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

[Posted: 9:30 AM EDT] | PDF

It’s GDP day!  It has been well forecast for months that Q2 GDP would be an epic negative.  It turned out to be bad, but not as bad as expected.  GDP fell 32.9% on an annualized basis compared to expectations of a 34.5% decline.  See below for the details.  It’s a risk-off day so far.  We have a plethora of policy news as the Fed held its meeting, the tech giants met with Congress, and the stimulus bill is a mess.  News on China is extensive as well.  We discuss pandemic updates.  The Weekly Energy Update is available.  There is a lot to cover so let’s get to it:

Policy news: 

• There were no major surprises from the Fed. Rates remain unchanged and QE will continue at $120 billion per month, with $80 billion to Treasuries and $40 billion to mortgages.  As we noted yesterday, the Fed has extended its backstop programs; forex swap lines were also extended.  Overall, the statement was somewhat downbeat, with comments suggesting the pandemic is continuing to weigh on economic activity.  Hence, the FOMC decided to continue its extraordinary support for the economy and financial markets.  There were no dissents to the decision.
• CEOs of Apple (APPL, 380.16), Google (GOOGL, 1523.51), Facebook (FB, 233.29), and Amazon (AMZN, 3,033.53) all testified remotely in front of the House Antitrust Subcommittee. It would be difficult to describe the testimony as friendly.  Anger at the large tech companies is bipartisan, although the reasons for the displeasure are not.  Democrats were upset with the monopolistic behaviors of the firms and their fostering of misinformation; Republicans were angered by censorship of right-wing views.  Social media firms try to hide behind algorithms to suggest their software is unbiased; in reality, the goal is eyeballs on screens, so there is a documented manipulation.
  • It would be difficult to argue that at least three of these firms (GOOGL, FB, AMZN) are not engaging in blatant anti-competitive behavior. They have purchased rivals and duplicated and engaged in predatory pricing actions of products on platforms.  Their ability to generate profits and revenues in any season is probably not possible without market dominance.  Their actions would have already been curtailed under legal standards prior to the mid-1980s.  That hasn’t happened under current standards because it is hard to argue that consumers have been hurt.  However, labor has; we offered a framework in our WGR series last year, “The Economic Triangle: Parts I and II.”  Using that framework, antitrust policy over the past 35 years has aligned the interests of capital and consumers against labor.  The well-documented rise of populism suggests that alignment is probably near an end and new (or a return to pre-1985) antitrust policy is part of that realignment.
  • At the same time, although anger is universal, complaints are not. Democrats are attacking the firms mostly on size and behavior grounds, but the GOP is divided.  The GOP establishment mostly wants social media to not censor right-wing views, while GOP populists are more aligned with Democrats over the market power of these firms.  Look for the tech firms to try to exploit this difference.  Although we do expect these firms will eventually face antitrust actions, it will probably be a while.
• It is looking increasingly unlikely that a stimulus package will be ready before August 1, when the current measures expire. The GOP is deeply divided.  The White House mostly wants spending and lots of it (although the Chief of Staff may have misgivings), whereas GOP populists want spending too but the establishment wants to slow the rise of the deficit.  If the Senate majority leader wants a bill, he can cobble together a majority with Democrats, but that will hurt his own caucus.  Democrats have already rejected a patch measure.  Some Republicans are offering new programs, meaning consensus is not occurring.  The lack of a plan is likely weighing on market sentiment this morning.

China news:

