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.
- There has been rising speculation for weeks that the budget’s spending target would be cut. The general expectation is that spending around $2.0 trillion would be a reasonable target. Within that lower target, lawmakers are now working on spending priorities. Manchin (D-WV) is a key swing voter and is starting to dictate terms. He is officially opposing most of the environmental proposals in the budget, forcing negotiators to either give up on these goals or to use some other tool to achieve them. Although progressives are pushing a discussion of the costs of not spending on various goals, ultimately, politics is about power, and, with a narrow majority, power is given to those with swing votes.
- As the labor force fails to expand, labor is suddenly finding itself with power. Last week, we noted a rising number of labor actions. Hollywood has avoided a strike by reaching an agreement with producers. It’s also worth noting that this isn’t just a U.S. problem; Europe is facing similar worker shortages. We expect firms will use a variety of tactics to cope; higher wages and better working conditions, higher prices, and investment in new technology are all in the mix. So far, profit margins have been high, but we worry they are almost certain to narrow in the coming quarters.
- Supply shortages also affect workers. Anyone who has bought a car recently can attest to nearly non-existent inventories and the lack of haggling with dealers. The lack of supply is changing the role of car sales personnel and will probably lead to fewer workers who are much better paid.
- A WSJ article points out the problem of public sector pension fund managers. They have high return hurdles in a world of very low-interest rates. The situation has led managers to have no other choice than to take more risk in portfolios. This outcome is, of course, of concern and raises the stakes over policy tightening. The pension system may not be able to cope with a bout of Fed tightening.
- The ECB may expand its buying of Eurobonds.
- Facebook (FB, USD, 324.76) plans to expand its use of AI to manage its platform. Results so far have underwhelmed. If AI doesn’t do the trick, the company may be forced to hire many more content moderators.
- Oats used to be one of the quieter areas of the grain markets. That might not be the case this year, as drought has reduced this year’s crop. Oats aren’t just for breakfast porridge anymore; they’re also a “milk,” which has boosted demand.
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.
- It’s official; the “stoplight” coalition of the SDP, FDP, and the Greens has started the process of forming a government. If they can form a government, Olaf Scholz will be the next German chancellor. Although this configuration is no surprise, it will be the first of its kind in Germany. It remains to be seen how stable it will be. The policy differences between the groups are vast (the FDP is a libertarian party, while the SPD and Greens are pro-government).
- Lebanon is rapidly descending into chaos. The political situation in the country has been tenuous for years, but recent crises, such as the port explosion, have revealed underlying divisions that may not be manageable. The country was wracked by civil war in the 1970s and seems to be on a path to repeating the process. The most recent problem is that Hezbollah appears to be stifling the investigation into the port explosion, most likely because the evidence will reveal it was caused by its negligence.
- The EU Parliament is pushing national European governments to take a harder line on Chinese imports from Xinjiang.
- Criminal groups in Haiti kidnapped U.S. missionaries.
- The U.S. arrested a Colombian businessman linked to corruption in Venezuela. The Maduro government has pulled out of talks over the arrest.
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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