Daily Comment (October 15, 2020)
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EDT] | PDF
Good morning. Equity markets are pointing to a lower opening; stalled stimulus and rising COVID-19 cases are the likely culprits. We lead with China today, with a particular focus on Taiwan/U.S. relations. Pandemic news is next. As winter approaches, we are seeing rising infection rates and partial lockdowns. An update on policy news and Brexit follows. We are also watching rising unrest in Thailand and problems in Afghanistan. Tech news is next, with an update on real estate, the economy, and odds and ends. Please note that due to Monday’s holiday, the DOE data is delayed until today, so the Weekly Energy Update will be published tomorrow. Here are the details:
- Since relations were normalized with China in 1978, the U.S. has engaged in strategic ambiguity regarding Taiwan’s defense. It didn’t want China to think we had abandoned Taipei but also didn’t want Taiwan to believe it had an ironclad security guarantee to prevent Taiwanese adventurism. We are seeing a rising call from the foreign policy apparatus from all sides, suggesting strategic ambiguity should be replaced with a clear statement of defending Taiwan from forced unification. The fear among analysts is that without a clear policy, the potential for miscalculation from Beijing is elevated. Essentially, the argument is that the facts on the ground have changed; the U.S. faces little risk that Taipei will attack China. Instead, without an overt statement of U.S. intention to defend Taiwan, Beijing may assume the U.S. won’t defend the island. Such a policy would infuriate Beijing, but it would let China know where we stand. Of course, if the U.S. does make such a policy, it must back it up or lose creditability.
- We note that the U.S. is moving to sell missiles and drones to Taiwan.
- As the year has progressed, China’s economic recovery has gathered momentum. Much of this growth is coming from the industrial sector which has been boosted by goods production. The last time we saw significant stimulus, in the wake of the Great Financial Crisis, commodity demand lifted strongly. We are seeing something similar this time around; copper imports rose to their second highest level on record, just down from the previous record hit in July.
- Car sales have also jumped, recording the first quarterly rise in two years. Production is recovering too. Households have been an important element of the recovery. Much of the spending appears to be coming from higher debt levels.
- General Secretary Xi has presented new regulations for managing the Politburo and the Standing Committee of the Politburo. The former is given the job of overseeing the CPC, although Standing Committee is the real power. These new rules will give Xi even more power to shape agendas and allow him to have input on all new policies.
- Although U.S. foreign policy has shifted to a clear adversarial stance, business groups continue to try to maintain relations with China. The foreign policy apparatus has been framing the tensions as a new Cold War. This may be due to the force of habit. Another analog could be Germany and Britain before WWI. The two countries were geopolitical adversaries but had close economic relations.
- For the first time ever, China has sold a sovereign bond directly to U.S. investors. The $6.0 billion offering was USD denominated. The bonds had four different maturities (3, 5, 10, and 30-year maturities) with coupons of 0.40%, 0.55%, 1.20%, and 2.25%. The 10-year note exceeds the comparable yields on Treasuries by 50 bps. Most of the sale went to institutional buyers.
- The U.S. is considering putting Ant Group on the trade blacklist. Ant is about to go public; it is currently an affiliate of Alibaba Group (BABA, USD, 301.04).
- The State Department is warning international banks to avoid business contacts with Hong Kong individuals who are under American sanctions.
- The U.S. has named a coordinator for Tibetan issues, a measure designed to anger the Xi government.
COVID-19: The number of reported cases is 38,574,120 with 1,093,253 deaths and 26,720,847 recoveries. In the U.S., there are 7,917,223 confirmed cases with 216,904 deaths and 3,155,794 recoveries. 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 weekly state Axios chart is updated.
- As we have been reporting, there has been an upswing in infections as the temps fall. New York is coping with a surge. Europe is too, with central Europe emerging as a hotspot. Both areas are attempting to slow the spread without widespread lockdowns. France has implemented a curfew in selected cities. Portugal is implementing new measures. So has Northern Ireland. In the U.S., it is the less populated states in the interior that are seeing the fastest infection rates. Some of this reluctance to enforce lockdowns is due to the economic damage they cause. In addition, compliance might be low because of growing opposition to such measures. To some extent, avoiding lockdowns is a tacit decision to accept the costs of herd immunity.
- As the race for a vaccine continues, a cautionary note has emerged from Nevada regarding a reinfection of COVID-19. The second infection was more severe than the first, suggesting there was a mutation and the first infection didn’t protect this person from the second strain. The problem of mutation is the reason we have to get a flu shot every year; we may find that a vaccine for COVD-19 requires something similar. An additional complication is that we could very well have multiple vaccines, and it won’t be evident for some time which one works best (or if different vaccines work better with different groups of people). Repeat infections do appear to be rare.
- Polls suggest that most people will accept a vaccine but are taking a wait and see approach before being inoculated. That will tend to slow the pace of immunity.
- In some good news, daycare facilities are unlikely to be a vector for the disease. COVID-19 does appear to have less impact on the very young, and staffers and their charges seem to be at low risk. Getting daycares up and running is critical to boosting employment.
