Daily Comment (October 18, 2021)

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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday!  Risk markets are lower this morning as Treasury yields rise.  Our coverage begins with China news this morning, including comments on weak Q3 GDP.  Economics and policy are next, where we look at the progress on the budget and the situation in the labor markets.  Crypto follows; a bitcoin ETF has been approved but with caveats.  We close with the international roundup and pandemic news.

China news:  China’s GDP plummets, and a hypersonic missile surprises military analysts.

  • China’s Q3 GDP fell to 4.9% from last year (down from 7.9% in Q2) and up 1.6% on a Q/Q% annualized basis. Power shortages and supply chain snarls adversely affected the data.  The longer-term outlook isn’t all that positive either.  Beijing’s decision to rein in residential real estate will tend to weaken China’s growth going forward.  It has been well known for some time that China has used investment, mostly with leverage, to maintain greater than 6% GDP growth.  A more realistic growth rate is probably closer to 3%.  At that rate, China can likely slow its debt growth.  However, cutting growth to that level creates a bevy of new risks.  Commodity consumption is at risk, and it isn’t obvious whether General Secretary Xi has been able to substitute some other factor for CPC legitimacy.  In other words, the CPC has argued that it gains legitimacy by fast growth.  Xi is trying to substitute nationalism or national pride (“Chinese Dream”), but it isn’t clear whether the people buy in.  So, there is much to watch in the coming months and years.
  • In August, China tested a nuclear-capable hypersonic missile that circled the globe before landing near its target. Military analysts were caught by surprise by Beijing’s rapid development in this space.  Hypersonic missiles are mostly gliding vehicles that travel at five times the speed of sound.  Although slower than a ballistic missile, they don’t follow a fixed path and are thus harder to track.  Current anti-missile systems would not be of much use, and warning systems are less effective as well against these vehicles.  This test suggests China is a much more formidable nuclear adversary than analysts thought and will likely trigger a response in U.S. defense spending.
  • NATO leaders say they are focusing on the security threat from China. This announcement is important because NATO has traditionally paid attention to Russia.  We find it interesting that NATO made this announcement as Chancellor Merkel is preparing to exit Germany’s leadership.  Germany has tended to push back against confronting China.
  • Brazilian ranchers are worried about the ongoing ban on beef exports to China. A couple of cases of mad cow disease in September triggered the initial ban, but Brazil thought the restrictions would be lifted by now.

Economics and policy:  The House is back as Congress tries to pare back the budget.

Crypto:  An ETF is coming, and stablecoins are in the news.

  • The SEC has approved a bitcoin ETF, but it won’t be a grantor trust but instead is based on U.S. futures. We suspect regulators are uncomfortable with backing the product with bitcoin itself on concerns about supply and the use of the product for money laundering.  There is a downside to using futures, two in fact.  First, the product will likely have a K-1 for tax reporting, which usually discourages retail participation.  Second, bitcoin futures trade in contango, which means the deferred contracts trade at a premium to the spot.  Futures ETF like this “roll” the contracts at expiration, so when they roll to the next contract month, they will pay a higher price than the one they liquidated, all else held equal.  In other words, there will be a negative “roll yield” that will tend to depress the price of the ETF relative to spot bitcoin.
  • The stablecoin Tether was hit with a $41 million fine for misrepresenting its reserves.

International roundup:  Germany begins to form a government, and Lebanon spirals into civil war.

COVID-19:  The number of reported cases is 240,773,139, with 4,900,537 fatalities.  In the U.S., there are 44,934,688 confirmed cases with 724,632 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 494,698,695 doses of the vaccine have been distributed, with 408,265,959 doses injected.  The number receiving at least one dose is 218,805,579, while the number receiving second doses, which would grant the highest level of immunity, is 189,141,481.  For the population older than 18, 68.4% of the population has been vaccinated.  The FT has a page on global vaccine distribution.

  • Colin Powell, the four-star general who was Chief of Staff during the First Gulf War and later Secretary of State during the George W. Bush administration, has died due to complications from COVID-19. He was fully vaccinated.  Powell was 84.  His passing shows that even with vaccination, COVID-19 remains a threat to older people.
  • The U.S. will ease travel restrictions for fully vaccinated foreign nationals on November 8.
  • The Kremlin is attempting to silence analysts who are challenging the government’s official statistics on the impact of the pandemic.

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[1] Referring to the colors of the parties.