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

[Posted: 9:30 AM EDT] | PDF

Good morning!  It’s Monday and the first trading day of May.  Various global markets are closed or seeing light trading today due to lingering May Day celebrations.  U.S. equity futures are trending higher this morning.  Economics and policy lead off our coverage today.  International news comes next, followed by an update on China.  We close with our usual pandemic update.

Economics and policy:  Labor markets, inflation worries, and colleges dominate the news.

• One of the factors economists are trying to discern is the effects that follow a pandemic. We know that policy actions have flooded households with cash.  This wall of money has raised inflation fears.  However, we have contended that it is critical to follow the money.  In other words, the mere presence of liquidity does not mean inflation will follow.  The WSJ notes that much of the cash is being held in older households, where it is less likely to be spent.  The latest data, which for Q4, from the Fed’s Distributional Financial Accounts, shows that cash held by the top 10% of households rose $451.6 billion from Q3.  For the 89% to 51% middle, it rose $89.9 billion, and for the bottom 50%, it rose $47.7 billion.  Some of this data will change with recent fiscal injections, but there is clear evidence that the bulk of the liquidity is in households that will either hold it for a while or likely use it to buy financial assets.
• That doesn’t mean we are not seeing price increases. Lumber prices are soaring, the consequence of rising demand that hit an industry that has been contracting supply since the Great Financial Crisis (here’s a great podcast on the topic).  We are seeing numerous reports that industries, from restaurants to food processors, are struggling to find workers.  Some of this is due to households having all that cash.  Workers can be more discerning in employment opportunities.  However, there is also another issue.  During the pandemic, some workers who were laid off as businesses closed may have trained or found work in other industries.  Some of these industries had rather poor labor practices—often, they demanded flexible schedules that burdened workers and prevented them from managing childcare or working multiple jobs.  If these workers moved on, these industries would be forced to train new workers, and in a high growth period, will probably be forced to pay more or restructure jobs to make them more attractive.
  • Don’t underestimate the economy’s ability to adapt. For example, it looks like lumber pricing may be high for a while; we expect that soon we will see builders take a look at residential steel studding.  Steel has attractive properties for residential homebuilding.  It’s strong. It can withstand wind and earthquakes better.  It offers greater flexibility in design.  It used to cost about 15% more than wood framing.  With lumber prices up this much, steel will likely make inroads, and once it does, some of the lumber demand will be lost, permanently.  Although iron ore prices are up, it is important to remember that steel, unlike wood, is recyclable.
• Some of the pricing issues are due to the nature of this recovery. The last fast recovery from recession was 1982.  In every recession since then, the recovery has tended to be slow.  Businesses assumed this recovery would be too.  But, unlike previous business cycles, the fiscal and monetary response was so aggressive that we are seeing a true “V” recovery.  Expectations of a slow recovery led firms to downsize dramatically a year ago.  They shed labor and cut inventories.  Based on the past three decades of experience, that made sense.  Unfortunately, it was a mistake this time around.  Now, businesses are scrambling for workers and materials.[1]
• The consensus of policymakers is that the rise in prices will be temporary. We tend to agree with this assessment.  For now, the key to inflation is expectations.  We will know inflation is a problem when (a) firms begin to treat inventory as an asset instead of something to be minimized[2] and (b) when households buy, now fearing higher prices later.  We are watching residential real estate closely; home prices have been rising, as have mortgage rates.  If buyers continue to bid prices up on fears of the lack of supply, this would be a concern.  However, we would not be surprised to see prospective buyers start to balk at prices in the near future.  If they don’t, it would be evidence that inflation expectations are building.
  • Another worry is that policymakers are abandoning any pretext of fiscal control. The Biden administration is looking for higher taxes, suggesting a full abandonment isn’t underway quite yet.  Also, the path to higher spending isn’t going to be smooth either.  There is some evidence that infrastructure spending may not be as large as proposed.
  • It’s also worth noting that all the recently proposed infrastructure and family spending is over a decade, but the taxes would be implemented immediately, leading to a fiscal contraction. This fact is mostly being lost in the current discussion.
• College enrollment is down 5.9%. Some of this is due to the uncertainty surrounding the pandemic, but demographics and a drop in international students are also affecting it.  Although the highly selective colleges are turning away students, there are scads of colleges still looking for students even at this late date.
• There is a global sand crisis.
• European banks are building a plan to take on American payment firms.
• How did big tech get big? Through acquisitions.

