Daily Comment (March 18, 2021)

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

[Posted: 9:30 AM EDT] | PDF

Good morning!  U.S. equity futures have mostly failed to hold yesterday’s gains as long-duration Treasury yields continue to move higher.  Our coverage begins with economics and policy with a focus on the FOMC and monetary policy.  China news comes next as U.S. and Chinese officials prepare to meet in Alaska.  Pandemic coverage follows.  Our roundup of international news comes next, wrapping-up with technology.  We finish with a cautionary ESG tale.

Economics and policy:  We recap the Fed and other items.

  • The Fed didn’t exactly surprise anyone. Policy rates and QE remained unchanged.  However, in the forecasts, the FOMC has lifted its GDP forecast to 6.5% for this year, up from 4.2% in December.  The forecast for core PCE was lifted to 2.2% this year, from 1.8% in December.  Inflation is expected to fall in 2022-23.  So, the FOMC is indicating that inflation will be transitory.  The “dot” plot showed a modest rise in support for a higher policy rate in 2023, but the majority still expect to keep rates steady through the end of 2023.
(Source: Federal Reserve)

Overall, market action in the wake of the decision was surprisingly bullish.  Equities rallied, the dollar declined, precious metals rallied, but long-duration Treasuries did end the day with higher yields.  It’s not obvious what the financial markets were expecting.  There appeared to be great concern about rising long-duration Treasury yields going into the meeting.  Nothing about yield curve control or increasing QE was revealed.  The Fed did not decide on supplemental reserve ratios, and if last year’s adjustment is not extended, bank demand for Treasuries will likely decline.  Going into the meeting, it appeared the fear was the FOMC would allow inflation to rise unrestrained.  It’s hard to see how that was addressed.  It is not clear if the rally described above was merely a relief rally that won’t be sustained, or somehow, without saying much, the Fed managed to calm concerns.  Market action this morning suggests that yesterday’s rally is fading.  In the cold light of morning, it is clear the Fed hasn’t resolved the issue of long-duration interest rates.  It looks like we are probably on a path for 10-year T-note yields to approach the 1.90%/2.00% area; the key question is whether that level will trigger financial stress.

  • There is a growing recognition that the U.S. fiscal stimulus action is far surpassing other developed economy nations. This development will have multiple effects.  First is that U.S. economic growth will be much stronger than Europe or developed Asia.  Second, and one area that seems to be overlooked by economists as they lift their economic forecasts, is that U.S. imports will likely rise.  The past four decades have shown countries that make strong unilateral fiscal expansions tend to see much of it lost to imports.  France in the 1980s was a classic example.  However, the impact on the U.S. might be less.  The U.S. is less globally integrated which will tend to mitigate the impact, and much of the recovery spending will likely focus on services, which face less import competition.
  • Treasury Secretary Yellen is supporting a global minimum corporate tax. One of the problems in taxing capital is that if one nation has a low tax rate, corporations can shift activity to that nation, leading to lower taxes.  By supporting a corporate minimum, this “race to the bottom” could be avoided.  Such a provision would be a negative for earnings.
  • Surprisingly, Congressional Democrats seem to be declining to use the Congressional Review Act, which allows Congress to reverse regulatory changes occurring near the end of an outgoing administration. However, the actions must be taken within 60 days of the new regulation.  Simply put, time is running out, meaning that many of the late Trump-era regulations could stay on the books.
  • Here’s something to watch—many states raise payroll taxes, which pay for unemployment insurance, after a recession. This is done to rebuild reserves.  This tax hike could slow hiring as the tax is paid on the number of employees.  Essentially, this tax raises the cost of rehiring.
  • Samsung (005930, KRW, 82300) is warning that the semiconductor shortage could increase in the near term.

China:  The U.S. and China meet today in what looks to be a tense atmosphere, and Myanmar is a growing problem for China.

COVID-19:  The number of reported cases is 121,319,246 with 2,682,660 fatalities.  In the U.S., there are 29,608,162 confirmed cases with 538,093 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 147,590,615 doses of the vaccine have been distributed with 113,037,627 doses injected.  The number receiving at least one dose is 73,669,956, while the number of 2nd doses, which would grant the highest level of immunity, is 39,989,196.  The FT has a page on global vaccine distributionU.S. case counts are steady or falling in most states.


International news:  There were elections in the Netherlands, and protests are emerging in Lebanon.


An ESG cautionary tale:  Danone (DANOY, USD, 14.31) has been something of a “poster child” for ESG.  For example, last summer, the company officially adopted a French legal status, enterprise à mission, or a purpose-driven company, signaling to shareholders that it would not be solely focused on profit maximization.  Emmanuel Faber, the CEO and chairman who implemented these changes, has been ousted due to poor stock performance.  Investors like the conscience soothing that comes with ESG investing as long as it doesn’t affect equity performance.

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