Daily Comment (January 22, 2020)
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EST]
Davos continues, impeachment dominates the news (but has no discernable impact on financial markets) and we continue to monitor the coronavirus. Lebanon gets a new government, Norway’s fails and Italy’s might be close to failing. Here is what we are watching this morning:
Coronavirus: Yesterday, the first case was reported in the U.S. A man in Washington state, who recently visited Wuhan, tested positive for the virus. The death toll is up to nine, with over 400 confirmed cases. Equities are rebounding this morning on expectations (hopes?) that Beijing will do a better job of handling the outbreak compared to its less than transparent actions in 2003 during the SARS outbreak. We view this expectation as rather heroic. Two issues concern us. First, there is anecdotal evidence that cases are being underreported. Second, Beijing’s drive to isolate Taipei means that Taiwan isn’t part of the WHO, meaning its data isn’t being tracked. Historically, pandemics tend to have a notable, but short-term, effect on financial markets and the world economy. It usually hurts transportation and consumption. We are not anticipating a serious problem for the U.S., but it could be a bigger issue for Asia.
Governments: After three months without an official government, a new one is in the process of forming in Lebanon. Designed to be technocratic in nature in order to tackle the serious financial problems facing the country, the fear is that it will come under the sway of Hezbollah as the Sunni parties have decided not to join the new coalition. Meanwhile, a spat over allowing a Norwegian IS member to return has led the Progress Party to leave the ruling coalition in Norway, ending the parliamentary majority of the current government. In Italy, Luigi Di Maio resigned as leader of the Five-Star Movement. He is currently the foreign minister. Although he is not expected to leave his position, his resignation raises fears that the Five-Star party might disintegrate, weakening the current ruling coalition. Italian bond yields and CDS prices rose.
Trade: Tensions with China are easing in the wake of the Phase One deal. Markets are now shifting to the effects of the arrangement. One potential impact is that WTI could gain on Brent due to the need for China to import energy from the U.S. Although there are expectations that China will buy a significant amount of U.S. grain, we note that China has been stockpiling domestic grain to support prices. Wheat and rice dominate their government purchases but could lead to inventory dumping to meet the demands of the new trade deal. U.S. attention is now shifting to the EU, where the first skirmish is over digital taxes. Although the U.S. and France have come to a truce, the U.K. is showing surprising tenacity in maintaining its threat to implement such taxes. We doubt Westminster will maintain this stance as the U.K., at some point, will want a trade agreement with the U.S. The EU has every reason to tax U.S. technology firms; Europe has failed to develop firms of similar scale and thus it can gain revenue and some degree of control through tax policy. Naturally, Washington will oppose such measures, mostly by threatening Europe’s auto industry.
Energy: Two news items of note. The civil war in Libya has, over time, affected oil supplies. It appears that production and exports are being curtailed again due to tensions. The most recent event is the blockade of oil exports by the leader of the eastern part of Libya, Gen. Khalifa Haftar, has blockaded oil exports. Production is falling to near zero. Interestingly enough, this news hasn’t lifted prices, a clear indication of the market’s oversupply. Another market facing oversupply is natural gas. Despite being in the dead of the northern hemisphere winter, U.S. prices have declined below $2.00 MCF. The root of the current problem is associated gas that is produced by frackers in the production of oil. The natural gas, that usually is also produced in this process, is a byproduct and is price insensitive. Cheap natural gas is a supportive factor for chemical makers and fertilizer companies.
Argentina: Could we be seeing yet another Argentine default? The markets are already concerned about the new Peronist government in Argentina. However, this default may come from the provincial level and the new governor of Buenos Aires province wants to delay a bond payment for three months. There is fear that the more radical wing of the Peronist party may be pushing to confront foreign creditors and lead to yet another default.
Production delays: On Tuesday, Boeing Co. (BA, $313.37) announced that it does not expect to restore production of the 737 max until midyear at the earliest. The suspension of production is expected to ripple throughout the economy, as it will likely impact many of Boeings suppliers. As a result, many of its suppliers have already begun laying off workers. Initial estimates suggested that the slow down production could cut any where from 0.3% to 0.5% from annualized GDP figure in Q1.
 Paradoxically, price lows often occur in January. This is due to the mechanics of storage. Most U.S. storage is in depleted wells which must be filled and drained on a regular schedule to protect well integrity. Salt domes, the other type of storage, can be flexibly filled and depleted, but old wells must inject gas at a steady pace in the summer and withdraw it in the winter. A mild January is a death knell for prices; the gas in the wells must come out and compete with current production. Without robust home heating demand, prices can collapse.