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

[Posted: 9:30 AM EDT]

Good morning!  Equity markets continue under pressure this morning.  We update the COVID-19 news.  The Weekly Energy Update is available.  Here are the details:

COVID-19:  The number of reported cases is 4,364,172 with 297,491 deaths and 1,418,656 recoveries.  In the U.S., there are 1,390,764 confirmed cases with 84,136 deaths and 243,430 recoveries.  For those who like to keep score at home, the FT has created a nifty interactive chart that allows one to compare cases and fatalities between nations, scaled by population.  Here is another map from Axios, showing the growth of new cases by state.

The virus news:

• The good news:
  • One of the tools being developed in the fight against the virus is blood antibodies. These drugs are developed either from the blood of humans who have recovered from COVID-19 or from animals who have been immunized.  This report from the FT is a primer on the process.
  • We have been reporting on new UV light processes to disinfect public areas. A robot equipped with a UV light has been able to disinfect hospital rooms.
  • Researchers at Yale say they have found that saliva is superior to nasal swabs to test for COVID-19 infection. If true, this would make the testing process much easier.
  • Border controls and social distancing measures are being relaxed.
    • In a bid to save the tourism season, Europe is reopening its borders.
    • Mexico is easing distancing and border measures. One of the problems for some American businesses has been the disruption of trade flows with Mexico.  These measures should ease those concerns.
  • The bad news:
    • Wuhan has launched a mass testing drive after a series of new infections from COVID-19 were reported.
    • South America is seeing a surge in cases without the resources to cope with the economic fallout from the virus.
    • Although children usually have mild cases of COVID-19, there are reports from New York of 100 cases of an inflammatory syndrome that comes from the virus. It is unclear if this development represents yet another mutation of the virus.
    • The medical establishment is working feverishly to create a vaccine for COVID-19. However, there is the possibility that a vaccine may not be accepted by part of the public.  This would slow herd immunity if this outcome develops.   Meanwhile, data from Spain suggests only about 5% of the population has been infected with COVID-19 and thus herd immunity is much further off (70% is considered a minimum for herd immunity).
    • The WHO’s chief scientist, Soumya Swaminathan, told a group yesterday that it may take four to five years to get COVID-19 under control, depending on medical developments and virus mutations.
      • Although one would wish for something different, it is also likely that the virus will simply need to be accommodated. Broad lockdowns do blunt the initial rise of the disease but are not a permanent solution.  After all, economic disruption and social isolation carry their own dangers.  What Swaminathan is really getting at is that society will need to learn to cope with the virus, similar to how we accommodate influenza and other infectious diseases.
      • This may mean that vulnerable populations will take greater precautions than others.
      • One of the more disturbing, but not surprising, elements of the current situation is that COVID-19 has become politized. This leads to binary thinking—either you open the economy full bore and risk rising infections or stay locked down for good and have no growth.  But, in reality, this isn’t the only set of choices.  We can build safety into our economy without complete social distancing and have vulnerable populations take additional measures without having those who are less at risk carry the same burden.  Will things be different?    Airplanes may need to build different seating arrangements.  Some things may cost more.  A generation may learn to cook at home.  Hotels are figuring out how to sanitize so patrons will return.  But, people and societies are remarkably adaptable.  This will get figured out.

The policy news:

• Chair Powell warned yesterday that further stimulus measures will likely be necessary from both fiscal authorities and the Fed to offset the weakness in the economy. He backed further Congressional action to stimulate growth.  He expressed worry that a deep and long recession would have long-lasting negative effects on the economy which policymakers should make every effort to avoid.  The tone of his comments weakened investor demand and pushed stocks lower yesterday.
  • The Fed may curb bank dividends due to the pandemic.
  • The Fed is easing conditions on its Term Asset-Backed Loan Facility (TALF), which is designed to allow CLO managers to finish deals that were negotiated prior to the economic downturn.
• Although the Fed continues to downplay the likelihood of negative interest rates, President Trump remains a fan.
• Congress is considering a bill that would give states more leeway in how they spend their stimulus money. It would not be allowed for funding retirement programs, but it would give states some latitude to use the money for non-virus-related spending.  President Trump expressed support for the measure.
• Tax breaks and deferrals are helping companies bear the economic slump. This factor is one of the parts of the stimulus that has generally been less appreciated.
• On-the-fly changes to the payroll protection program is worrying some small businesses that have taken the loans, fearing they could run afoul of changes that occurred after they took the money. There is always a tension between oversight and speed.  The more oversight one has, usually the less fast money can get distributed.  The problem with post-hoc changes is that potential recipients will be leery of accepting such programs in the future.

