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

[Posted: 9:30 AM EST]

Update on the coronavirus and the FOMC meeting begins today.  Asian equity markets remain under pressure, but Europe and the U.S. are stabilizing.  U.K. defies U.S. on Huawei (002502, CNY 2.99)  Here is what we are watching this morning:

Coronavirus:  The infection rate and death toll continue to mount.  Infections are now over 4,500 and the death toll is over 100.  Hong Kong is increasing travel restrictions from the mainland.  The quarantine hospital in Beijing has reopened to deal with the Wuhan virus.  In what could be a significant disclosure, the mayor of Wuhan, Zhou Xianwang, reports that rules imposed by the central government limited what could be disclosed in the early stages of the outbreak.  This puts the Xi government in a bad light, suggesting it is making similar errors to the SARS crisis and exacerbating the spread of the disease.  Japan reported its first domestic transmission of the virus.  Meanwhile, governments are moving to evacuate citizens from Wuhan; the worry is that they may be inadvertently spreading the disease, although it would be a true “own goal” if these evacuees are not monitored closely.  The CDC has expanded its travel warning to all of China.  In a rather curious development, China has been receiving donations from Western firms.  As the virus spreads, worries about the hit to global growth are rising as well.  We suspect this event will reduce growth; the collapse in oil prices is clear evidence that market participants think so too.  However, it is also important to remember that one of the functions of the financial markets is to offer a place where such events can be discounted.  It is quite possible that some markets are underestimating the impact, while others are overdoing it a bit.  The fact that European and U.S. equity markets are stabilizing is probably an example of properly discounting the impact of distance from the epicenter of the pandemic.  What remains to be seen is if the Asian equity markets (or oil prices, for that matter) have overestimated the effect.

FOMC:  Although no change in rates are expected, Chair Powell will almost certainly be peppered with questions in the press conference about the expansion of the balance sheet.  Although the official line from the committee has been that the expansion to protect the repo market was not QE, financial markets have, thus far, ignored those directives.  In other words, markets are treating this as QE4.  Thus, there is a risk that if the Fed moves to withdraw the liquidity, financial markets might not take it well.  It should also be noted that committee members are far from united on policy; although we suspect these divisions will lead to stasis in the short run, in the long run, it makes divining the path on policy much more difficult.  However, for now, we expect the Fed to maintain steady rates and keep ample liquidity in the financial markets.  Still, any hint of reducing the balance sheet may not be taken well.

Britain:  The U.K. has officially defied the U.S. and will allow a limited level of Huawei products into its telecommunications system.  The Johnson government believes it can restrict the use of Huawei products and thus reduce the chances that the equipment could compromise security.  This will not be taken well by Washington because the policy will likely be adopted by the rest of Europe as well.  We will be watching to see what sort of retaliation will be delivered by the U.S.  At a minimum, the decision could put the British on the defensive as they try to negotiate a new, post-Brexit trade deal with the U.S.

United States-Japan-South Korea-France:  The “Five Eyes” intelligence-sharing alliance (the U.S., the U.K., Canada, Australia and New Zealand) has reportedly begun to coordinate with Japan, South Korea and France to better track North Korea’s missile program and sanctions busting.  The “Five Eyes Plus” framework also includes Germany on issues related to the cyberthreat from China.  In spite of the trade and defense budget tensions among the allies, the expanded intelligence sharing is a welcome sign that the countries can still cooperate against clear threats.

Eurozone:  The ECB said six Eurozone banks have failed to meet their capital requirements, up from just one bank last year.  Most concerning, the report said that because of bad business models and poor internal governance, “most significant institutions” in the Eurozone don’t even generate enough earnings to cover their cost of capital, which naturally impedes their ability to build internal capital, or raise new equity.  That goes far toward explaining the weak investment performance of many Eurozone banks over the last decade.  Given the prevalence of banks in the European stock market indices (and in the broader international indices as well), it also helps explain the outperformance of U.S. stocks over the same period.

