Daily Comment (January 11, 2021)

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

[Posted: 9:30 AM EST] | PDF

Good morning.  Equity markets are weaker this morning. Numerous reasons are causing this weakness.  Political unrest, rising COVID-19 infections, and the simple fact that markets don’t rally in a straight line are all part of today’s decline.  The underlying factors remain—accommodative monetary policy is a potent factor in supporting asset prices.  Our coverage starts with the political situation in President Trump’s last week of office.  Rising criticism of the Fed is next.  The China news update follows.  Pandemic information is next.  We update the post-Brexit world, India’s farm crisis, Kyrgyzstan, and an economic roundup.  The Asset Allocation Weekly is available.

Politics:  Although the House leadership continues to press toward issuing articles of impeachment, this action probably won’t go anywhere.  First, time is short.  Impeaching someone when out of office may be symbolic, but it is not much more than that.  Second, Congress only has so much bandwidth, and President-Elect Biden, due to the high likelihood he will be a one-term president, will probably see a faster erosion of this political capital.  Thus, if he wants to move on policy, he can’t have Congress debating impeachment that is unlikely to pass anyway.  Instead, there are two developments from the events last week that we are watching closely.

The Fed:  As asset markets continue to rally, the Fed is starting to come under increasing criticism from establishment figures.

  • Mohamed El-Erian warns that if the Fed engages in yield curve control, the Treasury market’s ability to signal inflation worries will be lost. He also points out that liquidity injections have become the key reason for investor optimism.  El-Erian also notes that unconventional policy, initially used as an emergency measure, has become conventional.
  • Sheila Bair, former head of the FDIC, suggests that the backstop policies the Fed implemented in March didn’t do anything to boost investment and simply lead to more debt issuance.
  • Members of the FOMC are also expressing concern about market activity. We note in particular a quote from Neel Kashkari, President of the Minneapolis FRB, who said, “I don’t know what the best policy solution is, but I know we can’t just keep doing what we’ve been doing.”  We must admit, his admitting the lack of a policy solution is both refreshing and unsettling, the former because policymakers rarely acknowledge the uncertainty, the latter because he doesn’t know.

In our opinion, these criticisms highlight the downside of the moral hazard problem.  When a policy protects a person from risk, it should not be a surprise that risky behavior follows.  However, none of these criticisms discuss the alternative.  If the Fed doesn’t engage in yield curve control, the strength in housing will fizzle.  If the Fed had not put the backstops in place in March, the financial markets would have seized up, and another 2008 (or worse) would have likely developed.  Officials often discuss implementing “macroprudential” policies.  Putting such policies in place does work—Glass/Steagall did a great job making the financial system safe at the cost of deep inefficiency.  But, even there, financiers eventually figured out how to evade these sanctions.  There is no simple solution.  If you allow financial discipline to work, you have to live with occasional financial panics, and such events have become politically unpalatable.  If you protect the system from panic, excessive risk-taking tends to follow.  We do closely follow these criticisms because if Congress decides to limit the ability of the Fed to act, the potential for a financial accident will increase.

China:  In the waning days of the Trump administration, Taiwan, tariffs, and investment policy each remain in focus.

COVID-19:  The number of reported cases is 90,367,346 with 1,936,436 fatalities.  In the U.S., there are 22,410,249 confirmed cases with 374,341 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 22,137,350 of the vaccine has been distributed with 6,688,231 of first doses injected.


 Post-Brexit:  The U.K. is now dealing with the fallout from Brexit.  Although most goods traded between the EU and the U.K. are free from tariffs, items that are reexported can be subject to tariffs, which was not the case before.  U.K. businesses are struggling to figure out the new regime.  In addition, being free of the EU looks like it means a lot more paperwork and regulations for British industry.

India:  The standoff between India’s farmers and the government continues.  The Modi administration is trying to deregulate the sector; small farmers are concerned this will mean reduced support from the government and the loss of their farms.  Modi rarely loses, but this battle may be difficult to win.

Kyrgyzstan:  Last year, we discussed the situation in the country.  Over the weekend, elections were held and Sadyr Japarov took nearly 80% of the vote.

Economic roundup:  Here is a list of items we are watching:

Automakers are being forced to reduce production due to a shortage of computer chips.

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