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

[Posted: 9:30 AM EDT]

Good morning.  It’s ECB day!  The ECB continues to support the EU economy.  It’s June 4, the 31^st anniversary of the Tiananmen Square Massacre; we note China is playing up the current U.S. civil unrest as a counterpoint to Beijing’s actions in Hong Kong.  Global equities are mostly lower this morning, as risk markets take a breather from recent strength; however, we have seen some recovery on the ECB news.  We cover the ECB meeting and look at the latest with China.  As usual, we update what we know about COVID-19.  We have a new Weekly Energy Update, with a special look at natural gas. Let’s get to it…

ECB:  In its prepared statement, the European Central Bank announced it will expand its emergency QE by €600 billion.  Interest rates remained unchanged.  It also said purchases will continue into June 2021.  Market reaction was swift; as the global risk-on rally has been supported by central bank action, news of the ECB’s move lifted global equities.  In something of a surprise, the EUR rallied as well.  Usually, QE is bearish for a currency.  In the press conference, ECB President Lagarde didn’t offer any major surprises

China:  Lots of China news:

• On the 31^st anniversary of Tiananmen Square, China has reacted by quashing usual memorial ceremonies in Hong Kong. Despite the crackdown in Hong Kong, protests continue and security forces have reacted with arrests.  China is deflecting the usual annual criticism by pointing to the current unrest in the U.S.
• PM Johnson has indicated he will admit 3.0 million Hong Kong residents to live in the U.K. with a potential path to citizenship if China implements its national security law. Beijing is not happy with the development.
• One of the features of Hong Kong compared to the rest of China is that the former was less affected by China’s “Great Firewall.” Tech companies put virtual private networks (VPN) in Hong Kong to prevent Beijing from interfering in internet traffic.  There are growing worries that the new national security law will put Hong Kong within the firewall and thus implement censorship.  Of course, there are also worries that the new law will stifle free speech.
• So far, China has not reacted strongly to the U.S. actions taken with regard to the national security law. It may be that Beijing wants to see what the U.S. will actually do; if the response remains mild, it may signal that China feels the actions taken by the U.S. are not significant.
• The U.S. has threatened to block Chinese airlines from coming to the U.S. as China has denied American airlines from flying to China. This morning, China relented and will allow limited flights by international carriers.
• It is evident that the Chinese economy has been hit hard by the trade war with the U.S. and the pandemic. Thus far, the policy reaction has been rather subdued.  We note that the central government announced it will send money directly to local governments, a sign Beijing is growing worried about slowing growth (and rising unemployment).
• Huawei (002502.SZ, CNY 2.900) has been having a tough run of news recently. As we reported last week, the CFO lost her bid to avoid the extradition process as a Canadian court ruled she must stand for the proceedings.  There is confirmation that the company did, in fact, evade U.S. sanctions on Iran (which is why the CFO is under house arrest).  The U.K., which was open to restricted use of the company’s products in its 5G network, is reversing course in the aftermath of Hong Kong and strong U.S. pressure.  All this is bad news for the company.
• China has cancelled some U.S. farm shipments, increasing the odds it will fail to meet its Phase One agreements.
• The U.S. is expected to designate at least four Chinese state-run media companies as foreign embassies, which will restrict reporters’ ability to operate.
• A new bill is circulating in the Senate that would restrict foreign access to U.S. research.

Civil unrest:  The widespread civil unrest is further delaying the reopening of small businesses.

Foreign news: 

• Germany has unveiled a second COVID-19 stimulus package of €130 billion, bringing Germany’s total fiscal spending to €3 trillion. Given the degree of German stimulus, we will be watching to see if Germany’s trade surplus reverses as slower-growth Eurozone nations send exports to Germany.  If this continues, it would suggest that Germany is taking on a regional hegemonic role, a reversal of previous behavior.  The EU has been aggressive in spending during this downturn.
• PM Johnson and European Commission President von der Leyen are likely to engage in direct talks to break the current deadlock on a new trade deal.

COVID-19:  The number of reported cases is 6,530,067 with 386,392 deaths and 2,820,488 recoveries.  In the U.S., there are 1,851,520 confirmed cases with 107,175 deaths and 479,258 recoveries.  For those who like to keep score at home, the FT has created a nifty interactive chart that allows one to compare cases and fatalities between nations, scaled by population.  Axios has updated its U.S. infection map.