Russia:  Kremlin-controlled natural gas monopoly Gazprom said it will complete the NordStream 2 gas pipeline from Russia to Germany by itself, after several European firms pulled out of the project.  The decision is being reported as a victory for the U.S. sanctions announced last month, which were designed to impede Europe’s increasing dependence on Russian gas.  It now looks like the project will be completed anyway, which will also reduce the potential market for U.S. gas exports.

Odds and ends:  Tech firms are becoming increasingly worried they will face a patchwork of regulations, so they are pushing for a global regulator; of course, a single regulator is easier to capture.  The EU is warning the U.K. that it should not try to make deals with individual nations in trade negotiations.  Although this is technically impossible (individual nations in the EU give up their right to make their own trade pacts) the U.K. could use threats on various industries to sway talks.  The U.S. is telling the EU that if they want a trade deal, they are going to import the “boogeyman” of agricultural products, the chlorinated chicken.  The ceasefire in Libya is breaking down.

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

[Posted: 9:30 AM EST]

Global equity and commodity markets continue to sink on the Wuhan virus.  The U.K. prepares to officially leave the EU on Friday.  The Fed meets this week as it considers new tools.  Italian markets get some positive news.  Here is what we are watching this morning:

The Wuhan virus:  The virus infection rate is soaring.  The death toll is now above 80 and China is extending the New Year’s holiday to keep citizens in place.  The U.S. has confirmed five cases of the disease. The State Department is organizing flights to pull U.S. diplomats and some private citizens from Wuhan.  Hong Kong is preventing anyone from the Hubei province from entering the territory.  Fifteen nations, or territories have now confirmed cases, although the vast majority are in China.  Current estimates suggest that China’s GDP will likely decline from 0.5% to as much as 1.2%.  Wuhan is a major industrial hub for China and thus the outbreak is having a significant economic impact.  Of course, fear is dampening consumption activity in what is a major shopping season for China.

The CPC leadership is scrambling to contain the spread of the virus.  Official warnings of an “accelerating” spread are uncharacteristically frank.  One of the problems with authoritarian regimes is that they claim full control, so events such as these undermine that image.  One of the characteristics of this virus is that it is contagious during an incubation period that can last up to two weeks.  Simply put, a person can carry the disease and be completely asymptomatic for a rather longer period.  Thus, containing the spread will be tricky.

So, what is to be done…at least for investors?  First, these sorts of events usually have a three to five month period where they have a significant impact on financial markets.  There is always a fear that this one will be different, and it is possible that it will be.  However, more than likely, the Wuhan virus will peak in the next six weeks and then the recovery will start.  Second, it’s important to note that the operative factor affecting financial markets from this virus is fear.  The CDC estimates that between 291k to 646k die each year from influenza.  It is highly unlikely the Wuhan virus will be as lethal.  Still, there is a level of familiarity from the flu[1] that reduces the uncertainty surrounding it, so the market effects are usually muted.  Overall, the Wuhan virus is a big deal but investors should not overreact.

Italy:   On Sunday, local elections were held in the region of Emilia-Romagna.  Such elections would not usually be a matter of concern outside of Italy, but Matteo Salvini of the League entered the race to restart his plans to capture the government.  Interestingly enough, he was defeated by the center-left incumbent governor Stefano Bonaccini.   With the national government consisting of the Democrats, and the left-wing Five Star Movement now looking more secure in the short term, investors are aggressively bidding up Italian bonds.  So far today, the yield on the benchmark 10-year note is down 16 basis points to just 1.07%.  Across the West we are seeing political alignments in flux; in Europe, conservatives are joining up with environmental parties, and center-left parties are flirting with communists.  It is unlikely that any of these “odd couple” arrangements will hold, but the fact they are occurring at all shows the degree of political stress that is affecting Western democracies.

Brexit:  The official break occurs on Friday, although most of the rules will remain in place as the two sides negotiate the trade relationship.  By year’s end, freedom of movement between the U.K. and the EU will end; it is possible that visas will be required.  Brexit may have already cost the U.K. its preeminence in finance; London is no longer considered the world’s top financial hub.   Meanwhile, the Johnson government is risking the ire of the Trump administration over Huawei (002502, CNY, 2.99).  There is growing concern that a major casualty of Brexit could be the British auto industry.

