Daily Comment (February 11, 2021)
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EST] | PDF
Good morning! Equity futures are higher again this morning. Our coverage begins with policy, where we look at Chair Powell’s comments and the controversy over the size of the stimulus. China news comes next; President Biden and General Secretary Xi had their first phone call yesterday. The usual pandemic update follows. EU news is up next. We have some comments on bitcoin, and we close with a roundup of international news.
We have a plethora of recent multimedia offerings. First, our new chart book, which recaps the changes we made to our Asset Allocation portfolios, is available. Being Thursday, the Weekly Energy Update was published today. As we noted yesterday, a new Confluence of Ideas podcast was posted. And, the current Asset Allocation Weekly is also available (updated every Friday). You can find all this research and more on our website.
Policy and Economics: The Fed and fiscal policy are the focus today.
- The primary reason equities are so strong is due to high levels of liquidity; low inflation is the other supporting factor. Thus, there are two threats to equities. The first is that inflation will rise. Although January CPI, released yesterday, indicated that price levels are mostly steady, as we noted recently, base effects will lead to higher inflation in Q2. These increases should be temporary, and the market effect will likely be modest because this rise has been well telegraphed. But, if the increases last into Q3, concerns about mounting inflation could become a problem. The second issue is the withdrawal of stimulus. If the Fed begins to reduce QE or signal rising interest rates, we expect a major negative market reaction. Chair Powell, in a speech to the Economic Club of NY, indicated that no changes in policy are being contemplated now or in the near future. Financial markets took the news well.
- On a side note, President Biden has an empty position on the Board of Governors. President Trump nominated Judy Shelton, but her nomination stalled in the Senate, and the White House withdrew her from consideration last week. Biden is reportedly considering Lisa Cook. She is an economist at Michigan State and was an economist on the Council of Economic Advisors during the Obama administration. We would rate her a “5” dove.
- In addition, Governors Quarles and Clarida, vice chairs for Supervision and the Fed, see their terms as vice chairs end in 2022. (Quarles’s term as governor ends in 2032, but Clarida’s term will expire next year). It is possible that Biden could fill the open vice chair positions with Governors Brainard or Cook if he proceeds with the latter’s nomination. The bottom line is that the board is getting increasingly dovish.
- One of the ramifications of the pandemic has been a drop in economic migration. Several nations, in order to slow the spread of the virus from abroad, closed their borders, and air travel became more difficult, which played a role as well. There are growing concerns that the drop in migration will lead to slower global growth.
- There is currently a debate among economists regarding whether or not the current stimulus plan debated in Congress is too large. Larry Summers has represented those suggesting it’s too big. Others have argued that given the uncertainty, it is better to run the risk of overdoing it rather than repeat the experience of the Great Financial Crisis when the stimulus was too small.
- Our take is that a good case can be made that the stimulus was too small in 2008-09 but not for the reasons often expressed. It wasn’t too small because of the damage to the economy but because households were deleveraging.
- There are essentially two paths to resolve excessive private sector debt. The first is to simply allow the markets to adjust. This path usually leads to deep declines in asset values, sharp increases in unemployment, and a collapse in growth. But, once asset values adjust, the economy has a good base to recover. The second path is to move private sector debt to the public sector balance sheet and then use financial repression to gradually reduce the relative size of the government’s debt by reducing the return to the bondholders.
- During the Great Depression, Hoover tried the first path. It was such an economic disaster that the process was completed with a private/public debt swap, which occurred as part of WWII. Although the war was not caused by the need to address private sector deleveraging, the outcome was the same. Through massive government spending and borrowing, private sector debt was shifted to the public balance sheet and then reduced over time through financial repression.
- One fear of a stimulus that is too large is that households will use the funds to spend, overheating the economy. This could happen. However, we continue to watch the situation with real estate. Last week, we noted the high level of rent arrears and how stimulus checks could be going to reduce these arrears. We note in recent articles that households are building mortgage balances due to forbearances granted resulting from the pandemic. It is also possible that stimulus money will go to addressing the forbearance issue. If so, the inflationary impact will be much less than feared.
