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

[Posted: 9:30 AM EDT] | PDF

Good morning and welcome to the third quarter!  We are now in the second half of 2021.  U.S. equity futures are mostly marking time this morning, but commodities are starting the second half on a tear.  Tomorrow, we get the June employment data and, as a reminder, the Daily Comment will take Monday off; we will be back on Tuesday, July 6.  Our coverage today begins with the current heatwave in the Northwest, along with other temperature anomalies.  Economics and policy, China news, the international roundup, and pandemic updates fill out the rest of today’s comments.

Heatwave: More than 130 Canadians in the Vancouver area have perished in the unusual heat.  Lytton, BC temps hit a record high of 121.3^o on Tuesday.  The high temps aren’t just limited to British Columbia; southern Manitoba recorded 14 record highs this week.  The hot weather is triggering wildfires in Canada.  In the U.S., 76 fatalities related to the heatwave have been reported in Oregon and Washington State.  One of the problems with these sorts of events is that infrastructure wasn’t built for these temperatures.  For example, the Portland light rail system had to close due to power cables “frying” in the heat.  Because the region is historically temperate, air conditioning is installed less often.

As demand soars for fans and room air conditioners, prices have been rising and scammers are out in force.  Interestingly enough, we are also seeing soaring temperatures in Siberia with reports of 118^o.

One of the features of climate change appears to be that normal cycles become amplified.  Heatwaves become hotter, cold snaps colder.  Building codes are usually written using temperature ranges that reflect history.  As a result, when cycles become amplified, infrastructure isn’t built for the extremes.  The cold temperatures in Texas last winter caused mayhem mostly because, under normal conditions, winterizing doesn’t make much sense, no more so than buying an air conditioner in Seattle.  However, cities will need to rethink their building codes as unusual events become more “usual” and that will lift costs.

Economics and policy: There are rising expectations of tighter monetary policy, costs continue to rise, and regulators push back against decentralized finance.

• We continue to monitor the rising sentiment for tighter monetary policy. A recent survey of economists suggests at least two rate increases over the next 30 months.  Interestingly enough, we are seeing a steady decline in longer-duration yields, which would suggest a growth slowdown and less concern about inflation.
• Reports of rising wages, signing bonuses, and other hiring incentives are continuing. Although these increases raise fears of inflation, it is also possible that margins and future earnings will come under pressure as well.
• Amazon (AMZN, USD, 3457.05) has been demanding equity, often at a deep discount, from firms that use its platform to sell merchandise. This news will add to antitrust scrutiny of the firm.  We also note the company has asked that the new FTC Chair recuse herself from investigations of Amazon due to academic papers she has written.
• The lack of shipping capacity coupled with strong demand is sending shipping costs soaring. This is the time of year when retailers begin ordering for the winter holidays, meaning that either prices will remain elevated or margins will be under pressure.  There are indications that shipping firms are ordering new vessels, which means that we will likely see shipping costs normalize in a couple of years.  But that won’t help contain price levels in the near term.
• Ford (F, USD, 14.86) announced it would idle or reduce output in several plants this summer due to the lack of semiconductor chips.
• One factor we are watching is the rapid rise of non-defense capital goods orders. This lift should increase productive capacity and eventually help alleviate the current supply bottlenecks.