A “new” Fed tool:  The FOMC meets this week; no change in anything is expected.  According to reports, the Fed is dusting off an old tool.  During WWII, the Treasury would inform the Fed of its borrowing needs and the rate it wanted to pay; the central bank would expand its balance sheet to accommodate the government’s borrowing.  This process continued in some forms until the Fed became independent in 1951.  Essentially, what the Fed is considering is fixing Treasury rates across the yield curve to ensure that rates will remain low.  This policy could become very important if fiscal funding followed an MMT structure; the worry about MMT is that the deficits could trigger a jump in bond yield brought on by “bond vigilantes.”  Under this policy, there would be no bond vigilantes.  Of course, other rates might rise; however, in this period, we note that corporate rates also tended to fall.

 

This chart shows the 10-year T-note and Baa corporate bond yields of similar duration from 1935 through 1958.  Note that the spread consistently declined then slowly rose as the Fed lifted interest rates to cool inflation.  The 1934-51 period is financial repression at its finest; what was missing in this earlier period is the current level of financial engineering.  The creation of various products to generate higher yield would be the real “bull market” if the Fed “goes back to the future.”

Global Housing Market:  On top of the risk that China’s coronavirus may spread abroad, data from the Dallas Federal Reserve shows global home prices in the third quarter of 2019 were up just 1.8% from one year earlier (net of inflation), compared with a recent peak of 4.3% in 2016.  The continued slowdown in housing reflects the world’s general economic slowdown in recent years, weaker cross-border demand in the midst of trade wars, and reduced affordability.

United States-European Union:  U.S. Commerce Secretary Ross warned that the Trump administration will retaliate if European Commission President von der Leyen’s proposed tax on carbon imports is protectionist.  The threat raises a new area of friction that could result in a worsening trade war with the U.S.

Germany:  The IFO Institute’s January business confidence index pulled back to a seasonally-adjusted 95.9, short of both the December reading of 96.3 and the expected figure of 97.0.  The expectations index fell to 92.9 from 93.8.  Although German activity has improved a bit in recent months, the data suggests the economy remains anemic.

 

India:  The government said it plans to sell its entire stake in Air India after its proposal two years ago to unload 76% garnered no interest.  Officials also lowered the amount of debt that would be passed on to any buyer.  The proposal is positive for Indian stocks, as it appears to show the government’s commitment to push through meaningful privatizations.

Iraq:  Cleric Moqtada al-Sadr reversed course and withdrew his support for antigovernment protestors, after many of them criticized him for trying to hijack their movement for his own political gain.  Despite al-Sadr’s withdrawal of support, and a new effort by police to get control of the situation, mass demonstrations against the government are being held again today.  Separately, a suspected militia rocket attack struck the U.S. Embassy and injured one person yesterday.  It was reportedly the first known direct hit on the Embassy compound.

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[1] Actually, we have been worried about the flu for some time; the fourth WGR we wrote in 2006 was on Avian Influenza.

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

[Posted: 9:30 AM EST]

Happy Friday!  Davos continues, and the coronavirus continues to dominate the news on the eve of the “year of the rat.”  Here is what we are watching this morning:

Coronavirus:  The virus has now been blamed for 25 fatalities and has infected an estimated 830.  Confirmed cases have been reported in China, Japan, South Korea, Macau, Taiwan, Singapore, Vietnam and Hong Kong.  China is clamping down on travel in a bid to contain the virus’s spread.  Eleven cities have some degree of a travel ban, and Disney’s (DIS, 142.20) Shanghai resort has closed.  Casino stocks fell on reports of the infection being found in Macau.  Even parts of the Great Wall have closed.  Hospitals are struggling to deal with the influx of patients.  Both the U.K. and Italy are investigating potential cases.  One model of epidemics puts the actual infection rate at closer to 4k.  So far, this new virus does not appear to be as virulent as SARS; it has caused fewer deaths and those who have died have tended to be elderly with other chronic conditions.  S&P estimates the event could reduce China’s GDP this year by 1.2%.  The CNY has weakened as the virus has spread.  Due to expectations of an influx of Chinese tourists amid the Lunar New Year holiday starting today, Japanese officials are beefing up airport screening against the Wuhan coronavirus.  They are also tightening their plans for a potential pandemic during the Tokyo Olympic Games this summer.  At least one Olympic-related boxing match has already been canceled in Wuhan, and a women’s qualifying soccer match was moved to Nanjing.

