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

[Posted: 9:30 AM EDT] | PDF

Happy Friday!  Equity futures are mostly marking time this morning.  We lead off with foreign news; Iran, North Korea, and Russia are the focus.  We also update news on China, followed by policy news and the latest on the pandemic.  We wrap up with market details.  Being Friday, a new Asset Allocation Weekly is available; you can find it at the end of this report, and through this link.  The companion podcast and chart book are available as well.  This week’s topic returns to an old favorite, the level of retail money market funds.  Here is what we are watching this morning:

Foreign news:

• The U.S. officially filed a complaint with the U.N. Security Council to trigger the “snapback” provisions of the Iran nuclear deal. The primary goal of the U.S. is to extend an arms embargo that is set to expire in October.  Given that the U.S. suspended its participation, the proposal did not get a warm welcome from the other members.  Although it is certain the proposal won’t pass (both China and Russia have a permanent veto and want to sell arms to Iran), the U.S. complaint puts Europe in an uncomfortable position.  The European members of the council are siding with Russia and China against the U.S.  That isn’t their normal position.  In addition, Europe was a supporter of the deal; not supporting the snapback increases the odds it will officially fail.  What makes this situation especially difficult is that Iran is clearly violating the agreement.  Tehran would argue that the U.S. actions forced it to, but that doesn’t matter all that much.  We would look for the European members to do everything they can to delay the vote.
  • Complicating matters is that Iran just unveiled a new medium-range missile, highlighting the country’s threat to the region.
  • Iranian naval forces have reportedly seized a UAE fishing vessel it accused of venturing into its waters. Iran is angry at the UAE’s recent decision to normalize relations with Israel, and this is apparently its way of expressing displeasure.
• Germany is prepared to fly Alexei Navalny out of Russia after his apparent poisoning. So far, the Kremlin is blocking his departure.  Poisoning remains a favorite tool of the Kremlin for dealing with opponents.
• It is always difficult to know what is going on in North Korea. It’s a closed society with a limited number of contacts with the outside world. In a rare admission of failure, Kim Jong-Un, at a party meeting, admitted that his first five-year plan, launched in 2016, has not met its goals.  He attributed the failure to COVID-19, flooding, and sanctions.  Although the government still claims there are no cases of COVID-19 in North Korea, the virus did close the border with China, choking off trade.
  • A development we continue to watch is the steady rise of Kim’s sister, Kim Yo-Jong, who is now said to be the “second in command.” This ascension appears tied to other efforts by Kim to delegate greater responsibility to other officials.  This decision may be an admission that his government was too centralized or a way to assign failure to other officials.
• The U.S. is deploying $300 million of frozen Venezuelan assets to undermine the Maduro regime.

China news:

• The flooding crisis shows no signs of abating. The city of Chongqing, with a population of 30 million, is making flood preparations for its biggest flood event in four decades.   As water backs up behind the Three Gorges Dam, officials are opening the floodgates.  Inflows into the electric turbines are at 75 million liters per second and the floodgates are seeing flows of 42.9 million liters per second, the most since the dam was constructed.  The maximum level of the reservoir is 175 meters; the waters are forecast to reach 165.5 meters tomorrow.  If the dam is breached, it would not only be a major embarrassment to the Xi government, but it would add to downstream flows and exacerbate flooding.  The Leshan Giant Buddha carving, a massive monument carved into the side of a river valley, is “getting his feet wet” for the first time since 1949.
• Although the U.S. has essentially implemented a “death sentence” to Huawei (002502, CNY 2.96), Beijing has not, so far, retaliated against U.S. firms operating in China. We suspect there are two reasons.  First, China still needs U.S. knowhow and investment, and second, there is probably hope that a Biden government will relax some of the Trump administration’s policies.  We suspect the second hope is on shaky ground; Trump could be reelected, and Beijing may be underestimating the degree to which the U.S. policy establishment has turned on China.  Once China realizes the trend against it is secular, we would expect retaliation to begin in earnest.
• The U.S. isn’t done with actions against China—this coming from an unlikely source, the Home Furnishings Association.
• There appears to be a policy shift coming in China. We are hearing more about a “dual circulation” economic policy, which looks to turn China’s economic focus inward.  This news would confirm a couple of longstanding factors.  First, throughout China’s history, it has cycled from focusing outward to inward.  It does the former when it wants to spur growth.  The coastal areas become export hubs, leading to much better growth but widening regional income gaps.  As these gaps lead to political and social divisions, leaders turn the economic focus inward, which leads to slower growth, but greater political unity and stability.  Mao took China inward, while Deng moved outward.  Xi has been focusing on political and social unity, and thus shifting the economy to a more domestic focus, which would be consistent with this policy.  Second, China’s economic development since 1978 has been investment and export-driven.  The distortions from this policy have created a situation where the policy is no longer able to generate growth without excessive debt creation.  A shift to consumption has been a longstanding recommendation; this “dual circulation” policy might facilitate that move.  If China follows through, it would have significant effects on the global economy.

Policy news:

• Next week, the KC FRB will hold its annual Jackson Hole Policy Symposium; this year, due to the pandemic, it will be virtual. There are reports that Chair Powell will use the event to unveil the Fed’s changes in the inflation reaction function, likely moving from a 2% core CPE target to an average target.  This would be a de facto easier policy stance.  Although this move has been expected, the actual announcement would likely give some support for gold and Treasuries.
  • Numerous former Fed officials are calling on the Senate to reject Judy Shelton for Fed governor. We doubt this will matter; we expect she will be approved.
• President Trump indicated that if he gets a second term, he will implement a policy that offers tax credits for reshoring and tariffs on firms that refuse to move jobs back to the U.S. It isn’t clear exactly how that would be implemented, but it does beg the question: if this was a policy goal, why did it have to wait until the second term?
• The ECB is signaling it will likely add to accommodation in the fall.
• The FTC is questioning Facebook (FB, 269.01) over anti-trust issues.
• Earlier this year, we commented on a growing movement away from running corporations solely on the basis of shareholder value. A number of business groups have indicated they support such a move.  Under a Biden presidency, such proposals may find government benchmarks for these goals.

COVID-19:  The number of reported cases is 22,709, 116 with 794,256 deaths and 14,562,070 recoveries.  In the U.S., there are 5,576,089 confirmed cases with 174,290 deaths and 1,947,035 recoveries.  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 R_t data shows that just over 60% of the states are reporting a reading under one, suggesting a slowing infection rate.  Alabama has the lowest reading, while Hawaii has the highest.

• In a reversal, the CDC will return to collecting COVID-19 infection data. The data was shifted from the CDC to the Department of Health and Human Services last month, but delays have led the government to return to the CDC for data collection.

Economics and Markets

• This recession is hitting New York real estate harder than 9/11 and the Great Financial Crisis.
• Although markets are powerful structures, they don’t always supply everything a society wants. When this occurs, the formal economic term for it is “market failure.”  Some market failures are simply tolerated because the costs of the failure are not enough for government to intervene.  Others are large enough to where government does overrule the market.  One classic case of this was universal phone service.  Stringing wires into rural America was a money-losing proposition, but government leaders feared that if large swaths of low population areas were denied service, it would adversely affect those regions.  Thus, a deal was struck with Ma Bell—provide universal service and the company would be allowed to be a virtual monopoly.  The company paid for the money-losing service with high charges on long-distance, which was mostly funded by businesses.  Note that no such deal was made with broadband, and this service has not been universally provided to rural and low population areas.
  • We see a similar situation with air travel.  The government usually requires airlines to provide service to smaller cities.  We note that airlines are threatening to cut off several smaller cities due to an impasse on pandemic relief.

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