The economic news:

• Colleges are facing a serious problem in the fall. Offer only online courses and students (and their parents) may wonder why they are paying a mountain of tuition when online should be much cheaper.  Open up campus, and there is the potential of virus outbreaks.  Some state schools have already decided that online is their best option.  At the same time, most college students would rather go back to campus.
• Advertisers are questioning whether they should continue ad campaigns when consumer spending is falling. Media outlets will almost certainly face less ad revenue as the year progresses.
• Borrowers are trying to get forbearance from their lenders. They are finding the lenders are overwhelmed with demand and are struggling to respond.
• About 3% of restaurants have closed for good and another 11% may close permanently in the next 30 days according to a recent survey. More than 3k retail stores have closed as well.  It is estimated that 100k small businesses have closed due to the downturn triggered by the pandemic.
• COVID-19 has caused significant disruptions to food distribution. We have noted the shutdowns to meat processors and are starting to see local news reports about much higher meat prices.  The disruption of food distribution is a global problem; in some areas, food goes to waste because processors are trying to shift from making restaurant sized packages to smaller ones for households.  In other parts of the world, food shortages are developing.  As lockdowns ease, some of this problem will subside.  But there will simply be some food lost due to this crisis.
• After the Great Financial Crisis, there was great fear that the expansion of the Fed’s balance sheet and the fiscal deficits would trigger an inflation problem. Those fears turned out to be baseless, in part because households engaged in austerity; they boosted saving and reduced their debt.  Companies are preparing for another round of household austerity in the wake of the COVID-19 crisis.  After all, the lessons since 2008 for households is that having savings is necessary and avoiding debt is not a bad thing either.
• The WSJ survey of economists had no big surprises; the majority expect a “swoosh” recovery and the levels of uncertainty are high. Nevertheless, growth is expected to recover as the year wears on.

The market news:

• Two areas of the debt market are starting to raise concerns among investors:
  • Collateralized loan obligations (CLO) are structured loan products with various degrees of risk. The first cut of payments tends to be highly rated; the last cut tends to be near junk.  However, as we found during the 2008 financial crisis, no matter how one cuts up something, a bad loan is simply a bad loan.  There are worries that we may be facing another round of trouble in this complex market.
  • The slump in emerging markets is raising concerns about emerging debt.
• The U.S. is pressing chipmakers to move production out of China and into the U.S. Taiwan is under specific pressure in this arena.
• The IEA monthly report projects global demand fell 21.5 mbpd in May but did indicate market conditions are starting to improve.
• Fitch is warning that its downgrades of financial and corporate debt are on pace for a record.

The foreign news:

• News out of China has been coming fast and furious. Here is a rundown:
  • Increasing pressure on China from the U.S. has foreign exchange traders leaning toward a weaker CNY. Currency weakness would undermine the Phase 1 deal and weaken the impact of tariffs.
  • China, upset with Australia’s position on an investigation of the origins of the pandemic, has suspended some beef imports. Beijing is threatening other measures as well.
  • New Zealand is facing similar threats over its support of Taiwan.
  • As we noted yesterday, the U.S. is restricting federal retirement programs from buying Chinese equities. Beijing is worried that further measures may be forthcoming.
  • President Trump has indicated he has no interest in renegotiating the Phase 1 trade agreement, despite the pressure brought by the pandemic. Meanwhile, China has granted waivers on some tariffs of U.S. goods.  China is increasing its soybean purchases as well.  However, China’s imports of Brazilian soybeans hit a record in April, raising doubts that Beijing will meet its Phase 1 targets with the U.S.  The Phase 1 deal has a target of $36.5 bn of agricultural products in 2020; so far, about $3.0 bn have been purchased.  Why is China buying from Brazil?  The BRL has been making new record lows; in CNY, Brazilian beans cost about 20% less.
  • The S. has extended its ban on U.S. companies using equipment made by Huawei (002502, CNY 2.99).
  • Vietnam is encouraging its fishermen to defy China’s fishing ban in the South China Sea. China implements a seasonal ban to build fish stocks; however, if other nations comply, it is granting China sovereignty over these waters, which other nations dispute.  In related news, the U.S. Navy is boosting its presence in the seas off Malaysia to support that nation in its maritime disputes with Beijing.
• Conditions in Turkey continue to deteriorate. The lira has been weakening, foreign reserves are falling and COVID-19 is hitting the country.  President Erdogan is warning of a coup, although there isn’t much evidence to support this concern.
• There are elements of supports for Brazilian President Bolsonaro who are backing a military coup. Essentially, it appears they want to end the democracy and implement rule by decree.

WTO:  The head of the WTO has resigned a year before his term ended.  The WTO leadership has been under great strain due to rising trade tensions, and Roberto Azevedo has apparently decided to move on.

Islamic State:  Islamic State is becoming active again in the area on the Iraq/Syrian frontier.  This region is generally not controlled by either Damascus or Baghdad, and with the U.S. reducing its troop strength it appears the group is coming alive again.  One sign of activity is that Islamic State is being blamed for a series of crop fires in Iraq.

U.K.:  In anticipation of trade talks with the U.S., Westminster is planning to cut agricultural goods tariffs on U.S. farm exports.  As one would expect, there is opposition from British farmers to the news.

German courts:  Although Chancellor Merkel was (as expected) non-committal, the judges of Germany’s Constitutional Court are holding firm on their position in the fight over ECB QE.  If Germany continues on this path, the Eurozone will either (a) acquiesce to German hegemony over the Eurozone, or (b) likely accelerate the breakup of the single currency.  This is a very difficult dilemma.

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