The underlying market questions from this event are how deep and how long?  In other words, how big of a decline will this trigger and how long will it last?  The SARS history does offer some clues and it suggests that it will have a rather large impact but it won’t last long.  Note the pattern of China’s consumer confidence:

SARS occurred in 2003; it clearly had a short-term impact on consumer confidence.  On the other hand, industrial production did drop but also recovered quickly.

The comparisons to 2003 do have problems; the Chinese economy was in a robust growth phase.  That is not the case now.  But, the most likely outcome is that this will be a short-term event.

Eurozone:  IHS Markit today said its composite purchasing managers’ index for the Eurozone came in at a seasonally adjusted 50.9 in January, matching the December reading but falling short of the expected reading of 51.2.  The index is designed so that readings over 50 point to expanding activity, so the January figure suggests the Eurozone economy continues to grow at a lethargic pace.  One bright spot, however, was that the manufacturing PMI rose to 47.8.  That still points to contraction in the factory sector, but it is better than the reading of 46.3 in December and it beat the expected reading of 46.8.  IHS Markit also released its single-country indexes, which showed significant improvement in the all-important German manufacturing sector.  Germany’s manufacturing PMI beat expectations by rising to 45.2 from 43.7 previously.  France’s manufacturing PMI was better as well, rising to 51.0 from 50.4.  In sum, the figures provide a glimmer of hope that the Eurozone economy could be turning the corner.  The figures are therefore boosting European stocks so far today.

United Kingdom:  The flash IHS Markit/CIPS composite purchasing managers’ index for the U.K. rose to a seasonally adjusted 52.4, smashing the December reading of 49.3 and handily beating the expected reading of 50.7.  The January index for manufacturing beat with a rise to 49.8, but, because of the dominance of Britain’s service sector, the key index for the country is its services PMI.  That index jumped to 52.9 in January, reaching its highest level since mid-2018.  The figures suggest the British economy is bouncing back nicely from the Brexit debate.  Even though the figures undermine any expectations for a new cut in interest rates, they should be positive for British stocks going forward.

United States-China:  The Commerce Department’s proposed rule that would make it harder for U.S. firms to sell to Chinese telecom giant Huawei (002502.SZ, 2.99) from their overseas factories is reportedly being resisted by the Defense Department on grounds that hurting the U.S. firms’ sales would damage their ability to conduct research and development.  The news highlights the split within the Trump administration when it comes to China policy.

Europe-Iran:  Even though Germany, France and Britain last week triggered a dispute-settlement mechanism under the 2015 nuclear deal with Iran, European diplomats now say they won’t reimpose sanctions on the country unless it significantly ramps up its violations of the agreement.  However, it’s not clear whether Iran would hold the line on its nuclear activities, given that its leaders are probably still itching to take revenge for the U.S. killing of Gen. Qassem Soleimani earlier this month.

United States-Iraq:  In protest against the U.S. killing of Gen. Soleimani on Iraqi soil, tens of thousands of Iraqis have launched a demonstration calling for U.S. troops to be expelled from the country.  The protest is being led by an old foe of the U.S., the Shiite cleric Moqtada al-Sadr, who was the first Shiite leader to call for armed resistance after the U.S. invasion of Iraq in 2003.  We suspect he is being egged on by the Iranians, who would likely consider a U.S. expulsion from Iraq to be sweet revenge for the killing of Gen. Soleimani.