- There is a raging debate underway as to whether nations should simply allow the virus to circulate to build natural herd immunity or continue with partial lockdowns. Under this debate are unresolved philosophical questions about ethics. Simply put, the issue of natural herd immunity isn’t really about science, it’s about moral philosophy. Unfortunately, many of those engaged in the debate probably haven’t approached the questions of morality in any systemic manner.
- We continue to monitor studies that suggest blood type might be a factor in the likelihood of infection from COVID-19. Regrettably, most of the studies we see are flawed (they mostly don’t adequately control for other factors).
Policy news: Although talks continue, and it does appear both sides are close in terms of total spending, how the funds are allocated remains a sticking point. Treasury Secretary Mnuchin admitted yesterday that the odds of getting anything done before the election is unlikely. We would agree. In fact, it isn’t likely much will get done in the “lame duck” session either. Even if we have a unified government after the election, we don’t expect a filibuster-proof Senate, meaning it may not be an easy task to get stimulus next year either. Although we don’t expect a double-dip recession, we do think we are setting up the prospects for another slow recovery, which is actually fine for stocks but could be explosive socially and politically.
- Governor Qualls suggested that the level of Treasury borrowing may require some degree of permanent QE to allow the financial markets to function. That policy is skirting debt monetization.
Brexit: Negotiations are coming down to the wire, and one trend we are staring to notice is a rising level of alarm on the EU side. EU negotiators have assumed they had the upper hand and could dictate terms. PM Johnson has acted all along as if this wasn’t the case. What has started to emerge is that the EU negotiating team may have forgotten an important characteristic of the union. They have 27 nations to placate, and if one of them decides that the pain of Britain leaving without a deal is too painful, they can push for an agreement. We still expect some sort of deal to be made and enough “fudges” provided to allow both sides to live with the outcome, with some disruption, but nothing that won’t be manageable over time.
- EU business groups are warning against a hard Brexit.
- PM Johnson set a deadline for negotiations for today when the EU summit meeting is underway. It looks like the deadline will pass without incident.
- One potential fallout from Brexit is that support for Scottish independence is rising rapidly. Although the Johnson government continues to ignore the threat, it is looking more likely that the U.K. may shrink.
Thailand: Thailand has rules against criticizing the king. It has some of the world’s lèse-majesté laws, criminalizing even casual remarks about the royal family. Thus, it was newsworthy when the royal family, in a rare visit to Thailand (the family spends most of its time in Germany), faced widespread protests as its motorcade passed through Bangkok. The government has implemented state of emergency orders, limiting organized gatherings in an attempt to reduce protests. The king is very unpopular, unlike his father, who died in 2016. Coups are rather common in Thailand as are military governments. However, there has been persistent unrest in the country that may become revolutionary at some point.
Afghanistan: As the U.S. prepares to exit Afghanistan, the Taliban is becoming bolder in its bid to take control. The exit of U.S. troops is increasing the risk that the current government will lose control.
Technology: Tech firms are facing new regulations from the EU. France and the Netherlands, specifically, are taking the position that the firms need to be broken up. In the past, successive U.S. administrations have protected these firms that are overwhelmingly American. However, legislators and judges are becoming increasingly hostile as well.
Real estate: One of the initial actions taken in March was to suspend evictions. The idea was that the pandemic would be brought under control in a few months, and between enhanced unemployment benefits and the $1,200 payment to households, renters and landlords could work out accommodations. Unfortunately, the pandemic continues, and fiscal support has waned. Landlords and renters are at odds over who will bear the burden of adjustment. Currently, there is an eviction moratorium in place, but recent guidance suggests that landlords, under certain conditions, can begin eviction proceedings. These new guidelines have emerged after landlord groups pushed back against the moratorium. If evictions become widespread, we could see a further widening of inequality and a further down leg in the “K”-shaped recovery.
- In related news, renters have been moving to the suburbs in search of space. The trend is starting to affect rents in dense cities, such as San Francisco.
- Vacation home demand has also increased.
- When a Commercial Mortgage Backed Security (CMBS) has problems, management of the security shifts from the “master” to the “special servicer.” The latter acts as a sort of receiver and determines the “workout.” We are seeing a steady rise of securities that are being transferred to special servicers, an indication of stress.
Economics: A number of papers we have noted recently state that households have shown a strong propensity to use some of the stimulus money for either saving or debt repayment. Although saving may eventually become spending, the decision to use the funds for debt service suggests a strong desire to improve household balance sheets. This trend would mean that the potential inflationary impact of payments to households might be less than expected.
- Local coffee shops are closing; expect more chains to replace them.
- Majority leader McConnell has put forth a “targeted” stimulus bill worth $1.8 trillion. Although reaction from House leadership has been cool, the difference in total funding isn’t that great and it may be difficult for the House to reject it. Of course, if the goal is to pass something, we would see the two current versions go to a conference committee and a unified bill would emerge. We suspect both sides are posturing, and the odds of something getting passed before the election (or even before a new Congress is seated) is unlikely.
Odds and ends: Japan has an agreement to sell defense goods and technology to Vietnam. One of the overlooked issues surrounding the U.S. and China is that America has long-time allies in the region, and they have the capacity to improve the military capability of their neighbors even without U.S. involvement. Vietnam and China have had disputes in the South China Sea. Newer military equipment is a potential threat to Beijing.