Daily Comment (December 3, 2020)

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  U.S. equity futures are steady this morning in front of tomorrow’s employment data.  There is a lot of news this morning.  We lead off with China news, as the House passes the Senate bill on the issue of auditing Chinese firms listed in the U.S.  Congressional and Fed news comes next; a pandemic relief bill may be coming.  In Middle East news, OPEC is near a deal, and the Saudi blockade on Qatar may be over.  We update the pandemic news next.  Brexit and the EU budget follow.  We take a look at Russia’s activities in Africa and farm reform in India.  Finally, we close with economic odds and ends.  Since it’s Thursday, a new Weekly Energy Update is available.  Here are the details:

China:  Here is the latest:

  • In a rare unanimous vote, the House approved legislation that would ban Chinese listed firms on U.S. exchanges unless they submit to American-approved auditors. Firms will have three years to comply.  We note that the SEC is working on a plan that would allow Chinese auditors to receive U.S. approval which may allow Chinese listings to continue.  There are two elements underlying this issue.  The first is that lax auditing standards have led to weak investor protections, and forcing Chinese firms listing in the U.S. to match American accounting standards would provide better protection.  The second is that rising tensions between China and the U.S. may lead Beijing to prefer Chinese firms list in Hong Kong or Shanghai.
  • Australia’s Former PM Turnbull is trying to cool tensions between Australia and China, asking businesses to not publicly criticize Beijing. As we have noted recently, relations between the two countries have been deteriorating; it all began when Canberra sought an international investigation of the COVID-19 outbreak in Wuhan.  Since then, China has been disrupting trade and has been waging escalating criticism of Australia.
  • There is often a tendency to assume that new administrations can easily reverse the policies of their predecessors. It is usually much more difficult than expected.  Regarding China, it is becoming increasingly obvious that attitudes between the U.S. and China are hardening on a bipartisan basis.  In a political environment where there is little common ground, China is emerging as one area of broad consensus.  This situation is evident by a recent Congressional committee position that U.S. investment in China should face greater scrutiny.
  • The U.S.-China Economic and Security Review Commission, a bipartisan group that monitors relations between the two nations, in its annual report recommended an ambassador-level appointment to Taiwan. Such an appointment would anger Beijing, who sees Taiwan as a province.
  • We continue to monitor China’s spate of SOE defaults. The newest event is tied to Huachen Automotive Group (BCAUF, USD 0.91).  The automaker is well connected, the largest SOE in Liaoning province.  Lenders, who have lent CNY 33.5 billion (USD 5.0 billion), supplied credit to the firm mostly due to its state ties.  Although a default hasn’t occurred yet, negotiations between creditors and the firm have started, and there is potential for a credit event.
  • An apartment leasing firm called Eggshell is catching the attention of financial regulators. The firm was involved in a form of rental carry; it would offer tenants a discount if they signed up for bank loans.  The bank would collect the rents.  The firm would then pay landlords by borrowing shorter term loans and earning the difference.  The pandemic cut the demand for leasing, leaving less revenue to service the landlord loans.  It appears the company is starting to default on these bank loans, and it is unclear how authorities will resolve the issue.
  • There are growing reports of “house flipping” in major Chinese cities, a sign of easy credit and strong housing demand.
  • The Xi government is considering extending the official retirement age. Currently, men can retire at 60 years old and women at age 55.  Given China’s aging demographics and longer life expectancy, extending the retirement age makes sense.  However, recent proposals to make the change have not gone over well.
  • Despite widespread attempts to curtail Chinese investment in U.S. technology firms, state back investment funds are continuing to place funds in American firms. It is not evident that these investments received approval by CIFUS.  It is possible they were given permission, but it wasn’t made public.
  • More than 1,000 Chinese nationals involved in research in the U.S. have left the country. There has been increased scrutiny of Chinese intellectual theft, and this large number of exits suggests that either (a) there was a lot of espionage, or (b) the monitoring had become onerous.  It is possible both options are true.
  • Director of National Intelligence Radcliffe is expected to give a speech today warning of the Chinese threat to national security. It is not all that common for a person of Radcliffe’s stature to make such a public declaration.  There is an element within the Trump administration that is pushing the idea of a cold war with China that isn’t necessarily consistent with the populist goal of ending American hegemony.
  • The U.S. is banning cotton products from the Xinjiang region on evidence that forced labor may be involved in the production of these goods.

