really hard.  Under normal circumstances, we expect the smaller states or France to be leery of free trade deals, but if the Dutch are done with free trade then there is little hope that any new treaties are possible (take note, Brits!).  Why the trouble?  Agriculture.  Farmers in the Netherlands are afraid of the agricultural power of the central North American plains; however, as usual, the worries are couched in safety terms.[1]  Second, despite recent visits by Facebook (FB, 214.18) CEO Mark Zuckerberg, the EU is still giving the company the cold shoulder and pressing for more extensive regulation.

Russia-Turkey:  The Turkish government yesterday sent a delegation to Russia in an effort to forge a ceasefire agreement for northwestern Syria.  Nevertheless, Turkey continues to pour troops and equipment into the area and has threatened to attack Syrian forces there if they don’t stop targeting Turkish-backed rebels.  Such a Turkey-Syria conflict would raise a serious risk that Russia would be drawn in.

Odds and ends:  In defense of U.S. projection of power, Sen. Graham (R-SC) pushed back against a Trump administration proposal to withdraw U.S. troops from areas of Africa.  This stance shows how the establishment remains at odds with the populists over the U.S. hegemonic role.  As turmoil continues in Germany, there are growing calls for Chancellor Merkel to resign.  A sign of the times—Greek and Italian bond yields are falling as investors view them as alternatives to Bunds.  The Taliban says it has a peace deal with the U.S.  Car dealerships are encouraging beleaguered car buyers to purchase a vehicle before selling or trading the old one and voluntarily allow the current car to be repossessed.  Such stories usually start to emerge when credit stresses are rising.  Sen. Sanders (I-VT) and Rep. Ocasio-Cortez (D-NY) have introduced legislation that would ban fracking in the U.S. by 2025.  Although the bill has no chance of passage, it shows a striking blindness on the part of the populist left.  The cost of adjustment for this bill, designed to combat climate change and other environmental ills, would fall almost entirely on low income households who would face significantly higher gasoline costs as oil production falls and prices rise.

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[1] For the record, even with consuming “unsafe” food, Canadians manage to have a life expectancy of 82.3 years, just beating the Netherlands at 82.1

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

[Posted: 9:30 AM EST]

Happy Friday and St. Valentines Day!  It’s rather quiet in the financial markets, with bonds doing well and equities grinding higher.  We update news on COVID-19.  There is unrest in Colombia, and more legal action on Huawei (002502, CNY 2.61).  We have additional color on Johnson’s cabinet shakeup.  Judy Shelton is under fire.  Canada faces a rail strike.  Here are the details:

COVID-19:  The number of reported cases is up to 64,467 with 1,384 fatalities.  After yesterday’s jump due to changes in reporting methods, today’s increase is more in line with previous patterns.  Sentiment is slowly moving away from “what is this virus all about?” to “how much of a negative impact is it going to have?”  Here are a few of our observations.  First, traditional stimulus measures, such as cutting interest rates and taxes, have less effect.  Essentially, for China and parts of Southeast Asia this event is disrupting production.  Adding liquidity into limited supply is a recipe for inflation, at least in the short run.  What needs to happen is a reduction of fear and a resumption of production.  That outcome will only come with time.  It is important to note that Chinese officials are working at cross-purposes to some extent.  Although they want to boost growth, they are also continuing aggressive actions to quarantine suspected cases, thus hampering the movement of people necessary for economic recovery.  Second, the ripple effect from this event will probably be a function of the overall dependence on the Chinese economy.  For example, China is one of the few customers willing to buck Iranian sanctions.  The virus is reducing Iranian oil exports to China and thus putting additional pressure on the Iranian economy.

Colombia:  The ELN and dissident members of the FARC rebel group launched an effort to shut down the country, warning that they will kill anyone nationwide who ventures outside their home from 6:00 am on Friday until Monday.  We believe the threat is a show of force after the successful national strike earlier in the winter.  If this signals a new round of unrest in Latin America, regional stocks would come under renewed pressure.

