Daily Comment (June 9, 2020)

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

[Posted: 9:30 AM EDT]

Our newest podcast episode, “The Long-Term Effects of COVID-19,” is available.  In this episode, we discuss how the COVID-19 pandemic will likely accelerate the reversal of the equality/efficiency cycle toward equality.

Many countries continue to report falling coronavirus infection rates and economic reopening, helping to push the NASDAQ to a record close yesterday.  All the same, it appears that the official declaration of a recession in the U.S. and sobering trade data from Germany have helped spark some profit-taking in the financial markets today.  As always, we recap all the key news below.

United States:  Yesterday, the arbiter of the U.S. business cycles, the National Bureau of Economic Research, officially declared that the economic expansion that began in March 2009 came to an end in February 2020.  The surprise wasn’t that the NBER’s Business Cycle Dating Committee believes the U.S. economy has been in recession ever since then.  Just about all economists and financial market analysts around the world, ourselves included, have thought that for some time.  The surprise was that the group moved so quickly to declare the recession, rather than waiting until deep in the downturn or even later like it usually does.  The quick designation likely reflects the extreme depth of the pullback, which has made it obvious to just about everyone.  The big question is whether a recovery is at hand, and if so, how long and robust it will be.  We think things have stopped getting worse and the recovery is now starting.  The NBER therefore, could declare an end to the recession sooner than it has in the past.  Given the depth of the decline, however, we suspect the recovery back to the previous level of activity will be long and fitful.  A key risk is that officials could withdraw the supportive monetary and fiscal policies they’ve deployed to date and take the wind out of the recovery’s sails.  Indeed, yesterday Senate Majority Leader McConnell and White House advisor Hassett both suggested that improving employment numbers would mean any further fiscal packages to support the economy could be scaled back.

COVID-19:  Official data show confirmed cases have risen to 7,142,462 worldwide, with 407,067 deaths and 3,316,747 recoveries.  In the United States, confirmed cases rose to 1,961,187, with 111,007 deaths and 518,522 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.


Real Economy

  • German exports dropped by a record 24.0% in April, coming in worse than expected and leaving foreign shipments for the month down 31.0% from April 2019.  Imports also contracted sharply in April, with a drop of 23.6% from the previous month.  As shown in the tables below, this produced a sharp drop in the country’s trade balance for April.
  • Although weakened demand from the crisis has driven down overall inflation so far, many food prices are rising at their fastest pace in decades.  This has the potential to further weigh on overall demand, as consumers are especially sensitive to rising costs for essentials like food.

U.S. Policy Response

  • As we mentioned yesterday, today is the first day of the Fed’s latest two-day policy meeting.  Given that the policymakers have made it clear they don’t want negative interest rates, the benchmark fed funds rate will be held unchanged at essentially 0.0%.  The real debate will likely be over yield curve control.  Besides watching that debate closely, we’ll be parsing the policymakers’ latest forecasts for the economy and the future fed funds rate.
  • The Fed announced another set of changes to its Main Street Lending Program for small and medium businesses. This is as it strives to make the $500 billion program more attractive to borrowers and banks, without taking undue credit risk when it ramps up in the coming weeks.  The loans still will be run through the nation’s banks, which can sell 95% of the loans to the Fed, but under the latest set of changes:
    • The minimum loan amount will be reduced to $250,000 from $500,000, which will make the program more attractive to smaller firms.
    • The maximum loan amount will be raised to $35 million for new loans, or up to $300 million to refinance an existing loan if a firm’s total debt, relative to its 2019 earnings, is below certain thresholds. Those maximum loan amounts had been set at $25 million and $200 million, respectively, in late April.
    • The maximum loan term will be extended to five years from four years previously.
    • Businesses will be allowed to defer principal payments for the first two years instead of just the first year.

Foreign Policy Response

NATO-China:  NATO General Secretary Stoltenberg called for nations around the world to join with the alliance to resist China’s “bullying and coercion.”  In his speech, Stoltenberg warned that, “The rise of China is fundamentally shifting the global balance of power, heating up the race for economic and technological supremacy, multiplying the threats to open societies and individual freedoms and increasing the competition over our values and our way of life.”  While there is now broad consensus around the world regarding China’s aggressive moves to build, expand and exercise its power, Stoltenberg’s statement reflects what may be another growing consensus:  That because of China’s size and aggressiveness, resisting it will probably require the combined power of many like-minded democracies operating in alliance, i.e., not just individual countries pushing back against China, but a clash of Western Civilizations against a Chinese Civilization seeking its renaissance.

China-Hong Kong:  Hong Kong-based hedge funds are exploring ways to move their operations elsewhere as China prepares to impose sweeping national security legislation on the city.  According to one advisor who works with hedge funds in the city and elsewhere in the region, “Hong Kong as we know it is dead.  It will become just another city in China. The hedge fund community will move on to Singapore and elsewhere.”  Separately, thousands of protesters rallied Tuesday evening in downtown Hong Kong, defying a police ban on demonstrations to mark the one-year anniversary of a million-person rally that thrust the city into its biggest turmoil in decades.

North Korea-South Korea:  The North Korean state news agency KCNA said the inter-Korean communication line by which the two governments speak daily, as well as a separate hotline to the South Korean president, will be severed from midday on Tuesday.  The move is in retaliation for South Korean non-governmental groups that have been sending balloons and drones to drop anti-North Korean leaflets over the country, though it probably also reflects Kim Jong Un’s frustration at the collapse of the denuclearization talks with the U.S.

United States-Russia-China:  U.S. Special Envoy for Arms Control Billingslea said the U.S. and Russia have agreed to open a new round of arms control talks in Vienna later this month, and that China has been invited to participate as well.  The talks may include discussions to extend the New START nuclear arms treaty that is due to expire in February 2021.

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