Daily Comment (February 14, 2020)

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

[Posted: 9:30 AM EST]

Happy Friday and St. Valentines Day!  It’s rather quiet in the financial markets, with bonds doing well and equities grinding higher.  We update news on COVID-19.  There is unrest in Colombia, and more legal action on Huawei (002502, CNY 2.61).  We have additional color on Johnson’s cabinet shakeup.  Judy Shelton is under fire.  Canada faces a rail strike.  Here are the details:

COVID-19The number of reported cases is up to 64,467 with 1,384 fatalities.  After yesterday’s jump due to changes in reporting methods, today’s increase is more in line with previous patterns.  Sentiment is slowly moving away from “what is this virus all about?” to “how much of a negative impact is it going to have?”  Here are a few of our observations.  First, traditional stimulus measures, such as cutting interest rates and taxes, have less effect.  Essentially, for China and parts of Southeast Asia this event is disrupting production.  Adding liquidity into limited supply is a recipe for inflation, at least in the short run.  What needs to happen is a reduction of fear and a resumption of production.  That outcome will only come with time.  It is important to note that Chinese officials are working at cross-purposes to some extent.  Although they want to boost growth, they are also continuing aggressive actions to quarantine suspected cases, thus hampering the movement of people necessary for economic recovery.  Second, the ripple effect from this event will probably be a function of the overall dependence on the Chinese economy.  For example, China is one of the few customers willing to buck Iranian sanctions.  The virus is reducing Iranian oil exports to China and thus putting additional pressure on the Iranian economy.

Colombia:  The ELN and dissident members of the FARC rebel group launched an effort to shut down the country, warning that they will kill anyone nationwide who ventures outside their home from 6:00 am on Friday until Monday.  We believe the threat is a show of force after the successful national strike earlier in the winter.  If this signals a new round of unrest in Latin America, regional stocks would come under renewed pressure.

Huawei:  New charges have been assigned to Huawei; the company has been accused of racketeering, conspiracy and conspiracy to steal trade secrets.  This action will certainly raise tensions between Washington and Beijing and reduces the likelihood of a Phase Two deal.  In fact, it may undermine the execution of the Phase One agreement.

Johnson:  PM Johnson’s cabinet shakeup was much more than a mere post-election restructuring.  The headline news was the resignation of Exchequer’s JavidHe was ordered to fire his staff so Johnson could create a separate unit in the ExchequerJavid correctly realized that accepting this change would make him a mere figurehead and resigned.  Reports suggest that Johnson wants to boost spending in the areas of the country that flipped from Labour; Javid was less keen on increasing spending.  As always, there is some person willing to accept unattractive terms and Johnson did find someone.  Our overall take is that Johnson has opted for loyalty over other attributes.  For the markets, expectations of fiscal stimulus lifted the GBP.

Is Shelton in trouble?  Although President Trump initially selected conventional figures for Fed governor positions, in the past couple of years he has offered more radical candidates, all of whom have failed to get nominated.  The latest in this group is Judy Shelton, who in the past has argued for a gold standard, deliberate monetary policy to trigger a weaker dollar and reduced independence of the central bank.  Surprisingly, senators are pushing back much harder than we expected and it is possible that Shelton will join Herman Cain and Stephen Moore on the list of candidates that couldn’t get confirmed.  If she fails, we would view it as a win for the establishment.  However, we would not be surprised to see other governor candidates in the future suggest policies to reduce independence or intervene in exchange rates.  If the U.S. is going to reflate, such policies are probably necessary.  Nevertheless, Shelton’s positions do seem muddled.  On the one hand, she calls for a return to the gold standard and appears reluctant to deploy unconventional policies such as QE but has little problem with overtly engaging in currency depreciation.  Our suspicion is that she is really a political candidate who wants policies designed to keep her favored party in power.  In our reading of Fed history, this type of appointment would be a first for the Fed and perhaps such an appointment is a bridge too far for the Senate to cross.  So, we will see if these “misgivings” evolve into rejection.

Canada:  The country’s biggest railroad said it has shut down operations in eastern Canada because of widespread rail blockades set up by activists protesting the construction of a major natural gas pipeline.  Since the shutdown is likely to result in layoffs and significant disruption to Canada’s economy, we expect it to be a near-term headwind for Canadian stocks.

Odds and ends:  At yesterday’s T-bond auction, the newly issued 30-year sold at a 2.061% yield, a new record-low at auction.  Research from the White House staff suggests that foreign nations are suppressing drug prices, which essentially means that Americans are subsidizing the cost of new drug research that foreigners free ride on by setting lower prices.  We will be watching to see if the U.S. uses this research as a trade tool to apply export taxes on foreign nations who engage in such practices.  If it does, it should be bullish for U.S. drug makers as the ultimate goal will be to boost foreign drug prices.  France and Germany are trying to strongarm the EU competition regulator to allow for the creation of concentrated national champions.  One of the reasons U.S. equities have outperformed the world is that U.S. large cap firms are more concentrated due to lax anti-trust enforcement.  Market power has given these firms the ability to consistently generate higher profits.  If the EU gives France and Germany what it wants, similar structures may be created.  One element is that the EU is considering creating a single market for data in a bid to weaken the grip of U.S. tech firms on Europe.  At the same time, the U.S. appears to have misgivings about the dominance of American tech firms.  The DOJ held a conference on whether top digital platforms have become so dominant that they’re discouraging investment in new products.  Some venture capitalists at the meeting complained that it’s hard to develop a product in markets dominated by a tech giant.

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