• The Consumer Financial Protection Bureau has finalized rules for foreclosures which are less onerous to mortgage creditors. Before foreclosure, the account must be delinquent for 120 days.  The borrower has no options available other than foreclosure, has abandoned the property, or has been unresponsive to servicer outreach.  On the one hand, these rules will probably slow foreclosures; on the other, it won’t completely prevent a delinquent borrower from relinquishing the collateral.
• One of the debates that occurs among cryptocurrency supporters is the idea of a closed versus open loop system. If an owner of a cryptocurrency could conduct economic activities (e.g., buying groceries, purchasing financial assets, using the currency to settle debts) solely among other users, in theory, they could operate completely independently of the regulated financial and economic system.  For example, a household could buy something without paying sales taxes.  In reality, though, the acceptance of cryptocurrencies is not sufficient to allow for a broad closed loop system.[1]  Therefore, holders of cryptocurrencies have to interact with the broader financial and economic system and they run the risk that their gains may be taken away by numerous means.  This situation was demonstrated recently when the U.K. cracked down on Binance (BNB, USD, 289.12).  Users with GBP accounts found they could not convert their holdings to local currency.  In other words, what is often characterized as a “currency” is more like an illiquid asset.
• Closely related to the crypto situation is decentralized finance, or “defi.” In listening to numerous podcasts on this industry, we have been struck by how, in the end, it’s really all about regulatory arbitrage.  The tech industry wants to do to finance what it did to taxis and hotels.  However, this “move fast and break things” mentality is running up against a regulatory wall.  For example, we took note of FINRA’s treatment of Robinhood; regulators hit the firm with $70 million in fines for causing “widespread and significant” harm to customers.  Society will tolerate disruption in some industries, but finance is probably too important for tech to have the same impact as it has had in other areas.  That doesn’t mean that new technologies won’t emerge but being able to engage in activities without regard for regulation isn’t likely to be tolerated.
• Higher input costs and rising exports are sending propane prices higher. High prices in the summer aren’t normal.  Usually, prices peak in the winter, when households are using the fuel for home heating.[2]
• We are monitoring the OPEC meeting. So far, the lack of a production increase from the U.S. is emboldening the cartel to keep prices elevated.

 China:  The CPC is gearing up for the 100^th anniversary of the founding of the party.  Fake souvenirs are proliferating.

• China is building more than 100 new missile silos in the Western desert. This development suggests China is expanding its nuclear deterrent.  Although this expansion does raise alarms, in some respects, a fixed silo is more for show than a danger.  After all, a silo can’t be moved and is visible by satellite.  In other words, this looks to us more like a signal of deterrence.  We are much more concerned about mobile launchers, such as the DF-26 or submarine launched missiles.
• The U.S. and Taiwan are preparing for new trade and investment talks. These negotiations will not be welcomed by Beijing.
• In our recent research[3] on Taiwan, we noted that Japan would be particularly vulnerable if Beijing were to take control of Taiwan. Japan’s leaders rarely make public statements about this problem but Japan’s Deputy Defense Minister Yasuhide Nakayama recently suggested that Japan should protect Taiwan “as a democratic country.”  Needless to say, the CPC was furious with the description of Taiwan as separate from China.  We also note that the U.S. and Japan are conducting military exercises in the South China Sea; these exercises are designed to prepare the U.S. and Japanese militaries to respond to Chinese military aggression against Taiwan.
• China remains well behind its Phase I trade agreement commitments.
• China’s “beige book” quarterly survey indicates increased caution by households and businesses. Households are reporting that they are reducing spending on non-essential items and businesses are complaining about tighter credit conditions.  Meanwhile, rising corporate spreads are raising concerns about defaults.
• China’s “wolf warriors” have taken a strongly nationalistic stance in diplomatic discussions to the point where it may be undermining Beijing’s ability to gain cooperation from other nations. Complicating matters is that Chinese social media has become increasingly nationalistic, meaning that toning down the wolf warrior rhetoric raises the risk that the government could face online criticism that is difficult to contain.
• Although the Fed has been rather sanguine about the introduction of the eCNY, the ECB is much more worried. It is unlikely a digital CNY will woo users to dump dollars, but the EUR, which is less used for reserve purposes, might be displaced.  These worries will likely push the Europeans to move quickly on a digital EUR.
• China is aggressively investing in Chinese metal mining which may give it an advantage in the electrification of transportation.
• YouTube (GOOG, USD, 2441.79) has taken down videos from Xinjiang that gave testimony to China’s repression.

 International roundup:  Mexico moves to legalize marijuana, Venezuelans are coming to the U.S./Mexican border, and we are watching North Korea.

