Daily Comment (July 1, 2021)

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 121.3o 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 118o.

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.

  • 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 100th 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.

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.

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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).”