- We also note that recent surveys tend to confirm that the transfers were primarily used for debt reduction.
- One of the issues we are watching with great interest is the rapid rise in food commodity prices. Although developed economies tend to exclude food and energy prices from their policy inflation rates, for much of the world (and for less affluent households in the developed world) food prices are very important to political stability. There are reports that the Philippines are facing higher food prices. Usually, the first response by governments is to freeze prices, which President Duterte has implemented, which only leads to shortages. High food prices played a role in the Arab Spring, and we fear another bout of global unrest is possible if our expectation for higher food prices develops.
- Salesforce (CRM, USD, 236.29) has announced that most of its employees will stop using a central office full time. Instead, workers will either work from home on a permanent basis or only use the office on a part time-basis. The office space will be restructured mostly for meetings and collaboration. The company projects that at least 65% of its workforce will use the office one to three days per week.
- The SEC is increasing its enforcement staff for new investigations.
- State governments are moving faster than the federal government to regulate tech.
China: The presidents have a conversation.
- Presidents Biden and Xi had their first phone call The readout suggests that Biden confronted Xi on several issues, including human rights, trade practices, and coercion of Taiwan and other nations in the region. They did discuss areas of potential cooperation, such as climate change. Overall, the Biden policy on China tends to agree with Trump’s position that China is a strategic competitor but differs over tactics. However, what the new administration’s tactics will look like remains a work in progress. For example, the administration has just formed a Pentagon task force on China, suggesting that Biden is still formulating the tactical response.
- A clue to watch is who the administration settles on for the role of the Commerce Department’s Bureau of Industry and Security. Currently, there are two candidates, Kevin Wolf and James Mulvenon. Wolf is a trade lawyer who has helped companies seeking exemptions to technology restrictions, while Mulvenon is an expert on Chinese military and technology. Nominating Wolf would suggest that Biden wants to work with China and will take a less stringent role on technology; Mulvenon’s nomination would signal just the opposite.
- In the U.S., tech firms are famous for the mantra of “move fast and break things,” which is another way of prompting disruption. Therefore, we have watched Elon Musk’s sourcing of Tesla (TSLA, USD, 848,60) into China. Beijing’s policies are mostly about stability; the recent moves to rein in Chinese tech firms shows less tolerance for the U.S. tech mantra. We note that Tesla is apparently running afoul of regulators on quality issues. Although China lacks the American tort bar on such issues, it is quite possible the government may turn out to be more effective in slowing things down.
- Here is a postmortem on Phase I of the Chinese trade deal.
- The Trump administration policy toward Taiwan was very supportive; Taipei is watching with trepidation as the new administration settles in.
- As the U.S. tries to build an anti-China coalition, Beijing isn’t standing still. It is working to woo nations to align with it to thwart this effort. Central and Eastern Europe have become a target for Chinese influence, which mostly comes from investment. Meanwhile, Sweden is becoming Europe’s most strident opponent to China’s goals in the region.
COVID-19: The number of reported cases is 107,435,033 with 2,357,210 fatalities. In the U.S., there are 27,288,290 confirmed cases with 471,764 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 65,972,575 doses of the vaccine have been distributed with 44,769,970 doses injected. The number receiving a first dose is 33,783,384, while the number of second doses, which would grant the highest level of immunity, is 10,469,514. The Axios map shows marked declines in infection rates.
- The slow rollout of vaccines and the hesitancy of some citizens to be vaccinated suggests that herd immunity may not be achieved until Thanksgiving. The delays will likely allow for new variants to develop, which may render the current vaccines less effective. Our take is that we will be moving from pandemic to endemic, meaning that COVID-19 will be with us for good, and we will adjust to it the same way we manage influenza.
- The Iranian government, due to its anger at the West, has raised doubts about the vaccines from the U.S. and Europe. It has, instead, built a campaign around Sputnik V. Unfortunately for the Mullahs, Iranians are skeptical of the Russian vaccine, meaning that vaccination rates are low.