Huawei:  New charges have been assigned to Huawei; the company has been accused of racketeering, conspiracy and conspiracy to steal trade secrets.  This action will certainly raise tensions between Washington and Beijing and reduces the likelihood of a Phase Two deal.  In fact, it may undermine the execution of the Phase One agreement.

Johnson:  PM Johnson’s cabinet shakeup was much more than a mere post-election restructuring.  The headline news was the resignation of Exchequer’s Javid.  He was ordered to fire his staff so Johnson could create a separate unit in the Exchequer.  Javid correctly realized that accepting this change would make him a mere figurehead and resigned.  Reports suggest that Johnson wants to boost spending in the areas of the country that flipped from Labour; Javid was less keen on increasing spending.  As always, there is some person willing to accept unattractive terms and Johnson did find someone.  Our overall take is that Johnson has opted for loyalty over other attributes.  For the markets, expectations of fiscal stimulus lifted the GBP.

Is Shelton in trouble?  Although President Trump initially selected conventional figures for Fed governor positions, in the past couple of years he has offered more radical candidates, all of whom have failed to get nominated.  The latest in this group is Judy Shelton, who in the past has argued for a gold standard, deliberate monetary policy to trigger a weaker dollar and reduced independence of the central bank.  Surprisingly, senators are pushing back much harder than we expected and it is possible that Shelton will join Herman Cain and Stephen Moore on the list of candidates that couldn’t get confirmed.  If she fails, we would view it as a win for the establishment.  However, we would not be surprised to see other governor candidates in the future suggest policies to reduce independence or intervene in exchange rates.  If the U.S. is going to reflate, such policies are probably necessary.  Nevertheless, Shelton’s positions do seem muddled.  On the one hand, she calls for a return to the gold standard and appears reluctant to deploy unconventional policies such as QE but has little problem with overtly engaging in currency depreciation.  Our suspicion is that she is really a political candidate who wants policies designed to keep her favored party in power.  In our reading of Fed history, this type of appointment would be a first for the Fed and perhaps such an appointment is a bridge too far for the Senate to cross.  So, we will see if these “misgivings” evolve into rejection.

Canada:  The country’s biggest railroad said it has shut down operations in eastern Canada because of widespread rail blockades set up by activists protesting the construction of a major natural gas pipeline.  Since the shutdown is likely to result in layoffs and significant disruption to Canada’s economy, we expect it to be a near-term headwind for Canadian stocks.

Odds and ends:  At yesterday’s T-bond auction, the newly issued 30-year sold at a 2.061% yield, a new record-low at auction.  Research from the White House staff suggests that foreign nations are suppressing drug prices, which essentially means that Americans are subsidizing the cost of new drug research that foreigners free ride on by setting lower prices.  We will be watching to see if the U.S. uses this research as a trade tool to apply export taxes on foreign nations who engage in such practices.  If it does, it should be bullish for U.S. drug makers as the ultimate goal will be to boost foreign drug prices.  France and Germany are trying to strongarm the EU competition regulator to allow for the creation of concentrated national champions.  One of the reasons U.S. equities have outperformed the world is that U.S. large cap firms are more concentrated due to lax anti-trust enforcement.  Market power has given these firms the ability to consistently generate higher profits.  If the EU gives France and Germany what it wants, similar structures may be created.  One element is that the EU is considering creating a single market for data in a bid to weaken the grip of U.S. tech firms on Europe.  At the same time, the U.S. appears to have misgivings about the dominance of American tech firms.  The DOJ held a conference on whether top digital platforms have become so dominant that they’re discouraging investment in new products.  Some venture capitalists at the meeting complained that it’s hard to develop a product in markets dominated by a tech giant.

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

[Posted: 9:30 AM EST]

After a steady rise, equities are lower this morning following a jump in reported infections; we update news on COVID-19.  The nominating process for the remaining two vacant governor positions begins today.  PM Johnson shakes up his cabinet.  The CDU/CSU begins the process of selecting a new party leader.  We update the energy data; the IEA warns of weakening oil demand.  French unemployment falls (see foreign economic data below).  Here are the details:

COVID-19:  Due to new reporting standards, there was a massive jump in reported infections in China.  The new count is 60,407 with 1,370 fatalities.  Health authorities in Hubei province started counting clinically diagnosed cases as infections.  Previously, only a positive laboratory test would trigger a diagnosis.  There have been serious concerns about undercounting; testing kits were seen to be inaccurate, or worse, because they had a tendency to produce false negatives.  The new reporting does show a noticeable bump in the data.

