Daily Comment (May 29, 2020)

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

[Posted: 9:30 AM EDT]

Good morning and happy Friday!  Global equities are softer this morning as tensions between the U.S. and China continue to rise.  We discuss the latest with China.  As usual, we update what we know about COVID-19.  The Weekly Energy Update is available.  Chair Powell is holding a virtual discussion with former Vice Chair Blinder at 11:00 EDT.  Let’s get to it…

China:  The National People’s Congress has come to a close and it was a momentous meeting.  The decision to extend the national security law into Hong Kong, overriding the former colony’s legislature, strongly signaled that Chairman Xi is done with the “one country, two systems” approach that was adopted at the handover in 1997.  Here are the key points we are watching:

Equity markets have staged a remarkable recovery since the March lows.  As we detail in this week’s Asset Allocation Weekly (see below), much of this rally has been driven by supportive Fed policy.  However, a flare-up in tensions with China is a risk to the rally that we will continue to monitor.

COVID-19:  The number of reported cases is 5,837,541 with 360,919 deaths and 2,437,965 recoveries.  In the U.S., there are 1,721,926 confirmed cases with 101,621 deaths and 399,991 recoveries.  For those who like to keep score at home, the FT has created an interactive chart that allows one to compare cases and fatalities between nations, scaled by population.

The virus news:

  • The good news:
  • The bad news:
    • Herd immunity is the best long-term solution to managing the virus. Unfortunately, the world appears a long way from achieving that level of immunity.

The policy news:

  • The House has passed a bill easing rules on PPP loans. Policy restrictions were discouraging companies from taking the loans so Congress is moving to address that issue.  However, there may be some sticking points about the House bill that will need to be changed to get passage through the Senate.
  • As extraordinary measures approach their end dates, Americans are growing worried that they may not be able to find new jobs or go back to their old ones. If this is the case, the economy could stall later this year.  We do expect other forms of relief to come (rules that reduce the cost of hiring and employment bonuses, for example), but if they fail the economy will bear some risk.
  • The Fed’s balance sheet is now over $7.0 trillion. We noted earlier this week that officials are considering yield curve control.  Policymakers at the Fed are continuing to look for ways to support the economy and, as noted in the opening, Chair Powell may address some of those today.

The finance news:

  • One of the reasons we don’t expect the Fed to engage in negative nominal policy rates is because of the heavy reliance of the non-bank system on money market funding. Negative policy rates would almost certainly cause money market funds to “break the buck” and trigger disintermediation.  We note that money market fund managers are already under stress, waiving fees to offer investors at least some paltry yield.
  • One of the common media questions is, “Why is the stock market ignoring the economy?” As we detail in this week’s AAW, it has to do with the expectations of a short recession and massive policy support.  However, the U.S. equity market isn’t the only one doing well.  The Tehran Stock Exchange has been on a tear.  There are a couple of reasons for this rally.  First, Iranian investors have the TINA[1]  Second, equities do offer some protection from high inflation.  Interestingly enough, we saw something similar in Zimbabwe during its hyperinflation period.  Although rising inflation harms P/Es, stocks do offer some element of inflation protection as firms can boost earnings and become something of a safe haven relative to bonds during periods of high inflation.

The foreign news:

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[1] There Is No Alternative.