• Taiwan has become a flashpoint in U.S./China relations. Beijing is imposing sanctions on Lockheed Martin (LMT, 386.66) over arms sales to Taipei.  Analysts suggest the sanctions are not terribly damaging for the company, but more of a warning shot.  However, the Global Times, a CPC mouthpiece, warned that rare earths could be affected.  China has used its dominance in rare earths before, against Japan over the Senkaku Islands (also referred to as the Diaoyu Islands by China).  The warning by the Global Times suggests that Beijing may return to constraining the supply of rare earths again if tensions escalate.  Rare earths, although not all that rare, are critical to numerous high tech and defense applications.  We are seeing some production outside China, but a cutoff of supply would be a problem.
• Unemployed graduates are a risk to stability. China is making a particular effort to expand state jobs to absorb new graduates.
• The recent decision by the U.S. to close China’s consulate in Houston appears to be a signal to China. The U.S. has become aware of how China uses consulates not only for espionage but also for monitoring Chinese nationals and other former citizens.
• This week’s WGR, along with Part II next week, discusses recent Chinese policy. In next week’s report, we will examine China’s policy from Beijing’s perspective.  We continue to monitor China’s position for insights into future behavior.  We note that Xi’s policy of aggressive confrontation is facing some criticism within the CPC.  In addition, two hawkish generals, Dai Xu[1] and Qiao Liang, have cautioned that the PLA is no match for the U.S. military at this juncture and prompting a war could be catastrophic.  The generals note that:
  • The U.S. has developed a profound hatred for China, which is a new development.
  • The U.S. government’s negotiating stance has changed, becoming aggressive and well beyond what China expected.
    • Although not part of the general’s comments, we note that China hawks within the administration are reported to have made contacts with members of the Biden camp. This would suggest these members of the administration are preparing for the possibility of a change in office and are attempting to establish a policy that will extend beyond 2020.
  • No nation has come to China’s defense, suggesting that either the U.S. is still powerful enough to coerce compliance or, more likely, the rest of the world sees China as a threat and supports U.S. policy.
  • A united front is developing around U.S. policy, not China’s.
  • The U.S. isn’t a paper tiger; it’s a potent one that can inflict damage.
  • The U.S. has remarkable ability to course correct and adjust (democracies are actually pretty good at this).
  • The U.S. is less interested in ideology and values and is more driven by economic interests.
  • It was bad policy to say out loud that China was going to surpass the U.S. (in Xi’s defense, Khrushchev made the same mistake in the 1960s).
  • The U.S. really doesn’t care if it offends other nations; it has lots of allies and doesn’t sacrifice its own interests.
  • China needs to understand it is not the world’s superpower; the U.S. is, and Beijing needs to admit that fact.
  • Don’t talk about “sharing information” with the U.S. Americans see that as intellectual property theft.
  • Elections don’t matter all that much as national strategy lasts beyond whomever is in the White House.
  • You don’t fight the U.S. alone.

These admissions are remarkable.  We doubt these two generals will survive these comments; as we noted, one has already tried to deny them.  But this does show that the triumphalism of President Xi is not universally held.

• U.S. spy aircraft have been stepping up their flights around mainland China.
• There are reports that President Trump is “willing to accept more risk” with regard to China. It is not clear what exactly this means but it appears to be related to building a coalition of nations around China.
  • The FBI is warning that China is trying to interfere with our elections. We discussed this issue in our recent WGR on the elections.
• This is a big one. Chinese banks are being warned to prepare to lose access to the S.W.I.F.T. network.  We have not heard anything official out of the U.S. on this threat, but if it were implemented, it would clearly divide the world.  Given the high number of comments from U.S. officials recently, one would think this would have been mentioned if such a move is imminent.  If adopted, this policy would remove China from the global financial system; alternatives are not really workable.  Again, there hasn’t been anything out of Washington on this, but this would be a major hostile act if implemented.
• The Pentagon is warning that China is becoming a more potent nuclear threat.
• For background, Miles Maochun Yu is emerging as an influencer of the SoS.
• We are seeing pushback from the establishment against the administration’s China policy. Richard Haass, the president of the Council on Foreign Relations, opined recently that the recent hawkish turn is a mistake and a misreading of history.  This is no surprise; the establishment has done quite well by integrating China’s economy into the world economy.  Haass notes that the Trans-Pacific Partnership would have been a great tool to force China into adopting the U.S. trade system.  Haass is correct…except those sorts of trade agreements are no longer politically possible in the U.S.  Populists on both sides contend that such deals harm their interests and passing them is probably not possible.
  • On a related note, Australia, which has been a target of Beijing’s ire recently, is negotiating with great care with the U.S. on trade, clearly wanting to overtly take sides. According to reports, the U.S. and Australia are quietly building a defense plan as well.
  • The EU and China held talks on trade and economics this week. Surprisingly, not a peep was heard about how talks went.  That usually means they did not go well at all.
• The U.S. is warning Brazil about using Chinese telecom technology.
• Serious flooding continues on the Yangtze River.
• The Phase One tracker shows that China is woefully behind its obligations and it is highly unlikely it will be able to achieve its targets. However, rising corn prices in China could lead to a lift in buying of U.S. grain.
• China hacked the Vatican.