Congressional and Fed news:  Negotiations on a pandemic relief bill are heating up.  A new proposal for $908 billion in aid is being considered.  This bill is less than a third of what Congressional Democrats were pushing in October.  Some of the thaw in relations is based on the idea that a Biden administration will push for another round of stimulus after inauguration, so getting a smaller bill passed now for immediate aid has gained favor.  We do note there is increasing speculation that the FOMC may increase bond buying in an attempt to cap long-duration Treasury yields.  History suggests that without an explicit signal that the Fed will expand its balance sheet to any degree to prevent rates from rising, this effort will probably fail.  In the last decade, periods of QE tended to coincide with rising long-term interest rates, as the market viewed the balance sheet expansion as potentially inflationary.  We do expect the Fed to eventually engage in yield curve control in a bid to lift housing.

  • Mark Kelly (D-AZ) joined the Senate yesterday and, by doing so, seems to have ended Judy Shelton’s chances of being confirmed for the FOMC. It does appear that Chris Waller, the head of research for the St. Louis FRB, will be confirmed.  That will leave one open position on the committee.  Waller is a conventional choice, but Shelton was controversial, and, in the end, there were enough establishment Republicans who simply couldn’t vote for her confirmation.
  • The Beige Book reflects an economy that is losing momentum. Four of the 12 districts reported negative growth, and others noted that growth is slowing.

Middle East and OPEC:  We discuss the OPEC meeting in today’s WEU, but since the report goes to the editors Wednesday afternoon, we didn’t have the actual outcome of the meeting.  And, we still don’t; members are deadlocked over a production agreement.  It was widely expected that the cartel would extend production cuts through Q1 2021.  However, we may see a modest production increase, because there is a rising push from some members to boost output.  We still expect a deal, but it is becoming clear that discipline is fraying.

COVID-19:  The number of reported cases is 64,648,033 with 1,495,919 fatalities.  In the U.S., there are 13,925,990 confirmed cases with 273,847 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.  Rates of hospitalizations are rising in most states.


Brexit and the EU:  EU officials are warning the bloc is preparing for a hard Brexit.  We still expect a deal, but it won’t come until near the end of the month.  There will be wide protests from EU nations stating that they haven’t been given enough time to look at the agreement, but in reality, the unwieldy confirmation process of the EU almost requires near crisis conditions for agreements to be reached.

Russia and Africa:  Russia has been expanding its influence in Africa.  It has approved a new naval base in Sudan and has boosted arms sales in the regionU.S. restrictions on arms sales have created an opening for Russia to sell military items to the region.  One factor that seems to be driving Russia’s activity is that it is actively seeking mining ventures.  As the world moves away from oil, metals become critical for the new infrastructure.  Thus, acquiring mines is paramount, especially to an economy so dependent on oil.  The U.S. still has a significant influence on the continent but is facing competition from Moscow.

India:  The Modi government is planning to deregulate the agricultural markets in an effort to boost productivity.  However, the proposal isn’t sitting well with farmers.  Usually, agricultural reforms benefit larger farms and tend to disadvantage smaller farmers.  Fears of being deprived of income are leading to widespread protests.  There is no evidence that the government is prepared to backtrack.

Economic odds and ends:  Here are various stories we are tracking.

  • Bankruptcies: Aggressive fiscal and monetary measures have led to a sharp decline in bankruptcies.  This is true in the U.S. and Europe.  However, we would expect a surge in insolvencies next year.  The trick is going to be sorting out which firms are insolvent and which ones are merely illiquid.  There are all sorts of stories circulating about “zombie” companies, but we suspect that some of these will return to normal life as growth accelerates.  Nonetheless, some are truly insolvent and need to be liquidated.
  • Libor: LIBOR was slated for termination at the end of 2021.  However, it looks like it has been granted a partial reprieve.  The IBA, the body that complies and publishes LIBOR rates, will halt publication for one-week and one-month LIBOR at the end of next year, but they will publish other rates until June 30, 2023.
  • Soybeans: Soybean prices have been surging in recent weeks, helped by Chinese buying and dry conditions in South America.  However, reports that Chinese buyers are trying to cancel earlier orders due to negative crush margins[1] has led to a sharp decline in Chicago soybean prices.

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[1] A crush margin is the value of products from soy, mainly soymeal and soyoil, compared to soybean prices.