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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Friday!  It’s a quadruple “witching day,” the day when stock index futures, single stock futures and their associated options expire.  It is not unusual to see heightened volatility on such days.  Equity markets are mostly stable, so far, this morning.  We begin our coverage with yesterday’s Bank of England meeting, which ended after we wrote yesterday’s report.  China comes next, with more on TikTok.  We update the pandemic news, followed by the latest on Brexit.  A wrap-up of world news comes next and we close with economic news.  Being Friday, there is a new Asset Allocation Weekly, along with the associated podcast and chart book.  Here are the details:

Bank of England:  Normally, we don’t comment on the proceedings of this particular bank; although the U.K. financial system is important to the world, the British economy doesn’t have an enormous impact any longer.  On the other hand, the U.K. is sometimes a harbinger of trends that affect the U.S.  For example, the rise of Tony Blair coincided with a similar figure, Bill Clinton.  And, Brexit itself was a reflection of the rise of American populism.  Although policy didn’t change, the Monetary Policy Committee warned that a return of the virus could trigger another downturn, which led the leadership to hint that the bank was “exploring” negative nominal policy rates.  The GBP fell on the news.  The BoE has, up until now, followed the Fed path, using QE and forward guidance in lieu of negative rates.  The idea that the BoE appears to be preparing the markets for negative policy rates is new.  Although we don’t expect the Fed to follow this path (negative nominal rates bring havoc to the shadow banking system by effectively making money market funds untenable), the fact that the BoE is considering it raises the idea that this may become a trend here as well.

China news: 

• The ongoing issue with TikTok continues. The company has accepted U.S. changes to the deal, which mostly center around data security.  Hurdles remain, however.  There are elements of the administration that want majority U.S. ownership of the company. Congress is weighing in as well.  According to reports, the company is proposing two separate entities, a global and U.S. company, both domiciled in the U.S.  It’s the global entity that will have both Oracle (ORCL, 60.18) and Walmart (WMT, 136.69) investments.  TikTok’s current owner, ByteDance, is offering to go public in the U.S. in a bid to woo Washington to agree to the deal.  There is one other issue; Beijing has yet to weigh in on the arrangement and may scotch the deal.  Despite all these efforts, the Commerce Department has ordered a ban on transactions over TikTok and WeChat starting Sunday.
• Yesterday, we noted that General Secretary Xi is pressing for greater control over private sector firms. Communism in China is steadily evolving into a form of corporatism, where firms remain nominally private but will, at times, have their corporate goals subsumed by the state.  In return, the government has promised aid and support.
• As tensions rise between the U.S. and China, direct foreign investment is declining. Beijing is trying to shift its focus to Europe but is struggling there as well.  Meanwhile, Congress is considering legislation to assist the economy in decoupling from China.

 COVID-19:  The number of reported cases is 30,205,226 with 946,673 deaths and 20,548,561 recoveries.  In the U.S., there are 6,676,410 confirmed cases with 197,655 deaths and 2,540,334 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 show that 22 states have a reading less than one (infections are not spreading) while 28 are showing the opposite condition.  Hawaii has the lowest reading, Delaware the highest.

Virology: 

• Moderna (MRNA, 67.89) and Pfizer (PFE, 36.82) have revealed their vaccine testing plans, an unusual step; these are normally a closely guarded secret.  Moderna’s timeline will still be testing into late this year and maybe early next year, although some results may be ready by late October or early November.  All this suggests that a vaccine before year’s end is less likely.  At the same time, vaccine distribution plans for the U.S. remain unresolved.  It will take a while for the vaccine supply to increase and governments have to determine a plan of access while supplies are limited.
• WHO is warning European governments that a second surge in COVID-19 cases may be underway.
• As the odds of a winter surge in cases increases, the medical sector is better prepared due to advances in treatment protocols. One of the reasons hospitals were overwhelmed earlier this year was attributed to a focus on efficiency that left them with less surge capacity.  We discussed this issue in general terms earlier this year.

 Brexit:  The U.S., on a bipartisan basis, is warning PM Johnson not to create a border crisis in Northern Ireland.  One of the more interesting facets of the U.K.’s recent Internal Market Bill is that it may not have been necessary.  There is a mechanism in the Withdrawal Bill for making adjustments.  In fact, the EU has made several changes to which the U.K. has already agreed.  The Johnson government could have raised its concerns within the current arrangement.  The fact it didn’t may mean the U.K. didn’t think the EU would agree or Johnson may have simply made a mistake.  British creditability has taken a hit, and its behavior may make it more difficult to make future trade agreements.

World news:  Belarus is planning  to close its border with Poland and Lithuania, although reports from the frontiers suggest it hasn’t occurred yet.  It isn’t clear why the borders are being closed, although we suspect Lukashenko is worried about activists fleeing the country.  This announcement may be a precursor for a crackdown.  Peru’s president is facing an impeachment vote; Martin Vizcarra has been under scrutiny over an influence-peddling scandal.  Aleksei Navalny was poisoned in his hotel by a water bottle testing positive for Novichok.  A rare hurricane level storm has formed in the Mediterranean; it is expected to make landfall in Greece.

Economy and policy news:

• The governor of Illinois is warning that budget cuts may be looming due to a drop in revenue. This is an issue we have worried about for some time, that falling state and local government spending could weaken economic growth.  Some members of Congress are criticizing the Fed for not using the muni backstop more aggressively.  These backstops are a source of confusion, in part because the Fed hasn’t done a good job in explaining their purpose.  The media tended to treat the Fed’s creation of various facilities as direct aid; the Fed seems to view them as an expansion of Bagehot’s dictum about offering support during a financial crisis at ample levels but with a penalty rate.  In other words, the backstops are there to ensure a market will exist when the dealers won’t make a market.  It isn’t designed to bypass Congress in making fiscal decisions.
• Congress is apparently close to a deal to avert a budget shutdown; although there are backchannel talks on another stimulus package, nothing concrete has emerged. Airlines are indicating that without additional government support, furloughs are likely to begin October 1.
• In recent years we have seen a remarkable recovery in home prices; many homeowners find themselves with home equity that is tough to make liquid. Wall Street is preparing to buy these homes, giving liquidity to these homeowners and turning the homes into rental property.
• The NY FRB has created an index that one can use to estimate current quarter GDP. Using this index, we estimate Q3 GDP will rise 22.6% on an annualized basis.

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