• The Mexican Supreme Court has struck down laws that restricted the use of recreational marijuana. Mexico’s Senate has already passed a law legalizing recreational use.  The court decision paves the way for Mexico to potentially become the world’s largest legal cannabis market.  We are a bit surprised that the drug cartels haven’t moved to stop legalization; we suspect they don’t view marijuana as a lucrative enough market to become involved.
• The presidential vote count in Peru continues to be disputed. Pedro Castillo has claimed victory, but he won by only 44,058 votes.  His opponent, Keiko Fujimori, is refusing to concede.
• A record number of Venezuelans were met at the U.S./Mexican frontier by Border Patrol officers. According to reports, many of these refugees had already escaped Venezuela[4] and were living in other South American nations.  COVID-19 conditions led them to flee those nations.  Due to difficult relations between Washington and Caracas, Venezuelan refugees tend to receive favorable treatment by immigration courts.
• It is always difficult to know with certainty what is occurring in North Korea. It isn’t called the “hermit kingdom” for nothing.  We have been watching a number of recent developments.  First, it appears that North Korea is facing some level of food scarcity.  Grain prices outside of Pyongyang are rising.  Kim has ordered rice from military inventories to be released; his father tended to protect the military, so this decision suggests conditions may be worsening.  Second, we are seeing rather odd behavior in the forex markets, which may mean North Korea is about to engineer a devaluation or is trying to punish speculators.  Third, Kim has criticized officials who were in charge of public health, suggesting it was a “grave incident.”  This may indicate there are increasing problems with COVID-19.
• The German Green Party candidate for chancellor is facing allegations of academic plagiarism. This unwelcome news is coming on the heels of reports that Annalena Baerbock padded her resume.  Her party has been sliding in the polls after making a surge in early May.  We note that the recent German fiscal budget shows a narrowing of the deficit for 2022, which will tend to dampen growth.
• The U.K. and EU have deferred a ruling on the meat trade; this issue had caused a row recently.
• We continue to monitor the minimum global corporate tax. Financial services apparently have been granted a carve out, and the proposal is increasingly being seen as a win for U.S. tech firms.

COVID-19:  The number of reported cases is 182,285,056 with 3,948,970 fatalities.  In the U.S., there are 33,666,198 confirmed cases with 604,718 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 381,949,830 doses of the vaccine have been distributed with 326,521,526 doses injected.  The number receiving at least one dose is 180,674,739, while the number receiving second doses, which would grant the highest level of immunity, is 154,884,686.  The FT has a page on global vaccine distribution.

• Bloomberg has created a COVID-19 resilience rating system that rates how well a nation is reopening. The index has three major factors and four components for each factor.  The U.S., due to high vaccination rates, ranks #1.
• Meanwhile, overseas the pandemic continues:
  • Indonesia is seeing a surge in cases and rapidly rising oxygen prices. The government is likely to reinstitute lockdowns to curb the spread of infections.
  • Australia has implemented lockdowns in seven cities.
  • Southern Europe was counting on a return of tourists to lift economic growth. The return of the virus is undermining that goal.
• The Bolsonaro administration in Brazil is being hit with a vaccine scandal as it appears his administration overpaid for an Indian vaccine that had not emerged from its clinical trials. Allegations of corruption have emerged.
• China is using disinformation to undermine the government in Taipei over its management of the pandemic.
  • Singapore is preparing for a situation where COVID-19 is endemic; in other words, we live with it like other infectious diseases, such as influenza.  The plan mostly rests on widespread vaccination.

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[1] In theory, a group of users could create a closed loop for certain activities, such as buying contraband.

[2] We have seen concerns about higher propane costs for grills; we would note that real grilling involves wood or charcoal and using propane is merely using a gas oven outdoors.  It cooks, but falls short of real grilling.

[3] See our WGR series, “The Geopolitics of Taiwan: Parts I (5/3/21), II (5/10/21), and III (5/17/21).”

[4] We discussed this issue in 2018.  See our WGR series, “The Venezuelan Migration Crisis: Parts I (9/17/18)  and II (9/24/18).”