• The good news:
  • When thinking about a problem, it is helpful to know more about the issue one is trying to resolve. For the most part, medical researchers have been treating COVID-19 as primarily a respiratory disease.  This led to the crash production of ventilators and the search for antiviral medicines.  However, there is growing evidence that although the virus spreads through the lungs, the biggest impact may be vascular.  The virus’s primary impact may be to infect the endothelial cells in blood vessels.  When these cells become inflamed, it could lead to microclotting and would explain the wide variety of symptoms.  Unlike seasonal flu or SARS, which tend to remain in the lungs, COVID-19 spreads throughout the body, causing damage to kidneys, conditions close to frostbite in toes, and strokes.
    • If this is how the virus works, the best protection may come from ACE inhibitors, statins and blood thinners. There are trials now underway to see if losartan, a common high blood pressure drug, may prevent the worst symptoms of the disease.  In other words, if taking cardiovascular medicine prevents fatalities and hospitalizations, we could treat COVID-19 with common drugs and extreme measures to avoid the disease may not be necessary.
  • Scientists are studying patterns to see if there is a genetic basis that might explain the wide variation seen in the reaction to infection. There is evidence to suggest that there are sizeable numbers of asymptomatic cases and, at the same time, fatalities.  If a common genetic threat could be found, it may allow for less stringent lockdowns and could help in determining who should get vaccinated before others.  A recent European study suggests that having Type A blood increases the likelihood of a more serious reaction to infection.
  • The U.S. has selected five firms as vaccine finalists. Narrowing the list will allow the government to focus its efforts on producing a vaccine once an effective candidate emerges.  In related news, Eli Lilly (LLY, 152.53) is testing a new drug that is derived from antibodies developed from patients infected with the virus.
• The bad news:
  • When I was in the Jesuits (Bill talking here), one of “ours,” a missionary in Belize, had suffered an auto accident. He recovered from his injuries with one problem: he had no sense of taste.  Although he would get hungry, he was completely indifferent to what he ate.  It led to some rather odd dinner situations.  The loss of taste and smell is noted as an effect of COVID-19 and some cases indicate the change may be long-lasting.
  • Sweden’s social distancing policy was more relaxed than what was seen elsewhere. The primary leader behind that policy has admitted the policy probably wasn’t strict enough, allowing for too many fatalities.
  • Recent studies confirm what the anecdotal evidence suggested: nursing homes have been especially hard hit by COVID-19.

Policy news:

• Europe is unveiling new digital services taxes, which the U.S. views as unfairly targeting American tech firms. So, the U.S. is considering tariff retaliation if the EU continues toward implementing such taxes.  In related news, the EU is also considering changing the rules for online content, making social media firms accept greater accountability for content.
• The Fed’s direct lending program to business has had few takers, in part on borrower concerns of the stigma of taking federal money. Overcoming this issue has been a persistent problem with direct government lending.  During the 2008 financial crisis, the Fed and Treasury forced the major banks to take funding to avoid this problem.
• Meanwhile, Illinois has decided to tap the Fed’s municipal bond program with an issue of $1.2 billion of one-year notes.
• The DOJ has indicted executives in the chicken processing industry for price fixing. Consumers have been complaining about high meat prices for some time; this move by the government may partially explain why prices have been elevated.

Finance news: 

• The Labor Department will allow private equity into 401k programs.
• Japanese regulators are warning banks about their positions in U.S. CLOs. Japanese banks, in a search for yield, own about 20% of this U.S. market.  Fears over credit quality triggered the warning.

Economy news: 

• Although businesses are starting to reopen, factories are finding their supply chains are disrupted, which is hampering their ability to ramp up output.
• As noted before, we continue to closely watch for “gaps” in the supply/payment chain that could disrupt the financial markets. One  area of concern is rent payments.  Small businesses that have been closed are unable to make their rent.  This loss of payment is a risk to landlords, who face their own creditors.  We expect that either the Fed or Congress will need to inject funding to support this part of the economy at some point; if support doesn’t occur, it may raise the risk of economic disruption.
• Another area of concern is small non-bank lenders; these firms may need to raise capital in the coming weeks or be forced to reduce their lending.
• As the rich world economies weakened, foreign remittances from workers sending money home to the emerging markets have collapsed. This drop is having a negative impact on EM economies.

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