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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Friday.  Hurricane Delta is expected to make landfall in Louisiana today.  U.S. equity futures continue to trend higher this morning.  Since stimulus hopes are supporting the rally, we begin with commentary on the state of negotiations.  World news is next; we cover EU sanctions on Russia, U.S. sanctions on Iran, rising tensions in Cyprus, North Korea’s Saturday parade, and an update on Brexit.  With China still working through its Golden Week holiday, news flow is unusually slow, but we are seeing the CNY rally.  We wrap up comments with our COVID-19 update.  Being Friday, a new Asset Allocation Weekly, podcast, and chart book are available.  Here are the details:

Stimulus talks:  Although the two sides continue to talk, we are getting so close to the election that it is about impossible to get something passed before November 3.  In some respects, the basic outlines of a deal remain in place—House Democrats want a large fiscal program, while the Senate is much less enthused.  The White House continues to vacillate between no talks to wanting a big deal.  The current ploy is to offer small, targeted aid, e.g., to the airline or restaurant industries.  House Democrats are willing to consider such aid but only if it is part of a large package.  So, if the odds of a deal are so long, why are equities continuing to trade as if something is coming?  The consensus is that whoever wins in November will make stimulus his first order of business.  We agree with this idea, but getting an actual deal done may not be as easy as it looks.  The lack of stimulus is having an impact on the economy; there is growing evidence that the Q3 bounce[1] is stalling, and economists are now estimating that the labor market won’t reach the last cycle peak until 2023.  The inability to pass legislation will probably lead to a pause in growth. Equity markets are assuming that (a) the next government will be successful in lifting fiscal spending, and (b) the Fed will probably resume aggressive balance sheet expansion as the economy slows.

World news:  Lots of news on this front.  Here are the details:

• The U.S. announced sanctions on 18 Iranian banks, including the Middle East Bank, which manages Iran’s food and medicine imports. Although such imports are exempt from sanctions, including this bank will probably affect imports of these goods.  We doubt that Tehran will retaliate in front of the U.S. elections, hoping for a thaw if Biden wins.  In the meantime, China will likely expand its business with Iran as Beijing is less worried about American sanctions.
• In 2015, hackers launched a cyberattack on the German Bundestag; the EU is preparing sanctions against Russian military officers said to be involved in the action.
• Cyprus is divided; the northern part of the island is controlled by Turkish Cypriots, the south by Greek Cypriots. The northern government opened a section of beach that has been effectively closed for years.  This is mostly a symbolic move, but it exacerbates tensions with the southern government and will likely involve the EU and Turkey.
• North Korea will hold a military parade on Saturday, marking the 75^th anniversary of the founding of the Workers’ Party. Analysts will be watching to see if Pyongyang unveils any new missiles and other hardware.  There will be a special emphasis on indigenous hardware, including launch vehicles.  Although we don’t know for sure which candidate Kim Jong Un would prefer, we do note that last year state media referred to VP Biden as a “rabid dog” who should be “beaten to death.”
• Although there is still little definitive news on EU/U.K. trade talks, optimism for an agreement remains elevated. Meetings between PM Johnson and EU Commission President von der Leyen have lifted hopes.  In some respects, the parties had better negotiate a deal; MPs report that the majority of businesses are unprepared for a hard Brexit and are essentially wagering that the sides will reach an agreement

China:  The CNY is rallying.  China’s economic recovery is outpacing much of the rest of the world, and it appears that it has been able to manage the virus.

This chart shows the CNY/USD exchange rate on an inverted scale; a rising number indicates a stronger CNY.  We have placed a star at the current exchange rate.  Interestingly enough, a stronger currency will make tariffs increasingly effective.  Note that since early 2018, when the U.S. began implementing widespread tariffs on China, the CNY depreciated, offsetting much of the effect of the tariffs.  The recent recovery in the Chinese currency will tend to enhance the trade impact of the tariffs.

COVID-19:  The number of reported cases is 36,565,929 with 1,062,636 deaths and 25,484,014 recoveries.  In the U.S., there are 7,607,890 confirmed cases with 212,789 deaths and 3,021,252 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 R_t data is showing an increase in states with rising infections; 13 states are showing falling infections, while 38 states and the District of Columbia are exhibiting rising infections.

Virology: 

• The WSJ has an investigative report showing that COVID-19 was circulating in the U.S. as early as mid-January, well before officials were able to confirm that infections were taking place in real time. This data makes sense.  The first cases appeared in California, a state well connected to China.  New York, New Jersey, Florida, and Texas were close behind.  All four are globally integrated and thus would be vulnerable to foreign transmission.  Tomas Pueyo, who has been commenting on the pandemic and penned the famous “The Hammer and the Dance,” recently wrote a NYT op-ed calling for stricter border controls.  Simply put, if you want to contain the virus, don’t let outsiders in.  This prescription is a direct threat to globalization, but Pueyo makes a strong case for “fences.”  The WSJ report tends to confirm Pueyo’s position.
• The data on the virus is becoming increasingly clear; young people are more likely to contract the virus, but older people are more likely to die from it. Essentially, the young have become a vector for their grandparents.
• There are a number of firms testing antibody treatments, including some with high concentrations of these antibodies.
• The WHO has a program to try to distribute vaccines to less developed nations. China has decided to join the effort, most likely as a public relations move.

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[1] Using the NY FRB Weekly Economic Index, the current projection for Q3 annualized GDP is +27.8%