Both charts show the same data but the chart on the left uses a logarithmic scale, which shows the rate of change in the data; the chart on the right uses a linear scale and has been used by some media outlets to highlight the “hockey stick” nature of the increase.  Although the jump in the data is clearly noticeable, even using the more legitimate log scale, it should be treated as a one-off event.  In a sense, the new reporting should be treated as a data revision.  The good news is that the increase in the number of cases highlights that most of those infected are suffering a mild case of the disease.  So, today’s equity weakness is probably not a proper reaction to this news; on the other hand, the rally we have seen over the past several days was ignoring the likelihood of under-reporting so today’s drop could also be seen as a correction to previous overconfidence.

In related news, China continues to fire province-level officials over the handling of this crisis.  And, proving the universality of Rahm Emmanuel’s dictum that a political leader should never let a crisis go to waste, Chairman Xi has installed his close ally, Xia Baolong, as leader of the Hong Kong and Macau Affairs Office.  Xi is clearly working to extend his control over the restive Hong Kong.  The banking system is showing some signs of stress as the virus weakens the economy.  Global tourism is weakening as well.  China’s car sales plunged 22% in January.

PM Johnson’s shakeup:  The most notable firing is Sajid Javid, who was Chancellor of the Exchequer.  However, there were numerous other sackings.  The government is expected to announce replacements throughout the day.  It is still uncertain what these replacements will bring.  The GBP did move higher on the news.

The Fed nominating process:  At long last, Christopher Waller and Judy Shelton go before the Senate Banking Committee at 9:00 EST today.  To some extent, Waller may be the most fortunate candidate in recent memory; he is a conventional candidate and, most likely, Shelton will take a grilling.  She is a very unconventional candidate.  She has supported the gold standard and has expressed doubts about the very wisdom of having a central bank.  For GOP senators, this nomination may prove to be yet another loyalty test to the White House.  Our view?  We have been expecting doves to be nominated to the vacant seats and both these candidates will be reliable advocates for rate cuts.  It will make the composition of the Fed more dovish.  At the same time, as we move from an efficiency to an equality cycle, central bank independence will be undermined.  What we are concerned about with Shelton is that she may not be a dove or hawk in the traditional sense but may instead represent a “new bird.”  She may be a political bird who will support easier policy when a Republican controls the White House but call for tight policy when a Democrat is in the Oval Office.

Odds and ends:  As AKK leaves the leadership of the CDU/CSU, new candidates for the job are circling.  The vetting process is beginning with familiar names emerging for a second chance at the position.  And, here’s one to ponder—Greek 10-year bond yields have fallen below 1% to 0.98%.

Energy update:  Crude oil inventories rose 7.5 mb compared to a forecast rise to 3.2 mb.

In the details, U.S. crude oil production rose 0.1 mbpd to 13.0 mbpd.  Exports fell 0.4 mbpd, while imports rose 0.4 mbpd.  The rise in stockpiles was more than 2x what was forecast.  The rise in imports coupled with the decline in exports prompted the large rise.

This chart shows the annual seasonal pattern for crude oil inventories.  This week’s rise was consistent with seasonal patterns, and the gap between the normal pace of inventory accumulation and the actual has narrowed significantly.  The next two weeks are usually steady so continued accumulation will put the current year above normal.

Based on our oil inventory/price model, fair value is $59.72; using the euro/price model, fair value is $47.58.  The combined model, a broader analysis of the oil price, generates a fair value of $51.04.  We are seeing a steady decline in all of the fair value calculations as the dollar strengthens and oil inventories rise.  However, the combined model is within range of fair value so we may see some consolidation in the coming weeks.  The IEA, citing the impact of the COVID-19 virus, has cut its global oil demand forecast by 365 kbpd.

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