Daily Comment (August 9, 2021)

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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday.  It’s inflation week—the CPI comes out on Wednesday.  U.S. equity futures are modestly lower this morning, but the real story is in commodities.  Oil and precious metals are tumbling this morning in the face of higher Treasury yields.  Overnight, gold futures fell over $60 per ounce; prices have recovered well off their lows but are still down this morning.  What’s going on?  The solid employment data has lifted expectations of Fed tightening.  But it is also important to remember that market liquidity tends to thin in August as traders take vacations.  Thus, market moves can be exaggerated.  Our coverage this morning begins with economics and policy.  China news is up next, followed by the international roundup.  We close with pandemic news.

About that employment data: Much of the turmoil we are seeing in markets was tied to the employment report.  The data showed clear improvement in the labor markets and raises pressure on the FOMC to react.  Although there is some concern that the survey period did not catch the recent delta variant issues, we suspect that labor markets will continue to recover.  One item worth watching is the participation rate of the 24-54 age bracket.  The 65+ participation rate continues to decline as older workers, more vulnerable to COVID-19, opt for retirement.  Although we are not at a level of complete recovery, we are at a point consistent with a fed funds target of around 1%.

A reading above 82 will increase the likelihood of some form of tightening.

Economics and policy: The infrastructure bill is near the finish line in the Senate.  The IPCC has released its updated climate report.

 China: Markets continue to grapple with regulatory changes, and nationalism is on the rise.

  • From 1979 to mostly the present, China has had its own efficiency cycle, which allowed entrepreneurs to build businesses and become rich. Although Hu Jintao commented on the problem of inequality, Xi is doing something about it.  His anti-corruption campaign weakened the ability of capital owners to affect policy.  Now, Xi is going against out-of-favor industries directly.  The losses are notable.  There is wide debate about the path forward; is Xi merely trying to weaken power rivals, or is this move tied to industrial policy?  Although the answer might be “yes” to both, we suspect the latter is the most important.  If so, investors can probably still do ok in areas that China favors.  At the same time, industry leaders would be advised to keep a low profile.
  • One emerging trend we are watching is the generational attitude differences developing in China. The millennials in China have only seen an ascendant China.  They appear no longer content to bide time and wait, and they are intolerant of foreign criticism of China.  This emerging nationalism looks to us to be similar to conditions seen during the Cultural Revolution.
  • The crackdown on China’s tutoring industry appears to be an attempt by the CPC to reduce social tensions. However, the drive for tutoring is partly driven by rising youth unemployment.  If good jobs at the entry level are scarce, it makes sense to take whatever steps are necessary to acquire one.
  • Despite these trends, some business leaders are calling for new trade talks with China and tariff reductions. Although we think tariffs are a misguided policy (a deliberate policy to appreciate the CNY would be far more effective), it appears to us that business leaders are out of step with the political trends.  If anything, there is a higher likelihood of additional trade and investment restrictions.
  • Underlying all these issues is China’s shaky financial system. A recent directive argued that the banking system should stop lending to local government financing vehicles; if this were to occur, widespread defaults would likely follow.  The directive was pulled shortly after its release.  Its disclosure could have been a mistake, or a trial balloon.  But it does show that China has a serious delinquent debt problem that won’t get better by continued funding.  However, cutting off liquidity will only lead to default and the consequences of default could be destabilizing.  Everything we are seeing from the CPC leadership suggests consolidation and centralization.  So, our take is that the central government will use the indebtedness of the local governments as an opportunity to bring them under control.

 International roundup:  The Taliban’s role; Lukashenko remains in power in Belarus a year after the elections.

COVID-19: The number of reported cases is 202,872,928 with 4,297,550 fatalities.  In the U.S., there are 35,765,233 confirmed cases with 616,829 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high frequency data on various factors.  The CDC reports that 407,561,705 doses of the vaccine have been distributed with 351,400,930 doses injected.  The number receiving at least one dose is 194,866,738, while the number receiving second doses, which would grant the highest level of immunity, is 166,477,481.  The FT has a page on global vaccine distribution.

  • The delta variant continues to spread rapidly across the U.S. Community transmission rates remain elevated across the country.  States with high infection rates are scrambling to find hospital bed capacity.  The variant has become dominant due to its high contagion rates.
  • Although the mRNA vaccines were the first out of the gate, the technology remains finicky. Handling procedures make them difficult to distribute and the new technology is probably one factor behind vaccine resistance.  Much of their success was due to deft management; the companies involved tested their vaccines when infection rates were elevated, which gave them lots of test subjects, and emerging firms teamed up with established ones to ramp up production.  The Novavax (NVAX, USD, 189.89) vaccine is near the end of its clinical trials and should be available soon.  It has some distinct advantages.  Because it’s based on an existing technology, its handling is less stringent.  The fears surrounding mRNA should not be part of this vaccine.  And, trial data so far suggest it is more effective than the mRNA vaccines.  Reports indicate that side effects are less, which has been a barrier for some low-income groups who fear missing work if they become ill from the injection.

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