Daily Comment (May 5, 2021)

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

[Posted: 9:30 AM EDT] | PDF

Today’s Comment opens with Treasury Secretary Yellen’s gaffe – or Freudian slip – on rising inflation and interest rates.  Even though she has tried to walk that statement down, it will likely play into suspicions that the Federal Reserve may not be able to hold off on tightening monetary policy for as long as it says.  Next, we review other key U.S. and foreign developments that will likely impact the financial markets today.  Finally, we review the latest news regarding the coronavirus pandemic.

U.S. Monetary Policy:  After suggesting that passage of the Biden administration’s spending plans might require the Fed to hike interest rates to keep the economy from overheating, Treasury Secretary Yellen late yesterday tried to walk back her comment by insisting that she was neither predicting nor recommending that the central bank should tighten monetary policy.  Rather, she asserted she didn’t foresee any lasting rise in inflation.  While it’s a surprise that a policymaker as seasoned as Yellen would make such a mistake, it may be that the former Fed chair is still adjusting to the more political role of a cabinet secretary.  All the same, her initial statement is likely to be taken as a Freudian slip that shows even administration policymakers expect a more serious acceleration in inflation and may need to hike interest rates earlier than the Fed is willing to admit.  That could spark a renewed bout of inflation concerns, rising bond yields, and volatility in the equity markets in the coming days.

U.S. Fiscal Policy:  An analysis by the Tax Policy Center indicates that President Biden’s proposal to hike capital gains taxes to 43.4% for those whose income exceeds $1 million would affect less than 1 in 20 taxpayers who file Schedule D.  However, the tax hike would apply to almost two-thirds of the entire volume of capital gains, simply because so many of those gains are earned by taxpayers with very high incomes.

United States-Taiwan-China:  Amid rising fears of a Chinese seizure of Taiwan and calls for the U.S. to explicitly commit itself to Taiwan’s defense, White House Asia chief Kurt Campbell warned that there would be significant downsides to “strategic clarity.”  Campbell’s pushback echoes a recent statement by Director of National Intelligence Haines that a U.S. shift away from strategic ambiguity and toward an explicit commitment to defend Taiwan would be seen by China as deeply destabilizing and could make China even more aggressive.

  • Asked whether the world should be preparing for possible conflict over Taiwan, Campbell played down the risk, saying the Chinese military activity was merely an effort to “turn the screws” on Taiwan.
  • Despite Campbell’s pushback against an explicit commitment to Taiwan, the administration and U.S. allies continue to take a tough stance on China.  At a meeting of G7 foreign ministers today, Japanese Foreign Minister Motegi voiced “grave concerns” over China’s unilateral attempts to change the status quo in the East and South China Seas.  He said Japan is also concerned about Beijing’s handling of human rights in connection with the Muslim Uyghur minority in the Xinjiang region.
  • Because of China’s growing power and the rising threat of conflict with the U.S., especially over Taiwan, we continue to deepen our focus on the region.  We have published a new, multi-part Weekly Geopolitical Report series on the geopolitics of Taiwan and its place in the global technology industry; Part I can be found here.

European Union-China:  The EU today unveiled draft rules that would grant the bloc’s antitrust regulators new powers to block foreign companies from making acquisitions in Europe or from receiving public contracts if they are deemed to have benefited from government subsidies. Companies will face stiff fines if they fail to comply with the EU’s demands.

  • Although the rules don’t single out China specifically, that country would be a main target.  If approved by all 27 of the EU’s member states and the European Parliament, the rules would allow the bloc to crack down on state-subsidized Chinese companies in much the same way it has targeted big U.S. multinationals.
  • The legislation is the latest sign of Europe’s shifting stance toward China, the bloc’s biggest trading partner for goods and a crucial market for its exporters.  As we have discussed many times previously, growing friction between China and the world’s liberal democracies could be economically disruptive and potentially catch investors in the crossfire.

Spain:  The center-right People’s Party scored a spectacular victory in a pivotal regional election in Madrid — doubling its share of the vote, inflicting a humiliating defeat on the country’s governing Socialist Party, and prompting the resignation of the leader of the radical leftwing Podemos Party.

