Daily Comment (February 8, 2021)

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

[Posted: 9:30 AM EST] | PDF

Good morning, and Happy Monday!  Congrats to Tampa Bay.  U.S. equity futures continue to tick higher.  Our coverage this morning starts with economic and policy news.  Updates on Europe come next, followed by an overview of international news—we touch on India, Iran, Cuba, and Myanmar.  China news follows; our pandemic coverage comes next.  We close with a technology update.  The current Asset Allocation Weekly is also available.

Policy and Economics:  Here are some of the highlights.

  • One potential threat to the rally in equities would be a rise in inflation. Although we expect inflation to rise in Q2 on base effects alone (the yearly change will look large because Q2 2020 inflation plunged resulting from pandemic shutdowns), a sustained acceleration of price levels would send long-term interest rates higher and contract market multiples.  Because of this threat, we are paying close attention not only to stimulus measures but the path of liquidity injections.
    • As part of the pandemic response, the federal government, along with state and local governments, implemented eviction and foreclosure moratoria. Although the action has prevented a mass increase in homelessness, the impact on payment streams has not been resolved.  Landlords face payment delays that could move further up the payment chain, leading to a default on mortgage bonds.  Once moratoria are lifted, evictions could start, but that won’t necessarily help landlords; it may be difficult to find new tenants without reductions in rent.  In addition, foreclosure may lead to falling home prices.  One solution would be to socialize the problem—send money to renters and mortgagees who use the payments to make their rent or mortgages, securing the payment chain.  If the funds are used for this purpose, the inflation impact would be negligible.
    • Since the Great Financial Crisis, households have been deleveraging, although the pace has slowed in recent years. The injection of stimulus funds could find their way to accelerate the deleveraging process if recipients use the money to reduce their debt load.  The WSJ reports that there is some evidence this is occurring.
    • Treasury Secretary Yellen argued that if the full stimulus bill passes, the U.S. could be back at full employment by 2022. Perhaps, but if the stimulus is saved or used to reduce debt levels, the economic impact will be muted, and the immediate impact on inflation will be weak.  At the same time, if household deleveraging is the result, it will create conditions for a sustained recovery in future years.
  • Another path for liquidity could be the financial markets. The recent “flows vs. pros” event could reflect that trend.  One area that has been highlighted is the “cost” of commission-free trading.  As the adage goes, if something is free, the user is likely the product.  Commission-free trading usually has two characteristics.  First, there is payment for order flow.  Your commission-free broker pays a wholesale trading firm to execute your retail trade inside the exchange’s bid/ask spread.  How can they do this?  The retail flows tend to be random, while the exchange market maker must accommodate institutional flows, which are not.  Thus, the exchange bid/ask is wider than what would be required for retail, allowing a wholesale trading firm to execute the order inside the official bid/ask spread.  When your commission-free broker advertises that they gave you “price improvement,” they are referring to the price inside the exchange’s bid/ask.  The retail broker and the client share in the price improvement, which is revenue to the former.  Second, the retail firms get information about you, like all “free” tech firms offer, which they can use or sell.  Our take is that we won’t see market manipulation charges with the GameStop (GME, USD, 63.77) situation; however, increased scrutiny on (a) payment for flow and (b) what the retail brokers do with your information may occur.
  • Although tax revenues to state and local governments didn’t fall as much as feared, the pandemic has lifted spending, putting pressure on these governments.
  • The U.S. has lifted its objection to Ngozi Okonjo-Iweala’s appointment to Director General of the WTO.
  • As immigration restrictions are relaxed, immigrant flows on the southern border are increasing.

European news:  Trouble with Russia and Draghi is making progress in forming a government in Italy.

  • EU foreign policy director Josep Borrell got a frosty reception on a visit to Moscow on Friday. At a press conference, Russian Foreign Minister Lavrov called the EU an “unreliable partner” and accused European leaders of lying over Alexei Navalny’s poisoning.  The press conference was something of a disaster; the Russians managed to trip Borrell into criticizing U.S. policy toward Cuba.
    • The public dressing down suggests a number of insights. First, the Navalny issue is apparently a very sensitive one for the Kremlin.  The official stance of President Putin is to treat Navalny as a non-entity.  Clearly, talk of EU sanctions for Navalny’s arrest is part of this unexpected reaction.  Second, Russia is viewing the EU as an insignificant threat.  The fact that the Nord Stream 2 pipeline continues to move forward and the EU is willing to make an investment deal with China suggests that human rights issues grab headlines but don’t affect policy.  Thus, the public humiliation of Borrell was seen as an acceptable risk.  Third, Russia has correctly assessed that the EU isn’t a military threat and believes the bloc is easy to divide over issues.  In addition, although the Biden government is looking to return American foreign policy to its previous hegemonic position, Moscow is assuming that this is a short-term reversal of the dominant trend.  We would tend to agree with that assessment.
    • Russia expelled three EU diplomats over the Navalny criticism.
  • Mario Draghi has received conditional backing of Italy’s two largest political parties, which improves the odds he can form a government.
  • Some corporate borrowers in Europe are able to receive a more negative interest rate on their paper than those set by the ECB.
  • The U.K. is considering a special tax on tech companies who have prospered during the pandemic. It reminds us of President Carter’s “windfall tax” on oil companies during his term.
  • And finally, in France, it is no longer illegal to eat your lunch at your desk.

International news:  Iran, Cuba, Myanmar, and India were all in the news.

China:  Relations between Washington and Beijing remain strained.

  • In his first phone call with China’s Yang Jiechi, SoS Blinken leveled the Chinese diplomat, indicating the U.S. intends to hold Beijing “accountable for its abuses.” Last week, Yang laid the blame for deteriorating U.S./China relations at the feet of Washington.  Blinken’s call appears to be the American response.  Although there are concerns that the Biden administration will be “soft on China,” the concern over human rights will not be popular with the Xi regime.
    • Secretary of Commerce designate Gina Raimondo’s confirmation has been put on hold over fears she won’t maintain restrictions on technology exports to China. We expect her appointment to be confirmed, but the appointment for the Bureau of Industry and Security, which is part of Commerce, is key.  That is the body that regulates dual-use technologies and will be an important element in China policy.  Kevin Wolf is the designate for this position.
  • Relations between China and Australia remain strained. Beijing arrested Cheng Lei, an Australian journalist, on spying charges.  Australian farmers warn they could face massive losses due to China tensions; however, as we saw with the U.S., over time, export patterns do adjust.
  • It isn’t just the U.S. that is using antitrust law to corral tech firms; China is too.

COVID-19:  The number of reported cases is 106,228,670 with 2,318,696 fatalities.  In the U.S., there are 27,008,565 confirmed cases with 463,482 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 59,307,800 doses of the vaccine have been distributed with 41,210,937 of those doses injected.  The number receiving the first dose is 31,579,100, while the number of second doses, which would grant the highest level of immunity, is 9,147,185.


Technology:  The auto industry is facing periodic shutdowns due to semiconductor chip shortages.  In a reversal of “just-in-time” inventory models automakers are starting to stockpile chips, which, in the short run, will increase demand and cause further shortages to develop.

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