A tale of railroads:  Union Pacific (UNP, 187.19) is adopting “precision-scheduling railroading,” which is a plan to run fewer trains on tighter timetables with more cars.  It is improving efficiency at the cost of 3,000 jobs.  This is a truism of economics; productivity improvements coupled with slow growth usually mean that the benefits of the productivity enhancement goes to capital.  Labor’s participation in the improvement is usually reliant on a stronger expansion.  In other words, if the economy is robust, those 3,000 workers will easily find other work.  But, if it’s not, they may become unemployed.  In the current situation, the most likely problem is that these displaced workers will find jobs but at a lower pay than their current ones.

FICO:  The FICO score is the backbone of modern consumer finance.  Prior to the development and adoption of the FICO score, the creditworthiness of households was determined by individual loan officers.  The officers relied on the specific knowledge of the community; the system generally worked well but was inefficient.  The FICO score allowed a lender to quickly ascertain a borrower’s creditworthiness without community knowledge.  This not only fostered national lending (as opposed to local lending only) for households, but it also gave financial firms the ability to efficiently securitize loans to build bonds that could be sold to investors.  For consumers, the FICO score can determine access to credit and the cost of borrowing.  The Fair Isaac Corporation (FICO, 415.08) is adjusting its scoring system to pay closer attention to rising debt levels and trigger downgrades faster for borrowers in arrears.  The expected outcome will be a wider gap between safe and risky borrowers and make it more difficult for risky borrowers to access credit.  It remains to be seen if this change will affect consumption.

Energy update:  Crude oil inventories fell 0.4 mb compared to the forecast rise of 1.0 mb.

In the details, U.S. crude oil production was unchanged at 13.0 mbpd.  Exports fell 0.1 mbpd, while imports fell the same amount.  The decline in stockpiles was unexpected.

 

This chart shows the annual seasonal pattern for crude oil inventories.  This week’s decline was a bit below normal.  As the chart shows, oil inventories usually rise into late spring and then decline significantly into late summer.  Last year, this pattern was disrupted to some extent because of exports.

Based our oil inventory/price model, fair value is $64.53; using the euro/price model, fair value is $50.92.  The combined model, a broader analysis of the oil price, generates a fair value of $55.18.  We are seeing the divergence between dollar and oil inventories narrow as dollar weakness persists.  Given the level of geopolitical risk, prices have not moved significantly above the inventory fair value price, although the combined model would suggest a richly valued market.  With inventories poised to rise seasonally and tensions seemingly easing, softer prices are more likely in the coming weeks.  The recent epidemic in China has been a bearish event for oil prices.

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

[Posted: 9:30 AM EST]

Davos continues, the ECB meets, but it’s the coronavirus dominating the news.  The U.S. is setting its trade sights on the EU.  Here is what we are watching this morning:

Coronavirus:  The latest death toll is 17 and the number of confirmed cases now exceeds 600.  According to reports, the majority of fatalities are older men who, like many older people, had other chronic conditions.  On the surface, the Chinese government is acting decisively to contain this outbreak.  It has now banned travel from four cities, including Wuhan.  Despite the show of force, there are persistent reports of underreporting of potential cases, especially among younger people.  Meanwhile, we continue to compare this event to the 2003 SARS epidemic.  However, the conditions in China are significantly different from 17 years ago; one major change has been the spread of mass transportation.  Simply put, it’s a lot easier for infected people to move about, increasing the chances of spreading.  This likely explains the quarantine; however, it is unclear how effective the ban will be.  We are seeing two important market events.  First, as one would expect, Chinese equities are taking a hit over the outbreak.  Second, worries that the outbreak will slow global growth have been bearish for crude oil.  Seasonally, crude oil tends to weaken this time of year so fears surrounding the coronavirus have been yet another bearish factor.