  • Even though the PP will have to rely on the support of the hard-right Vox party to govern, the victory still marks a major turnaround for Spain’s main opposition party, which had suffered falling support in recent years.
  • The victory will also mark PP regional chief Isabel Díaz Ayuso as key to the party’s future.  Basing her campaign on the slogan “Freedom,” Díaz Ayuso has clashed repeatedly with the Socialist-led national government over coronavirus policy, imposing fewer restrictions than the rest of the country and keeping the region’s hospitality industry open for months.

Israel:  Following Israel’s inconclusive elections earlier this year, Prime Minister Netanyahu missed a deadline to form a new government by midnight last night.  As a result, the country’s president is now expected to offer Netanyahu’s rivals an opportunity to assemble a government or hand responsibility for selecting a new prime minister to Israel’s parliament. If those efforts fail, Israel could be heading toward another election—the fifth since 2019.

COVID-19:  Official data show confirmed cases have risen to 154,458,235 worldwide, with 3,230,178 deaths.  In the United States, confirmed cases rose to 32,513,803, with 578,504 deaths.  Vaccine doses delivered in the U.S. now total 318,474,035, while the number of people who have received at least their first shot totals 147,894,671.  Finally, here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.


  • Newly confirmed U.S infections fell to approximately 40,000 yesterday, well below both the seven-day moving average of 49,619 and the 14-day moving average of 52,446.  On a less positive note, however, new deaths related to the virus rose to 916.  Meanwhile, the CDC reported that 56.4% of U.S. adults have now received at least one dose of a vaccine, and 40.8% have been fully vaccinated.
  • President Biden set a new goal of getting 70% of U.S. adults at least one vaccine dose by July 4 and having at least 160 million U.S. adults fully vaccinated by the same date.  To accomplish that, the administration will reallocate doses to states with higher demand and direct pharmacies to offer walk-in vaccinations.
  • New data show that EU member states have now administered 33.6 vaccine doses per 100 inhabitants.  That’s less than half the level in the U.K. and the U.S., but it’s a big jump from just a month ago and far more than in most developing countries.
    • The data suggest that the EU vaccination program is now moving into high gear after the removal of bureaucratic and logistical issues that snarled the early stages of its vaccine campaign.  Of particular importance: deliveries from vaccine manufacturers have risen sharply, allowing governments to relax their rules regarding which of their citizens are eligible for a shot.
    • Coupled with renewed lockdowns in many areas, the faster vaccination push holds out the promise that EU infections, hospitalizations, and deaths could soon start to fall.  If that sparks a quick economic rebound similar to that of the U.S., it would likely be positive for risk assets in Europe and elsewhere.  We note that it could also prompt some rebound in European bond yields and potentially put the dollar on a downward path again.
  • Despite the improvement in Europe, the virus resurgence in India continues unabated.  A key problem is a nationwide shortfall in oxygen supplies, leaving many COVID-19 victims to die from asphyxiation.

 Economic and Financial Market Impacts

  • Fortunately, data on the global service sector continues to show a rebound, even in some countries still facing high or even worsening infections.  For example, India’s Purchasing Managers Index for the service sector only fell to 54.0 in April, compared with 54.6 in March (see data tables below).  As with all PMIs, the index is designed so that readings over 50 point to expanding activity.  While stock prices have softened recently in India, Brazil, and some other countries facing high or worsening infection rates, the resilience of the service sector could help explain why stock prices have held up better than might have been expected.
  • Just as the post-pandemic recovery looks set to favor small-cap stocks in the U.S., an analysis by the Financial Times shows a similar dynamic has taken hold in the U.K.  The FTSE index of small-cap equities excluding investment trusts has soared almost 70% over the past year, widely outpacing the 23% rise for the FTSE 350 Index of the biggest stocks listed on U.K. markets.
  • The National Center for Health Statistics said the pandemic pushed total U.S. births down 4% to just 3.61 million in 2020, marking the lowest total since 1979.  Although it’s not clear how much of a rebound might be in store for 2021 and the coming years, the result will be at least some additional slowing in population growth and stronger population aging in the coming years.  This will tend to be a headwind for economic growth and inflation.

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