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

[Posted: 9:30 AM EDT] | PDF

Happy employment Friday!  We cover the data below, but the quick take is that it was stronger than forecast.  Well, after a steady rise, equity markets took a hit yesterday.  They are recovering this morning, although tech remains under pressure.  China is cracking down on Inner Mongolia; the locals aren’t taking it well.  We cover other China news, too.  Up next is policy news, followed by pandemic updates.  Economic and foreign updates close today’s comments.  And, being Friday, a new Asset Allocation Weekly is available, in the below section and also on our website.  The corresponding podcast and chart book are also available.  Due to the Labor Day holiday, the next Daily Comment will be out on Tuesday of next week and the next Asset Allocation Weekly reports will be published on September 18.  Here are the details:

About yesterday:  As noted above, there doesn’t appear to be any particular news item that triggered the market decline; equity markets do experience occasional inexplicable swings.  The most likely culprit was that equities were frothy, and options market behavior was suggesting excessive speculation.  The rally in tech stocks, and growth in general, had caused market internals to become unbalanced, so the decline was mostly centered in that space.  But, with the Fed continuing to be accommodative, yesterday probably doesn’t signal any changes in direction.  At the same time, we may be seeing a better internal balance.  Value and non-tech may be seeing some flows in the near term.

Inner Mongolia and Beijing:  At the start of the school year, Beijing decided that Inner Mongolian schools would conduct classes in Mandarin instead of the native language.  The locals didn’t take the news well.  Students vacated classrooms (despite attempts by local officials to lock them inside) and haven’t returned.  China’s geopolitics require that the Han core be protected by controlling the outer regions.  Those regions act as buffers to outside invaders.  Stabilizing these areas is critical; ideally, the CPC wants to suppress non-Han culture to prevent any groups from either being wooed by outsiders or acting as an internal threat.  Thus, over the years, Tibetan culture has been suppressed.  Recently, the Uighurs have faced extreme measures to undermine their culture.  Apparently, Mongolians are next.

The exact threat Beijing is facing from Tibet, Xingang or Inner Mongolia is difficult to see.  However, it is clear that General Secretary Xi won’t tolerate anything that smacks of alternatives to the party.  Religion, in general, has been suppressed; Christian churches have been closed.  Falun Gong has been suppressed.  The actions against Hong Kong appear designed to eradicate the very idea of being a “Hong Konger.”  Such behavior doesn’t sound like confident leadership.

Other China news:

• China’s drive to develop an indigenous semiconductor business appears to be facing some headwinds. A plant in Wuhan is struggling to develop due to the lack of funding.  Another in Chengdu closed for the same reason.  It isn’t clear why the funding isn’t being provided by the government, but it is clear that private investors are not confident in China’s ability to develop this industry.
• The Global Times, an organ of the Chinese government, is trotting out the old threat not to buy U.S. Treasuries. The report argues that the risk of U.S. credit is rising (which is patently ridiculous; as long as the debt is in the dollar, there is no credit risk) due to the expanding deficit.  There was also the usual “watch out, if you push us, we will dump our bonds,” which is an idle threat, too.  One of two outcomes would occur.  Either the Fed would buy the bonds, keeping U.S. rates steady, or the prices would fall, hurting China’s return.  However, we report this story because there is another possibility.  China’s trade surplus with the U.S. remains large but is narrowing; on a goods basis, year-to-date through July, this year’s deficit is $117.3 billion compared to last year’s $213.4 billion over the same period.  So, it is likely that China will not accumulate as many dollars this year.  It is possible China may decide to hold the reserves in EUR due to the new Eurobond.  We have been seeing the dollar weaken against the CNY for the past few weeks.  This trend may accelerate.
• China is denominating some of its commodity trade in CNY. Iron ore is being purchased at CNY prices instead of dollars.  For the Brazilian and Australian companies taking CNY as payment, they either must (a) hold the CNY in Chinese financial assets, or (b) buy Chinese goods with the funds.  Of course, an individual company can easily swap the CNY for local currency or dollars, but somebody ends up with CNY from these transactions.  This sort of news does suggest a fracturing of global finance and is a negative for the dollar.
  • We are seeing adjustments being made to allow CNY holders to buy Chinese financial assets. Capital controls are being eased to allow foreigners easier access to Chinese bonds.

Government shutdown news:  Funding for the government will expire at month’s end.  Amid the continued inability to agree on another stimulus package, there have been worries that Congress would fail to pass an overall spending bill.  This would cause the government to close.  Reports indicate that Speaker Pelosi and Treasury Secretary Mnuchin have agreed on a short-term spending package to avoid this outcome.  Although it would need to pass both houses in Congress, the agreement appears non-controversial and will likely be adopted.

• The Chamber of Commerce is arguing for a new stimulus package, suggesting the “K”-shaped recovery is a threat to its members.

COVID-19:  The number of reported cases is 26,333,573 with 869,306 deaths and 17,543,692 recoveries.  In the U.S., there are 6,151,101 confirmed cases with 186,806 deaths and 2,266,957 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.  Half the states have a R_t below 1%; Massachusetts had the lowest infection rate, while South Dakota had the highest.

Virology: 

• There is nothing simple about COVID-19. Researchers at the Oak Ridge National Laboratory in Tennessee set the Summit supercomputer to work this summer processing data on 17,000 genetic samples.  This computer is a beast—it was the world’s fastest until last June.  Even with this computing power, it took a bit over a week to process the data.  The research suggests that COVID-19 triggers a “Bradykinin storm”[1] instead of a cytokine storm.  Excess Bradykinin leads to leaky blood vessels and may explain many of the cardio issues reported with COVID-19.  In addition, a rise in this factor can also lead to an overproduction of hyaluronic acid, which acts as a fluid absorber.  In the lungs, it can cause the often-reported effect of people “drowning,” even when on ventilators.  Treatment for a Bradykinin storm includes anti-inflammatory drugs and a whole host of steroids.  Interestingly enough, Vitamin D should also be helpful.  This research is still preliminary, but it does offer potential insights and treatment.
• A new symptom has emerged from COVID-19―insomnia. It doesn’t seem to be directly tied to the virus itself, but to a psychological response to the stress it causes.
• It is possible the vaccine that emerges will require cooling. This report discusses the efforts to build a cold storage supply chain.

Economic and Market news:

• Truck lines are reporting increased business, adding to evidence that the economy continues on the recovery track. Inventories subtracted 3.5% from GDP in Q2.  The reports from trucking companies would suggest that we are seeing some restocking, which will boost Q3 GDP.
• Although rating agencies have a negative outlook for municipal bonds, flows continue to move into this sector and prices are holding up. We suspect the Fed’s backstop is preventing a selloff.
• Negative interest rates cause bizarre outcomes in markets. The euro short-term rate, the rate that banks borrow from each other (similar to fed funds before 2008), has seen its interest rate fall to -0.557%.  Essentially, it is banks paying other banks to take their excess liquidity.

Foreign news:  In Venezuela, President Maduro has pardoned more than 100 political prisoners ahead of elections.  At the same time, the opposition is splintering, meaning it is possible Maduro could win the upcoming elections fairly.  Meanwhile, in Libya, forces that prevented the eastern region strongman, Khalifa Hifter, from gaining power in the country’s west are breaking into factions and fighting among themselves.  If this continues, we would look for Hifter to make another drive at taking control.

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[1] What’s a Bradykinin?  Here you go!