Trade:  The focus on trade is now shifting to the EU.  The EU’s tactics up to this point have been to offer modest proposals and avoid direct confrontations with the U.S.  This action is similar to how China initially dealt with the White House, but clearly the administration was not placated.  So far, Treasury Secretary Mnuchin and Commerce Secretary Ross have been the point persons in the U.S. to the EU.  This was true with China for a while.  But, the real “game” doesn’t start until USTR Lighthizer shows up.  This trade situation could get quite messy.  First, we are only nine months away from U.S. elections; the EU likely hopes it will deal with a new president.  Second, the EU is, by design, a slow-moving body and it isn’t obvious it can react quickly if the U.S. starts applying tariffs.  Third, the EU really wants to apply digital taxes; we suspect this will be a red line for the U.S.  Fourth, the EU is considering CO₂ border adjustment taxes, which would apply a tax on the EU but also to imports based on the carbon policies of their trading partners.  This action would be an anathema for the U.S.  Fifth, U.S. exports to the EU are much higher than China; on a rolling-four quarter basis, it is 3.7x larger.  Thus, the EU will have many more targets to apply retaliatory tariffs on the U.S. compared to China.

ECB:  Although the press conference was still underway at the time of this writing, policy remains unchanged.  We are starting to hear pushback from Eurozone bankers on negative interest rates.  We suspect they are trying to see what sort of influence they will have with Legarde; they clearly got nowhere with Draghi.

Canada:  The Bank of Canada yesterday kept its benchmark short-term interest rate steady at 1.75%, right where it has been since October 2018.  However, by cutting its forecast of near-term economic growth, the policymakers also laid the groundwork for a potential cut in rates sometime in the future.

Russia:  In a unanimous vote by ovation, the lower house of parliament gave first-reading approval to President Putin’s proposed constitutional changes, which will allow him to continue ruling Russia even after his term as president expires in 2024.  Once the amendments get through two more readings in the lower house, they need to pass the upper and a promised referendum.

Saudi Arabia:  United Nations investigators have concluded that Jeff Bezos, the founder of Amazon (AMZN, 1,887.46) and owner of the Washington Post, had his cell phone hacked via a WhatsApp account linked to Saudi Crown Prince Mohammed bin Salman.  Shortly after Bezos and bin Salman traded phone numbers at a meeting in April 2018, bin Salman sent Bezos a video containing secret spyware, possibly to gain information on former Post columnist Jamal Khashoggi, whom the Saudis murdered in October 2018.  The hack may have also allowed the Saudis to release compromising information on Bezos’s extramarital affair last year.  The UN researchers, who were hired by Bezos, have asked the U.S., Saudi Arabia and other countries to investigate the matter.  The incident underlines the crown prince’s risky adventurism as he takes a more aggressive tack on Saudi national security.

United States-Iran:  Brian Hook, the U.S. Special Envoy for Iran, said in an interview that if the new leader of the Islamic Revolutionary Guards’ overseas force behaves as previous leader Gen. Qassem Soleimani did, he would meet the same fate.  In other words, he would be subject to possible assassination by the United States.

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

[Posted: 9:30 AM EST]

Davos continues, impeachment dominates the news (but has no discernable impact on financial markets) and we continue to monitor the coronavirus.  Lebanon gets a new government, Norway’s fails and Italy’s might be close to failing.  Here is what we are watching this morning:

Coronavirus:  Yesterday, the first case was reported in the U.S.  A man in Washington state, who recently visited Wuhan, tested positive for the virus.  The death toll is up to nine, with over 400 confirmed cases.  Equities are rebounding this morning on expectations (hopes?) that Beijing will do a better job of handling the outbreak compared to its less than transparent actions in 2003 during the SARS outbreak.  We view this expectation as rather heroic.  Two issues concern us.  First, there is anecdotal evidence that cases are being underreported.  Second, Beijing’s drive to isolate Taipei means that Taiwan isn’t part of the WHO, meaning its data isn’t being tracked.  Historically, pandemics tend to have a notable, but short-term, effect on financial markets and the world economy.  It usually hurts transportation and consumption.  We are not anticipating a serious problem for the U.S., but it could be a bigger issue for Asia.

