by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EDT]
Good morning and happy Monday! Equity markets are on a tear this morning, and oil is also higher. Reports that vaccine trials are going well are boosting stocks. There wasn’t much news on China overnight, which probably accounts for some of the lift. We update the COVID-19 news. Here is what we are watching:
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. It also has a chart showing global lockdowns.
The virus news:
- The good news:
- We are seeing a global reopening of economies, although, as one would expect, some new clusters of infections are being reported. In the media, the reopening debate is often pitted as health vs. the economy. However, this binary position lacks necessary nuance. A recent paper on the Nordic response concludes that mandated shutdowns had less of an impact on the economy compared to the virus itself. In other words, just because lockdowns are lifted doesn’t mean that recovery follows rapidly. People remain selective on what activities they will engage in based on perceptions of risk.
- Vaccine research continues at a rapid pace. A reliable vaccine is the fastest way the world will return to any semblance of normal.
- Italy has reopened its borders and suspended quarantines for visitors.
- The bad news:
- As we have been documenting for some time, the range of effects from COVID-19 infection varies widely. Large numbers appear to have either very mild cases or are completely asymptomatic. Others are struck with a variety of maladies, including blood clotting, organ failure, etc. Even months after recovery, some victims continue to report effects from the disease.
- In the U.S., COVID-19 cases are now rising in rural areas as the crisis starts to dissipate in the urban centers. Unfortunately, the medical systems often lack resource depth and thus may have higher risk of fatalities. A larger elderly population increases that risk.
The policy news:
- Chair Powell was on 60 Minutes last night and warned that the downturn could be quite lengthy. At the same time, he noted the central bank has unlimited financial firepower and could continue to respond to potential problems.
- Although we don’t disagree that the Fed has virtually unlimited ability to create money, allocation is another matter. The Fed’s Main Street Lending Program continues to struggle to fill a gap in policy.
- Late last week, the Fed warned that financial stress could return for banks. We have noted that the stress indices we monitor have been falling recently in response to Fed action. However, financial stability suggests the Fed’s aggressive “dike plugging” exercise still may not be enough.
- Political haggling has the next round of stimulus on hold. Although more help is critical, it is also important that spending be targeted to supporting the recovery.
- Firms are returning Paycheck Protection Program funds, deeming the threat of audit is greater than the need for the funds. Although there have been some high-profile cases of misuse, there is a risk that the desire for accountability may end up reducing the effectiveness of the program. The government is attempting to adjust the balance of stimulus and accountability by easing some of the restrictions.
- The creaky state unemployment claims bureaucracy has been overwhelmed by the sheer number of claimants. This conduit has become a serious problem in delivering aid to unemployed workers.
- Under current conditions, we expect a surge of bankruptcies. Unfortunately, the American bankruptcy court system, considered a model for the world, is too becoming stalled as the number of companies surge. Firms are in limbo as courts fail to handle the rising caseloads.
The finance news:
- The credit union is a fixture of U.S. consumer finance. Created as an alternative to banks and finance companies, these entities are designed to serve a narrow audience, often employees working for a single firm or industry. The COVID-19 recession has increased the risk of this business model for industries that have faced serious downturns. By design, the customer scope of these financial firms is limited, so when an industry is especially hard hit the credit union that serves the employees is suddenly at risk.
- The dollar continues to rally but, for now, the White House appears OK with that. Part of this acquiescence to dollar strength could be that reversing it might be close to impossible. Despite Fed efforts to ease pressure through swaps and other measures, many nations are still scrambling for greenback and thus demand remains elevated. On the other hand, as the recovery gains strength, we could see the dollar ease later this year.
The economic news:
- As part of his aforementioned interview, Chair Powell warned that the economy may not recover until 2021. A bit of explanation is in order. In business cycle parlance, the recovery phase begins when the economy stops falling; recovery lasts until the economy exceeds its previous peak, whereby the expansion phase begins. Powell also warned that the unemployment rate could reach Depression-era levels of 25%.
- Automakers are reopening, but the restart will likely be halting as workers learn how to build cars while wearing protective gear. One major worry is that Mexican parts manufacturers remain on lockdown, which may delay parts shipments and slow the U.S. restart.
- Industries are trying to figure out what the post-COVID-19 world will look like. As we work from home and use video conferencing, it is quite possible that firms will shrink or eliminate home offices. One of the issues facing the U.S. is that workers have been flocking to cities in recent years, reducing the population in suburban and rural areas. However, if we can work from anywhere, maybe it might make sense for workers to return to the lower cost parts of the country, which would reverse the recent decades of social and economic problems plaguing rural areas.
- It’s no secret that airlines are struggling. But, as is often the case, some parts of the economy benefit. Repossession firms for airplanes are seeing a surge in demand for their services.
- NASCAR is back.
The foreign news:
- Although the news about China was overall rather light compared to previous weekends, new restrictions on Huawei (002502, CNY 3.06) have raised fears on the viability of the company. At the same time, there is evidence the company is figuring out how to use fewer U.S. parts in its phones.
- The EU wants to ensure that China won’t use the crisis to acquire European firms hurt by the recession.
- Brazil’s health minister resigned; this is the second resignation in a month.
- Nicaragua has generally shunned lockdown measures, most likely because its economy would be unable to cope with the economic ramifications. There is evidence the country is taking steps to undercount the COVID-19 death toll.
Brexit: Last week, we reported that trade talks between the EU and Britain were not going well. It would appear the most logical outcome is an extension to give negotiators more time to develop a trade agreement. However, PM Johnson has expressly ruled out asking for one. This situation raises worries that a hard Brexit may be coming. One possibility to avoid such an outcome would be a conditional extension, allowing both sides to continue talking without asking for a formal extension. This is exactly the kind of “fudge” or “can-kicking” action that the EU does best. The financial markets, especially the GBP, have been worried about a hard break, and the potential for a conditional extension reduces that likelihood.