International roundup:  Iran is in the news, the EU and G-7 counter Russian propaganda, and Kim Jong-un won’t be ignored.

• Two items of note on Iran.
  • Although this news started circulating last week, Iran and the KSA are holding “secret” talks (not much of a secret anymore!). We suspect this is because Riyadh has concluded that the U.S. is eventually going to leave, and these two powers are going to have to get along.
  • There were reports in Iran state media that the U.S. and Iran had struck a deal where the U.S. would give Iran money, and Tehran would release prisoners. Washington has denied the reports.  Although we would not be shocked by such an arrangement, it is also possible that Iran “leaked” the news to pressure the Biden administration.  It is also conceivable that hardline elements in Iran released the reports to undermine talks, knowing that this deal would be unpopular in the U.S.
• In the face of persistent Russian disinformation, the EU and G-7 nations are proposing steps to counter these activities.
• The Biden administration is said to be offering North Korea a new policy that tries to fall between the arms-length Obama policy and the grand gesture Trump policy. So far Pyongyang seems unimpressed.
• Madrid is holding regional elections in Spain. The campaigning is getting especially ugly.
• Protests against taxes in Colombia are increasing.

China:  Regulators are cracking down on fintech, small businesses are struggling, and a new opioid is emerging from China.

• Last November, the Ant Financial IPO was scuttled at the last minute. That started a trend where tech firms that had ventured into fintech are now facing scrutiny from regulators.  Tencent (TCEHY, USD, 79.66) is facing antitrust penalties.
• Sluggish consumer demand is leading to a slow recovery for China’s small businesses.
• There are reports that a new synthetic opioid, Isotonitazene, called “Iso,” is starting to circulate. It is said to be similar to fentanyl and may be a response to Chinese authorities cracking down on fentanyl production.

COVID-19:  The number of reported cases is 152,946,524 with 3,204,301 fatalities.  Global cases have reached a new peak.  In the U.S., there are 32,422,234 confirmed cases with 577,046 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 312,509,575 doses of the vaccine have been distributed, with 245,591,469 doses injected.  The number receiving at least one dose is 147,047,012, while the number of second doses, which would grant the highest level of immunity, is 104,774,652.  The FT has a page on global vaccine distribution.

Virology

• Although cases in the U.S. continue to decline, India is facing a serious crisis. It recorded 400,000 new cases and record fatalities.  In local elections, the BJP, PM Modi’s party, suffered losses; pundits tie the losses to the pandemic.  India’s health care system is under severe strain.  Starting tomorrow, the U.S. will restrict travel from India.
• South America is also seeing widespread infections.
• Turkey has announced its first full lockdown.
• In the U.S., researchers are concluding that herd immunity is unlikely. Vaccine hesitancy likely means that the U.S. won’t reach a point where 70% of the population is either vaccinated or has immunity from being infected.  That doesn’t mean that some degree of normalcy will return, but we will likely see COVID-19 become endemic.  That could mean that, like the flu, it will cycle through the population on occasion, leading to localized lockdowns.
• The AstraZeneca (AZN, USD, 53.07) blood clotting problem appears mostly to affect young adults.
• Drug companies are working on making the next generation of COVID-19 vaccines easier to take; nasal sprays or pills might replace injections.

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[1] Semiconductors are a classic example.

[2] When we move from just in time to just in case inventory management.