COVID-19:  The number of reported cases is 17,054,819 with 667,707 deaths and 9,984,590 recoveries.  In the U.S., there are 4,427,493 confirmed cases with 150,716 deaths and 1,389,425 recoveries.  For those who like to keep score at home, the FT has created a nifty 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 Axios map shows an improving situation, with case growth slowing, although here in Missouri things are looking rather ugly.

Virology: 

• One of the puzzles of COVID-19 has been the wide dispersion of the effects on patients. Many are completely asymptomatic.  As professional sports return and consistent testing of this population ensues, it has been interesting to note how many players test positive without symptoms or conditions so mild they mistake it for a cold.  At the same time, others are severely impaired or fail to survive in infection.  One development vexing doctors are cases where patients appear to have long-term symptoms of the disease but fail to test positive for it.
• The Sandinista-led government in Nicaragua has been dismissive of COVID-19 and is now persecuting doctors who are calling for measures to reduce the spread of the virus.
• China is reporting an outbreak of cases in the northeastern regions. Nine cities have reported new cases.
• Vietnam, which appeared to have completely eradicated the virus, is seeing a return of cases.
• Johnson & Johnson (JNJ, 146.54) began human trials for a vaccine that protected monkeys.
• The FDA is expected to rule on convalescent plasma as a treatment.
• The FBI is investigating claims that China attempted to steal COVID-19 research from the University of Texas.
• One of the areas of failure has been the inability of policymakers to craft a policy mix that reduces the risk of the virus while protecting the economy. This has been a breakdown along many fronts.  Medical advice has been contradictory at times; face masks were downplayed then recommended.  Initially, there was great worry about the virus on surfaces; now we know most of the spreading is in the air.  At its heart, managing the virus is about probabilities.  What activities are high risk?  Who bears the most risk from contracting the virus?  Humans are not very good at measuring probabilities.  We often fear things that have a low probability of harming us and blithely engage in actions that are rather dangerous (the classic example is the fear of flying when the most dangerous part of the trip is getting to the airport).  Eventually, we will learn to live with this virus and it will likely require some changes in behavior until a vaccine is developed and widely adopted.

Market and Economy news:

• Although it’s not a huge surprise, high frequency reports suggest that loan default rates are rising. Hospitality is showing the greatest weakness.  Risky bond issuance has increased in Europe as well.
• As we have touched on before, one of the great debates is whether the $600 per week boost for unemployment is weakening employment growth. The level, for much of the country, represents more than their normal pay.  The University of Chicago found that 68% of workers received more from unemployment than what they earned from working.  Anecdotal reports suggest that some businesses were struggling to find workers due to the supplemental benefits.  However, a study from Yale did not find that the higher benefits had an appreciable effect on employment.  That is probably because there were much fewer jobs to return to.  Policymakers are debating this issue; the House stimulus package would keep the benefit, while the Senate version would reduce it to $200 per week.  This looks like a structure for bargaining.  We expect a supplement between these two figures.
  • The risk to the economy in the short run is that cuts will probably slow spending, which appears to be softening due to the resurgence of COVID-19 cases.
  • There is probably a bigger risk that extending the supplement could adversely impact employment later this year. The recovery is continuing, and, at some point, labor demand is going to accelerate.  The trick is to keep the supplement in place long enough to support consumption but not so long as to crimp output.
• The Chicago Board of Options exchange is considering an order batching system that would reduce the ability of high-speed traders to gain advantage in trading.
• All the major retailers will close on Thanksgiving. Perhaps this is one good outcome from the pandemic.

Foreign news:

• In our five-part WGR series on the upcoming elections, we discussed the potential for foreign nations to affect the outcome. In the report, we noted that Russia’s primary goal was probably less about electing a certain candidate and more about sowing chaos.  Recent reports accuse Moscow of spreading pandemic misinformation to undermine the public health response.  Whether or not this is true, the fact that the discussion is even occurring indicates Russia’s success.
  • It’s not just U.S. elections that are subject to Russian action; Belarus is accusing Moscow of direct interference.
• The Pentagon has confirmed that nearly 12K troops will be leaving Germany soon. About 5,600 will be dispersed throughout other NATO countries and the remainder will return to the U.S.  The WSJ editorial page pans the move.
• Iran has constructed a wooden aircraft carrier to practice small vessel attacks. S. bases in the region increased their alert status.

Odds and ends:  Coming to a safe near you…a new metal said to be harder than diamonds.

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[1] For the record, Dai Xu disavowed his comments on a social media post yesterday.  It’s not clear why, and doesn’t necessarily mean the comments are not a reflection of some within the PLA.