Daily Comment (May 21, 2020)

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

[Posted: 9:30 AM EDT]

Good morning!  Equity markets are taking a breather this morning.  China is preparing for its CPC spring meetings.  Germany bends (a little) on a Eurobond.  We touch on the Fed minutes and update the COVID-19 news.  The Weekly Energy Update is available, as is our most recent podcast.  Here is what we are watching:

COVID-19:  The number of reported cases is 5,016,171 with 328,471 deaths and 1,913,103 recoveries.  In the U.S., there are 1,551,853 confirmed cases with 93,439 deaths and 294,312 recoveries.

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.  One chart worth noting: the virus is rapidly becoming an emerging world problem.  This is partly because these nations can’t absorb the costs of lockdowns.

The virus news:

  • The good news:
  • The bad news:
    • Chinese doctors dealing with a new outbreak in the northern provinces of Jilin and Heilongjiang report that COVID-19 appears to be mutating. Compared to what was observed in Wuhan, patients appear to be asymptomatic longer, which facilitates the spread of the disease.  At the same time, they are reporting fewer cases of widespread organ problems; instead, they are seeing the more serious cases concentrated on lung issues.
    • Although children have mostly been spared from the worst of COVID-19, there are rare cases where a few children suffer from severe inflammation. Here is what to look for.
    • A Chicago area auto plant was forced to close soon after reopening after a supplier closed. Another plant in Michigan closed as a worker tested positive for COVID-19.  We continue to closely watch Mexico’s return to work, which will be critical for the auto industry.
    • The head of the CDC warns of another uptick in infections later this year.
    • The experience of the polio vaccine offers a cautionary tale for the eventual COVID-19 vaccine. After Jonas Salk developed the vaccine, a number of drug companies licensed the process to distribute it to the public.  Sadly, one of the drug companies made a serious error.  The Salk process involved a vaccine that used dead polio viruses.  The drug company in question inadvertently failed to kill the virus; instead of sending out a vaccine, it sent out live polio viruses.  The company sent out 165k vials of the tainted vaccine which not only infected some of those who received it, but the newly infected, in some cases, passed it on to other family members.  As one would expect, there was a great rush to distribute the vaccine which likely contributed to the error.
      • Although this story has been mostly lost to history, we doubt the drug companies have forgotten. If they don’t get some protection from lawsuits, they will be very careful in testing the vaccine before distributing, which will inevitably slow its dispersal.
      • At the same time, the news of a vaccine will raise the clamor for distribution, which will increase the odds of a mistake. Given the rising skepticism about vaccination, in general, an error would have serious ramifications.
      • On this topic, the EU has been slow to spend on vaccine research, increasing the chances it will be in the back of the line when the eventual vaccine is distributed.
      • Vaccine nationalism is another risk. The moral quandary of vaccine distribution will become a problem at some point.  Discussing how we should distribute the vaccine once it emerges would make sense.

The policy news:

  • Earlier this week, Treasury Secretary Mnuchin and Chair Powell testified before Congress. Although the media has mostly focused on the “compare and contrast” between the two testimonies (Mnuchin was upbeat, while Powell pushed for more fiscal stimulus), the most critical part we found was that the Treasury secretary indicated that his department was ready to “take losses.”  One of the unknowns has been that as the Fed’s balance sheet expands to accommodate its backstops, the central bank is really not able to take losses.  If it does, it will eventually need to be recapitalized by the Treasury.  Mnuchin admitted that this will be the case.
  • Speaker Pelosi is working on revamping the small business lending program. The Paycheck Protection Program, put together in haste, has suffered serious flaws.  Companies and non-profits that probably didn’t need the support got it, while small firms that needed it were denied.  Banks were unsure how to make loans, so they concentrated on existing relationships.  Small companies became afraid they would be audited; the short time frame to use the funds has discouraged firms from taking the loans.  The fact that Congress is taking a second swing at this is good news.
  • Meanwhile, the Senate continues to slow walk the recently passed House bill. Majority Leader McConnell (R-KY) has indicated that enhanced unemployment benefits won’t be extended.  These benefits have been controversial; although welcomed by households, the benefits, especially outside the coastal urban areas, often exceed what employees earned on their jobs.  Thus, they have an incentive to avoid finding new employment.
  • Although we are on the record as forecasting deglobalization, the fact remains that reversing the trend of the past four decades will not be easy. Companies have become adept at managing far-flung supply chains that lower costs.  Getting them to “come home” will be hard and probably require incentivesEconomic advisor Kudlow floated tax breaks for firms that relocate back to the U.S. as one idea to foster reshoring.  Additionally, we are seeing examples of the government supporting reshoring by contract distribution.

The finance news:

The economic news:

The foreign news:

Brexit:   Westminster announced its tariff plans for the EU if a Brexit deal is not reached.   Meanwhile, PM Johnson sketched out a trade deal with the EU, similar to the one the group struck with Canada.  Brussels is not happy with that proposalPositions between the two sides are hardening.  And, quietly, the Johnson government is admitting there will be customs checks at the shore of the Irish Sea for trade going to the British Isles.

Libya:  The civil conflict in Libya continues to rage, causing widespread hardship.  For the past year, Gen. Khalifa Hifter, who has support of the Gulf States and Russia, has been expanding his area of control, from east to west, heading toward Tripoli.  However, over the past week, Hifter has suffered some significant setbacks as U.N. backed forces centered in the east have seized a key airfield and taken control of two cities.  As turmoil increases, we could see Libyan oil exports fall and there may be a rise in refugees to Europe.

Turkey:  The TRL has been under pressure for months due to falling reserves and rising inflation.  Under normal circumstances, Turkey could petition the U.S. for help; the Fed has been remarkably generous in providing liquidity to nations to ensure ample dollar liquidity.  However, Ankara has fallen out of favor with the U.S. for its treatment of the Kurds and for accepting delivery of a Russian-built S-400 missile system.  So, as its reserves dwindle, it is facing increasing pressure to either (a) raise interest rates to stop the outflows, (b) ask the IMF for help, or (c) find help elsewhere.  The first two options will entail pain, so Turkey went with the third option, getting a boost in its swap line with Qatar.  Qatar is on the outs with other GCC nations and Turkey has been supportive, keeping troops there to discourage the other GCC nations from military adventurism.  It looks like it has been rewarded for its efforts with Qatar.

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