Governments:  After three months without an official government, a new one is in the process of forming in Lebanon.  Designed to be technocratic in nature in order to tackle the serious financial problems facing the country, the fear is that it will come under the sway of Hezbollah as the Sunni parties have decided not to join the new coalition.  Meanwhile, a spat over allowing a Norwegian IS member to return has led the Progress Party to leave the ruling coalition in Norway, ending the parliamentary majority of the current government.  In Italy, Luigi Di Maio resigned as leader of the Five-Star Movement.  He is currently the foreign minister.  Although he is not expected to leave his position, his resignation raises fears that the Five-Star party might disintegrate, weakening the current ruling coalition.  Italian bond yields and CDS prices rose.

Trade:  Tensions with China are easing in the wake of the Phase One deal.  Markets are now shifting to the effects of the arrangement.  One potential impact is that WTI could gain on Brent due to the need for China to import energy from the U.S.  Although there are expectations that China will buy a significant amount of U.S. grain, we note that China has been stockpiling domestic grain to support prices.  Wheat and rice dominate their government purchases but could lead to inventory dumping to meet the demands of the new trade deal.  U.S. attention is now shifting to the EU, where the first skirmish is over digital taxes.  Although the U.S. and France have come to a truce, the U.K. is showing surprising tenacity in maintaining its threat to implement such taxes.  We doubt Westminster will maintain this stance as the U.K., at some point, will want a trade agreement with the U.S.  The EU has every reason to tax U.S. technology firms; Europe has failed to develop firms of similar scale and thus it can gain revenue and some degree of control through tax policy.  Naturally, Washington will oppose such measures, mostly by threatening Europe’s auto industry.

Energy:  Two news items of note.  The civil war in Libya has, over time, affected oil supplies.  It appears that production and exports are being curtailed again due to tensions.  The most recent event is the blockade of oil exports by the leader of the eastern part of Libya, Gen. Khalifa Haftar, has blockaded oil exports.  Production is falling to near zero.  Interestingly enough, this news hasn’t lifted prices, a clear indication of the market’s oversupply.  Another market facing oversupply is natural gas.  Despite being in the dead of the northern hemisphere winter[1], U.S. prices have declined below $2.00 MCF.  The root of the current problem is associated gas that is produced by frackers in the production of oil.  The natural gas, that usually is also produced in this process, is a byproduct and is price insensitive.  Cheap natural gas is a supportive factor for chemical makers and fertilizer companies.

Argentina:  Could we be seeing yet another Argentine default?  The markets are already concerned about the new Peronist government in Argentina.  However, this default may come from the provincial level and the new governor of Buenos Aires province wants to delay a bond payment for three months.  There is fear that the more radical wing of the Peronist party may be pushing to confront foreign creditors and lead to yet another default.

Production delays: On Tuesday, Boeing Co. (BA, $313.37) announced that it does not expect to restore production of the 737 max until midyear at the earliest. The suspension of production is expected to ripple throughout the economy, as it will likely impact many of Boeings suppliers. As a result, many of its suppliers have already begun laying off workers.  Initial estimates suggested that the slow down production could cut any where from 0.3% to 0.5% from annualized GDP figure in Q1.

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[1] Paradoxically, price lows often occur in January.  This is due to the mechanics of storage.  Most U.S. storage is in depleted wells which must be filled and drained on a regular schedule to protect well integrity.  Salt domes, the other type of storage, can be flexibly filled and depleted, but old wells must inject gas at a steady pace in the summer and withdraw it in the winter.  A mild January is a death knell for prices; the gas in the wells must come out and compete with current production. Without robust home heating demand, prices can collapse.

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

[Posted: 9:30 AM EST]

It’s Davos week!  World leaders in politics, business, academia and media are all gathering in Davos, Switzerland.  Your Daily Comment team is skipping the event this year, remaining in picturesque downtown Webster Groves instead.  It’s a risk-off market this morning as the Chinese coronavirus has clearly mutated to person-to-person transmission.  With the Chinese New Year coming on Friday, massive travel is likely which could foster the spread of the virus.  In other news, the IMF has lifted its growth forecast modestly.  Iran changes tactics on its nuclear program.  Here is what we are watching this morning:

Coronavirus:  This new respiratory virus, originating in central China, is spreading rapidly as it becomes evident that the disease can be spread via human contact.  The number of confirmed cases has tripled, to 218, and six fatalities have been blamed on the disease.  New cases have been reported in Thailand, Japan and South Korea.  Another worry is that the Lunar New Year begins on Friday; this event usually triggers a mass migration in China as workers who have moved to cities return home for the week-long holiday.  The concern is that this new virus will have a similar effect to SARS, which noticeably slowed China’s growth.  China has faced some criticism for the slow reporting of this virus, but authorities argue that the reporting and testing systems created after the SARS crisis are likely to blame.  Worries about this virus have triggered some selling in equities this morning (gold is down as well); we suspect the mere uncertainty surrounding the virus is behind the selling, although one could argue the near unidirectional pattern of equities recently was overdue for at least a period of consolidation.

Davos:  It is the 50^th anniversary of this gathering.  Although it is an important event, it has taken on a sheen of tone-deafness in recent years.  Last year’s theme of inequality being discussed by billionaires is a good example.  Still, this is one of the few times when leaders across different areas gather simultaneously, which does mean the potential is elevated for newsworthy events.  One interesting side note: local officials say they broke up a probable Russian effort to bug the venue last summer.  Police were alerted when a pair of ostensibly Russian plumbers had an unusually long stay at the resort.  Police and Swiss federal officials suspected the pair of posing as tradesmen to install surveillance equipment at key facilities around town to monitor the private conversations of the world leaders attending the forum.

IMF:  The IMF has released its semiannual report on global growth.  It is looking for a modest lift to GDP this year, at 3.3%, up from 2.9% in 2019.  Monetary policy easing (there were 71 rate cuts by 49 central banks last year) and a détente in the trade war with China account for the improved outlook.  Although this is positive news, it should be noted that in October the IMF projected 3.4% growth for 2020.  Interestingly enough, CEOs are not nearly as optimistic as the IMF.  It should be noted that globalization continues to retreat; foreign investment has declined to a near-decade low.

Iran:  After the EU moved to begin the process of reimplementing sanctions in light of Iran’s nuclear activity, Tehran abruptly declared it would not take any further steps to violate the 2015 agreement.  However, in a change of tactics, Iran indicated it would withdraw from the nuclear Non-Proliferation Treaty if its nuclear program is referred to the U.N.  In other words, if the EU brings Iran’s recent violations of the 2015 agreement to the UNSC, Iran will threaten to sell its nuclear technology.  It appears that Iran has concluded that further violations of the JCPOA would be counterproductive, but it has shifted its threats to sway the Europeans.

Russia:  President Putin has released a draft of the constitutional changes he floated last week to help him stay in power past the end of his term in 2024.  As we reported earlier, the changes will weaken the power of the president and prime minister.  The draft amendment shows that the State Council – an advisory body made up of parliamentary leaders and provincial governors that Putin already heads – will gain new responsibility to “coordinate . . . the organs of state power.”

Eurozone:  The European Central Bank’s latest bank lending report showed corporate loan demand fell 8% in the fourth quarter, even though credit standards were broadly unchanged and the ECB had cut interest rates in September.  Surveyed banks expected corporate loan demand to fall 9% further in the first quarter of 2020.  According to the ECB, the decline in corporate demand largely reflects weak economic conditions and reduced capital investment.  In contrast, high consumer optimism and low interest rates boosted demand for housing loans by 25% in the fourth quarter.  As in the U.S., the question is whether soft corporate investment and manufacturing will eventually offset the strength in the consumer sector.

Digital tax:   Facing the threat of U.S. tariffs, Paris has suspended its levy on U.S. tech firms.  Treasury Secretary Mnuchin has warned the U.K. and Italy over their digital tax initiatives.

Odds and ends:  China’s growing bad debt is catching the attention of U.S. vulture investors.  Meng Wanzhou’s extradition trial began yesterday.  The transportation strike in France appears to be fizzling as workers need their wages and unions are divided.  North Korea has replaced its foreign minister; there was no official announcement and it isn’t clear what exactly happened to Ri Yong Ho.  Moody’s has cut Hong Kong’s credit rating to Aa3 from Aa2 due to continued social unrest.

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