- The WHO visit to China worked out well for Beijing. The group essentially sided with China’s narrative on the virus, downplaying the source as a virus lab and maintaining the idea that the virus may have entered China on imported frozen food. There are concerns that the WHO is under regulatory capture by Beijing, and this recent trip will tend to support that thesis.
- Although it looks like the WHO mostly placated Beijing, the team did start an investigation into 90 cases of what appear to be SARS infections that were reported in central China as early as October 2019. Unfortunately, there is no easy way to determine whether the infections reported in October were COVID-19. Serological tests have shown no antibodies, but they would have dissipated over time. Still, it is possible that COVID-19 has been around much longer than just last January.
- For Japan, one of the most effective tools in reducing virus transmissions has been orders to close restaurants by 8:00. Japan’s mask compliance is generally high, but the one place that mask-wearing is impossible is during meals. By reducing dining out, the country has been able to curtail infections.
- Due to the slow vaccine rollout and uncertainty about the level of immunity the vaccine will offer, companies are realizing that remote work will likely be extended well into 2021.
- A combination of antibody drugs from Eli Lilly (LLY, USD, 203.54) has been approved for use. It will be given to patients who contract COVID-19 that are in high-risk categories.
European news: Military posturing is the order of the day.
- In response to Russia’s continued militarization of the Arctic, the U.S. is deploying four B-1 bombers and 200 personnel to the Orland Air Base in Norway. The unit will begin missions in the region within the next three weeks.
- The U.S. Navy quietly sent the destroyer USS Porter, the guided-missile destroyer USS Donald Cook and the supply ship USNS Laramie into the Black Sea for exercises. The American Navy ships were joined by vessels from Turkey for joint exercises. The exercises ended yesterday. There were two takeaways from this event. First, although exercises are not unusual, this one was insofar as the Russians weren’t notified in advance. Second, Turkey has been on the outs with the U.S. since it purchased the S-400 from Russia. This exercise may signal that Ankara is trying to improve relations with the new administration.
International news: Iran, India, and the U.K. were all in the news.
- Iran has begun producing uranium metal, a clear violation of the JCPOA. The metal could be formed into a warhead…but, the metal produced was not highly enriched, meaning that Iran isn’t quite at the bomb-making level yet. This is yet another provocative step taken by Tehran to move toward nuclear status.
- Twitter (TWTR, USD, 67.77) has blocked accounts tied to the farmer protests after the Modi government threatened to arrest company employees for not complying with government orders.
- The border problems that the U.K. hoped to avoid are proving more difficult than expected. Port staff in Northern Ireland will be allowed to return to work after a week off. The staff was kept away from the office after unionists physically threatened the workers. The Johnson administration wants a grace period into 2023 to manage the North Sea border. The EU probably won’t be that generous. The unionists fear that keeping Northern Ireland in the EU’s trade bloc but separate from the U.K. on a trade basis will increase the likelihood of Ireland’s unification.
- Last month, stock exchanges in Amsterdam became the largest stock exchanges in Europe, with higher volume than London.
Bitcoin: The structure of bitcoin is unique. Most transactions are either (a) totally anonymous but require face-to-face contact (e.g., cash transactions), or (b) require a central authority (middleman) to complete the transfer. Bitcoin transactions are pseudo-anonymous, in that they can be seen by all but are in a code that only the wallet holder knows their identity, and the transaction doesn’t require a central authority. Instead, “miners” crack puzzles to compete for the right to record the transaction on the distributed ledger and are paid for their efforts. This process creates a situation where transactions can occur over distance without a bank or other financial intermediary involved. There is a downside, however. The mining is done through massive computational power that is so energy taxing that environmentalists are starting to warn that bitcoin is becoming an environmental hazard. For example, bitcoin farming represents more energy consumption than the nation of Argentina. For firms and investors with ESG concerns, it begs the question as to whether fostering bitcoin doesn’t violate the “E” of ESG.
- Despite the energy consumption issues, BNY Mellon (BK, USD, 41.74) announced it would begin providing custody services for holders of bitcoin.
- Mastercard (MA, USD, 334.21) is preparing to offer its network to facilitate cryptocurrency transactions.
- Looking for a good background podcast on cryptocurrencies? Here is one we recommend.