by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EST] | PDF
Good morning and happy Monday, the first of 2021! We’re back and rested from the holiday break. Equity markets are higher this morning, and commodities are on a tear. The dollar is dropping in the new year, and bitcoin rose to new records. Our coverage begins with the pandemic news; we are adding a new statistic, tracking the path of inoculations of the COVID-19 vaccines. The Georgia Senate runoff elections are next. An update on China follows. Brexit is done (it will be nice to talk less about that topic), but now the sorting-out process begins. Headlines on finance are next. We close with a short note on Iran. Here are the details:
COVID-19: The number of reported cases is 85,192,180 with 1,844,687 fatalities. In the U.S., there are 20,639,854 confirmed cases with 351,590 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 13,071,925 doses of the vaccine have been distributed, with 4,225,756 of the first doses injected. Here is a global look at reinfections; so far, there have been 31 confirmed cases of COVID-19 reinfections.
- The surge in cases that began in November is stretching medical system resources. In Europe, countries are preparing to extend and enhance lockdowns.
- Although there has been some consternation over the slow pace of vaccinations in the U.S., this isn’t a unique situation. Worldwide distribution has been slow. Even though governments have been planning for distribution for months, there is always a slip between planning and the actual event. The current vaccines have more complicated logistics than normal due to the requirement of cold storage and two doses.
- In the U.S., state and local governments are in charge of distribution, leading to different priorities by locale. And, acceptance of the vaccine has been surprisingly slow among medical professionals. We view these issues as normal, but the return to growth that has been forecast by the financial markets is probably more of a second-half event than Q2.
- There is an increasing discussion about concentrating on a single dose of the currently approved vaccines with the booster to be delivered later (if at all). The idea is that the single shot offers some degree of protection, and the problems of distribution are making two shots difficult to execute. Although not an ideal outcome, it is important not to allow the perfect to become the enemy of the good.
- In addition, cutting the Moderna (MNRA, USD, 104.47) dose in half is under consideration to expand distribution. A half dose would be given to those between the ages of 18 and 55.
- Prominent officials have been quietly lifting their estimates of herd immunity. There are probably two reasons for this increase. First, as we noted earlier, we don’t know if the vaccines currently used provide sterilizing immunity or merely prevent symptoms. In other words, does the vaccine prevent infection or simply stop illness. If it’s the latter, we will probably need more than a 70% inoculation rate to reach herd immunity. Why? Because the vaccinated could become asymptomatic carriers of COVID-19. On the other hand, if the immunity is sterilizing, a lower number will achieve the herd-immunity goal. Second, we suspect this is a form of ‘nudging’ to encourage people to accept the vaccine. The idea is that if there is widespread acceptance, we can get back to normal sooner.
- The British variant of COVID-19 appears to be spreading rapidly around the world.
Georgia: The Senate runoff elections will be held tomorrow, and indications suggest the race is tightening. Prediction markets have flipped to the Democrats. If that bet holds, it would give control of Congress to the Democrats, although the margin will be very narrow. In our estimation, Senator Manchin (D-WV) would become the swing vote in the Senate, meaning that extreme policy measures would be unlikely to pass. However, a Democratic sweep could trigger weakness in equities. We would expect any pullbacks to be temporary.
China: the crackdown on tech continues.
- We are seeing a global regulatory assault on technology. The U.S. has opened several anti-trust actions against major tech firms, the EU is widening its regulatory reach, and China is bringing the major tech firms under party control. In China, the thrust appears to be to curtail the financial functions of the tech firms. We are seeing a broadening concern over bad debt in the Chinese financial system. There are clear worries that the loosely regulated tech firms could become a conduit for increased lending that may be risky. If the heavily regulated official banking system is generating a lot of bad debt (a function of an economic system driven by investment growth), the non-bank system could cause major problems.
- Japan is acknowledging that Taiwan is critical to its security. If China were to take control of Taiwan, this base of operations could cut off Japan from South Asia trade flows. Japan’s defense ministry is asking the incoming Biden administration to “stay strong” in the face of increasing Chinese belligerence against Taipei. 
- The NYSE is delisting three Chinese telecom stocks in response to a U.S. government ban. The shares will cease trading on January 11, and trading in ETFs and closed-end funds that hold these shares will be halted on that date. There is growing speculation that China’s oil majors may be next.
- Strong export demand for Chinese goods is causing capacity issues for global shipping, driving costs higher.
- The EU and China have an investment deal, and China has been cementing arrangements with Asian nations. These developments will weaken the ability of the U.S. to build an anti-China coalition.
Post-Brexit: Now that a deal is done, the messy details are next to be worked out. Spain, the EU, and Gibraltar have worked out a temporary arrangement to allow for free transit between the U.K. territory and Spain.
Finance: Money markets and the Fed are the headliners this morning.
- A Treasury working group has pointed out several problems with money market funds but did not lay out any specific recommendations. The problem with money market funds is they are “runnable.” Because they lack government backing, holders can demand redemptions, which force the funds to liquidate assets and can cause a financial cascade of problems. One obvious solution would be to bring them into the FDIC, but that would lead to restrictions that would reduce the attractiveness of the funds. In addition, regulation could potentially corral the non-bank financial system, making it less unstable but also less efficient. Thus, it’s no surprise that specific recommendations were not made. However, the odds of “something” being done at some point are high.
- A related issue is a growing concern that T-bill rates may challenge zero soon. One-month bill rates are down to six bps, and with cash balances elevated, there are growing worries about where to park the funds. Short-dated T-bills are a “safe” option, but if T-bill rates go negative, it will add additional pressure to money market funds.
- The Treasury is proposing new regulations on cryptocurrencies to reduce the use of the product in money laundering. As one would expect, the crypto industry is not pleased.
- Recent wrangling over the stimulus bill highlighted another issue—the Fed’s ever-expanding mandate. IOHO, much of this is due to the Fed needing to become the “dealer of last resort” by providing backstops to various financial instruments used for collateral. However, it’s a small leap for the Fed to begin broad asset accumulation; other central banks have gone down this path, and it is conceivable that instead of being a backstop, the Fed could become the market maker, setting rates on a host of instruments. This issue has profound effects on financial markets, potentially weakening the financial markets’ ability to allocate capital efficiently. After all, if there are no losers, then every investment is feasible.
- Last week, the U.S. increased tariffs on the EU over aircraft subsidies. They will go into effect on January 12.
Iran: The anniversary of the death of Qassem Soleimani passed yesterday. The Pentagon initially ordered the U.S.S. Nimitz home but reversed course and told it to return to the Middle East. We continue to monitor developments.
 The importance of Taiwan will be the subject of a future WGR.