by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EDT] | PDF
The summer doldrums are upon us. Equity markets are mostly steady, with the dollar weakening. We detail the claims data below, but they are showing improvement. We lead with market and economic news this morning, followed by China. Foreign news is next, with updates on the situation in Belarus. We close out today’s report with an update on the pandemic. And, being Thursday, we have a new Weekly Energy Update. Here are the details.
Market and Economic news:
- In this week’s Asset Allocation Weekly, we discuss the risk to the economy from cuts in state and local government spending (with further analysis in our podcast and chartbook). Library systems, including St. Louis County, have announced layoffs. Cities, strapped for revenue, are reporting job cuts. Reports suggest that cities are suffering more in this downturn than in 2008. Although talks on fiscal stimulus are stuck, the Fed is lowering the rates it charges to state and local government borrowers who use its emergency lending program. We risk seeing a repeat of 2010-11, when falling state and local spending more than offset federal spending, slowing the recovery. In the current situation, it raises the potential for either a stalled recovery or an extended recession. Fed officials are raising concerns that the lack of stimulus is threatening the recovery.
- If working from home is now the future and perhaps remote learning is too, then the location of where you live is less important than the functionality of one’s quarters. Being in a tiny neighborhood or big city with exorbitant veterinarian costs doesn’t make sense when one can’t go outside much anyway. And thus, we are seeing a rising flight to the suburbs for lower per square foot costs of housing and backyards. Even proximity to shopping isn’t a feature now that home delivery is available.
- Remember “liar loans”? These were infamous during the 2007-09 recession as dodgy, no-documentation mortgages were found to be classic examples of Hyman Minsky’s third class of financing, “ponzi financing.” At the residential level, they don’t appear to have returned. But, interestingly enough, we are seeing reports that commercial property borrowers may have overstated their property’s income and lenders may have encouraged the practice. If so, this could raise risks in commercial mortgage-backed security markets.
- Mortgage refinancing activity has been elevated in recent months as mortgage rates have declined. The primary guarantors of these mortgages, Fannie Mae (FNMA, 2.11) and Freddie Mac (FMCC, 2.09), are applying a new fee to newly refinanced mortgages of 50 bps. The fee is ostensibly to protect the firms from loan losses, although mortgage lenders are viewing it in less sanguine terms. The fee will tend to dampen refinancing activity, all else held equal.
- One of the problems with using executive orders to legislate is that Congress controls funding. Thus, if the White House wants to fund something via executive orders, it has to find the funding from some other source. To fund the $300 per week additional boost to unemployment insurance, the government is using $44 billion from FEMA funding. Unfortunately, that funding may only last six weeks.
- One of the key components in solar panels, polysilicon, is in short supply after a series of explosions at processing plants in China. Since the industrial mishaps in July, prices are up 50%. China supplies two-thirds of the world’s polysilicon and nine of the top 10 solar panel manufacturers are Chinese. This news highlights the problem of deglobalization. When the world is perceived to be at peace, extending and concentrating supply chains is rational. It looks less so in a fractured world.
- The gig economy firms are facing an increasingly adverse legal environment. The district attorney of San Francisco has been filing injunctions against the gig firms forcing them to treat their workers as employees. The business model of these firms borders on regulatory arbitrage; treating their workers as independent contractors allows them to avoid much of the regulatory cost of employees. The firms are threatening to quit California over the dispute.
- The U.S. is considering a free trade arrangement with Taiwan and Beijing is furious. After the CPC took control of mainland China in 1945, the Nationalist Chinese moved to Taiwan and established the Republic of China. For years, both sides claimed to be the legitimate government of China. Interestingly enough, this led to a period of stasis; the threat to this tacit agreement was if Taiwan ever decided it was a country independent of China. The U.S. action would be similar to China making a free trade deal with California, independent of the federal government. Polls suggest that the majority of Taiwan residents view themselves as singularly Taiwanese. Taiwan independence would be a flashpoint for conflict.
- Despite looming restrictions on Chinese companies listing in the U.S., Chinese firms continue to flock to U.S. exchanges and Wall Street continues to collect fees for their service.
- According to reports, the Xi regime has warned its military not to fire first in standoffs with the U.S. military.
- We have been watching the fate of Taiwan Semiconductor (TSM, 79.39) for some time. The firm is a critical supplier of semiconductors; it also straddles the superpowers, providing products to both China and the U.S. Both nations want to influence the company. Earlier this year, it announced it was building a production facility in the U.S. Today, we note reports that Chinese firms are poaching talent from the company.
- In our WGR series on the elections, we noted that various foreign nations were poised to try to affect the outcome of our election. China was mentioned; we commented that its methods were probably not as sophisticated as Russia’s (which are world class, IOHO). However, that isn’t to say China’s methods are crude. Reports indicate that China has created a network of fake social media accounts to promulgate polished videos against President Trump. We expect more of this sort of activity as November approaches from a variety of nations.
- Despite an aggressive crackdown, protests continue in Belarus. Thousands have been arrested. Security forces have resorted to live ammunition against protestors. At this point, we don’t think Lukashenko will be forced from power. Unlike in Ukraine, Belarus doesn’t have a natural division. Ukraine has been divided between a Russia-sympathizing east and a Europe-sympathizing west. In Belarus, there is no obvious alternative to Lukashenko. He has greater control over the security apparatus. However, even if he survives this threat, it is unlikely the country will thrive. The election will likely spur the young and talented to emigrate, causing a brain drain. It is likely Lukashenko will be forced to improve ties with Russia as Western nations will be less inclined to deal with him. This means less flexibility in dealing with Putin. Thus, he will survive, but in a weakened state.
- There are reports that Iran seized an oil tanker in the Persian Gulf. The vessel was held for five hours, then released. It is not clear why it was boarded or why it was allowed to leave. Oil markets ignored the news. The event is one in a series of provocative acts by both the U.S. and Iran over the past year. They have raised tensions but not enough to trigger a war.
- Israel claims that North Korean hackers attempted to breach one of its defense firms.
COVID-19: The number of reported cases is 20,648,298 with 750,030 deaths and 12,849,485 recoveries. In the U.S., there are 5,197,749 confirmed cases with 166,038 deaths and 1,755,225 recoveries. For illustration purposes, the FT has created a nifty 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 weekly Axios map shows a clear improvement in cases in the U.S.
- We have been reporting a large backlog of testing results that has rendered testing useless. If the results of a test take more than 10 days, by that time, the patient has probably recovered. As a result of this backlog, we are seeing a drop in testing; the good news is that the backlog will likely ease, meaning those getting tested will get their results sooner.
- The most helpful testing is one that generates a rapid result. Although such tests exist, the machines that read the tests are in short supply.
- Although testing and reporting protocols in the developing world are considered weaker than in the developed world, it does appear that the rate of change is slowing in the former. However, the caseloads seem to be plateauing at a high level, which will tend to dampen growth in the emerging world.